Mixed Bag for the Wellington CBD Office Sector

FOR IMMEDIATE RELEASE - 10 November 2008

Mixed Bag for the Wellington CBD Office Sector

Wellington, NZ (11 November 2008)

The drivers behind the CBD office market are showing mixed signals.

So says the latest research released by CB Richard Ellis (CBRE).

Looking at the fundamentals, the overall Wellington CBD office net absorption exceeded 3,000sqm for the first six months of 2008 – the fourth consecutive six-monthly survey period with positive net absorption, says Hui Yeoh, CBRE Wellington’s Research Analyst. However, he points out that this is mainly driven by the substantial uptake by 50 Victoria Street and other A grade buildings.

“50 Victoria Street, in the Chews Lane precinct, alone has contributed 7,236sqm of positive net absorption as the entire building was taken up by LTNZ (now part of NZTA) in February. Adding this with the significant uptake by other A grade buildings in the likes of Deloitte House and Maritime Tower, this resulted in a positive net absorption of over 9,000sqm which managed to offset the negative net absorption from other grades.”

The majority of the negative net absorption for B, C and D grades came from core CBD.

Another interesting statistic to consider was the overall vacancy rate in the Wellington CBD office market, dropping to 2.5% - the lowest ever recorded by CBRE, based on the June 2008 survey. Again, Yeoh says that we can’t read too much into this. This is due to the fact that apart from the impact of positive absorption, the temporary removal of two D-grade vacant buildings (Aorangi House in Thorndon and Feltex House in Te Aro which have been undergoing refurbishment) from the surveyed stock also contributed to the vacancy decline.
“So, we could say that these numbers overstate the strength of market fundamentals and they have to be read with a grain of salt.”

Between the end of 2007 and mid 2008, vacancies fell in Te Aro (3.8% to 2.0%) and Thorndon (3.1% to 0.6%) but increased in the Core CBD (2.7% to 3.1%). In terms of the different quality grades, D grade had the biggest fall from 11.6% to 7.1%, thanks to the withdrawals of the aforementioned buildings. A grade experienced a fall in its vacancy from 1.7% to 0.8% while B and C grade vacancies increased from 1.8% to 2.0% and 3.6% to 3.9% respectively. Interestingly, Premium grade saw an increase in its vacancy rate from 0% to 0.9%, its first increase since December 2006.

CBRE Research also notes that net rental growth was still evident within both Prime and Secondary office sectors over the third quarter, although the growth rate has eased. For the year ending September 2008, Prime and Secondary net rent series rose by 11.0% to $348 per sqm and 8.7% to $205 per sqm respectively.

“Research indicates that there are prospects for continuing rental growth in the Prime sector albeit, the rate of growth is likely to ease over the next twelve months. Lower underlying demand levels for secondary stock is likely to result in rental levels plateauing sooner and possibly easing, especially in locations that are exposed to upcoming major lease expiries, for example Manners Street.”

Yeoh believes that this will result in the gap between Prime and Secondary rents to increasingly diverge in the future.

David Fisher, CBRE’s Director of Office Services agrees with Yeoh. With a number of C grade buildings becoming vacant over the next one to three years, it is imperative that the owners of these buildings put in place strategies to attract suitable tenants. As a bare minimum, an understanding of what the potential competition can offer and prevailing market terms for similar space is essential. Owners that take Environmentally Sustainable Design (ESD) principles into account and refurbish their buildings appropriately will have an advantage in their market.

“As rentals for new developments increase and pressure goes on tenants to consider cost implications, we may well see some of the better refurbished and modernised existing buildings becoming serious competition to new developments. The rental gap between the two alternatives in many cases may dictate choice,” suggests Fisher.

In the office investment market, there has been paucity of transactions throughout 2008 and it was no different for the September quarter.

However, based on the cautious market sentiment and current tight credit conditions, CBRE Research maintains its softening stance on yields. Prime indicative yields have eased by 24 basis points to 7.57% in the three months to September 2008 while Secondary indicative yields have softened by 43 basis points to 9.18% over the same period. For comparison purposes, in the year to September 2008, Prime and Secondary yields have eased by 0.64% and 1.20% respectively.

Yeoh puts this down to the spill-over effects from the global credit crunch which is definitely being felt locally and the demise of many mezzanine finance companies, resulting in restricted availability of funds.

He adds that there has been a decline in the number of prospective buyers of high value stock as they are seeking higher yields to offset additional risks especially in a market shrouded with uncertainty and off-market campaigns that have not been as effective as hoped for.

On the flipside, Ryan Johnson, Managing Director of CBRE Wellington, believes that a property such as Maritime Tower which has one of the strongest Weighted Average Lease Expiry (WALE) within the New Zealand CBD office market and an enviable mix of international and blue chip corporate clients would still be seen as a excellent addition to one’s portfolio under the current market conditions.

“The combination of WALE exceeding nine years, investment grade lease covenants and modern building ensures that Maritime Tower will remain the capital city’s most sought after address,” he adds.

One significant transaction that settled in September 2008 was the sale of the Registered Master Builders Building (Wakefield Street) for $12.5 million – it indicated an initial yield of 6.38% and an equivalent market yield of just above 8.0%.

The Outlook
CBRE believes that in the leasing market, there is still some potential rental uplift for quality office space especially for those tenants who are facing a rent review over the next six to twelve months given the magnitude of recent market rental growth.

However, the forecast unemployment rate increases in the private sector and projected government budget deficits will have an adverse impact on office demand and vacancies especially for those secondary properties that are being vacated by upgrading occupiers during the next two years.

On the investment front, Johnson believes that Prime grade properties will still be in good hands over the next three to five years as there will be limited premium grade supply being developed, a disparity between construction costs & rentals and restricted development sites in Wellington’s geographically constrained CBD.

About CB Richard Ellis
CB Richard Ellis Group, Inc. (NYSE:CBG), a Fortune 500 and S&P 500 company headquartered in Los Angeles, is the world’s largest commercial real estate services firm (in terms of 2007 revenue). With over 29,000 employees, the Company serves real estate owners, investors and occupiers through more than 300 offices worldwide (excluding affiliate offices). CB Richard Ellis offers strategic advice and execution for property sales and leasing; corporate services; property, facilities and project management; mortgage banking; appraisal and valuation; development services; investment management; and research and consulting. CB Richard Ellis is the only commercial real estate services company named one of the 50 “best in class” companies by BusinessWeek, and was also named one of the 100 fastest growing companies by Fortune. Please visit our Web site at www.cbre.com.

ENDS

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