CBRE: Auckland commercial property market overview

Review and overview:

Office net absorption was strong in the second half of 2022. The overall central business district (CBD) office vacancy rate fell from 15.6% in June last year to 14.0% at the end of December 2022. The non-CBD office vacancy rate also declined, reaching 7.5% by the end of 2022.

By the end of 2022, the overall industrial vacancy rate had fallen to 0.1%. Across a market totalling 13,600,000 square metres, only 7623 square metres of B-, C- and D-grade space was vacant. However, of approximately 384,000 square metres under construction, 78,000 square metres remained unoccupied and available to lease.

Large-format retail properties, A-grade non-CBD offices and A-grade CBD offices recorded healthy rental growth. B-grade market rents generally faced downward pressure. Both A- and B-grade industrial markets recorded exceptional growth.

Higher interest rates have significantly affected our yield assessments over the past two quarters. However, limited transaction activity means we have relied more on CBRE's market interactions and available bidding data than on direct sales evidence, aiming to find a middle ground between vendors' and buyers' differing expectations. The result is yields 60–120 basis points higher than in 2022.

 

The economy

 

The quarter-on-quarter change in production GDP of -0.6% was weaker than most expected. Looking ahead, the first-quarter outlook remains discouraging. With higher-frequency data pointing to continued weakness in 2023, the economy could experience a mild recession this year.

However, not all factors pose downside risks to the economy. Migration and tourism are beginning to rebound strongly, and both will have a positive economic impact in 2023.

Although overall cost expectations remain high, pricing intentions are easing slightly, suggesting domestically generated inflationary pressure is losing some momentum. CPI inflation held steady in the final two quarters of 2022, while non-tradables inflation was below the Reserve Bank of New Zealand's expectations.

Markets continue to expect CPI inflation to return within the target ceiling of 3% in the second half of 2024. However, views differ widely on how quickly inflation will fall over the coming quarters, particularly given the recent cyclone disaster and the effects of reconstruction.

This uncertainty has kept both the Reserve Bank of New Zealand and markets cautious. Long-term interest rates were unusually volatile in the first quarter of 2023, reflecting unexpected events and influences, including stronger-than-expected US economic and inflation data and the emerging banking crisis.

Uncertainty is likely to keep increasing over the coming months amid a varied mix of major global and local economic and monetary influences.

 

The investment market

 

The cumulative rise in interest rates, up 275 basis points since mid-2022, has significantly affected the commercial property market and CBRE's indicative yield assessments for the December quarter of 2022. A lack of completed transactions means measures such as yields are based on other observable indicators, including CBRE's market interactions and available bidding data, alongside an assessment of historical yield spreads against current borrowing costs.

The cost of debt and availability of capital are key influences on buyer demand, favouring investors with the debt financing headroom and capacity to continue investing. In the current environment, investors favour opportunities to add value that can still deliver reasonable returns. Overall, we expect sales volumes to increase in 2023, as the pressure of rising debt costs on some owners interacts with well-capitalised buyers' appetite to acquire properties at lower prices.

Although required returns and the risks involved in achieving them vary across commercial property types, we continue to see upward pressure on yields across all sectors. Among the various influences, this reinforces the dominant effect of interest rates on pricing. Industrial remains the most favoured asset class, but our assessments show that prime industrial yields rose by 46 basis points in the final three months of 2022, more than in other commercial property sectors. This may be because A-grade industrial yields were the lowest of all property types at the end of 2021, leaving them most exposed to rapid interest rate increases.

 

CBD office vacancy

CBD office net absorption was strong in the second half of 2022, exceeding 17500 square metres. This reflected very healthy demand for prime space, alongside relatively stable secondary office performance, with only a slight decline in absorption. It was the Auckland CBD office market's strongest second-half performance since the second half of 2015.

Strong net absorption in the Premium grade reflected a combination of tenants upgrading office quality, such as Fusion 5 and Anthony Harper; expanding their office space, such as Precinct Properties and Forsyth Barr; and demand from tenants either new to the market or moving from very small office buildings not monitored by our research team, such as Zim Shipping and FIFA. After substantial losses in the first half, A-grade net absorption was also positive in the second half of 2022. Secondary net absorption declined slightly, as modest growth in B-grade absorption was offset by negative C-grade absorption.

With absorption or demand remaining high, the overall CBD office vacancy rate declined in the second half of 2022, rising from 15.6% in June last year to 14.0% at the end of December.

Over the six months to December 2022, Premium vacancy fell sharply from 8.4% to 3.7%. Further declines are expected given tenants' strong preference for high-quality space. A-grade vacancy remained broadly stable despite positive absorption, as the completion of 131 Queen Street added more than 7,000 square metres of available vacant space. In the secondary market, the reduction in vacancy was driven more by vacant offices being withdrawn for refurbishment, redevelopment or a change of use.

 

CBD office rents

Our data shows strong rental growth in the Premium office market in the second half, supported by persistently healthy, stable demand and the resulting rapid decline in vacancy. A-grade buildings also recorded reasonable rental growth, but to a lesser extent: only 4 of the 18 A-grade buildings we track recorded growth in the fourth quarter.

Office incentive levels have been more stable over recent quarters, although they vary widely, ranging from 8% to 21%. This reflects the continuing significant influence of factors such as individual landlords' circumstances on the rental performance of particular office buildings.

Secondary rent adjustments are continuing, with B-grade rents showing weakness in each of our recent quarterly assessments.

 

CBD office market outlook

 

Our base-case forecast indicates that new and refurbished office space will total 122000 square metres by 2026. Around 62000 square metres is expected to be withdrawn for refurbishment or a change of use, resulting in net CBD office supply of approximately 60000 square metres over 2023–2026. Tenant demand is expected to continue favouring high-quality offices, leading to a modest decline in their vacancy rates.

The withdrawal of vacant secondary buildings and new tenants moving into some refurbished buildings will keep market vacancy relatively stable in the short term. Over the coming years, however, tenants will continue moving to high-quality offices, placing sustained vacancy pressure on lower-quality buildings.

Rents: Prime office leasing trends reflect a divergence between Premium and A-grade offices. Continuing the rental growth trend of the past year, Premium rents are expected to increase by an average of 2.3% annually through to 2026, compared with 1.4% for A-grade rents.

In the secondary market, downward rent adjustments will continue next year and the year after. Historical data shows that, compared with prime office rents, secondary office rents are more sensitive to changes in GDP than to vacancy rates. This means that although economic conditions will be unfavourable for the secondary market this year and next, we expect secondary rents to begin recovering from the second half of 2024 as the economy recovers and grows, despite rising vacancy.

 

Non-CBD office vacancy

Non-CBD office vacancy declined in the second half of 2022. The largest decline was in B-grade space, partly influenced by building classifications, while A-grade vacancy edged down and C/D-grade vacancy remained broadly stable.

New supply in the non-CBD office market in the second half of 2022 included an extension to the office component of Ponsonby Central and the third stage of the Universal Drive complex development in Henderson. The comprehensive refurbishment of the office building at 1–7 The Strand in Takapuna was also completed.

Following negative net absorption of nearly 8000 square metres in the first half of 2022, conditions were much more positive in the second half of last year. We recorded net absorption of more than 15000 square metres between July and December.

Many tenants moved into A-grade offices in the second half, including space at 1–7 The Strand in Takapuna. Serato Audio also moved from 80 Grey Ave in the CBD to Ponsonby. Net absorption in the B-grade office market improved in the second half of 2022, supported by reasonable demand.

 

Non-CBD office rents

Over the past year, non-CBD office rents have outperformed comparable CBD offices, benefiting from stronger market demand.

As in the CBD A-grade market, strong demand for high-quality non-CBD office space drove annual non-CBD A-grade rental growth of 5% in 2022. Although growth was concentrated in prime offices, there was also some growth in secondary rents. This continued the healthy occupancy and demand conditions seen in 2021. In Manukau, for example, where the best offices are B-grade, sustained tenant demand has resulted in modest but continuing rental growth.

 

Non-CBD office market outlook

Net supply is expected to total approximately 75000 square metres by 2026. Several additional developments remain in the early planning stages and could be completed before 2026. As in the CBD, prime office vacancy rates are generally expected to fall. However, as new properties are completed and tenants move from older A-grade buildings into new ones, A-grade vacancy may experience occasional small peaks over the next five years. Secondary office vacancy will be more stable, remaining at 8–9%.

Rents: We forecast continued growth in non-CBD office rents over the next five years, but at a slower rate than in 2022. Given the uncertain economic outlook, A-grade rents are expected to grow 2.5% in 2023, with most of that growth likely in the first half, before slowing from the second half through 2024.

Good-quality secondary offices and recently refurbished buildings will also attract healthy demand. We therefore forecast modest growth in average secondary market rents over the next five years.

 

Retail property rents

Shopping centre rents are growing steadily, supported by several positive factors, including consumer spending driven by the tourism rebound and landlords raising rents in response to inflation.

Although market conditions support retail rental growth in some locations (prime CBD, Newmarket), properties with shorter lease terms of 2–3 years are still recording lower rental growth than other properties. We expect landlords to secure larger increases when those terms end.

The combined effects of rising interest rates, sharply higher living costs and a weak property market suggest household spending will slow significantly. Although recent interactions between CBRE brokers and retailers indicate that many retailers are expanding and are prepared to view the coming market weakness as a temporary difficulty, we expect both consumer spending and rental growth to slow over the next 18 months.

 

Industrial property vacancy

Overall industrial vacancy fell from 0.5% in December 2021 to 0.1% at the end of 2022. Across Auckland's industrial market of 13,600,000 square metres, only 7623 square metres of secondary space was vacant. There were no vacant properties in the prime market.

CBRE Research defines vacancy as space that is physically vacant and available to lease. It excludes available sublease space within some occupied premises and space still under construction that has not been pre-leased. For example, the development pipeline in November 2022 included more than 384000 square metres of industrial space under construction, of which 78000 square metres had not been pre-leased and remained available.

Following total supply of 99850 square metres in the first half, the market surged in the second half of 2022. New supply reached 236257 square metres, comprising 233277 square metres of new prime property and 2980 square metres of secondary property. Allowing for the refurbishment of some older properties, the net change in total property floor area in the second half was 195571 square metres, the largest in a decade. Total industrial net absorption was approximately 223000 square metres in the six months to December 2022. New developments were a major contributor, as all new properties were occupied with no vacancy. Another factor was the take-up of all existing prime space that had been vacant in the first half of 2022.

 

Industrial property rents

After three consecutive quarters of strong industrial rental growth in 2022, prime market growth slowed to 2.5% in the fourth quarter of 2022, while secondary rental growth eased to 1.6%. Contributing factors included rents on new properties exceeding market averages and strong growth in office rents at some industrial properties, which are now approaching prime office rents.

(Note: Industrial property rents are divided into rents for office areas and rents for warehouse or industrial areas. Each industrial property includes a small office component. These office areas are rented separately, and their rents are now approaching those of CBD offices.)

Warehouse rents in prime buildings continued to rise, reaching NZ$190–200 per square metre annually in the fourth quarter. However, broker feedback suggests tenants are also beginning to feel the pressure of high rents and are negotiating with landlords to bring them down.

 

Industrial property market outlook

We expect prime vacancy to increase modestly over the next two years. Our forecast includes industrial demand declining by 2024 to a level consistent with economic growth, leading to less new supply. Reduced supply will also help keep vacancy at normal levels. We forecast prime vacancy to remain below its historical average of 1.6% over the next five years.

Rents: Rents will continue rising in the first half, driven by higher development costs and sustained strong demand for industrial property. Rental growth will remain high in the first half of 2023, but market rental growth will slow from the second half of 2023 through 2024.

Prime industrial property is expected to deliver the strongest capital returns among Auckland's commercial property markets, thanks to very high near-term rental growth. Although this trend is expected to slow by 2024, prime industrial market rents are forecast to rise by nearly 35% overall during 2022–2026. Secondary market performance is expected to be weaker, but market rental growth is still forecast to exceed 25%. Both segments therefore offer positive capital return prospects, even as yields rise.