_When Caution Outweighs Conviction: Melbourne’s Valuation Reset

By David Way, Knight Frank Partner, Joint Head of Valuation & Advisory, Victoria

Melbourne is heading into 2026 with transaction volumes lower and capitalisation rates now reflecting a more cautious pricing environment. In an election-year cycle, it’s not unusual for the market to slow, and pricing adjusts to the change accordingly. While this period may frustrate short-term vision investors, valuation resets like this can create opportunity for disciplined capital with a longer-term mindset.

Returns are expected to be driven more by income growth, cashflow durability and the ability to execute well at an asset level. With yield compression forecast to remain modest, income growth will account for the majority of total returns from 2026 onward. In that setting, the priority is not chasing a quick rebound, but securing durable income in markets where pricing has reset and long-term fundamentals remain intact.

New Development Comes to a Halt

As Victoria moves into a state election year, decision-making often slows through the middle of the year as investors, developers and occupiers wait for clearer signals on policy settings and confidence.

This is particularly evident in development. New projects are being delayed, and final build pricing remains difficult to lock in. In the near term, many delivery programs are effectively on hold. Over time, reduced development today can lead to tighter supply tomorrow, which may support stronger rental and value uplift once demand normalises.

That said, build-to-rent is an example of a rental structure currently in a more awkward phase. Pricing in parts of the market still feels full, and there remains limited transaction evidence on stabilised, normalised assets. Occupancy headlines and rental growth expectations do not always reconcile cleanly with investor underwriting.

Some schemes are progressing, but the sector is not moving ahead at scale. With feasibility constraints persisting, BTR completions are expected to slow through 2026, which may further limit new supply in the near term.

Recovery Will Be Selective

The next phase of Melbourne’s recovery is unlikely to arrive evenly. Performance will be driven more by asset quality, location and repositioning potential, especially as many new builds are on hold.

In office markets, early signs of improvement are emerging in the Eastern Core, with recovery expected to extend gradually into adjacent precincts over time.

One indicator of the current reset is the widening disconnect between headline and underlying leasing economics. Melbourne office economic rents are sitting around 56 per cent above forecast rents which is the largest gap nationally. At the same time, the yield spread between Melbourne and Sydney prime office is now at a 20-year high.

Oversupply remains a factor, and incentives continue to shape outcomes. Face rents may be rising in some locations, but net effective rents have moved backwards in others once incentives and operating costs are taken into account.

The message for investors is simple: focus on the durability of income, and be clear about where growth is actually coming through.

Retail conditions remain mixed and highly location-dependent, while hospitality-exposed assets continue to face elevated staffing and utility cost pressures. In this environment, selectivity matters more than ever.

Tax Headwinds vs Long-Term Fundamentals

Melbourne has faced additional sentiment pressure in recent years, with policy settings affecting liquidity and offshore demand. Measures such as the Absentee Owner Surcharge and Commercial and Industrial Property Tax have contributed to a more cautious international investment environment.

However, the market has increasingly adjusted. Valuation spreads are now beginning to compensate investors for these headwinds, particularly domestic groups with longer-term horizons who are better positioned under the current settings.

The practical takeaway is that these factors are now more fully reflected in pricing. Rather than weighing on every transaction, they have become part of the broader valuation reset.

Policy invigoration is still yet to be seen, but if confidence improves over time, that shift could feed back into broader market activity and momentum.