Office vacancy rate set to soar

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VACCANT: Commercial rental rates are expected to drop, although it is impossible to know by how much.

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Wellington's commercial office market is set for a severe shock with empty floors predicted to double and rents to drop up to 20 per cent over two years, a new report says.

The Darroch Research report indicated a sharp rise in vacancy rates as new buildings are completed and tenants around the capital look to upgrade their premises.

An additional 21,400 square metres of vacant office space came on to the market in the six months to June, taking the vacancy rate to 8.8 per cent.

That was forecast to rise as high as 18 per cent by March 2012, Darroch consulting and research manager Ian Mitchell said.

"However, the majority of Wellington's CBD vacant office space was in average-quality buildings which often do not meet modern office user space requirements."

New projects under construction will add 90,000 square metres of space in the next two years, prompting a shuffle of tenants and more empty space, leaving landlords with older buildings and high debt levels vulnerable.

"The vacancies are going to be increasingly concentrated in that middle B-grade type of environment," he said.

Colliers rental expert Jim Pinson said lower-end tenants would look to relocate to higher spec offices and rents in older buildings would soften. "We are not seeing a softening in base rents, but there is an increase in the use of incentives."

Mr Pinson said there was widespread reluctance to drop base rents as it affected landlords' capacity to borrow, so sweeteners such as "rent free" periods were being thrown in to entice tenants.

However, it was inevitable base rents would drop, although it was impossible to know by how much.

The report estimated the extra supply would drive rents down by 15 to 20 per cent. Mr Mitchell said upgrades were needed to retain and attract tenants.

"The challenge will be whether they can access the capital to upgrade that space."

Redesigning buildings into apartments and student accommodation was one option that had been used in the past, but the CBD accommodation market was now more developed and there was no longer an easy entry option for old buildings, he said.

Mr Pinson said apartment dwellers were definitely more picky.

"In the old days people didn't mind apartments that had been switched from offices, but there are all sorts of issues that go with that so now they tend to prefer new builds."

Mr Mitchell said investment was needed proactively to maintain the value in a building's occupancy, rather than waiting for things to improve to afford the upgrade. "It's a circular sort of argument. The landlords who are already carrying a high level of debt may struggle."

However, many landlords had been around for a while and had seen tightening property cycles before. "They will appreciate the key is to keep your tenants happy and in place."

Building Horizon: An extra 90,000 square metres of new office space will hit the Wellington market over the next two years including:
Late 2010: Inland Revenue building, Featherston St; Redwood/Tenths Trust GSCB building, Pipitea; Customs House, Centreport April
2011: Vogel House extension, Mulgrave St
Mid-2011: Telecom building, Willis St