The latest Office Market Report released by the Property Council of Australia (PCA) reveals further signs of a two-tiered leasing market with lower grade office stock skewing vacancy results in some major CBDs but the market can expect to see improvements in vacancy figures in 2012, according to Investa Property Group ("Investa").

Tenant demand for Premium and A Grade space has continued to drive the market for the first six months of 2011 with absorption of Premium space averaging 35,000 square metres every six months, and A Grade space averaging 175,000 square metres over the last two years. Secondary stock however reports negative absorption creating a 'two speed office market' in many of our major cities including Sydney and Melbourne.

"The absorption of prime space continues to grow and create a market that is almost bi-polar in nature. Premium space is being absorbed at twice the historic average and A Grade space is being snapped up at a similar level - driving overall prime vacancy down to 6.2 per cent," said Peter Carstairs, Head of Research at Investa.

According to the recently released PCA figures Sydney and Canberra are the only CBD markets to have prime vacancy levels above 5 per cent - at 7.8 and 12.7 per cent respectively.

"Despite the apparent lacklustre result for Sydney's office markets - tenant demand for prime space remains twice the historic ten year average and more than 70,000 square metres of absorption has been recorded among Premium and A Grade assets. Sydney has also had significant additions to stock during the period, including the refurbished 20 Bond Street, 1 Bligh Street and Darling Quarter," Carstairs said.

"We feel Sydney CBD's vacancy rate in 2012 will decrease to reflect the delivery and absorption of this new prime space," said Carstairs.

Sydney's CBD office market is set to be boosted with 140,000 square metres of new space under construction, to be delivered before 2015, which Investa believes will still fall short of tenant demand levels.

"Traditionally we see supply levels average at about 136,000 square metres each year so the current pipeline of around 35,000 square metres per year for the next four years is not going to make much of an impact. We still feel the vacancy rate will decline over the medium term."

Commenting on the Melbourne office market Mr Carstairs said: "Melbourne is a different scenario with more than 270,000 square metres due for completion in the next four years, closer to the average completion rate, although still shy of the pace needed to keep up with demand over the medium-term, particularly given the high levels of pre-commitment in place."

Most markets including the Sydney and Melbourne CBDs have also suffered from a downturn in tenant demand for secondary stock in and B, C and D grades, all recording negative absorption in the first six months of 2011 according to the PCA Office Market report. Sub-lease stock has also grown sharply in some sectors with B Grade stock sublease space up by 25,000 square metres in Sydney during the first half of 2011.

"This pattern has been evident for the last two years and reflects tenants securing better quality premises at an opportune time in the cycle", said Carstairs.

"It poses an interesting challenge for the Australian property sector as tenants continue to abandon secondary stock in favour of new prime grade stock. Owners will need to make some tough decisions about their assets and development of new stock will need to be stepped up to meet tenant demand."