The paper, titled ‘Why are the Rents Low?  The affordability of the Melbourne CBD’  found the strength of tenant demand over the past four years in Melbourne had been unprecedented.

Head of Strategic and National Office Research, Andrew Ballantyne said the national CBD net absorption from 2004 to 2007 was approximately 2 million sqm, with Melbourne accounting for one-third of this total figure.

“Net absorption in Melbourne has averaged 166,000 sqm per annum over the past four years.  This is 100,000 sqm higher than the 30-average of 66,000 sqm per annum,” Mr Ballantyne said.

“Even when adjusting for the size of the market, net absorption as a percentage of total stock has been higher in Melbourne (17.1%) than the booming markets of Brisbane (11%) and Perth (14.6%), and almost twice the level of Sydney (9.6%).

Despite the unprecedented strength in demand, rental growth has been relatively sedate, while markets with comparable rentals have shown exceptional growth and the spread between rents in Sydney and Melbourne has increased.

“Although vacancy has declined from 10.2% at the start of 2004 to 3.3%in 2Q08, supply has capped rental growth in Melbourne. The acceptance of Docklands and Southbank Riverside by corporate occupiers and the lower rental levels in comparison to the traditional CBD core has acted as a deflationary mechanism on the whole Melbourne CBD market,” said Mr Ballantyne.

Director of Commercial Office Leasing, Stuart Colquhoun said the Melbourne CBD had benefited from affordable rental levels.

“Unlike other CBD markets, there is a trend for tenants moving from the fringe and suburbs into the CBD. The is the opposite of the trend in Brisbane and Perth where an elevation in real estate costs had forced a number of smaller tenants out of the respective CBDs.”

Examples of tenants who have relocated to the CBD in 2008 are Infosys (818 Bourke Street), Fujitsu Consulting (825 Bourke Street) and by the end of the year, National Foods will consolidate three suburban and one fringe location at 737 Bourke Street.

The non-university education sector is a growing sector across the eastern seaboard. This sector has proven to be a useful option for land lords with hard to lease secondary space.

“In Melbourne, lower rents are enabling this sector commit to new developments, providing a further diversification of the tenant base. Carrick Institute pre-committed to 7,129 sqm of space at 370 Docklands Drive and Global Campus Management has pre-committed to 17,000 sqm at 717 Bourke Street,” Mr Colquhoun said.

“The redevelopment of Docklands has assisted in the retention of CBD tenants. Campus style development can be facilitated within the CBD and tenants seeking this type of space are not forced to the fringe or suburbs.”

With the turmoil in the financial markets and the uncertain economic outlook, there is the potential that headcount reductions could increase sub-lease space to the market.

“The affordable rental levels in Melbourne could potentially limit the volume of sub-lease space entering the market. Real estate costs are a lower proportion of occupiers operating costs in Melbourne than other CBD markets, therefore they may decide to hold space. Tenants will remember 2003, when a number of occupiers sub-leased excess space and were caught out by the subsequent economic upturn.”

Looking ahead, Jones Lang LaSalle project that Melbourne will remain an extremely affordable option for tenants who are seeking prime space. Although vacancy rates are expected to remain below long-term averages through the next 5 years, a softening of tenant demand is expected to keep rental growth moderate.

“Rental growth for existing stock will be restrained in 2009 and 2010, however the rents required to make new developments viable will have to increase in the current environment. Cap rates have softened, borrowing costs have escalated and anecdotally the price of structural steel has risen by as much as 50%,” Mr Colquhoun said.