Flight to quality office towers a glimmer of hope for commercial property sector

Demand for quality office towers offers some potential for commercial property as ANZ warns the sector faces headwinds in hotel and retail spaces.

A flight to quality office towers is offering a glimmer of hope for the commercial property sector.

Analysis from ANZ shows commercial property is being impacted by hybrid working models and online alternatives to in-person business events and meetings, weakening the relationship between employment growth, office use and central business district retail and hotel use.

While the development pipeline for hotels and retail was sluggish, ANZ analysts noted that strong growth in office-based employment and the “flight to quality” had resulted in a solid medium-term pipeline of development, despite persistent work-from-home trends.

The bank’s senior economist, Adelaide Timbrell, said the office construction pipeline had defied the structural shift of worker presence in offices, as strong employment growth and the flight to quality stimulated new developments.

“The value of new office building approvals also continues to be well above pre-pandemic levels,” she said.

“The risks to office valuations and office demand may limit how many projects start construction in the short to medium term.”

Office construction activity for projects over $100m was 12.7 per cent higher in the 2023 financial year, and the potential investment pipeline for the office sector is set to peak above pre-pandemic levels in the 2025.

ANZ senior economist Adelaide Timbrell says commercial property faces headwinds. Picture: Arsineh Houspian

Offices were found to have benefited from growth in office-related employment and an increase in return-to-work mandates, with midweek attendance at 80 per cent of pre-Covid levels.

“The popularity of midweek attendance means offices need to accommodate the peak number of workers, not the average, across the week,” Ms Timbrell said.

But office rents were down 13 per cent since 2019 and building and funding costs had risen rapidly, she said.

Across capital cities, an estimated 17 office projects valued over $100m were completed in the past fiscal year.

A $2.2bn tower at Parramatta Square and the $1.5bn Salesforce Tower in Sydney are the most valuable projects.

Ms Timbrell said that half of the projects under construction started after 2021, meaning a “cliff” of construction activity following Covid had been avoided in the office sector.

Across the broader commercial property space, Ms Timbrell said higher funding costs and labour shortages had increased the risk or reduced the feasibility of some projects.

“Crowding out of investment from public sector and renewable energy infrastructure may limit the feasibility of some commercial building projects in the longer term,” she said.

Hotel approvals were yet to surpass pre-pandemic numbers as domestic visitor nights remained 3.5 per cent below 2019 levels. “Hotel demand will be limited by the impacts of global central bank tightening on consumption, as well as renewed competition from alternative short-term accommodation options,” Ms Timbrell said.

“The rise of non-hotel supply has been a major limiting factor for hotel development activity.”

Hotel construction activity weakened by 5.2 per cent in 2022-23.

This reflected a gap in hotel developments due to a per­iod of developer caution, before tourism spending bounced back.

Salesforce Tower in Sydney is among the biggest projects that finished in the past year. Picture: NCA NewsWire/ Gaye Gerard

In retail, subdued consumer spending reduced the value of building approvals in the past year as inflation and higher interest rates restrained household consumption and resulted in spending moving into other goods and services.

“The second half of 2024 will bring relief to household incomes through lower inflation, the start of rate cuts, tax cuts and other potential fiscal easing,” Ms Timbrell said.

“This improvement, as well as continued solid population growth, will add to retail ­demand.”

ANZ observed that mixed-use developments and redevelopments continued to dominate retail sector construction, while the need for a cohesive retail experience limited the range of possible buildings. .

Meanwhile, Cromwell Property said an independent external valuation of nine assets in Australia had resulted in a downgrade to eight. The December 2023 valuations reflected an estimated decrease of $192.1m or 7.5 per cent on portfolio book values since June 30, 2023, Cromwell said on ­Monday. The real estate investment group owns a sizeable portfolio of office buildings including the Qantas headquarters in Mascot, along with retail, industrial assets.