m3commentary MELBOURNE CBD OFFICE

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1 m3commentary MELBOURNE CBD OFFICE Spring 2016 Key Research Contacts: Jennifer Williams National Director NSW (02) Erin Obliubek Research Manager VIC (03) Casey Robinson Research Manager QLD (07) Zoe Haskett Research Manager SA (08) Janis McLaren Research Manager WA (08) m3property.com.au P1

2 CONTENTS Market Overview 3 Key Influences 4 Key Indicators 5 Significant Sales 7 Outlook 8 m3 CBD VALUATIONS 150 Collins Street, Melbourne 575 Bourke Street, Melbourne 53 Queen Street, Melbourne 248 Flinders Street, Melbourne 55 King Street, Melbourne Southern Cross West, 111 Bourke Street, Melbourne Southern Cross East, 121 Exhibition Street, Melbourne 850 Collins Street, Melbourne 600 Bourke Street, Melbourne 570 Bourke Street, Melbourne 469 La Trobe Street, Melbourne 747 Collins Street, Melbourne 469 La Trobe Street, Melbourne POSITIVE FUNDAMENTALS CONTINUE FOR THE MELBOURNE CBD OFFICE MARKET New supply is set to increase over the second half of 2016; Diversification continues to be the key for solid tenant demand, with the IT & Communication, Insurance and DEFINITIONS A-REIT: ASX listed Australian Real Estate Investment Trust Completion date: determined by issue of a Certificate of Occupancy Grade: is determined using the PCA report A Guide to Office Building Quality. Net absorption: is the change in occupied stock within a market over a specified period of time. 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 grade A. Secondary: Combination of grades B, C and D. WALE: Weighted average lease expiry. Financial Services sectors the main drivers; Rental growth remained stable across the CBD office market over the first nine months of 2016; and Investor appetite remains relatively healthy despite vendors exercising a degree of caution during a period of financial market uncertainty, evident by below average transactional activity. Comm3ntary Spring 2016 P2

3 MARKET OVERVIEW Although global economic growth remains at a moderate pace, positive fundamentals continue for the Melbourne CBD office market. The sector continues to benefit from strong population growth, a low interest rate environment and a diversified range of office users, evident by a below average unemployment rate and an improvement in State Final Demand for Victoria over the June 2016 quarter. It is these positive fundamentals which will contribute to the market remaining attractive to both local and private investors over the remainder of 2016 and leading into A diverse rental market continues to be a key underlying driver of Melbourne s CBD office market, supported low unemployment and white collar growth for the State. Tenant demand remains within the Melbourne CBD, driven by the migration of tenants from suburban and city fringe locations and strong demand from the IT, Financial and Government sectors. Although no new supply entered the market over the first half of 2016, over 100,000 square metres of stock is expected to reach completion in the second half of the year. Of which a significant proportion is already pre-committed. The CBD vacancy rate declined from 7.7% to 7.0% over the period January 2016 to July 2016, driven by a combination of stock withdrawals, solid tenant demand and attractive pricing conditions in the leasing market. Transactional activity within the Melbourne CBD office market remains with over $733.7 million worth of CBD office stock traded in the first nine months of 2016, due to continued strong demand from local and foreign investors. Southern Cross West & Southern Cross East Comm3ntary Spring 2016 P3

4 KEY INFULENCES $ ECONOMIC GROWTH As the Australia economy continues to move further away from a mining and resource driven economy, Victoria will continue to benefit from the transition. The State s final demand improved by 1.1% (seasonally adjusted) in the June 2016 quarter, according to the ABS. While the Australian Treasury Gross Domestic Product (GDP) is forecast to grow by 2.5% over and rise to 3.00% in EMPLOYMENT Australia s seasonally adjusted unemployment rate remains below the long term average of 6.9% at 5.6% as of August 2016, however unemployment continues to rise in mining and resource driven States. Job growth was recorded in Victoria for the month of August, with the seasonally adjusted unemployment rate down to 5.5%, this is Victoria s lowest reported unemployment rate since November The IT, Finance and Insurance sectors remain the main drivers of white collar employment in the State. Looking forward, the Victorian State Government predicts employment growth of 1.75% over the 2017 financial year, this will be largely driven by strong population growth while a diverse employment market will further strengthen the Victorian economy. JOB ADVERTISEMENTS The seasonally adjusted ANZ Bank job advertisement series suggests job ads across Australia fell 0.3% in the month of September, with annual growth slowing to 3.7% from 8.0% in the month prior. The recent fall in the number of job advertisements is consistent with businesses remaining cautious during a period of financial market uncertainty. BUSINESS CONFIDENCE The National Australia Bank s monthly business survey suggests business confidence remains at a reasonable level at +6 index points to be consistent with the long term average. Business conditions improved marginally to +8 index point, previously +7, the index remains above the series long term average with conditions expected to remain solid across most States over the near term. 150 Collins Street, Melbourne 575 Bourke Street, Melbourne Comm3ntary Spring 2016 P4

5 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Net absorption (000's m 2 ) m3property Research KEY INDICATORS Civic 11% Melbourne CBD Office Stock - July 2016 North Eastern 8% Flagstaff 7% Docklands 18% Spencer 5% Western Core 36% Eastern Core 15% Source: Property Council of Australia OMR, m3property Research STOCK AND SUPPLY Total stock in the Melbourne CBD office market marginally decreased over the first half of 2016 (from 4,464,167 million to 4,437,824 million square metres), due to no new supply entering the market and the withdrawal of 26,343 square metres of stock. Buildings to be withdrawn include 485 La Trobe Street for partial refurbishment and the conversion of 393 Swanston Street to student accommodation. Although no new supply completed over the first half of 2016, new builds due to complete in the later part of the year include Walker Corporation s Tower 2 (55,000 square metres) and Tower 4 (34,357 square metres) at 727 Collins Street. Precommitments to Tower 2 include KPMG, Maddocks and AECOM, and Link Group has pre-committed to Tower 4. The partial redevelopment of Rialto Towers at 525 Collins Street and 360 Collins Street will result in an additional 6,500 square metres and 5,698 square metres, respectively. Both refurbishments are ear marked to complete late 2016/early Melbourne CBD Office Net Absorption - July 2016 Source: Property Council of Australia OMR, m3property Research TENANT DEMAND According to the Property Council of Australia net absorption remained positive over the first half of Melbourne s CBD office net absorption in the twelve months to July 2016 was 67,026 square metres, this is just below the long-term average (since 1994) of around 68,600 square metres. Although a small amount of sublease space remains in the CBD office market, tenant demand (particularly for Premium space) remains sound. Driven by the migration of tenants from suburban and city fringe locations during an affordable rental market and continued demand from the IT & Communication, Insurance and Financial Services sectors. 53 Queen Street, Melbourne 850 Collins Street, Melbourne Comm3ntary Spring 2016 P5

6 Sales volume ($millions) Vacancy (%) Net Face Rents ($/m 2 ) m3property Research KEY INDICATORS $600 $500 $400 $300 $200 $100 $0 Source: m3property Research. 14.0% Melbourne Prime and Secondary Average Net Face Rents Prime Secondary Melbourne CBD Office Vacancy July 2016 RENTAL GROWTH AND INCENTIVES Net face rentals for premium accommodation within Melbourne s CBD typically range from between $380 to $700 per square metre, with net face rents relatively stable over the nine months to September Prime net face rental growth is expected to be limited over the December 2016 quarter, with average growth forecast in By comparison, net face rents within Melbourne s secondary office market continue to range from $325 to $450 per square metre. The decline in net effective rental growth at the end of 2015 fuelled the flight to quality trend, with tenants taking the opportunity to relocate from suburban and secondary locations to premium accommodation during an affordable rental market. Incentives across Melbourne s CBD office market continue to remain elevated, prime incentives to range from 27.5% to 37.5%, with secondary incentives in the range of 22.5% to 30.0%. We expect incentives to remain elevated before trending downwards in the second half of % 10.0% 8.0% 6.0% 4.0% 2.0% CBD 7.0% VACANCY The total vacancy rate for Melbourne s CBD office market fell to 7.0% in July 2016 with prime grade vacancy at 7.4% in January 2016 falling to 6.7% over the six month period. Secondary grade vacancy was recorded at 7.6% in July 2016 down 0.6% over the same period. 0.0% Civic Eastern Core Flagstaff North Eastern Spencer Western Core Docklands Source: Property Council of Australia OMR, m3property Research 3,000 2,500 2,000 1,500 1, Melbourne CBD Office Sales Volume Source: m3property Research. Office Sales over $5 million to end September INVESTMENT MARKET AND YIELDS Despite vendors remaining caution during a period of market uncertainty, evident in the lack of stock currently available to market, over $733.7 million worth of CBD office stock traded in the first nine months of Significant transactions to date for 2016 include the sale of 380 La Trobe Street to a private investor in the order of $175 million, 120 Spencer Street to Anton Capital for $165.2 million and the purchase of 1 Collins Street by a local private investor for $125 million. Private investors equated for the largest proportion of sales, by value, accounting for 45% of total purchasers to date for Although significant yield compression occurred over 2014 and 2015, limited transactional activity resulted in prime and secondary yields to remain stable over the first nine months of Prime yields to range from 5.25% to 6.25% and secondary yields to now typically range from 6.50% to 7.00%. The gap between government bonds and prime yields is currently the widest it s been over the past 10 years, however we expect the gap to start to compress towards the end of 2016 as prime yields tighten. Comm3ntary Spring 2016 P6

7 SELECT SALES TO DATE Property Date Price Equated Market Yield Vendor Purchaser 380 La Trobe Street, Melbourne In-DD $176,000, % Invesco Phillip Lim 114 William Street, Melbourne In-DD $161,500, % SRE Investment AFIAA Southgate, 3 Southgate Avenue, Southbank In-DD $578,000,000 ~6.50% Dexus Property Group ARA Assets Management 12 Riverside Quay, Southbank In-DD $160,000,000 N/A Esso Australia TBA Twenty8 Freshwater Place, Southbank In-DD $290,000,000 ~6.00% GPT/Frasers Property TBA 51 Queen Street, Melbourne Jun 16 $25,000, % Queville Pty Ltd Undisclosed 120 Spencer Street, Melbourne Mar-16 $165,200, % Harry Stamoulis Anton Capital 1 Collins Street, Melbourne Feb-16 $125,000, % Robert Magid Harry Stamoulis ~Expected Yield and N/A = Not Available Please contact one of our Commercial Valuers for a detailed sales analysis 55 King Street, Melbourne Comm3ntary Spring 2016 P7

8 OUTLOOK MELBOURNE CBD OFFICE The outlook for the Melbourne CBD office market remains relatively optimistic. Tenant demand is forecast to remain solid over the medium-term, with growth in white collar employment to be underpinned by an improving labour market and the rebalancing in the Australian economy from mining and resources to more diverse drivers of growth. Vacancy is expected to remain contained for the remainder of 2016 and 2017 before increasing in 2018 on the back of new supply and backfill space entering the market. Below average rental growth is expected for the remainder of 2016 with incentives likely to stay elevated before average growth increases in 2017 with incentives trending downwards. Transactional activity is expected to be solid for the balance of 2016, driven by continue local and foreign investor demand and positive market fundamentals. Demand for assets with secure cash flows provided by long term leases with strong lease covenants is expected to remain; in turn leading to further yield compression for prime assets over the remainder of 2016 and leading into KEY COMMERCIAL VALUATION CONTACTS Gary Longden Director VIC (03) Andrew Duguid Managing Director NSW (02) Ross Perkins Managing Director QLD (07) Adrian Burg Director SA (08) m3property provides national coverage in all States and Territories. Gavin Chapman Managing Director WA (08) 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.