TE Capital Partners, the investment arm of Singaporean developer Tong Eng Group, partnered with Singapore-listed builder Roxy-Pacific Holdings to purchase an office building in Melbourne’s CBD for A$145 million
“We are confident in the robust fundamentals that Melbourne’s CBD office market offers in the medium to long term,” said Emilia Teo, managing director of TE Capital. “The acquisition aligns with our focus on acquiring well-located core-plus and value-add opportunities in Australia and with capital values displaced under special circumstances.”
The Singaporean investors are acquiring KTS House, a 20-storey office building close to the Queen Victoria market. Some analysts pick the Melbourne market to outperform other regional locations, despite a general slowdown in commercial real estate transactions in the second quarter.
Discounted Asset
Located at 350 Queen Street, about five minutes walk from the Melbourne Central station and the upcoming State Library station. The 21,912 square metres (235,858 square feet) net lettable area property is said by TE Capital to be 87 per cent occupied, with current leases expiring in four years on average.
The property, which also has a retail component on the lower floors, was acquired from 3L Alliance, a Melbourne-based developer building the A$1 billion Queens Place mixed-used development comprising two 80-storey towers right next to KTS House. The project will feature a shopping and office complex with restaurants and cinemas already completed in the first quarter of 2021.
TE Capital and Roxy-Pacific are paying about A$6,617 per square meter for the Grade-B office building, according to Mingtiandi’s calculations. That’s about a 29 per cent discount on secondary office assets in the Melbourne CBD, which, according to CBRE, are currently valued at A$9,276 per square meter on average. Average prime office values in the city stand at A$11,500 square meters.
Commercial Property Deals Tumble
Kiran Pillai, senior director for institutional investments at CBRE In Melbourne, said average office values in the Melbourne CBD haven’t fallen despite the economic fallout from the Covid-19 pandemic due to a lack of significant transactions. The volume of commercial property deals in Melbourne tumbled 50 per cent to A$1.3 billion in the first of this year compared to a year ago. In contrast, the number of transactions fell to 11 from 22, according to CBRE.
While investors wait out any shift in capital values, rental demand may already be sliding in what has been one of the region’s best-performing office markets.
“We’ve seen extreme leasing conditions in the past three years in Melbourne with vacancy rates at record lows, but rents will likely soften to some extent following the Covid-19 pandemic,” Pillai said. “There have been media reports of large corporates including KPMG, Deloitte, PWC and several other financial institutions reassessing their office footprint which will impact the sublease market in the short term.”
Covid-19 Drags Rents Lower
Apart from the potential moderation in demand due to the pandemic, Pillai said the oncoming supply of new office buildings in Melbourne in the next two years would further temper rents. Net effective rents across the city have fallen 3.8 per cent in the first half of 2020, with the second quarter seeing sharper declines of 4.3 per cent, according to CBRE.
While much of the oncoming supply has been pre-committed, Pillai said: “an increase in backfill supply will make for a competitive leasing market.”
“Landlords should be spending the time now to reposition their assets to ensure they remain relevant and competitive in the market moving forwards,” Pillai said. “Well-managed assets against short-term cash flow risk are still desirable to investors, and we expect to see more transactions as we close out 2020.”
Positive Outlook for Melbourne Office Sector
The partners will spend an additional A$10 million to refurbish the building, TE Capital’s Teo said. She said that net annual rents in KTS House are expected to rise to A$500 per square meter from A$350 currently once the upgrading is completed.
Despite the near-term pressures the Melbourne office market faces on net take-up rates and leasing. In a recent report, Colliers International stated that average rents in the city would rise 2.9 per cent over the next five years, with tenant demand expected to improve once Australia eases travel restrictions. The biomedical sector is expected to be a vital driver of this demand since Melbourne is a global biomedical research centre.
TE Capital, founded by the third-generation family members of the 70-year-old Tong Eng Group, will own 60 per cent of the Melbourne property, while Roxy-Pacific will hold the remaining 40 per cent. While there is no cross-shareholding between the two companies, the developers have jointly built and invested in several projects.
In 2018, the partners bought the NSW Aboriginal Land Council’s building in Parramatta, a commercial district 24 kilometres from the Sydney CBD, for A$40.8 million. In Singapore last year, they co-developed two prime residential projects — the 85-unit Wilshire Residences and the 186-unit View at Kismis.
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