Think of office property and, no doubt, tall, glittering office blocks in a city’s CBD spring to mind. In many ways, such properties do dominate the office sector landscape. But office property is more diverse – there’s plenty of smaller, suburban office buildings around.

There are some additional complications with the sector though. Smaller office properties are often mixed use and incorporate either office and retail space or office and industrial space. As such they are often adapted to specific tenants and defy easy categorisation.

Perhaps for this reason, much of the information about office property tends to focus on those larger-scale office blocks. While owning such properties might seem out of reach for most investors, many who invest through real estate investment trusts (REITs) or syndicates actually do have investments in big, centrally-located office blocks.

In this article, we shine our sector spotlight on office property. We take a look at how office markets are peforming around the country, at some of the trends shaping them and get some advice from those in the know.

Thriving Super City Market

The City of Sails’ office sector is booming, thanks to a combination of strong levels of tenant demand, rising rents and low interest rates.

Collier’s annual market indicator shows that Auckland CBD office values were up by 11.1% year-on-year in the year ending September, while metropolitan office values were up 8.7%. Rents had also increased for both CBD and metropolitan offices, by 3.0% and 3.1% respectively.

Vacancy rates in both CBD and metropolitan offices were up year-on-year, to 6.2% (from 5.7%) and 6.7% (from 5.1%) respectively. The main driver of this increase was the pockets of vacancies in recently completed office buildings.

According to the Colliers report, there is a noticeable trend whereby many office landlords, especially in the city fringe, are upgrading their buildings. These newly refurbished buildings are receiving rental premiums and longer lease terms.

For New Zealand Mortgages & Securities director James Kellow, the value of quality commercial buildings in Auckland’s central city is as strong as ever, with demand for high-grade office space still outstripping supply.

He says good commercial buildings in downtown Auckland have never been worth more than they are today.

“This may surprise many given much of Auckland’s housing market is going sideways. However, in the central city desirable contemporary office stock is limited, overall vacancy rates remain low, and rents are still going up.”

That means it would be very difficult to find an office building in downtown Auckland that has lost value, he says.

“The only exceptions being buildings that landlords have simply not kept up.”

One of the reasons office stock is so tight is that many of the city’s existing office buildings are being converted into hotels and apartments. But Kellow believes the repurposed buildings are not being adequately replaced.

There are a number of major new build projects, including the Commercial Bay development opposite Britomart and Manson TCLM’s $250 million office development at 155 Fanshawe Street, nearing completion.

These will provide the CBD with much needed international-quality office space but, as much of it is pre-leased, it doesn’t put much new leasable supply into the market. Exacerbating the office supply shortage is the fact that developers can struggle to secure bank finance to develop offices plus there is very little development land actually available, Kellow says.

Additionally, tenants now have international-grade technology and environmental requirements and want large floor plates for connectivity and hot-desking and mixed-use spaces.

“But the challenge remains that much of the city’s existing office stock just can’t provide anything like that.”

Prominent Auckland investor David Whitburn agrees, saying that while Auckland’s office sector has seen some movement, supply constraints remain.

“The completion of projects like Commercial Bay will ease pressure on A-Grade premium office space but they will put pressure on lesser grade space. The market can probably absorb it though and some positive pressure will help to boost rents a bit.”

But both Whitburn and Kellow see the Auckland office market as strong going forward. Kellow predicts that with increasingly healthy yields on offer, it can expect a fresh wave of domestic and international investment in 2019.

Office Growth Tales

The scale and size of Auckland’s office market, along with the fact it is becoming increasingly attractive to international tenants and investors, means it receives most of the attention. But there are office properties around New Zealand – and significant office markets in Wellington and Christchurch as well as smaller cities like Hamilton.

Wellington’s market is also strong. As in Auckland, there is high demand for prime office space but it is in short supply. This is driving growth in the sector.

Collier’s annual market indicator shows that Wellington CBD office values were up by 9.9% year-on-year in the year ending September, while rents had increased by 5.9%. Overall office vacancy rates had dipped year-on-year to 7.7% from 7.8% at the same time last year, but prime CBD vacancy rates are much lower.

CBRE senior research analyst Richard Carr says they are still seeing a supply imbalance in the office market following the 2016 Kaikoura earthquake. “But we actually now have more prime stock than pre-quake levels and the demand is all about a clear shift in occupier preference for higher quality space.”

‘Flexible workspaces are becoming the point of reference for companies reassessing their commercial real estate requirements. Landlords need to understand this’ NICOLE FITZGERALD

At the same time, the Government continues to be particularly active as it looks to address a shortage of office space in the wake of 2016 and an ongoing expansion of the public sector, he says. “And while there’s currently 100,000m2 of new development projects circulating there’s no confirmed new builds.”

That means CBRE is forecasting continued rental growth in prime office space, along with low vacancy levels, for the foreseeable future.

One smaller city office market experiencing a similar high demand, tight supply trend is Hamilton. The sector is seeing healthy growth, thanks to businesses relocating due to more competitive prices and local businesses expanding and requiring larger office space.

The bulk of the city’s office space is in the CBD, but the area is going through significant revitalisation which is making it more attractive to tenants and supporting further growth. Lodge Real Estate commercial sales and leasing agent Dean Abraham says developers are leading the way, modernising older buildings and developing new complexes, which are often mixed use.

“Such developments are leading rejuvenation in the CBD. There has been some movement for suburban businesses – lawyers and accountants – to set up offices in town. And we are seeing a lot of smaller companies relocate rather than working from home. This is driving rental growth.”

The only problem is that the city also has a lot of old, outdated office buildings which need to be brought up to scratch, he says. “But the vendors are unrealistic about selling prices and not enough stock is coming on to the market.”

One office market to go against the trends evident elsewhere is that of Christchurch. The main reason for this is the post-earthquake commercial rebuild which has created a unique situation.

Collier’s latest report on the city’s office sector says there has been a sharp decline in office development over the past year. It notes that suburban relocations, internal CBD churn and smaller tenants leasing activity will erode tenant options despite the city’s aggregate 20% vacancy rate.

CBRE Christchurch managing director Tim Rookes says that with consenting volumes continuing to decline, all signs are that the commercial rebuild market is winding down and moving to a new state of normal.

“The conclusion of the development pipeline should provide some stability to market rental levels in the next 12 months and allow organic growth and tenant attraction to drive CBD vacancies lower. The city appears to have left the post-quake stasis and is now seeing more properties trade hands with transaction volumes currently more than double the pre-quake average.”

Flexible Office Space Is The Future

Moving forward, the office trend on everyone’s lips is the growth of coworking and flexible office spaces.

Generational changes, increasingly flexible work practices and fast-developing mobile technology mean that businesses now have very different requirements when it comes to office space. This means that not only are traditional cubicle and room-based office fit outs falling out of favour, but the trend towards shared spaces and co-working spaces is gaining major momentum globally.

New Zealand is not exempt from this. CBRE’s Pacific Corporate Co-working Survey: The Future is Flexible report shows that 39% of New Zealand office tenants are considering flexible solutions for the future. In the next two years, 47% of New Zealand office tenants plan to reduce their traditional leased office footprint space, while 47% are looking to increase co-working space use.

Further, reflecting the growing demand for flexible office solutions, the majority (53%) of office occupiers in New Zealand said they would prefer to be located in a building with a co-working centre. Demand for shared meeting and/or event space was high, with 81% of New Zealand office tenants saying they would choose to occupy a building that offered these facilities.

This all makes for new opportunities for commercial landlords ready to adapt to the changing needs of office tenants. Yet it seems many are challenged by the trend and have been slow to adapt to it.

CBRE Pacific director of workplace strategy Nicole Fitzgerald says there is opportunity for landlords to provide a range of co-working space options to meet the different requirements of industry groups. For example, they could adapt their existing office product to meeting the evolving needs of their tenants.

“Flexible workspaces are becoming the point of reference for companies reassessing their commercial real estate requirements. Landlords need to understand this and adapt accordingly or risk being left behind.”

Niche flexible workspaces are emerging and continue to experience rapid growth, she says. “These specialised offerings range from industry specific spaces and bio-labs to workspaces for mothers. Ultimately, they appeal to groups who aren’t interested in traditional co-working offerings.”

Office Investor

Veteran investor Glenn Morris has owned a number of smaller office properties in Nelson over the years. These days he is a part-owner of an office building in the Nelson CBD. In his view, office property investments can be challenging, although he says it might be different in the bigger cities.

But he has picked up a few learnings on the office sector in his time. One is that the rents people pay for office space are usually not as much as what they pay for retail properties. Another is that office space is usually on the second floor as ground floor space tends to go to retail. Yet second floor space costs more and rents for less.

“It can also come back to bite you if you adapt an office building extensively at the behest of a tenant,” he says. “We added an extension to our office block which was a delivery type space for our tenants and then they left. It took us a long time to find new tenants, as there was less demand for the space, and we had to reduce the rent.”

On the other hand, Morris has found that once an office property is up and running and tenanted it is generally plain sailing, unlike retail. “Office tenants tend to have a greater degree of professionalism. Their businesses don’t tend to be as volatile as retail can be. That makes for easier tenants and less stress.”

Investors interested in office space need to be aware that it is not a sector for the faint-hearted, he adds. “Many a person with great ideas has not done their homework and run into big problems with this sector. It is possible to make a good go of it. But you really need to have other sources of cash flow to tide you over in case of problems or vacancies.”