What will a broad-based economic recovery mean for the Brisbane office leasing market?

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1 What will a broad-based economic recovery mean for the Brisbane office leasing market? December 216 Summary Introduction Vacancy in the Brisbane office market has been rising since 212 due to a combination of weak tenant demand and elevated supply of new stock. The education sector has clearly expanded its office footprint over the past two years. Further demand is expected from a range of different sectors such as construction, professional services and finance. The contraction of mining related firms is continuing but at a slower pace; this trend is expected to continue. Vacancy in the Brisbane office market has been rising since 212 due to a combination of weak tenant demand and elevated supply of new stock. JLL is forecasting a peak in vacancy across both the CBD and Near City markets by the end of 216. A steady recovery is then expected, coinciding with an improvement in the Queensland economy. The recovery in the Queensland economy is expected to be broad based, in contrast to the resources sector that has driven growth since the Global Financial Crisis (GFC). The question is how this will impact on the office leasing market and which sectors might provide the strongest tenant demand over the next few years. The Brisbane office market since the GFC Unlike many office markets in Australia and around the world, Brisbane recorded positive tenant demand in the years following the GFC. This was largely a result of significant investment in resources projects in Queensland. Three major liquefied natural gas (LNG) projects worth approximately $7 billion contributed the most, along with three coal projects worth about $4 billion. Construction of these major LNG projects began in 21 and 211, yet the significant demand for office space occurred in the years prior. This was when the planning and design of the projects occurred, therefore triggering expansion of professional services, construction and mining firms during that period. The public sector was also expanding its office space requirements at that time. Figure 1: QLD non-residential construction Non-dwelling construction $75.8 billion Average* * Average from 2 to 2Q216 Source: ABS, JLL Research By 213, non-residential construction activity was at its peak in Queensland with the major resources projects well underway. However, office demand in Brisbane (both CBD and Near City) had declined significantly with net absorption in 213 of -98,9 sqm, the worst result on record. The decline in office requirements for mining, gas, construction and professional services firms was largely responsible. Whilst construction activity was still strong, much of the planning and design work for these projects had been undertaken, forcing a decline in white collar employment. To make matters worse, the Queensland Government was targeting a reduction of 14, public servants by the middle of 213. This resulted in a contraction in public sector office space of approximately 26,5 sqm in that year. Vacancy rose significantly in 213 from 9.5% to 14.4% across the CBD and Near City market, and has since risen to 16.6% in 3Q16. Office demand over the past two years in Brisbane has been subdued, yet still positive. The major driver of rising vacancy since 213 has been the supply of new office stock. New supply in the CBD has been particularly notable with the completion of 18 Ann Street (57,5 sqm), 48 Queen Street (55,4 sqm) and One William Street (75, sqm) in the past 12 months. 1 December 216

2 Jun-22 Jun-23 Jun-24 Jun-25 Jun-26 Jun-27 Jun-28 Jun-29 Jun-21 Jun-211 Jun-212 Jun-213 Jun-214 Jun-215 Jun-216 Figure 2: Net Absorption by Industry Sector (CBD and Near City) 15 sqm Construction & Property Education Mining, Electricity and Gas Finance & Insurance Services Professional, Scientific & Technical Services Public Sector Other Source: JLL Research A broad-based recovery The slowdown in mining construction investment has been a major drag on the Queensland economy in recent years. State Final Demand (SFD) growth in 215 was -2.5% y-y (ABS). Deloitte Access Economics is forecasting that SFD growth will be positive by the end of 216 at 1.2% y-y and 2.9% in 217. SFD growth of.7% in 2Q16 is the most recent evidence of an impending recovery. This recovery is not anticipated to be driven by one specific sector, rather by a wide range of industries. Whilst the post GFC boom was driven by resources, the Queensland economy is relatively diverse. As at June 215, the mining industry contributed just 7.2% gross value added to the Queensland economy (ABS). This is in contrast to Western Australia where mining contributes 34.% of the gross value added (ABS). So which industries are expected to grow and provide positive demand for the Brisbane office market? Education With weakness in the Australian dollar since mid-214, trade exposed industries have become much more competitive on the world stage. One such sector that benefits is education, particularly at a tertiary level. Foreign student enrolments have risen significantly in Queensland over the past few years, rising by 29.2% from June 213 to June 216. Figure 3: Foreign Student Enrolments in Queensland 9, 8, 7, 6, 5, 4, 3, 2, 1, Students USD The rise in enrolments has been led by an increase in students coming from China, India, Brazil and Taiwan. The relatively high quality education system in Australia has always attracted foreign students. However, the recent devaluation of the Australian dollar has made study much more affordable for foreigners, compared with other comparable destinations such as the U.S. or U.K. As shown in Figure 2, the education sector has increased its office footprint for the past three years in Brisbane. Year to 3Q16, education providers have expanded their office space in the CBD and near city by approximately 19, sqm. Vocational education and training (VET) providers, language schools and universities have all increased demand for office space over this period. The impact of currency on tuition fees Australia has recorded 516, foreign student enrolments over the year to June 216. For Chinese students, the United States is the preferred destination for study with Australia the second most popular (Australian Government). Whilst the quality of education is clearly important for students, the cost also plays a significant factor. Recent movements in exchange rates have impacted on tuition fees for foreign students. Figure 4, shows that comparable bachelor s degrees in Brisbane and Los Angeles were priced similarly in Chinese yuan at the beginning of 213. However a Chinese student enrolling in the middle of 216 would pay over 4% more per year to study in Los Angeles as opposed to Brisbane. This is purely a result of the weakening Australian dollar to the Chinese yuan, whereas the US dollar has strengthened in that period. Figure 4: University fees for Chinese students Brisbane vs Los Angeles CNY 3, CNY 2, CNY 1, Foreign Student Enrolments - QLD (LHS) AUD/USD (RHS) Source: Australian Government, RBA CNY Jan-13 Jul-16 Bachelor's degree - Brisbane (AUD36,3/year) Bachelor's degree - California(USD39,/year) Source: University of Queensland, UCLA 2 December 216

3 Jun-6 Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Tourism Queensland has always been a favoured destination in Australia for foreign tourists due to its warm climate, beaches and natural beauty. The tourism industry in Queensland was impacted significantly by the GFC as tourists, both foreign and domestic tightened their discretionary spending. The mining boom also contributed to the strengthening of the Australian dollar from mid-29, increasing the cost for foreign tourists and also making overseas holidays cheaper for Australians. Foreign visitor arrivals to Queensland fell following the GFC and then remained relatively stable until 213. Recent results have shown a significant rise in foreign tourist arrivals to Queensland with an 11.3% y-y rise in FY The weakened currency is having a significant effect with yearly arrivals well above the peak in 27. The rise of visitors from mainland China has also been a trend as the growing middle class have looked to travel abroad. Figure 5: Foreign visitors to Queensland 3,, 2,5, 2,, 1,5, 1,, 5, Foreign Visitors Source: TRA Pinpointing specific demand for office space from the tourism industry is difficult. This is because the primary benefit to the economy is from tourist s spending money on accommodation, food, retail and recreation which doesn t directly trigger office demand. Construction is one sector which could be indirectly effected by the rise in tourist arrivals. Since the GFC, there has been significant underinvestment in tourism assets. An example is that 11 of the 24 resorts on leasehold land in the Great Barrier Reef are currently closed. However, there has been significant investment in island resorts in north Queensland recently, particularly from international groups. Examples include the purchase of Hayman Island by Malaysian company Mulpha and South Molle Island being bought by China Capital Investment Group. A number of redevelopment plans have been proposed for islands in North Queensland. The proposed integrated resort and casino s in Brisbane and the Gold Coast are also significant projects that will provide economic activity to those regions. Examining tourism projects likely to proceed, a conservative estimate is that approximately $8 billion worth of construction will occur over the next five years. Other projects that are less certain include the Aquis Resort in Cairns ($2 billion), Lindeman Island redevelopment ($6 million) and the Great Keppel Island redevelopment ($592 million). Whilst these projects have not been committed, the recent success of the Hayman Island redevelopment should provide some confidence of the underlying market conditions at present. This construction activity should provide some office demand in Brisbane. Professional services/consulting firms will likely provide the most demand as technical expertise will be required for the design and construction of these projects. Although tourism related operators have generally not been a major source of office demand in the Brisbane market there may be some instances moving forward. One example is Flight Centre which has its global headquarters in Brisbane and will move into a newly constructed building in South Brisbane in 4Q16. Another example is Star Entertainment s decision to move its headquarters to Brisbane, expected to be a requirement of approximately 3, sqm. Residential Construction Residential construction has been a relatively strong sector, particularly in South East Queensland even though population growth has recently fallen below the national average. In the past, there has been a clear correlation between interstate migration to Queensland and the disparity in dwelling prices between Brisbane and Sydney. Net interstate migration last peaked in early 23, when Brisbane median house prices were approximately 5% of Sydney prices. In June 216, Brisbane median house prices were approximately 56% of Sydney s. Therefore, population growth is expected to recover in Queensland as the labour market improves. This should underpin some office demand from the construction sector, although in the short term this may not be evident as construction of inner city apartment projects appear to have peaked. Infrastructure Infrastructure spending in Queensland has been declining since 21 for reasons associated with rising public sector debt. With the possibility of further downgrades of Queensland s credit rating, the State Government has tightened its spending, resulting in declines in public sector capital formation. Figure 6 shows the impact that the increase in spending had on public sector debt in Queensland. From 28 to 21, infrastructure spending was above 4% of State and Local Government revenue collected in Queensland, compared to just 24% in 215. A sustainable long term level is around 25% which is the approximate level that both New South Wales and Victoria have averaged over the past decade. In Queensland, spending above that 25% level from 25 to 214 equates to approximately $53.4 billion, a key reason for the $67.9 billion increase in public debt over that period. Figure 6. QLD Infrastructure spending and debt 35, 3, 25, 2, 15, 1, 5, $ million Public Gross Fixed Capital Formation (LHS) 25% of Revenue for Infrastructure (LHS) Debt to Revenue ratio (RHS) Source: ABS 18% 16% 14% 12% 1% 8% 6% 4% 2% % 3 December 216

4 Based on infrastructure spending year to date, it is likely that 216 spending will exceed the total from 215. This will be the first y-y growth since 21. The FY16-17 Queensland Government Budget is estimating that capital purchases for the non-financial public sector will grow by approximately 19% this financial year and another 14% in FY The growth in infrastructure spending should provide some demand for office space, or at least limit firms that are contemplating contracting their office requirements. Major projects in the pipeline include; the Toowoomba second range crossing ($1.6 billion), Gold Coast Light Rail Stage 2 ($42 million), Gateway Upgrade North ($1.1 billion), New Generation Rollingstock train fleet program ($4.4 billion) and the Queensland Schools project ($1.4 billion). There are also a range of projects in the planning phase such as Cross River Rail, North Queensland Sports Stadium and the North Coast Rail Line Upgrade. Sectors most likely to benefit will be professional services and construction. Mining The resources sector was the major driver of office demand from 28 to 211. However, it has also been largely responsible for the significant amounts of sub-lease space and contraction of office requirements since then. The fall in commodity prices, driven by a slowdown in economic activity in China, has limited further investment in resources projects. The Carmichael coal mine, proposed by Adani and worth approximately $16.5 billion, is a major project that may still commence. The project has been delayed by a number of legal challenges, mainly linked to environmental concerns, over the past few years. If construction of the mine does occur over the next couple of years, it will trigger a reasonable demand for office space. It is worth noting the major gas projects completing at present were worth more than four times the investment proposed for this mine. The contraction of office space from mining related companies is slowing. Figure 2 shows that since 213, negative demand from sectors such as construction, professional services and mining has been decreasing. This will help overall net absorption for the Brisbane office market with positive demand sectors not being offset by mining related companies relinquishing space. Other Sectors The finance and insurance services sector has recorded negative net absorption in Brisbane for four of the past five years. Part of this is explained by the drive for improved efficiency in office space by transitioning to activity based working. It is expected that this sector will gradually show signs of growth. The financial and insurance services sector, however, has only contributed approximately 9% of leasing activity in the Brisbane market since 27. This is compared to 26% in Sydney and 21% in Melbourne. Professional services is another sector that should start to provide some growth. The sector, particularly engineering firms, has reduced its office footprint significantly as mining projects have completed. However, the fall in the Australian dollar has made professional services increasingly competitive on the international stage. In a recent paper, the RBA estimated that services exports rise by approximately 6% in the two years following a 1% depreciation of the exchange rate. Australia s trade-weighted exchange rate has declined by approximately 12% over the past two years. Recent examples of professional services companies expanding their office footprints include Herbert Smith Freehills, HWL Ebsworth and KPMG. As previously mentioned, the Queensland Government reduced its workforce in 212 and 213 which also resulted in a smaller office footprint. There has been moderate growth in office demand over the past two years for the public sector. Whilst the government is looking to hiring more employees over the coming years, it has indicated that this will largely be front-line staff such as police and healthcare workers. Therefore, increased public sector office demand is not expected in the near future. Conclusion The Brisbane office market experienced a difficult few years with negative leasing demand combined with elevated supply of new space. There are indications that vacancy will peak in 216 for both the CBD and near city markets. The negative demand from sectors such as professional services, mining and construction is subsiding after significant contractions due to end of the mining investment boom. Fewer contractions and sub-lease availabilities are expected moving forward. Education is showing clear demand for office space with the rise of foreign students a contributing factor. Whilst tourism operators have generally not provided significant tenant demand historically, construction activity for tourism projects should contribute some activity. The key take-away, is that one sector is not expected to provide the bulk of the office recovery, in contrast to 21 when the mining sector alone accounted for over 14, sqm of net absorption across the CBD and Near City Instead, net absorption is expected to be closer to 3, to 5, sqm per year and driven by a broad range of sectors. 4 December 216

5 Carol Hodgson Director tel: carol.hodgson@ap.jll.com Tom Broderick Senior Research Analyst tel: tom.broderick@ap.jll.com jll.com.au COPYRIGHT JONES LANG LASALLE 216. All rights reserved. For further details or to unsubscribe, please joneslanglasalle.research@ap.jll.com. The items in this publication have been compiled from the various sources acknowledged. The information is from sources we deem reliable; however, no representation or warranty is made to the accuracy thereof.