Investors wait to pounce on Melbourne office buildings caught in COVID crunch

A $1.5 billion property fund is waiting to pounce on distressed buildings if the COVID-19 crunch further disrupts Melbourne’s commercial property market, emptying office towers.

Commercial real estate agency CBRE estimates that between June and December last year the amount of available sublease space in the CBD soared 186 per cent to 182,416 square metres, a figure three times the normal annual average.

Office workers are few and far between in the city these days.
Office workers are few and far between in the city these days.Credit:Joe Armao

Two agents from prominent commercial property firms who asked not to be identified because it would jeopardise commercial deals, told The Age there was a long list of corporate tenants shedding space including Australian Super, Medibank, AGL, Origin, KPMG, NBN, CUB and Deloitte.

“That’s just the tip of the iceberg,” said an agent from another firm who agreed to speak on the condition of anonymity.

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NAB's building at 800 Bourke is known as the Rubik's Cube in property circles.
NAB’s building at 800 Bourke is known as the Rubik’s Cube in property circles. Credit:Darrian Traynor

One bank is offloading an entire building.

The pause in allowing more office staff to return to work announced earlier this month coupled with Friday’s announcement of a “circuit-breaker” lockdown and a return to working from home for many is likely to only add to the repurposing rush.

Staff are unlikely to return to National Australia Bank’s headquarters at 800 Bourke Street, dubbed the Rubik’s Cube because of its colourful exterior and shape, with the bank sounding out commercial agents to sublease the entire tower.

The seismic shift in workplace attitudes caused by the pandemic is prompting big corporations – which cannot break long-term leases they signed before the pandemic – to flood sublease markets with excess unwanted office floors because staff are working from home.

Finance giant MLC is understood to be taking 9000 square metres of the building’s available 56,000 square metres, but the bulk will remain empty unless filled by other tenants.

Marc Colella, industry director at global engineering and consultancy firm Aecom, said many large corporates were looking to reduce their real estate by about 20 to 30 per cent. “That’s quite significant.”

Many Melbourne offices could be repurposed
Many Melbourne offices could be repurposedCredit:Paul Rovere

Over the next 18 months tenants re-signing leases are likely to gravitate to premium quality buildings leaving a large tranche of secondary buildings vulnerable.

“I honestly think that all the B and C grade buildings are at risk here,” Mr Colella said. “If you’re an owner of one of those buildings, and if you’re not diligently looking at all your options, I think there’s going to be a revenue stream that’s going to be found wanting at some point over the next couple of years.”

Cashed-up property funds such as Paul Huggins’ Hamilton Chase are watching from the sidelines.

Mr Huggins’ private $1.5 billion fund is scouting opportunities. If the knock-on effect of tenants playing musical chairs hollows out secondary buildings, it potentially leaves them ripe for conversion to other uses, a phenomenon played out in other cities, such as New York.

Paul Huggins’ private investment fund is watching the market.
Paul Huggins’ private investment fund is watching the market.

“You will see valuations drop, because the owners haven’t got long-term leases and nice corporate tenants,” he said, while emphasising that such a scenario would not play out quickly and was more likely to take years.

There is a market for modular retrofitted apartments, particularly for larger units. “Will someone pay $2.5 million to $3 million for 200-300 square metres with a balcony near the top end of Collins Street? You’re damn right they will,” he said.

COVID-19 has prompted high-profile corporate chiefs to publicly foreshadow major changes to office rituals.

Telstra’s Andy Penn said last week: “work is now something we do, not somewhere we go”; while at the same time sanctioning staff to spend just two days a week in traditional offices and keeping 80 per cent of its contact centre workers at home.

The ongoing uncertainty and mounting glut of empty buildings is elevating concern for landlords, council officials and city-based traders.

Melbourne lord mayor Sally Capp said workers were critical to the health of the city. “Office employment accounts for almost two thirds of jobs in the municipality, so it’s critical we get workers back into the city as soon as possible,” Cr Capp said.

Before the pandemic, about 1 million people travelled into the city each day. The latest figures show average pedestrian activity is down 57 per cent compared with this time last year.

“There’s no denying the change we’ve seen over the last year has been profound, but many blue chip buildings are still holding their appeal,” she said.

Adding to the challenges are a wave of new glass towers being built across the city.

Premium office buildings will bounce back because they will attract tenants from B-grade and C-grade buildings, Savills Australia’s head of leasing Mark Rasmussen said.

“We’re forecasting a flight to quality.”

Mr Rasmussen dismissed the likelihood of a wave of conversions of B and C grade building to residential apartments. “Values would have to drop by more than half to make it feasible,” he said, and there was little evidence of that yet.

There are also significant regulatory and structural challenges standing in the way of adaptive reuse of buildings, including stringent residential regulations, access to daylight, natural ventilation, the age of buildings and quality of their facades, Mr Colella said.

Scott Keck, director and founder of property analysts Charter Keck Kramer, said no employers and hardly any employees want to leave the office entirely.

“Off course, there will be some shuffling and churn, but it’s not a disaster for the office market. The vacancy rate will correct itself in time.”

“This is not a desertion,” he said.

Several factors will keep offices stable and functioning. Not all tenants have leases expiring now so many will stay put, developers can rapidly adjust the supply of new buildings, and firms stuck with a lease for the next 18 months will probably just settle down, he said.

Cr Capp said that while workers need to be encouraged and welcomed back to the office, the city also needs to expand its horizons and attract new jobs and industries.

“This means supporting start-ups and innovation, and pitching our city to become the base of new headquarters for national and international companies.”

“We’re also in a position to learn from the successes and failures from other cities who are in similar situations,” she said.

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