Australia’s office block problem is getting worse

Office property values in Australia have plunged more than 10 per cent in the last six months and could fall further as high interest rates and the work from home trend take their toll on demand.

Investors are bracing for more bad news when landlords roll out their full-year results in August, with many office owners expecting values to fall further before any uptick in the market once new leases are signed.

Mirvac has sold a half share in the tower at 255 George Street.Credit: Louise Kennerley AFR

Landlords and property managers Dexus and Mirvac oversee a significant portion of Australia’s premium and A-grade office towers. Between them, they completed close to $2 billion in office deals over the past few weeks, but those deals were done at close to double-digit discounts to their book values.

Morningstar analyst Adrian Atkins estimates office values may plunge by 20 per cent from their December 2023 levels because of elevated interest rates and subdued tenant demand.

“We note that Dexus’ office values fell by 11 per cent during the past six months,” he said in a note to clients. “We expect tenant demand to slowly improve while new supply will be limited, which bodes well for the medium term.”

Atkins said Mirvac’s exposure to current weak conditions will be cushioned by its towers’ having high occupancy levels, around 95 per cent, and relatively long average lease terms of 5.7 years.

Mirvac’s offices are high-quality and in demand, however, under the latest deal, the $7.07 billion company sold a 50 per cent interest in 255 George Street tower in Sydney to Singapore-based Keppel REIT for $363.8 million – at a nine per cent discount to its book value.

The diversified group also sold 367 Collins Street in Melbourne to Hong Kong private equity firm PAG for $340 million. It did not reveal Collins Street tower’s book value.

Another A-grade office tower at 40 Miller Street in North Sydney was sold to US global investment manager Barings for about $145 million, at a near-14 per cent discount.

Mitsui Fudosan Australia has taken a 66 per cent stake in Mirvac’s planned office building at 55 Pitt Street in Sydney, but the company did not confirm a start date for the 55-storey tower or if law firm MinterEllison will be a tenant.

367 Collins Street, Melbourne Credit: Elke Meitzel

Mirvac chief executive Campbell Hannan said the group has delivered on its $1 billion asset sales target, adding further details will be released with its full-year results in August.

Meanwhile, Dexus exchanged contracts on three assets worth $383.2 million in June.

One of those was Sydney’s 5 Martin Place which is half-owned by Cbus Property. The super fund wrested the remaining half share from joint owners Dexus and the Canada Pension Plan Investment Board for $310 million, at a 24 per cent discount.

“[The] investment metrics displayed by recent sales activity support a softening in office market valuations,” Dexus chief executive Ross Du Vernet said.

“However, as a long-term investor, we have confidence in the value of our high-quality portfolio through the cycle. There is continued occupier demand for well-located, high-quality buildings as seen in our portfolio occupancy,” Du Vernet said.

Melbourne-based Growthpoint’s portfolio is also sliding. The value of 45 of its 57 directly owned assets has slumped $182.4 million or 6.2 per cent. Moelis Australia analyst Edward Day said Growthpoint’s “peak to trough” decline is about 20 per cent.

Newly appointed chief executive Ross Lees said the decrease in the draft external valuations is expected to result in a reduction of 25¢ per share to the group’s net tangible assets.

Citi analysts said the office sector remains “challenging” and is not yet at an inflection point where values will grow.

“Muted underlying tenant demand, corporate cost reductions and high overall vacancy and incentive levels continue to place the growth outlook for the subsector under pressure,” Citi said.

“We also anticipate further pressure on office capitalisation rates into the June and potentially the December reporting periods as inflation and interest rates remain stubbornly high.”

“We see little catalyst for a near term re-rating relative to higher growth subsectors,” the analysts said.

In Brisbane, where the office market has held up better than the southern states, private group Quintessential settled the purchase of an A-Grade office tower at 240 Queen Street for $250 million, at a steep discount to its original asking price.

The 26-storey tower in the city’s Golden Triangle precinct was flagged for sale in February by the Canadian funds giant Brookfield with a price tag close to $300 million.

Andrew Borger, Quintessential’s chief investment officer, said this acquisition of 240 Queen Street is a “top-tier asset”.

“Our planned $31 million regeneration works will further enhance its appeal and functionality, ensuring it remains a premier destination in the Brisbane CBD,” Borger said.

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.