Lounge to Luxury: The post pandemic workplace trend driving office capital values and market recovery

Rental growth and investor preferences for quality office assets will see office market recovery in 2024, according to Colliers’ research.

With 60% of leasing deals over 2022 accounting for tenants committing to prime grade office spaces, driving average national face rental growth of 5.3% across all grades, capital values will drop an average of 10% from peak to trough, compared to a 25% drop during the GFC, Colliers’ latest investment research reveals.

New occupier office strategies prioritising quality spaces, means office leasing values, including Premium face rents, which recorded the strongest year-on-year growth (6.2%) across the grades in 2022, will support capital values and ensure the market commences recovering in 2024, according to Colliers’ Head of Office Capital Markets Adam Woodward.

“Unlike historical patterns during times of economic turbulance, office leasing and capital values are not currently aligned.” Mr Woodward said.

“This means demand for new and enhanced workplace environments will see average capital values for Premium and A Grade office assets in CBDs decline by around 5% and 12% respectively, while values of B Grade assets may fall by as much as 20% by March 2024.”

“We anticipate capital values across all grades will commence recovery post March 2024, however, Prime values will remain significantly stronger.”

Highly sought-after wellness, experience and ESG features, often required to push leasing deals for quality assets across the line, will commence redefining the investment landscape this year, according to Colliers’ National Director of Research Joanne Henderson.

“Occupier demand and rents are ensuring prime office yields in CBDs are more resilient, softening 30 basis points last year to average 5.28%, while secondary office asset yields softened by 50 to 75 basis points to average 6.22%.” Ms Henderson said. 

“There remains a substantial pool of capital, and with interest rates expected to peak mid‑2023, we predict a faster recovery rate than the GFC, when it took around five years for capital values across all office grades to rebound.” Ms Henderson said.

Singapore and Hong Kong are likely to represent the largest share of offshore capital fuelling the market again this year, after accounting for 51% ($2.3 billion) and 27% ($1.2 billion) of foreign investment in the office market for 2022.

New South Wales secured the dominant share of investment, with 46% of sale activity last year. This will likely continue, with 60% of 750 global investors surveyed, identifying the Sydney CBD Office market as a top preference in 2023.

Mr Woodward commented; “In the investment markets, Australia, and the Sydney CBD, remain attractive on a global basis due to the stability of local markets and level of returns available when compared against other major international markets.

“Major institutions opted to consolidate holdings into the assets least likely to be adversely impacted by a valuation reset – Sydney Prime assets.”

While major sales activity in the Australian Capital Territory market exceeded $1.45 billion last year, surpassing the former annual record of over $1.42 billion in 2021, and doubling the earlier annual record of $780 million in 2019.

Investors are drawn to the security of a long WALE asset in a core location, and the average WALE for properties transacted in Canberra has increased from 5.8 in 2021 to 8.1 in 2022, according to Colliers’ National Director of Capital Markets & Investment Services Matthew Winter.

“With limited core-plus and value-add style investment opportunities available in 2021 and early 2022, record transaction activity has also been fuelled by announcements of Commonwealth Government occupier movements, stimulating interest from a new pool of investors seeking greater returns in a historically stable office environment.” Mr Winter said.

The recent announcements create over 148,000sqm of expiries in eight CBD assets between 2024-27, with potential for a further c.37,000sqm in 2026-27 arising from the active Department of Infrastructure accommodation brief.

“Canberra also experienced a flurry of listing activity in 2022 Q4 as institutional investors sought to rationalise non-core assets and future-proof national funds.” Mr Winter added.

Mr Woodward said; “As always, with turbulence comes opportunity, and by the close of 2022 several key transactions highlighted the continued appeal of the Australian Office Market.”

63% of respondents to Colliers Global Investor Survey stated the office sector remains their top pick for the APAC region.

Investors also emphasised quality assets and ESG, with 37% indicating they are planning a capital program – a disposal or acquisition strategy based on the environmental performance of their assets.

“An evolution of the office market defined by ESG and higher quality spaces will not only uplift capital values and attract increasing foreign investment this year, it will reshape the future of work in accordance with what we now expect from our office environments and how we use them.” Mr Woodward added.