Sydney Offices Turn Into Housing Avoiding Shakeout: Real Estate

Greenland Holding Group Co. likens its downtown Sydney luxury development to a “diamond in the sky” with floor-to-ceiling windows offering 360-degree views of the city. That’s a far cry from the 50-year-old concrete government office building from which the new tower will morph.

The Chinese state-owned company is among developers finding more lucrative uses for older commercial sites in a booming housing market as the supply of new office space in Australian cities surges and tenant demand falters.

“You’ve got a lot of new buildings being developed and a lot of tenants moving out of older buildings into newer ones,” said David Milton, managing director for residential at CBRE Group Inc., who’s marketing the Greenland apartments. “With the values we’re seeing in residential,” the best use for outdated office buildings is conversion to apartments, he said.

Greenland, Singapore-based Far East Organization Centre Pte and local pension funds are among those buying lower-quality properties as office tenants leave for newer buildings, pushing the amount of commercial space slated for conversion to record highs. Almost 47,000 square meters (505,904 square feet) of office space was withdrawn from the market last year to turn into apartments, according to Jones Lang LaSalle Inc., the most since the broker began keeping track in 2007 and almost double the 25,794 square meters in 2012.

Developers in 2013 bought A$364 million ($329 million) of office buildings in Sydney to turn into apartments, according to Colliers International, which doesn’t track historical data on the value of properties sold for conversion.

Livable Cities

The trend reflects record-low interest rates that have drawn foreign buyers and domestic investors to Australia’s housing market, boosting dwelling prices almost 10 percent in the past year. At the same time, an unemployment rate at a decade high 6 percent has weighed on office demand.

The country’s major city centers were once ghost towns on weekends as Australians favored free-standing suburban homes on quarter-acre blocks. Now they are “more livable and more enticing, with increasingly better restaurants, great little bars, great entertainment,” said Sydney-based Milton.

The average apartment price in Sydney, where about half the conversions were located in 2013 based on the Jones Lang LaSalle figures, rose more than 10 percent in the year to Feb. 28 to a record A$573,323, according to the RP Data-Rismark Home Value Index. Melbourne’s average price rose 7 percent to A$488,827, also a historical high.

“The Sydney housing market is quite healthy and promising, and I believe this trend will continue in the future,” said Sherwood Luo, managing director of Greenland Australia, the company’s Sydney-based subsidiary. “We’ll speed up our development and will invest more money in the Sydney market. We’re looking for other sites.”

Office Additions

In contrast, Sydney’s office vacancy rate climbed to 9 percent at the start of the year from 7.2 percent 12 months earlier, according to broker Colliers. Melbourne’s increased to 8.7 percent from 6.9 percent a year ago and is expected to rise to 9.7 percent by the end of 2014.

Apartment conversions are also increasing in New York, Dubai and London, where slowing demand for offices has prompted developers to seek more profitable uses for space in traditional commercial areas. In New York last year, telephone company Verizon Communications Inc. sold part of its former headquarters to a developer who will turn it into luxury housing. Dubai developer Damac Real Estate Development Ltd. changed six buildings planned as office towers to apartments in 2010, according to the company.

Even before the U.K. government last year proposed developers wouldn’t need permission to convert offices to residential buildings for three years, companies including Axa Real Estate Investment Managers Ltd. and Berkeley Group Holdings Plc began turning obsolete offices into apartments to counter slumping demand due to job cuts at banks.

Vacancy Rate

In Sydney, almost 800,000 square meters of office space will be built over the next five years, according to broker Savills Plc. Lend Lease Group’s A$6 billion Barangaroo harbor-front redevelopment alone will add 280,000 square meters in three towers.

The potential removal of about 130,000 square meters for conversion to residential or hotels over the next three years will prevent a blowout in the office vacancy rate, Savills said.

The increase in conversions in Australia has been driven by the entry of Asian developers including Shanghai-based Greenland and Far East, according to Rupa Ganguli, director of Australian residential research at Jones Lang LaSalle.

Greenland’s purchase of the former Sydney water board office for A$107.5 million, and the acquisition of two buildings overlooking the city’s Hyde Park by Far East and pension fund CBUS Super for A$143 million and A$59 million respectively were among last year’s biggest transactions for conversion, according to Colliers.

Conversion Risks

Demand for dwellings around city centers is set to grow faster than homes elsewhere over the next 12 months, according to a survey by National Australia Bank Ltd.

Conversions aren’t without risks. Replacing an office building with apartments can take as many as four years, from application for government approvals to the end of construction, according to CBRE’s Milton. In that amount of time, following its July 2006 peak, the U.S. housing market plunged 28 percent, the S&P/Case-Shiller price index shows.

While most developers mitigate these risks by selling a proportion of apartments before construction, a big enough drop in prices could push buyers to forfeit their deposits and walk away, which happened in Australia’s oversupplied Gold Coast in Queensland state following the global financial crisis.

Blackstone Group LP in 2012 gained approval to convert Gold Fields House, a 1960s office tower overlooking Sydney Harbour, into 197 luxury apartments and is yet to commence work at the site. Paul Heller, Australian managing director at Blackstone, declined to comment on the plans for the building.

Brutalist Architecture

Greenland plans to erect Sydney’s tallest apartment tower where now stands a weather-beaten Brutalist building. The architectural style -- coined from the French “béton brut,” used by Franco-Swiss modernist pioneer Le Corbusier to describe many of his post-World War II buildings -- favors exposed concrete for large public structures.

Inside the stained, grayish-brown building with crumbling paint on the ceilings, Greenland has set up a sales office for the luxury development. In the center is a model of the gleaming skyscraper that will occupy the spot in a few years.

About a quarter of the apartments in the first stage of pre-sales went to overseas buyers following marketing campaigns in Shanghai, Hong Kong and Singapore in addition to Sydney, CBRE’s Milton said in December.

Far East

Far East, Singapore’s biggest closely held developer, bought 227 Elizabeth Street in Sydney late last year. Jones Lang LaSalle, which marketed the property, highlighted the opportunity for conversion and a tentative design by PTW Architects to create 114 apartments and some retail space.

Conversion is a “possible long-term plan,” though Far East doesn’t currently have any concrete proposals, according to a spokeswoman for the company, who asked not to be identified citing company policy.

Far East has since bought a 23-story office building in Sydney’s center for A$151.8 million from the New South Wales state government. The late 1960s building -- opposite Sydney’s 125-year-old Town Hall and its adjoining train station, and a stone’s throw from one of the city’s busiest shopping districts -- could be converted to a hotel, retail and residential complex, according to a statement from Andrew Constance, New South Wales’s minister for finance and services.

Far East also bought two towers near Hyde Park from closely held developer Kyko Group for A$127 million.

Chinese Buyers

Asian builders are steering billions of dollars overseas amid regulatory restrictions at home and concerns their own property markets are overheating. Australia, one of the most popular destinations for Chinese buyers, is also favored by developers who are trying to follow the demand.

Chinese were the biggest investors in Australian commercial and residential property in the year ended June 30, plowing A$5.9 billion into real estate, a 42 percent increase from a year earlier, according to Australia’s Foreign Investment Review Board. The board approved more than 6,500 applications worth A$10.8 billion by overseas investors to develop residential property, data released this month showed.

For groups including CBUS, the largest building industry pension fund, the competition from foreign developers for a limited number of sites that work as apartments means the need for increased caution to avoid overpaying.

“It’s becoming a tad expensive but you need to stick to your fundamentals in respect to what you’re willing to pay,” said Adrian Pozzo, chief executive officer of CBUS Property, the real estate investment arm of the pension fund. “You can’t win every one.”

City Living

CBUS’s planned conversion of a 14-story building at 130 Elizabeth Street follows a similar luxury apartment redevelopment across the park completed in 2012 in partnership with AMP Capital Ltd., a unit of Australia’s biggest asset manager and Galileo Group. CBUS is also starting work on another development in Melbourne, demolishing an office building it bought about 3 1/2 years ago to create a high-end apartment tower overlooking the city’s Treasury Gardens, Pozzo said.

“Inner city living is the market to be in at the moment,” Pozzo said. “My word, we’re looking for more sites. So’s everyone else.”

Before it's here, it's on the Bloomberg Terminal.