COMMERCIAL PROPERTY Making Sense of the Lease or Buy Conundrum

With much of the office space currently under construction already pre-committed, Rob Bird, director of commercial leases with Colliers International, says those firms that don’t respond soon enough could find their relocation options severely limited. “It’s important organisations move to secure development that’s currently in the pipeline for completion over the next couple of years. Those who leave it too late may find that the level of construction activity going forward isn’t what it was,” says Bird.
What’s also attracting firms to commercial premises currently under construction is notable sea change in the underlying thinking around office shape and size. The current preoccupation developers have with larger floor plates (up to 2000 square metres) within smaller overall buildings reflects the prevailing mood of the medium-sized business market.
In fact, Bird is witnessing strong move by many firms to cut operating costs through consolidation. He says there’s strong push to amalgamate two or more business units at different locations into one central office. Lower-rise buildings, advises Bird, are also finding favour with many tenants. He says many firms now prefer to occupy an entire building rather than share it with several other tenants.
With office vacancy levels running at around 10 percent across major markets, Bird recommends firms needing over 2000 square metres of floor plate assess their options at least three years out. “With larger corporations and service organisations dominating the size and style of new developments, smaller companies are being left to soak up what’s left.”

Lease or buy?
So how do firms decide whether to lease or buy right now? According to Peter Churchill, corporate sales with Barfoot & Thompson, much of this decision depends on company’s cash flow, its cost of capital and the state of its balance sheet. For example, while firms like the Warehouse and the TAB have chosen to free up their balance sheets by leasing in recent years, two medium-sized firms in the telco/IT space are currently seriously considering property ownership solution.
With office space within CBDs typically controlled by financial institutions the opportunities to own and occupy tend to be in the industrial or fringe CBD areas. However, Churchill is witnessing the new phenomenon of the CBD strata title that lets firms own the floor they work on.
It’s easier to argue case for leasing when interest rates are high. But that said, if the move in interest rates is only short-term trend Churchill says it might still be good time to buy. “Developing businesses typically lease, then consider buying once the business is more established,” he says. “In addition to giving them greater control over the balance sheet it can also complement retirement strategy.”
Property gains aside, Churchill says growing number of companies are considering owner/occupation over leasing for both control and business security reasons. But with so many private and institutional investors looking to commercial property as an attractive asset class, he says it’s getting tougher for businesses to identify the right build opportunities.

Interest rate impact
So what impact is rise in interest rates having on commercial construction at the moment? It may have cooled the market’s heels somewhat, but from Churchill’s perspective it’s done little to curb major transactions. Key projects earmarked or under construction within the Auckland CBD include: The Manson Tower, the Britomart project, and outside the CBD there’s 30,000 (all pre-committed) square metres at the Viaduct Basin, 34,000 (uncommitted) square metres at Greenlane, and 15,000 (40 percent pre-committed) square metres of commercial office development at Newmarket. Interestingly enough, while there’s no clear drift in or out of Auckland’s CBD Bird is witnessing notable migration – especially by multinationals – away from main-street to more prestigious waterfront locations.

Incentives to shift
So with the demand for office space being what it is, are there any good inducements out there to shift? Churchill claims the standard incentives to shift are either free fit-outs or rent-free holiday. As rule of thumb, the longer the lease the better the inducements tend to be. For example, on six-year CBD lease tenants could expect six months rent-free or up to 12 months on nine-year lease. In most cases, advises Churchill, free rent is offset against fit-out costs. But with the supply of larger floor plate offices within modern buildings at its lowest for some time, tenants are erring towards much longer leases.

Golden rules
What are the golden rules for leasing these days? It’s critical, argues Churchill, that companies forecast what their future needs will be up to seven years out. That could mean engaging property consultancy to help understand all associated fixed and variable costs. It’s also important, advises Churchill to identify landlord who’ll accommodate your need to shrink or expand office space as demand dictates.

Outlook
With interest rates likely to go higher and commercial building looking to slow down, how are things shaping up for 2005? Contrary to Churchill’s prognostications late last year, demand with the commercial property market hasn’t tapered off. But with interest rates up, immigration coming off the boil and other asset classes – notably equities – performing well, he says it’s reasonable to expect corresponding slowdown in demand. But that said, he says if interest rates peak and GDP is sustainable at current levels, strong demand could last indefinitely.

State of the market
Meantime, leasing activity within some markets is being driven by existing companies wanting larger premises or ground-level exposure. On Auckland’s North Shore the office market again experienced strong leasing activity in 2003. According to Bayleys Research the net effect of lower construction levels last year, coupled with higher tenant pre-commitment has seen Shore vacancy rates drop from just under 11 percent in 2002 to under seven percent last year.
Bayleys Research now puts Auckland’s CBD’s overall office vacancy rate at 11.1 percent, down from 11.95 percent recorded in January 2004. While leasing activity remains strong in the CBD, the threat of space being left vacant by relocating tenants still exists as the Vodafone and NRM buildings get closer to completion. Meantime, the office vacancy rate of Auckland’s city fringe office market (Parnell, Grafton, Newmarket, College Hill and Newton) remains largely unchanged at just under 10 percent at Bayleys Research’s latest survey.
Further south, the Hamilton market remains in an under-supplied state with virtually no opportunities to lease large floor plates of qualityoffice space. Heading to the nation’s capital, overall vacancy of the Wellington CBD office market fell to 9.86 percent in December 2003, from 10.82 percent in June 2003.
Bayleys attributes much of the vacancy fall to several government departments moving into better quality accommodation.
The expansion of existing office-based businesses and the growth of the education sector underpins improved office occupancy in Christchurch. But despite slowdown in education growth, steady leasing activity is expected to warrant the renovations of older buildings, says Bayleys Research. Further south Dunedin’s office leasing market is being driven by the smaller firms currently in growth phase. With current pressure on vacancy levels, yet to show signs of slowing landlords are expected to enjoy sustained rental growth in the short to medium term.

Albany from the group up
The Albany Centre on Auckland’s North Shore, now boasting North Harbour Stadium conference facilities, an expanding Massey campus and over 30,000 square metres of (occupied) office space, is poised for another major phase of development over the next two years. While much of the proposed internal roading is well und

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