PRESS RELEASE: Incentives Limit Sydney CBD’s ‘Flight to Quality’

While past economic disruptions saw rapid rises and falls in premium vacancies, the situation remains stubbornly elevated, even amidst record-high headline incentives.
The COVID-19 pandemic initially mirrored historical patterns, causing a sharp spike in premium vacancies. However, unlike before, vacancies have remained notably high, with premium grade reaching 13%, the third-highest rate since Jan-94 at 21.4%, and then 28.8% in Jul-93. Additionally, premium vacancy now sits above A and B grade vacancy for the first time since Jul-18.

[Chart 1]
*Source: ResolveXO Research/PCA

So, has “flight to quality” stalled in Sydney despite favourable tenant conditions? Recent changes in Tenant Incentive Packages shed light on this.
Previously, tenants could allocate their entire Headline Incentive to fitout contribution, with landlords fully funding fitouts. Now, landlords seek to limit fitout contribution to around 50% of Headline Incentive levels, preferring the majority to be allocated towards rent abatement. These caps are unlikely to cover quality fitouts, especially in premium buildings, amid rising fitout costs.
Additionally, a landlord may require a supplementary bank guarantee to be held for the duration of the lease if a significant portion of the Headline Incentive is used towards fitout contribution, further confining a tenant’s cash flow.
“Typically, the main beneficiary of flight to quality, particularly in a tenant-favourable market, should be premium grade assets. However, if Incentive Package structures remain restrictive, I see A grade being the biggest beneficiary of tenants’ ‘flight to value’ (further seen in our research), and premium vacancy to remain elevated.”
– Kristina Mastrullo, Head of Research & Property Strategist

[Chart 2]
Source: ResolveXO Research ‘TrendXO’