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1 m3commentary BRISBANE CBD OFFICE Autumn 2017 Key Research Contacts: Casey Robinson Research Manager QLD (07) Jennifer Williams National Director NSW (02) Erin Obliubek Research Manager VIC (02) Zoe Haskett Research Manager SA (08) m3property.com.au P1

2 CONTENTS Market Overview 3 Key Influences 4 Major Brisbane Projects 5 Key Indicators 6 Significant Sales 8 Focus: Co-Working 9 Outlook 10 DEFINITIONS Compound Annual Growth Rate (CAGR): The annual growth rate over a period of year, calculated on the basis that each year s growth is compounded. Equated Market Yield (EMY): An annualised yield that is derived from the current net income and future changes to the net income over time with specific consideration of future rental growth. It is the rate of return over a specific time period that has been adjusted for rental growth. Grade: is determined using the PCA report A Guide to Office Building Quality. Net lettable area (NLA): defined in accordance with the PCA Method of Measurement. Pre-commitment: contract signed to occupy space in new or refurbished space prior to construction commencing. Prime: Combination of Premium and A grades. Secondary: Combination of B, C and D grades. WALE: Weighted average lease expiry. Yields have continued to tighten as investor demand outweighs the supply of assets on the market The refurbishment of 36 Wickham Terrace is expected to be completed this year, adding 18,450 square metres of supply to the CBD market. In addition, 300 George Street is being marketed (we expect construction to proceed with anticipated completion in 2019) and a development application has recently been submitted for a 30-level office tower at 320 George Street. A temporary increase in space occupied by the State Government and the withdrawal of a number of assets from the market resulted in the vacancy rate declining from 16.9% in July 2016 to 15.3% in January Demand from firms in the ICT (Information and Communications Technology), Education and Engineering sectors has strengthened (with a number of firms from these sectors increasing their space requirements), while firms from more traditional sectors (such as Legal and Accounting) are typically reducing their space requirements. Prime gross face rents remained stable during 2016 while secondary gross face rents declined marginally. Our ten-year forecast for rental growth is positive across both prime and secondary accommodation. Strong investor demand resulted in just over $1.0 billion of sales in the office CBD market during m3commentary Autumn 2017 P2

3 MARKET OVERVIEW Medium-term market fundamentals are positive for the Brisbane CBD office market, with Queensland business confidence remaining above the national level and state economic growth forecast to exceed national growth over the coming decade. While conditions in the leasing market remain historically subdued, there have been some recent signs of strengthening from selected sectors. In the investment market, demand remains strong and yields have continued to tighten. The Brisbane CBD saw a record-high 94,601 square metres of space absorbed during This aberration occurred largely as a result of the temporary increase in occupied space by the State Government while transitioning to its new premises as well as many associated backfill moves (due to holding additional space while fitouts and relocations are completed). We therefore expect that over the coming year, a correction in net absorption will occur as the Government progressively returns unrequired secondary space to the market. While we do not consider the 2016 net absorption figure to be a sign of the CBD market having strengthened considerably, this is not to say we believe conditions in the CBD are excessively weak. We are of the opinion that conditions are improving, just not as dramatically as suggested by the 2016 net absorption figure. The national office market is undergoing substantial change. Advancing technology is changing the way businesses work, allowing them to employ cheap offshore competition or software to undertake work traditionally undertaken by employees. The increasing use of cloudcomputing services and remote workstations has resulted in more employees working offsite. These trends have put downward pressure on demand for office space requirements from many traditional professional services firms (such as accountants and lawyers). Unsurprisingly, demand from the ICT sector has strengthened during recent years. South East Queensland is seeing a considerable transformation of the city s infrastructure and amenities. Engineering consulting firms appear to be benefitting from the large number of projects planned and and this is starting to result in some strengthening in demand from firms from this sector. For example, Snowy Mountain Engineering Corporation, who in January won the tender for the Logan Motorway Enhancement Project, has recently committed to 2,400 square metres of space in Kingsgate in Fortitude Valley. The firm currently occupies space in South Brisbane, and will be increasing its footprint by just over 200 square metres. WSP Parsons Brinckerhoff has also recently came to the market for 5,500 square metres of space in the CBD / Fringe. The engineering firm currently occupies circa-3,500 square metres in the CBD. Looking at the investment market, demand remains strong, with the total value of sales exceeding $1.0 billion during During the year, we saw some vendors choosing to maintain ownership of assets due to not being able to identify alternative investment opportunities at higher yields. This contributed to further yield compression. Offshore investors continued to have a notable presence, as highlighted by a number of acquisitions, including those by Hines Investment and ARA Asset Management. Finally, whilst we have largely been off their radar during recent years, A-REITs have now started to view Brisbane more favourably. This is on the back of improving conditions in the leasing market and stronger 10-year IRRs (due to a forecast strengthening in rental growth in the medium-term) relative to Sydney and Melbourne. m3property Valuations: Left: 126 Margaret Street Centre: 300 Queen Street Right: Roma Street (East Tower) m3commentary Autumn 2017 P3

4 Growth m3property Research KEY INFULENCES $ ECONOMIC GROWTH Gross Domestic Product (GDP) grew by 2.4% during Strongest growth was recorded in the Mining; Agriculture, Forestry and Fishing; and Professional, Scientific and Technical Services sectors. Queensland State Final Demand, a key indicator of the health of the state s economy, grew by 1.8% during Economic growth in Queensland is forecast to outperform national economic growth over the long-term. CASH RATE AND GOVERNMENT BOND RATES The RBA has lowered the official cash rate by 75 basis points over the past two years, with the most recent reduction (to 1.50%) being in August The low cost of debt remains a key driver of investor demand for commercial property assets. Historically low returns on government bonds have also encouraged stronger demand for property during recent years. EXCHANGE RATE While the value of the exchange rate has increased over the past year, it remains considerably lower than it was between mid-2009 and mid-2015, when it did not fall below 80 cents. The lower value has been a driving force behind strong investment demand from foreign investors. BUSINESS CONFIDENCE National Australia Bank s index of business confidence increased to 10 index points in January (0 = neutral). This is above the long-term average for business confidence and is favourable for future economic growth. Business confidence in Queensland remained above the national level at 12 index points. Confidence is a driving force behind tenant decisions to relocate / expand / contract etcetera. EMPLOYMENT The unemployment rate in Queensland has remained above 6.0% since December 2013 and as at January 2017, it was 6.1%. White-collar professions account for an estimated 43.4% of total employment in Queensland. The size of the Queensland public sector grew by 20,851 full-time equivalent positions between June 2013 (when it reached its lowest level since 2008) and September 2016 (latest data available). While major changes to the size of the public sector are correlated with changes in demand for office space in the CBD, most of the growth in the public sector during recent years has occurred in the Health and Education sectors, both of which employ mostly front-line, rather than office, staff. 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% Growth in Public-Sector Employment vs CBD Net Absorption Growth in FTE Employment Net Absorption m 2 Source: Property Council of Australia, Queensland Government, m3property m3commentary Autumn 2017 P4

5 MAJOR BRISBANE PROJECTS QUEEN'S WHARF DEVELOPMENT Includes over 2,000 apartments, 1,000 hotel rooms across five new hotel brands, a new casino, public space, retail space and restaurants and bars. Estimated to bring an additional 1.39 million visitors to Brisbane. $3 billion project. Scheduled completion in 2024 (integrated resort component in 2022). CROSS RIVER RAIL Proposed 10.2 km rail link between Dutton Park and Bowen Hills. $850 million has already been committed by the State Government. $5.2 billion project. BRISBANE METRO Proposed high-frequency subway systems linking Eight Mile Plains to Roma Street and Herston to St Lucia. Would be constructed over six years. The final business case is due to be released in May. Council-led project estimated to cost just less than $1 billion. BRISBANE LIVE ENTERTAINMENT PRECINCT Proposed $2 billion entertainment precinct at Roma Street. Includes residential, commercial and retail space and a 17,000 person arena. Market-led proposal by AEG Ogden. BRISBANE AIRPORT SECOND RUNWAY Will allow for the same level of capacity as the Hong Kong and Singapore airports. Regional economic benefits of circa-$5 billion per annum by Completion is expected to occur in $1.35 billion project. BRISBANE CRUISE TERMINAL Proposal for a new cruise facility that would cater to cruise vessels of all sizes and allow mega ships (270 metres plus) to utilise Brisbane as a base port. Subject to approval, construction could begin later this year (completion late 2019). $100 million project fully funded by the private sector. HOWARD SMITH WHARVES Includes a 5-star boutique hotel, exhibition centre, retail space, underground car parking for 350 vehicles, public space and restaurants and bars. Construction expected to start this year with completion in $100 million plus project. HAMILTON NORTHSHORE 304 hectare Urban Renewal precinct declared a Priority Development Area in Home for 15,000 persons and a workplace for 10,000 persons over the long term. A large amount of residential and commercial space has already been developed. m3commentary Autumn 2017 P5

6 m3property Research KEY INDICATORS 750,232m², 32.9% Stock by Grade 219,106m² 9.6% 918,330m², 40.3% Source: Property Council of Australia, m3property 56,917m² 2.5% 335,470m² 14.7% Premium A-grade B-grade C-grade D-grade STOCK AND SUPPLY According to the Property Council of Australia, there was 2,280,055 square metres of office space in the Brisbane CBD as at January 2017, representing the third largest CBD office market in Australia. Net additions during 2016 totalled 122,715 square metres, with three new buildings added to the market and a number of buildings withdrawn (predominantly for the Queen s Wharf Development). Prime space now accounts for 55.0% of total space in the CBD. Looking ahead, the full refurbishment of 36 Wickham Terrace will see 18,450 square metres of stock returned to the market this year. We also expect 300 George Street to proceed in the short term, with completion anticipated for ,000 75,000 50,000 25, ,000-50,000-75, , ,000 m 2 Net Absorption Net Absorption 20-year Average 10-Year Average Source: Property Council of Australia, m3property NET ABSORPTION Net absorption returned to the positive during 2016, with a record 94,601 square metres of space absorbed. Some net absorption was the result of Fringe and Suburban tenants relocating to the CBD and increased demand from tradeexposed industries. However, the result was largely due to the temporary increase in occupied space by the State Government. While 152,505 square metres of prime space was absorbed during the year, net absorption of secondary space was -57,904 square metres. This was the result of the State Government s relocation (largely from secondary assets to a Premium-grade building) as well as firms relocating from secondary to prime accommodation, given the affordable effective rents on offer. Vacancy by Grade Premium 12.2% A-grade 11.9% Prime 12.0% B-grade 19.7% C-grade 19.6% D-grade 15.3% Secondary 19.4% 0% 5% 10% 15% 20% Source: Property Council of Australia, m3property VACANCY The vacancy rate for the Brisbane CBD declined from 16.9% in July 2016 to 15.3% in January A vacancy rate of 15.3% represents 349,556 square metres of vacant space. Prime vacancy was 12.0% as at January The absorption of a large amount of Premium-grade space left vacant after the completion of 480 Queen Street resulted in premium vacancy decreasing from 21.1% to 12.2% over the six months. Close to 25% of premium space absorbed during the second half of 2016 was sub-lease space. In the secondary market, despite the withdrawal of 57,676 square metres of space, the vacancy rate crept higher during the second half of 2016 (to be 19.4% as at January). This was largely a result of tenants relocating to higher quality space on the back of affordable effective rents. m3commentary Autumn 2017 P6

7 Billions Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 m3property Research KEY INDICATORS $/m 2 $1,000 $900 $800 $700 $600 $500 $400 $300 Source: m3property Brisbane CBD Gross Face Rents Premium A-grade B-grade RENTS AND INCENTIVES Gross face rents currently average $840 for Premium-grade space, $650 for A-grade space and $540 for B-grade space. Incentives are averaging 35% for Premium and A-grade space and 39% for B-grade space. With 349,556 square metres of vacant office space available as at January 2017, and further stock to be completed over the coming year, there will continue to be many opportunities for tenants entering the leasing market as well as for existing tenants whose leases are close to expiry. It is our opinion that incentives have peaked for all grades of stock. However, we do not expect that they will decline rapidly in the immediate future. We believe that owners will continue to offer large incentives for the foreseeable future in lieu of dropping face rents. Investment Sales > $10 million $2.5 $2.4 b $2.0 $1.5 $1.4 b $1.0 $957.1 m $1.0 b $0.5 $758.7 m $ Source: m3property INVESTMENT MARKET There has been strong demand for investment stock in Brisbane during recent years, being the result of the weight of money, low interest rates and increased demand from foreign investors. The historically-low 10-year government bond rate has also been a key driver of demand as investors have looked to property to generate higher returns on investment. Offshore investors have increasingly been investing in Australian office assets due to Australia being perceived as offering stable economic returns, low sovereign risks, a stable policy environment and a transparent legal system. There was $1,004,857,500 of CBD office sales contracted and settled during The biggest sale of the year was a 33% share of 111 Eagle Street acquired by GPT Wholesale Office Fund for $284,200,000 (reported yield of 5.50%). During 2016, we saw some vendors choosing to hold onto assets due to not being able to identify alternative investment opportunities at higher yields. 9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% Source: m3property 5.50%- 6.50% Brisbane CBD Office Yields 6.50%- 7.25% 7.75%- 8.50% Premium A-grade B-grade YIELDS Strong investment demand, coupled with a shortage of assets for sale (relative to demand), has resulted in continued downward pressure on yields. Yields currently typically range between 5.50% and 6.50% for Premium assets, 6.50% and 7.25% for A-grade assets and 7.75% and 8.50% for B-grade assets. Prime yields tightened by circa-25 basis points during 2016 while B-grade yields tightened by circa-50 basis points. m3commentary Autumn 2017 P7

8 SIGNIFICANT SALES Property Date Price EMY Vendor Purchaser 111 Eagle Street (33% Share) Dec-16 $284,200, %* Abu Dhabi Investment Authority GPT Wholesale Office Fund 307 Queen Street Dec-16 $153,000, % GDI Property Group LaSalle Investment Mgmt. 126 Margaret Street Dec-16 $34,000, % Investec Undisclosed 348 Edward Street Nov-16 $49,000, % Harburg Investments Hines Investment 324 Queen Street Oct-16 $132,000, % Brookfield and DEXUS Abacus and Investec 100 Edward Street (50% Share) Aug-16 $18,847, % Qld Cane Growers DDH Graham 308 Queen Street and 88 Creek Street Jun-16 $37,310, % Unity Pacific Limited Primewest Fund Ltd 300 Queen Street Apr-16 $188,000, % Seymour Group Pty Ltd ARA Asset Management Roma Street (50% Share) Mar-16 $62,500, % GPT Wholesale Office Fund Lend Lease Festival Car Park, 45 Charlotte Street Mar-16 $45,000, % Seymour Group Pty Ltd Far East Consortium Note: This table includes settled sales over $10 million that went under contract during 2016; * reported. Please contact one of our office valuers for a detailed analysis of any of the above sales. DETAILS OF SALE Sale Price $132,000,000 Sale Date October 2016 Vendor Brookfield & DEXUS Purchaser Abacus and Investec Sale Analysis: 324 Queen Street LOCATION AND DESCRIPTION The property is situated approximately 150 metres by foot north-east of the General Post Office, within the Financial precinct of the Brisbane CBD. It is located at the corner intersection of Creek and Queen Streets. The site is improved with a semi-modern office building constructed circa-1975 and refurbished in The building comprises 25 levels of B-grade accommodation, ground level retail and basement parking for 98 vehicles (ratio of 1:203 m 2 ). It is certified with a 4.5 star NABERS Energy rating and a 3.5 star NABERS Water rating. TENANCY AND INCOME DETAILS Gross Passing Income $12,310,357 Net Passing Income $9,398,400 Gross Market Income $13,358,732 Net Market Income $10,440,848 Adopted Outgoings $2,917,884 Vacancy 4,195 m 2 WALE (by income) 3.85 years ANALYSIS Initial Yield 7.12% Equated Market Yield 7.35% Reversionary Yield (Fully Leased) 7.91% Internal Rate of Return (10 year) 7.65% Terminal Yield 7.50% COMMENTS At the date of transaction, the property was leased to an overall average to strong calibre of tenant, including ANZ, Allianz, Ausure and Brookfield Multiplex. At the date of sale, the property had a vacancy of 4,195 square metres over part of the ground retail and tower level office space. Consequently, the passing rental was approximately 10% below our assessment of the market rental prevailing at the date of transaction. All outstanding incentives at the date of sale were paid out by the vendor. Our analysis includes adopted gross face market rents of $575 per square metre (podium levels) and $600 per square metre (tower levels), letting up allowance of 12 months trending to six months, incentives commencing at 40% trending to 18% for the office space and 15% for the retail space throughout the cash flow, at a 50% retention factor. Our equated market yield calculation includes lease expiries over a 36-month horizon based on the exiting occupancy profile of the building. m3commentary Autumn 2017 P8

9 FOCUS: CO-WORKING Co-working is where different businesses work together in common, shared, rented, space. The origins of coworking are in California s Silicon Valley where it began as a way for start-up developers and designers (predominantly from creative industries) to work, and in many cases, collaborate together. Co-working emerged from (and was made possible by) a number of factors, including improvements in technology that allow workers to conduct business from any location, an increase in freelancers and business start-ups, a shift toward self-employment and the increasing proportion of Gen Y workers in the global labour force. Now, coworking is seen as a cost-effective option for many entrepreneurs, start-ups and microbusinesses. The growth of co-working has been extremely rapid. Coworking is no longer limited to creative industry professionals, with corporate workers such as consultants and lawyers being important sources of demand. Just ten years ago, there were only a handful of co-working offices globally. Now, there are an estimated 11,300 co-working spaces globally. Major cities such as New York and London embraced the co-working movement early on, but the trend has also recently gained momentum in a number of major Asian cities such as Hong Kong, Singapore, Shanghai and Tokyo. In Australia, Sydney and Melbourne have led the pack with a reported 60 co-working offices in each of these markets. Brisbane has also seen some co-working space established. However, this has not been to the same extent as Sydney and Melbourne, with space typically being less than 500 square meters. Regus, a global company providing serviced office / co-working space, has eight co-working spaces in Brisbane CBD (including at 480 Queen Street). Previously, most co-working spaces were in converted warehouses and factories. More recently, co-working firms are starting to lease and pre-commit to prime office buildings. For example, global co-working provider, WeWork, has recently committed to 4,300 square metres of space at Charter Hall s new office development at 333 George Street in Sydney and 6,000 square metres of space at 401 Collins Street in Melbourne (this is in addition to their current offices at 5 Martin Place in Sydney and 100 Harris Street in Pyrmont Sydney). With continued growth in the co-working trend, the decision for landlords to lease space to co-working providers or develop their own co-working platforms is becoming increasingly important. GPT and Dexus both offer co-working space across a number of their Sydney, Melbourne and Brisbane buildings. Global growth in the number of co-working offices is expected to remain strong, with forecast CAGR of 23.8% through to This will bring the number of co-working spaces globally to 13,800 by the end of 2017 and 26,000 by the end of The average size of co-working space is expected to increase over the short- to medium-term. Even in established co-working markets, there remains considerable room for growth. For example, a US report estimated that co-working space accounted for only 0.7% of the country s total office market. An estimated 66% of global co-working space providers have plans for expansion during As growth continues, it is important that building owners / co-working providers address changing trends in the market. For example, according to Emergent Research s annual global co-working survey, the proportion of coworking members who are not planning to leave their current co-working space has decreased from 66% in 2011 to 54% in Attracting new members has also grown as an issue for service providers (16% of providers surveyed). A rising trend in the co-working market is for offices with attached short-day care facilities or crèches. Some of these exist across the United Kingdom and United States and a handful have opened in Melbourne and Sydney. Another emerging trend is for co-working providers to engage entrepreneurs in residence to provide informal mentoring / advice to users of co-working space. We expect that co-working will continue to establish itself as an important segment of the Australian office market and that in time, Brisbane will start to see larger coworking spaces established like Sydney and Melbourne have seen during recent years. Sources: Emergent Research, AFR, JLL United States Left: WeWork at 5 Martin Place Sydney Right: Regus at 480 Queen Street m3commentary Autumn 2017 P9

10 OUTLOOK BRISBANE CBD OFFICE While conditions in the CBD appear to have improved markedly on face value, we note that the strong net absorption seen during the second half of 2016 was boosted considerably by the State Government s take-up of 1 William Street. We expect that over the coming year, a correction in net absorption will occur as the Government progressively returns unrequired secondary space to the market and as they further reduce their workspace ratio. While we expect vacancy to decline further during 2017, the decline will largely be as a result of the anticipated withdrawal of circa-40,000 square metres of stock from the market. We expect that the CBD is still a number of years from a more balanced ground between supply and demand. Over the medium-term, the Australian Government forecasts strong national growth in the number of ICT; Business, Human Resources and Marketing; and Design, Engineering, Science and Transport professionals. We therefore expect demand from associated employing industries (such as ICT, Environmental Services and Engineering Consulting Firms) to strengthen nationally. In addition to this, trade-exposed sectors such as Tourism and Education are expected to continue to benefit from the lower value of the Australian dollar, resulting in potential growth opportunities for these sectors. Focussing on Brisbane, demand from the Engineering Sector is expected to strengthen given the number of major construction projects planned for SEQ. While Brisbane has seen some co-working space established during recent years, we expect co-working will become an increasingly important part of the Brisbane office market going forward. Face rents are forecast to remain relatively stable during 2017 and landlords are likely to continue to offer large incentives as a result. When supply and demand return to a more balanced state, landlords are expected to increase face rents. As a result, while our short-term forecast for rents is for flat / minimal growth, our longterm forecasts are positive across all grades of stock. We expect that investor demand will continue to remain strong during the remainder of The low interest rate, improving market fundamentals and strengthening confidence in the wider Brisbane market will continue to be key factors driving demand. KEY COMMERCIAL VALUATION CONTACTS Ross Perkins Managing Director QLD (07) Michael Coverdale Associate Director QLD (07) Simon Hickin Director SA (08) m3property provides national coverage in all States and Territories. Andrew Duguid Managing Director NSW (02) Gary Longden Director VIC (03) DISCLAIMER m3property Australia. This report has been derived, in part, from sources other than m3property. In passing on this information, m3property makes no representation that any information or assumption contained in this material is accurate or complete. To the extent that this material contains any statement as to the future, it is simply an estimate or opinion based on information currently available to m3property and contains assumptions which may be incorrect. m3property makes no representation that any such statements are, or will be, accurate.