Sydney office rentals are set to soar, according to the Knight Frank Global Cities 2017 report.

The report forecasts that rental growth for prime office space will be 27.5 per cent between the fourth quarter of 2015 and the fourth quarter of 2019.

This strong growth is supported by higher yields relative to the global market.

Nearly $12 billion worth of offices changed hands in Sydney in 2015, which was 57% of Australia’s total turnover for the year. Investors, particularly foreign, were attracted by an improving tenant market and strong investment fundamentals.

Net absorption – Sydney CBD v Brisbane CBD as a % of total stock over six months

Weight of Funds

The report contrasts the Sydney market with Brisbane’s, which it says attracted 12% of total office investment at $2.6 billion for the period.

“As yields for core assets continue to fall under the weight of money seeking a safe return and with the expectation of lower for longer interest rates, there is also a greater weight of funds seeking a relatively higher return,” Matt Whitby, Group Director, and Jennelle Wilson, Senior Director, Research and Consulting, Knight Frank Australia, write in the report.

“Increasing interest in markets such as Brisbane is now in force, with indications that the negative influences in the tenant market have abated, and an expectation that the government sector is expanding once again.”

The yield gap between Sydney and Brisbane is at the highest level in 15 years, and there is the potential for this to narrow in the near future, which is attracting value-add buyers to the city and increasing the depth of offshore buyers.

Prime core market yields and spreads – Sydney CBD v Brisbane CBD

Melbourne booms

The report also focuses on the growth of housing in Melbourne’s inner city, though it adds that the office stock in the CBD grew by 1 million square metres over the past decade. That makes it the second-largest office market in Australia behind Sydney, with CBD-based employees increasing by 24% over that time. In contrast, retail supply has lagged, increasing by only 92,500 sq m since 2005.

It says Melbourne has become Australia’s fastest growing state capital as its population has risen 1.8% a year over the past decade, with 91,600 people moving in over the past year.

The growth has been most pronounced in the CBD, with a push towards inner-city living evolving in the early 1990s under a state government policy to promote residential development in the City of Melbourne.

That resulted in residential apartments increasing three fold over the past decade.

Melbourne’s population is projected to top Sydney’s by 2036, with a large proportion of new residents in inner-city suburbs.

Growth in city living driving mixed-use development

Melbourne CBD offices and retail stock v residents and dwellings

New economic drivers

For Sydney and Brisbane, there is a switch in economic drivers towards residential construction, transport infrastructure spending and the services sector, including the technology and creative services industries. This is a clear positive for Sydney, the Global Cities 2017 report says.

However, Brisbane is a diversified economy and besides the large exposure to the business services sector, the government sector is on the cusp of an expansion.

“There continues to be divergence in the short-term market conditions and rental growth performance in favour of Sydney, however we expect investment and occupier demand to pick up in Brisbane over the coming year as investors begin to embrace more risk and seek higher relative returns,” it says.