Property Outlook. March quarter May Inside. Economic Overview. Residential Property. Commercial Property

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1 March quarter May Property Outlook ANZ Property Outlook is produced half yearly by Contributors to this issue: Frank Foley (Co-Editor) Economist () 97 Ian James (Co-Editor) Senior Economist () 97 Ange Montalti Economist () Jasmine Robinson Economist () Melanie Hay Senior Economist () 97 8 Economics on the Web To view this publication, or other research products published online by Economics@ANZ, go to and click on the Economics link under ANZ Spotlight. NZ economic research can be accessed online by selecting New Zealand from the ANZ Worldwide dropdown box before clicking on the Economics link. Inside Economic Overview The Australian economy avoided the worst of the global economic downturn in and appears well placed to continue its impressive economic performance. However, future growth will take place in a somewhat less favourable interest rate environment, as the Reserve Bank takes back the interest rate stimulus put in place after September - and more. With dwelling construction and household spending expected to soften, the realisation of recent, strongly-improved business investment intentions will be critical to sustaining robust economic activity. (Melanie Hay: page ) Residential Property A very accommodating interest rate policy stance, stable economic environment and strong prices growth have encouraged construction levels well above those required to satisfy new household demand. Forward indicators of residential property activity are already peaking, but the triggers of rising interest rates and the final phase-out of the First Home Owner Grant will see residential building activity fall more sharply over the second half of. By year-end, dwelling oversupply will be rivalling mid-99s levels, rental market conditions will have eased further and average mortgage costs will be higher. These market signals are likely to weigh heavily on recent strong growth in house prices. The uninterrupted rise in the importance of speculative building and investor activity in recent years suggests more than usual market vulnerability to demand/supply mismatches. Inner-city markets are prime candidates for such imbalances, and while fundamentals remain sound presently, the risks are high, particularly in Melbourne. (Ange Montalti: page ) Commercial Property The real value of cyclically-influenced non-residential building commencements (ie offices, shops, hotels, factories and other business premises) rose only marginally in from, reflecting industrial sector weakness. A reduction in available office space has been more than matched by reduced takeup; but this weakening in demand is likely to be only a pause in activity. Industrial demand and supply were weak in and fundamentals in most markets are not pointing to a substantial pick-up. Strong growth in retail sales was consistent with a lift in shop commencements in ; but sales growth this year is not expected to support an increase in new building. Construction in the accommodation market may be turning around; approvals began to recover in the second half of last year. (Frank Foley & Jasmine Robinson: page 8)

2 Economic overview Outlook remains bright The Australian economy avoided the worst of the global economic downturn in, due to a combination of good luck and good management. In particular, lower interest rates and well-targeted fiscal policy measures provided crucial support to household spending and dwelling investment at a time when export demand was slowing sharply. Indeed household spending and dwelling investment contributed around. percentage points to GDP growth of.% over the year to the December quarter, underlining the importance of these areas of expenditure. With signs that the global economy is now recovering, Australia appears well placed to continue its impressive economic performance. However the Reserve Bank has already started to take back the cuts in interest rates that it made in the second half of last year as insurance against the world economic downturn. Higher interest rates, combined with the phasing back of the Government s First Home Owners Grant, are expected to dampen activity in the housing market, with growth expected to peak around mid-year. Growth in household spending is also likely to soften somewhat as interest rates rise, reflecting the burden of servicing record levels of debt. As a result, attention has now turned to alternative sources of growth going forward and partial indicators suggest that business investment is poised to grow strongly over the forecast period. Investment intentions have risen and corporate profitability is expected to be supported by rising productivity and lower import prices as a result of the stronger Australian dollar. Furthermore corporate balance sheets are in relatively good condition, with gearing remaining at low levels, while business confidence has continued to improve. Exports should also pick-up as the global economic recovery gains momentum, although the rise in the exchange rate will affect Australia s export competitiveness. In general though, imports are expected to rise strongly as a result of the pick-up in business investment and offset growth in exports this year, and, to a lesser extent, next year. Overall, GDP growth in Australia is expected to rise by.7% in - and.% in -. Non-residential investment set to pick up Business investment remained weak for much of, partly reflecting the squeeze on corporate profits and the high level of uncertainty about the domestic and global economic outlook. With that uncertainty now clearing, and the factors which combined to depress corporate profits fading, business investment is set to pick-up. While much of the strength in the near-term is likely to come from the mining industry, which has not suffered from the same squeeze on profits as other industries, investment intentions from the services sector and parts of manufacturing are stronger for -. Non-residential investment in particular is expected to grow strongly in -, after several years of falling activity. Both non-residential building and engineering construction declined in, by.% and.%, respectively. However, strong growth in mining investment is expected to underpin engineering construction this year, with work yet to be done increasing by 8% over the year to the December quarter. The outlook for - is also positive for many sectors of non-residential building. Non-residential construction, therefore, will offer support at a time when residential construction is forecast to soften and will help to underpin employment and activity in the construction sector. Interest rates heading higher The improved world economic outlook, combined with the expectation of further strong growth in Australia and a rise in medium-term inflationary pressures, were the key factors underpinning the Reserve Bank's decision to increase interest rates by basis points in May. We expect that the Reserve Bank will increase interest rates by a total of 7 basis points to % this year, although at this level monetary policy still could be considered to be supportive of economic growth. A further increase in interest rates of basis points is expected next calender year. Overall, interest rates are likely to rise by less over this economic cycle than previous cycles, largely reflecting the high level of household debt which will render households more sensitive to interest rate increases. Nevertheless, there are risks to the inflation outlook, particularly if reduced competitive pressures as a result of recent corporate collapses or further margin re-building place upward pressure on prices. If this is the case the Reserve Bank may have to increase interest rates by more than currently expected.

3 Residential Property National Trends The residential building industry has been experiencing greater than usual volatility in recent years, affected by the combined effects of the GST, changes to first-home-buyer compensation packages and major disruptions in the home warranty insurance industry. Expenditure on new dwellings jumped by a third in the second half of, to very healthy levels, reflecting the stimulatory effect of mortgage rate reductions and the extension of the First Home Owners Grant (FHOG). Renovations and extensions activity, while also recovering, has stalled more recently, also at reasonably strong levels. $bn, 999/ prices 7 New dwelling expenditure Alterations & Additions Building to peak soon Source: ABS Cat. No. 87.,. Number, sa, Finance approvals for established dwellings Building approvals Finance approvals for construction A considerable pipeline of work-in-progress (particularly in the medium-density and multi-storey sectors) should sustain the value of work done over the first half of. Forward indicators, however, suggest the number of new projects will be falling in the months ahead. Building approvals have fallen % since peaking in August and owneroccupier construction finance has tumbled, evidencing, in large part, an early instalment of a post-fhog correction in first-home buyer demand. Low interest rates, a rebound in consumer confidence and a resurgent labour market have sustained positive sentiment, providing life to turnover of the established market and to house prices. Typical for this stage of the dwelling cycle, investors/builders remain optimistic about housing prospects, with finance to this sector growing at its fastest annual rate since early. The basis points lift in official interest rates in May and further rises over will play a critical role in moderating very favourable sentiment and in redressing emerging market imbalances. Dwelling oversupply increasing The current level of building is well ahead of Australia s underlying dwelling requirement. March building approvals are running at an annualised rate of,, against an estimated annual underlying demand of 8, dwellings. While the market had been set to achieve broad demand/supply equilibrium by June a series of interest rate falls and an extended FHOG will instead create significant oversupply, estimated to reach 9, (equivalent to. month s production) by June. This is rivalling the oversupply experienced in the mid-99s. 9 Oversupply conditions to worsen Months demand Underlying Requirement (right) Shortage (left) Number, Completions (right) Shortage Surplus - (left) - Surplus June years SA WA TAS Source: ABS Cat. No. 87.,., Economics@ANZ estimates and forecasts 8 8 Months demand Shortage - - Surplus NSW VIC QLD Months demand Prospective further interest rate rises over the course of will coincide broadly with the phaseout of the extended FHOG, providing an adequate trigger for an accelerated downturn in housing activity and demand. These events will crystallise the effects of recent over-building on vacancy rates, house prices and rental growth. Renewed uncertainty surrounding home warranty cover could also undermine builder confidence at a vulnerable stage of the building cycle. Dwelling starts are estimated to fall from an expected, in / to, in / with around half of the decline directly attributable to the turnaround effects of the FHOG (+9, in / and 7, in /). Housing 'over-consumption' recedes Population growth is stabilising at a significantly lower level than experienced through much of the 98s, reflecting, in large part, lower average net See ANZ Property Outlook, Nov. edition June,. The initial $7,, being for GST compensation to all first-home buyers, will remain indefinitely.

4 overseas migration but also a weaker natural increase. Combined with an evolving age-mix, weaker population growth has translated into a lower dwelling requirement. Yet new dwelling expenditure has been exceedingly strong. Higher household wealth, uninterrupted economic growth and the significant structural fall in interest rates have boosted average spending per dwelling (on quality and space) over the second half of the 99s, offsetting the primary effects of weaker underlying demand. More recently, policy-induced distortions (ie, GST, FHOG) have been interfering with the natural cyclical pattern, also disguising weaker underlying demand Getting used to lower population growth Annual % change Total population Overseas migration (a) Natural increase (a) (a) % point contribution to annual % change in total population growth Source: ABS Cat. No.., 7. % of total Investor/builder finance as a % of total housing finance With the premium being spent on obtaining a better quality and size of dwelling returning to trend levels (see chart below), a projected fall in the number of homes to be built is unlikely to be cushioned by higher average spending per dwelling. A shrinking first-home-buyer market, a slowergrowing upgrader market and the compositional shift towards smaller, medium-density dwellings will also be having a significant dampening influence on dwelling investment, including renovations and extensions activity. $bn, real Spend on quality and size reverses Actual new dwelling expenditure At the same time a sharp rise in the share of speculative building activity will have important implications for industry dynamics. By increasing the likelihood of short-term mismatches between demand and supply, the market can expect greater volatility in activity and prices within sub-markets. House prices growth to moderate The weighted-average growth in established house prices for all capital cities over calendar was.%, the highest level since September 989. The acceleration, concentrated in the latter half of, reflects higher consumer confidence, a stable economic environment and the stimulus from lower mortgage rates. While much of the improvement in values in the past few years has been concentrated in Melbourne and to lesser extent Sydney, all mainland capital cities are now experiencing solid growth. Apart from the direct boost to prices from the GST over /, project-home prices growth (excluding land) has remained fairly subdued. Anecdotal reports suggest labour shortages in some trades have not been significant in affecting labour rates, and materials costs remain under control. Strength in prices growth recently is being propelled more by shifting demand patterns (localities and dwelling type), the mobilisation of new buyers triggered by the FHOG, and low interest rates, rather than by cost factors. The investing community also has been a keen participant, explaining the lion s share of increases in mortgage debt over the second half of the 99s. Momentum in prices growth can be expected to have continued over much of the first half of, as the economy continued to perform well and consumer sentiment rebounded. However, a softening is likely to emerge as the effects of dwelling oversupply, further interest rate rises and higher vacancy rates act as a catalyst for reassessment. Rental markets and mortgage servicing constraints are likely to be critical mechanisms for relaying this 'price' message to buyers. New dwelling expenditure (assuming constant real spend per dwelling) Dwelling starts forecasts( ): /:.9, /:, /:, / :, /: - Premium spent on dwelling quality and size (a) (a) compared to average amount spent in 99. Source: ABS Cat. No. 87.

5 State Trends While state performances continue to be influenced, in the main, by national policies, considerable divergences among states are already becoming apparent. Contrasting demand and supply conditions, migration patterns, and economic and employment prospects will continue to be key performance drivers. 9 9 Building approvals top out in most states Index: Jan-9 = 9 Victoria Queensland NSW Source: ABS Cat. No. 87. New South Wales South Australia Tasmania Western Australia Residential building in NSW has not fired-up in recent years, lagging the performances of other States. While ongoing delays arising from the collapse of HIH reportedly played some part in holding back recovery in the first half of, approvals have, once again, turned down, due largely (although not exclusively) to a sharp drop in medium-density activity. Relatively steady and moderate population growth has restricted growth in underlying demand in recent years and has been an important contributor to dwelling oversupply. However, with March building approvals already running close to underlying demand, restoration of fundamentals is likely to progress rapidly, particularly given the expected policy-induced fall in activity over /. While fundamentals in inner-sydney have been healthy, a recent sharp jump in new project approvals, if sustained over the first half of, could threaten market balance. Household formation would need to rise by around 7% from the / level to fully absorb the new capacity which this would create. After a period of relatively sluggish prices growth, Sydney s established house price growth accelerated sharply in the December quarter, taking annual growth through the year to 7% Approvals suggest weakness ahead Number, trend, ' NSW houses NSW flats, units etc Source: ABS Cat. No. 87., Unpublished ABS Statistics, Market Facts REIA, 8 7 % Sydney rental yield Sydney vacancy rate This burst is exacerbating already stretched affordability conditions, but is restoring some of the price relativity lost to Melbourne in recent years. A flood of new first-home-buyer homes will, over the second half of, begin to have an impact on rental markets, which are already showing signs of easing, particularly at the low-end. Vacancy rates are well above long-term averages, having risen to an all-time high over the past year. Combined with record low rental yields and rising interest rates, recent momentum in price growth is unlikely to be sustained in /. Risks remain in inner-cities Inner-Sydney Number * including conversions, rolling annual sum, June years Building Approvals* Approvals Dec -half annualised, seas adj Change in no. of households Inner-Melbourne Source: ABS Cat. No. 87., 87.,.,., Unpublished ABS Small Area Statistics Number Building Approvals Change in no. of households Dwelling starts forecasts ('): /:., /:., /:., /:.7, /:.9 Victoria Residential building in Victoria is cooling from nearrecord highs. Despite a very strong addition to dwelling stock over the second half of the 99s, Victoria still has a dwelling shortage. Indeed, pentup demand, equivalent to around month's production will still remain by June. These strong fundamentals should provide support to activity over the medium term. But given building approvals are currently trending well above

6 underlying demand (, versus, respectively), a sharp slowing in activity cannot be averted, particularly with interest rate and FHOG phase-out triggers now coming into play. The remarkable growth in inner-city residential construction seen since 998 is not sustainable. With considerable residential building proposed for inner-city locations, eg, the Docklands precinct, the depth of demand will be tested over coming years. Household formation needs to be held at recent record levels to avert the development of major oversupply and a weakening in values. Success in this regard is going to depend, in large part, upon finding the appropriate mix of residential product (eg, penthouses versus one-bedroom units) and having adequate owner-occupier presence to provide stability to demand. Suitable infrastructure and services support will be important also. While having slowed sharply in the December quarter, Melbourne's house prices were still up % over the year to December, being the strongest performer of all capital cities. Established house prices have now risen 9% since 99 or % per annum in real (inflation-adjusted) terms. However, REIV data suggests prices growth did continue to soften into the first half of. The onset of higher interest rates from May is likely to be a powerful moderating force on price growth over the remainder of the year. Number, trend, '... Approvals set to fall sharply VIC houses 7 % Melbourne rental yield deterioration in net migration to Victoria, a factor which should support housing demand. Dwelling starts forecasts ('): /:., /:., /:., /:., /:. Queensland The Queensland housing market is currently bucking the national trend with a dramatic rise in mediumdensity approvals in the March quarter and a sideways movement in detached housing. Total state approvals are trending at an annualised rate of 9,, well above the, required to satisfy new demand. At these levels, and without any real sign or expectation of a turnaround in migration outcomes, the process of restoring fundamentals is being hampered, particularly in Brisbane, where activity has lifted to an eight-year high. Approvals in other key coastal districts continue to languish at low levels. An expected downturn in activity will continue the process of adjustment to oversupply. Growth in Brisbane house prices has lifted noticeably over Calendar (up %), to its highest level since 99. The strongest growth has been recorded in CBD and riverfront localities. Approvals divergent within state Index: 99= Cairns 7 Brisbane Persons, Net interstate migration Queensland.... VIC flats, units etc. Melbourne vacancy rate Sunshine & Gold Coasts Source: ABS Cat. No. 87.,. - Victoria Source: ABS Cat. No. 87., Unpublished ABS Statistics, Market Facts REIA, Following a dramatic pick up in recent years, net interstate migration flows into Victoria have stabilised in the past few quarters. While demographics and lifestyle considerations may push interstate migration back into negative territory, these are more likely to influence movement in the longer-term. While relative house prices are an important second-order consideration for households contemplating a move interstate, it is job prospects and lifestyle considerations which are more likely to be the primary motivators. In the absence of a marked worsening in economic performance, there is little prospect of a sharp Given still very favourable affordability conditions, there is scope for prices momentum to continue into the medium-term, although rising interest rates and the imminent increase in first-home dwelling stock will ease market pressures over the forthcoming year, reflecting in a moderate weakening in prices and rental growth over /. Dwelling starts forecasts ('): /:., /:., /: 9., /: 7.; /:

7 South Australia The South Australian housing market has performed reasonably well in the past few years. Building approvals, while having peaked, have done so at relatively high levels. Medium-density activity is set to fall sharply and detached housing activity is showing the first signs of a response to the FHOG phase-down in the March quarter (the first-homebuyer share of finance approvals has dipped sharply). Population growth remains subdued with migration playing a relatively neutral role in influencing demand for housing in recent years. Activity is hovering at an unsustainable level (building approvals are trending at an annualised rate of, compared to an underlying requirement of,). There is every prospect of a hard landing for the South Australian market over the next two years, particularly with the market already in oversupply, a weakening rental market and a firsthome-buyer correction in store..8. Approvals at peak - about to weaken Number, trend, '. SA houses. SA flats, units etc Adelaide vacancy rate. -8 (right, inverted) Source: ABS Cat. No. 87.,., Market Facts, REIA 7 % change % Adelaide house prices (left) The FHOG's 'mobilisation' of first-home buyers, near record affordability and relative stability in economic conditions have generated some strength in prices growth (up % over the year to December ), following an extended period of relatively moderate growth. Some moderation in prices growth can be expected over / as demand tails off. In the medium term, sluggish economic and demographic growth prospects suggest resistance to any renewal of solid price growth. Dwelling starts forecasts ( ): /:., /:., /:7., /:.7, /:.8 Western Australia The Western Australian housing market is performing solidly and is well placed to weather the next twelve months better than most other states. Pent-up demand and more moderate growth in activity, recently, should minimise dislocation over /, as rising interest rates impact on affordability and confidence. Western Australia has experienced a significant decline in population in recent years (a turnaround of, in net interstate migration over the past four years). However, good economic prospects, stemming from a healthy mining sector outlook, should play a critical role in reversing or at least minimising this medium-term threat to housing demand and activity. Number (') Population growth slows Perth established Net overseas house prices migration 9 (left) - Perth vacancy rate Net interstate migration - (right, inverted) Source: ABS Cat. No..,., Market Facts, REIA % change % Price growth has been more constrained compared to other mainland states, leaving affordability at record levels. Vacancy rates are also approaching a level suggesting market pressures may ease over the rest of, particularly, given the strong response from first-home buyers recently. Dwelling starts forecasts ('): /:.9, /:., /: 9., /: 7.7, /: 9. Tasmania A stabilisation in population over the past year (following a number of years of declines) is a necessary first step to restoring scale to Tasmania s housing industry. Activity has been cycling in recent years at a level around half that recorded through the 98s and first half of the 99s. Building approvals have grown solidly through, with much of this attributable to the FHOG, but will more than likely reverse over the course of this year. Price growth has stirred but is likely to remain relatively weak over the medium-term, as rising interest rates and relatively weak economic prospects constrain demand. Dwelling starts forecasts ( ): /:., /:.8, /:., /:., /:. 7

8 Commercial property CBD office markets The value of office commencements in Australia may record a decline in -. Commencements in the six months to December were some % lower than in the same period a year earlier. 7 Some near term softness expected $mn Office Commencements Office completions Industrial markets The longer-term declining trend in the value of factory commencements in Australia continued in. Commencements were 8% lower than in. The decline in new factory construction is consistent with a long-term decline in the size of the manufacturing sector relative to the economy as a whole. While activity has picked up, manufacturing investment is not expected to be much stronger in, relative to, working against any strong resurgence in take-up of space or new construction. 9 Both supply and demand have softened ' persons $ mn Industrial employment 9 98/8 988/89 99/9 99/97 / Source: ABS Cat. No At the same time a decline in the value of office completions during was accompanied by reduced stock of available office space. The reduction in the total stock was small, but there was a much larger reduction in occupied space (i.e. in net absorption). This reversed a steady decline in the total vacancy rate for the capital cities and Canberra during the past three years, lifting it to.9% at December from.% at June. This decline in occupancy is consistent with global trends, where the collapse of the technology boom and the general economic slowdown has resulted in layoffs and cutbacks in planned expansion (although the impact has been much less severe in Australia than in the USA and Asia). Property and business services, Australia's largest industry, experienced declining employment during the months to March this year, more than offsetting the modest employment growth in the government and finance/insurance sectors. Factors such as white-collar downsizing, outsourcing and movement outside the CBD for some enterprises mean that obtaining pre-commitment remains an important principal for developers. In the near term, the combination of low interest rates, a strengthening economy and improved business confidence will translate into stronger business investment; and an increase in new office building activity is expected next year Industrial building commencements Source: ABS 87. and. 8 The main factor holding back new construction since the mid-99s has been an easing trend of employment in manufacturing and other industrial sectors. In a market that is not expanding strongly the attributes of industrial property (design, location etc) become key determinants of demand. Shaping the type and location of new supply coming onto the market is the improvement in road infrastructure, which is providing greater balance in the location of industrial areas surrounding many capital cities, particularly Melbourne and Sydney. Improved road infrastructure has encouraged the movement of factories to outer areas with greater land availability and lower establishment costs, with no loss of access to essential transport. It has also facilitated a clustering effect for both similar businesses and those in a value chain. The decline in the value of factory completions was accompanied by a much-reduced take-up of industrial space in, notably in Melbourne and Brisbane, according to research by Jones Lang LaSalle. Weak demand constrained growth in prime and high-tech rents, while depressing secondary rents in many areas. 8

9 Retail markets Some A$ bn worth of sales was generated by retailers in, up 8.% over the previous year. In the first three months of this year, retail sales grew by 7.7% over the corresponding period in. Last year's growth was partly a rebound from the weak post-gst sales environment in. However, it also reflected an improved economic climate with consumer spending underpinned by falling interest rates and petrol prices. Consistent with these conditions, the real value of shop-building commencements was up by.% in compared to. The real value work done was down by around.7%, however. Tourism accommodation markets The sharp drop in the real value of work done in the hotel, motel and holiday apartments segment has not abated. The real value of work done fell by % in compared with. Nevertheless, the real value of building approvals rose by.8% in the second half of compared with the first half, suggesting the likelihood of a pick-up in hotel construction in, albeit off a low base. A substantial pick-up, however, is contingent on a sustained recovery in leisure and corporate travel $ mn Hotel building activity slides 8 7 Shop building activity relatively stable 999- $ mn Real value of shopbuilding commenced ( qtr. mvg. avg.) Real value of hotels etc approved ( qtr. mvg. avg.) Real value of shopbuilding work done ( qtr. mvg. avg.) Source : ABS Cat No 87, DX Despite the lift in turnover, retailers profit margins have been squeezed, due to heavy price discounting to reduce stocks, as well as competitive pressures within the industry. Nevertheless, the increase in turnover prompted pressure from landlords for higher rents, exacerbating the bottom-line. While, there is scope for some margin restoration over the coming months, mainly reflecting the winding down of stock-adjustment-related price discounting, retail sales are expected to weaken in the latter half of the year as higher petrol prices, insurance costs, interest rate hikes and high levels of debt crimp consumer spending. This, in turn, is likely to limit the scope for further improvement in rentals. Rents are expected to remain broadly steady. At the same time building activity is likely to focus mainly on redevelopment projects. Trends toward better configuration of space as well as increasing customer traffic by improving the mix of tenants, and thereby offering a wider range of retail concepts, should improve the potential for enhancing returns over the medium term. Real value of hotels etc building work done ( qtr. mvg. avg.) Source : ABS Cat No 87, DX International visitor numbers have begun to recover following the September terrorist attacks on the US. Inbound tourist arrivals rose by.% over the year to February, the first increase since September, and.8% over the year to March. Projections by the Tourism Forecasting Council (TFC), released in April, are for international visitor arrivals to grow by.7% in and 7.% in, after declining by.% in. According to the TFC, international visitor nights spent in hotels, motels and guesthouses are forecast to rise by.% to 9. mn in, while domestic visitor nights are expected to fall marginally by.% to 7.7 mn nights, mainly reflecting a decline in the business segment. The drive-to destinations are likely to continue to be the main beneficiaries of improvement in the leisure travel market. Hotel oversupply, amidst an uncertain travel environment, has prompted heavy price discounting particularly by high-end accommodation providers, in order to keep occupancy levels up. With existing yields under pressure, some hotel projects have been transformed into residential dwellings, which has been particularly evident in Sydney. From here on, the emerging pick-up in tourism should help to improve the supply/demand mix and stabilise room rates. 9

10 Melbourne Less robust economic growth and corporate downsizing have slowed the growth in Melbourne's office market. In an environment of declining stock, take-up of available space was strongly negative in the six months to December last year. This nudged up the vacancy rate to.% in December from.% in June. Absorption of office space is likely to be negative for - as a whole. Demand is expected to improve somewhat as employment picks up progressively. However, further out there will be increased supply coming onto the market from -, with Melbourne leading the capital cities in CBD construction in the pipeline. Until the second half of last year, prime effective rents had been on a rising trend as the vacancy rate declined. Supply tightness as the economy gathers pace suggests future rents are likely to be stable-toimproving, at least until the weight of new building begins to have effect during -. Industrial development activity picked up in the final six months of last year. Take-up of, square metres in was in excess of the, square metres of new facilities produced. Development of road infrastructure has improved the access between the industrial areas of the west, north and southeast and the transport infrastructure of Port Melbourne and Melbourne's airports. Prime rents increased in the northwest and southeast last year and a shortage of developed land is expected to underpin rents this year. Melbourne s hotel sector is likely to come under pressure from significant new supply, although a recovery in tourist arrivals and a pick-up in corporate travel over the medium term should help to cushion the impact. In, retail sales in Victoria rose by.% in real terms, higher than the.% expansion recorded for Australia as a whole. This supported a pick-up in shop-building activity, with the real value of approvals in Victoria rising by about % in from the previous year. Growth in building activity is likely to slow, consistent with an anticipated easing in retail sales growth in. However, some redevelopment projects, such as the revamping of Melbourne Central, which is to start soon after Daimaru vacates its premises in July, are in the pipeline. Sydney The demand situation in Sydney's office market was particularly weak in the six months to December last year. With the adverse effects on business confidence from high profile corporate collapses and contraction in the technology sector, occupied office space declined by.8%. This pushed the vacancy rate up to.% in December - its highest level since the end of 999. On the positive side, sluggish demand is being read as only a pause in the market, and with the economy picking up faster than expected, the pause may well be shorter than anticipated. With this, previously-rising effective rents have stalled, and a substantial pick-up seems unlikely. The longer-term outlook for rents depends on the volume of space to be commenced from -. Industrial supply declined substantially in - by around a quarter. Western Sydney accounted for the majority of new space, although this was well down on the previous year. Supply looks set to increase in. Demand slowed last year as economic conditions softened and landlords were forced to increase incentives to attract tenants. Low interest rates also created a preference for purchasing rather than leasing. Most areas saw little growth in rents, or declines. As business investment strengthens and existing stock is taken up, rents are likely to firm. As with Melbourne, Sydney's road infrastructure is reducing differences in regional industrial areas and reducing variations in rents. Occupancy rates and takings for hotels etc remain under pressure due to the pre-olympics-induced construction boom. Weakness in building activity in the sector is expected to persist and residential conversions of hotels are likely to continue to help redress the oversupply situation. Meanwhile, some hotels are likely to embark on major refurbishment work to spruce up their properties in anticipation of a lift in leisure and business travel. Shop building activity in NSW has been relatively subdued with the real value of work done down some 8% in compared with. With retail sales growing at a moderate pace sales were up.%, in real terms, in, but lower than the Australia-wide growth performance of.% scope for a pick-up in building remains limited. Brisbane The office market saw a lift in supply, as well as a modest reduction in occupied space, during the six months to December. The vacancy rate rebounded to.%, after dropping to.7% in the previous six months. Nevertheless, over, square metres were taken up during the months to December on a net basis and demand was comparatively firm. The lowest vacancy rate is in A- grade space (.%), with recent completions lifting the vacancy rate for premium space to.%. Some reduction in overall vacant space is expected due to government demand.

11 New stock coming onto the market prompted an increase in rental incentives from landlords, and effective rents declined by 8.% over the six months to December. Construction of new industrial space nearly halved last year. At the same time demand was also weak, and take-up declined by around one-third compared with. The southern region accounted for the majority of space taken up; however, rents there declined slightly. Rents elsewhere were stable-torising. Both construction activity and rents are likely to be stable in the near term, although rents around Brisbane port are likely to increase. Brisbane s accommodation industry has benefited from the drive-to tourist market as well as a strong events calendar. The outlook remains favourable, as tourism picks up. This, coupled with limited new supply, suggests scope for better room rents. Retail sales in Queensland were up.% in from. This has helped to support a more promising outlook for shop-building activity during the year with approvals in Queensland growing by around 8% in, in real terms. Adelaide There was a small addition to office stock in the six months to December ; but demand weakness led to a substantial.% decline in occupied space. The rise in the total CBD vacancy rate to.9%, partly reflected some corporate downsizing. Primeend vacancies remain much tighter. While rents were unchanged in the final quarter of last year, the tightness at the top end of the market would suggest a modest improvement is likely. Industrial construction activity slowed during the course of. On the basis of work in the pipeline to be completed this year, a further decline is expected. Take-up strengthened in the December quarter last year after some earlier softness and the vacancy rate was stable. There has been little movement in either prime or high-tech rents. In terms of value of work done, hotel etc building activity in South Australia picked up in the second half of, albeit from a weak base. Nevertheless, building approvals for were some 7% below the previous year, suggesting a more subdued pace of activity going forward. Retail sales in South Australia were relatively strong in, growing by % in real terms, compared with. This has improved building prospects, with shop building approvals rising by some %, in real terms, in. Perth Office stock in Perth's CBD was virtually static and the overall vacancy rate was little changed in the six months to December, at.%. Occupied stock rose.% in the period but was down.% from December. Vacancies increased among premium properties. Apart from the Woodside project under construction, the outlook for prime office space is clouded due to the apparent difficulties of developers in securing precommitment for new projects. Prime effective rents eased towards the end of last year, reflecting higher vacancies and weak demand in this market sector. As business investment improves, lack of new stock should support some improvement in rents. Construction in the industrial market slowed dramatically in, with completions at less than half the level of recent years - with only a modest improvement foreseen this year. Take-up also slowed during the year, although it was well in excess of supply. The softness in demand caused previously stable prime rents to dip towards the end of last year. Other segments have remained stable. Despite the unfavourable travel climate, real average takings per available room and occupancy rates in Western Australia held up in the December quarter, compared with previous quarters, but were down on the December quarter. Building activity in the hotels etc sector has begun to recover with growth in the real value of work done shifting to positive territory since the September quarter, after seven consecutive quarters of year-on-year declines. Coming off a low base, expectations are for further expansion in sector building activity. In, real retail turnover in the state picked up marginally, growing by.7% from the previous year. Growth in the second half of was.% higher than in the first half, reflecting an improvement in consumer spending sentiment. Nevertheless, shop-building approvals remain subdued. Hobart Hobart recorded a moderate reduction in office stock of some 8 square metres in the six months to December. At the same time, net take-up of space topped square metres, mainly in B-grade buildings. Consequently, the overall vacancy rate declined sharply, to 9.8%, so that Hobart no longer has the highest vacancy rate among the capital cities. Without a significant increase in supply, vacancies should continue to trend downward, supporting rents.

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