The flight to quality is becoming increasingly evident in the CBD office markets of Australia’s two major cities of Sydney and Melbourne, but has been more pronounced in Melbourne as employers try to entice workers back into the physical office. 

New Knight Frank research has found a clear bifurcation in Melbourne’s market, with net absorption noticeably split between premium and A-grade and B, C and D-grade space.  

Overall demand for office space turned negative in the Melbourne CBD in H2 2022, with total net absorption of -15,654sq m after two continued periods of positive demand, and this fell to -55,708 for B, C and D-grade stock.  

However, demand for Premium and A-Grade space rose in contrast, with Premium Grade buildings having a net absorption of 15,243sq and A-Grade even stronger at 24,811sq m as flight to quality continues.  

Knight Frank Head of Research and Consulting Victoria Tony McGough said the Melbourne Premium and A-Grade markets remained resilient as the overall leasing market weakened with the uncertainty in global markets and the slowing economy.  

“Demand for A-Grade stock has been positive since COVID lockdowns finished in clear evidence of tenants trading up,” he said.  

“The bifurcation of the market between Premium and A-Grade and B, C and D-grade is also clearly illustrated in the vacancy rate, which rose overall to 13.8% in the second half of 2022, but this was concentrated in the secondary market.  

“A final addition of new Grade A supply combined with negative net absorption pushed vacant space 51,829sq m higher to a rate last seen in 1999.  

“However, it was driven by a jump in B-Grade vacancy of 3.4% to 20.8%. A Grade rates edged up to 13.7% while Premium Grade fell from 10.9% to 9.5%.” 

Knight Frank Head of Leasing Victoria Hamish Sutherland said it was expected demand would remain positive, if moderate, in the next five years as the economy initially slows before returning to average growth. 

“The vacancy rate is expected to peak in 2023 and with limited supply moving forward we expect to see consistent downward pressure on the vacancy rate,” he said. 

“It is likely to expect vacancy rates in secondary buildings will remain high, while prime rates will fall more quickly.”  

“Owners of lower-grade buildings will have to increasingly look at refurbishing their buildings, or alternatively repurposing the buildings into hotels for example, with brands like Marriott announcing they would like to open more hotels in the city, or as a last resort, redeveloping, to attract tenants.”  

The research found that in line with the bifurcation of markets in Melbourne’s CBD office market, prime net face rents rose 0.7% in Q4 2022 and 5.4% year on year to hold onto the gains made in H1 even as the market calmed.  

Rents edged up in most precincts over the fourth quarter of 2022, but again the East outperformed with 1.9% growth,” said Dr McGough.  

“The year has seen rental growth concentrated around the best precincts with the Paris quarter seeing growth of 12.1% over 2022, whilst Flagstaff saw 2%.  

“Not only are tenants preferring prime over secondary, but there is a clear preference for the better locations and better buildings within that category.  

“Going forward we expect to see very modest growth in 2023 for face rents with effective rents virtually flat as incentives remain high on the back of high vacancy rates.”