The Melbourne CBD: What is driving centralisation?

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1 November 2013 The Melbourne CBD: What is driving centralisation? Key Points Jones Lang LaSalle recorded a notable increase in the number of city Fringe 1 occupiers migrating to the Melbourne CBD over the past 12 months. 16 transactions (>1,000 sqm) took place, compared with three over the previous 12 month period. There is limited quality supply and a muted development pipeline in the city Fringe. Higher incentives available in the CBD and narrowing of the rental spread between the CBD and decentralised markets have precipitated a wave of centralisation. As a result, tenants are increasingly citing cost and quality advantages offered by Grade A assets in the CBD in their decision making. In this Pulse paper, Jones Lang LaSalle will assess what demand drivers are supporting tenant centralisation in the Melbourne CBD, providing insight on the medium term demand scenario for the Melbourne CBD. There is increasing demand from decentralised occupiers for quality, well presented stock - driven by cultural change, cost savings, business contraction and expansion activities, and changes in the way people are working. Companies are increasingly seeking enhanced corporate identity through location - connectivity to the CBD and surrounds offers firms closer proximity to clients and competitors. Higher incentives available in the CBD and narrowing of the rental spread between the CBD and decentralised markets have accelerated a wave of centralisation. Limited new supply has come online post-2009 in the city Fringe market, with only one project under construction. There is a significant shortage of contiguous space across the city Fringe, with only 11 prime grade options available above 1,000 sqm, compared with 39 in the CBD. Introduction Jones Lang LaSalle recorded 16 centralisation transactions (>1,000 sqm) over the past 12 months compared with three over the previous 12 month period. There is increasing demand from city Fringe occupiers for quality, well presented stock - driven by cultural change, cost savings, contraction and expansion activities, and changes in the way people are working. Is cost is a key driver? Since 2008, Jones Lang LaSalle has recorded 42 major tenant moves (>1,000 sqm) by occupiers moving into the CBD from decentralized locations. Major transactions over the past five years include: Lion (National Foods), Origin Energy, Melbourne Water, Bupa, Suncorp and Catholic Church Insurers. Our analysis shows 85% of these occupiers have relocated to the periphery of the CBD, with very few locating to the core CBD itself. Increasing vacancy rates have exerted upward pressure on incentives, notably in the CBD. Over the past 12 months, average leasing incentives increased from 24 months rent free (20%) to 35 months rent free (29%) - above peak levels recorded during the GFC and currently at their highest level in 17 years. City Fringe occupiers are increasingly looking at upgrading from lower grade assets and taking advantage of competitive rental terms. Good quality stock is leasing well, while it is difficult to attract tenants to secondary stock with no fit-out. Occupiers are seeking space with a generous fit-out incentive or an attractive turn-key solution which allows them to upgrade from their current accommodation. Jones Lang LaSalle has assessed average rent free periods (based on 10 year term) across a basket of grade A assets in the CBD and city Fringe precincts, as outlined in Figure 1. 1 City Fringe comprises the following locations: West Melbourne, North Melbourne, Parkville, Carlton, East Melbourne, Richmond, Abbotsford, South Yarra St Kilda, Port Melbourne.

2 Pulse The Melbourne CBD: What is driving centralisation? November Based on Grade A assets, our analysis shows, the average rental spread between gross face rents in the CBD and city Fringe sits at approximately 25%. However, taking into consideration the higher incentive levels offered in the CBD compared to the city Fringe, the average spread on an effective rent basis narrows to 12%. This spread becomes even more acute when comparing submarkets within the CBD and city Fringe markets. Figure 2: Melbourne CBD vs. City Fringe Office Supply Figure 1: Average Rent Free (months): Grade A Limited options for larger users With a lack of development activity since 2009, there is a growing understanding that a significant shortage of contiguous space in the city Fringe is emerging. At the end of Q3/2013, just 11 prime grade options were available in the city Fringe above 1,000 sqm, compared with 39 in the CBD. The TAL Service Limited transaction is a recent example. TAL previously located at 501 Swanston Street in the city Fringe, signed a 10.5 year lease at 380 La Trobe Street in the CBD. The Australian Life Assurance specialist took 6,090 sqm across the 4 th -8 th floors reflecting $370 per sqm (net) with an incentive of 25%. The incentive went towards amending the existing fit out and a rent-free period. In some cases higher incentives have precipitated centralisation. It is important to note, however, that this is not the sole driver for tenants relocating. When broken down into size cohort (Figure 3), large space options have nearly all been absorbed, with only four leasing options above 3,000 sqm available in prime grade stock across the entire city Fringe market. This compares with 27 prime grade options in the CBD. Scarcity has also emerged in buildings with typical floor plates in the 1,000 2,000 sqm size bracket. Only three prime grade options are available in the city Fringe, compared with 10 in the CBD. Figure 3: Melbourne CBD and City Fringe Vacancy by Size Cohort Quality supply is scarce in the City Fringe The development pipeline within the city Fringe office has been subdued post the global financial crisis. Between 2010 and 2013 (as at Q3/2013) Jones Lang LaSalle recorded just 26,265 sqm of completions (new developments and full building refurbishments) in the city Fringe office markets compared with 376,740 sqm of completions in the CBD. Currently 170,450 sqm of office space is under construction in the Melbourne CBD, compared with just 7,100 sqm in the city Fringe. Looking ahead, limited development activity is forecast over the medium term. City Fringe tenants with large space requirements for new or fitted space have increasingly been considering the CBD as an alternative. AAMI (Suncorp) is a recent example of a large space occupier moving into the CBD. Suncorp previously occupied 27,000 sqm across three CBD and city Fringe leasehold sites. The group of companies consolidated into one site at 530 Collins Street (15,450 sqm). Through

3 Pulse The Melbourne CBD: What is driving centralisation? November the adoption of Activity Based Work strategies, Suncorp was able to become one company, many brands at 530 Collins Street enjoying the benefits of site consolidation, space savings, and better quality office accommodation. This smaller footprint delivered higher quality space, included sky signage and a market incentive allowing the company to achieve a cost saving and cultural change outcome. High proportion of younger workers live in the CBD Over the past decade there has been an exponential increase in the number of apartments developed within the Melbourne CBD. An increasing acceptance of high density living, the level of amenity in the CBD combined with the close proximity to place of work or education facilities is making it attractive to live in, or near to, the CBD. As a result, Melbourne s CBD (including Docklands) population has increased by 47% over the past five years. Going forward, over the next 10 years (2014 to 2023), ID Consulting projects the resident population of the Melbourne CBD (and Docklands) will increase by 4.3% per annum. Figure 4: Melbourne CBD Resident Population Occupiers are seeking enhanced corporate identity Proximity to the public transport network is an important factor for most businesses, notably those seeking to attract the best talent to support their business operations. In Melbourne (state suburbs), approximately 30% 2 of CBD workers commute to and from work using some form of public transport. Companies are increasingly seeking enhanced corporate identity through location. Connectivity to the CBD and surrounds allows firms to have closer proximity to clients and competitors. Conclusion Centralisation has supported Melbourne CBD demand over the past 12 months. In the year ending Q3/2013, Melbourne CBD recorded positive net absorption (8,380 sqm) compared with negative net absorption (- 32,550 sqm) in the city Fringe. A lack of development activity and limited contiguous options for large space users in the city Fringe combined with higher incentives available in the CBD will continue to drive centralisation and support Melbourne CBD demand in the short term. However, a number of medium-term lead indicators have started to improve and point towards a demand recovery in the Melbourne CBD. A reactivation of business investment projects will have a positive impact on white-collar employment, supporting our forecasts of above trend net absorption in the Melbourne CBD projected for 2016 (75,000 sqm) and 2017 (110,000 sqm). Source: ID Consulting, ABS A large proportion of the younger workforce lives in (or within close proximity to) the CBD as outlined in Figure 4. When broken down into age cohort, 35% of the population currently residing in the Melbourne CBD (and Docklands) is between the years of age. Over the next 10 years, this figure is anticipated to increase by 25%, with an additional 4,000 residents. This demographic typically wants to work in the city as opposed to the outer suburbs. As a result employers in the CBD are able to draw on a diverse pool of talented staff. One of the challenges employers face is attracting and retaining quality staff, which in turn is setting the expectation to seek quality buildings in a central location. Kimberley Paterson Research Manager Victoria Research & Consulting tel kimberley.paterson@ap.jll.com Ashley Buller Director CBD Office Leasing tel Ashley.buller@ap.jll.com 2 Australian Bureau of Statistics, 2011 Census of population and housing, Melbourne (SSC20867) 6.2 sq kms

4 Pulse The Melbourne CBD: What is driving centralisation? November Case Studies GTA, one of Australia s largest transportation consultancies, previously based on High Street in Kew, recently took 1,000 sqm of fitted space on a 5 year term at 55 Collins Street. Staff retention and attraction was a priority for GTA. 55 Collins Street: GTA Consultants A move to a more central location was not only imperative but also allowed the company to provide a better service to State Government, private clients and partners who are primarily based in the CBD. Salta Properties, previously based at 650 Lorimer Street in Port Melbourne, relocated to 35 Collins Street. Salta Properties owns, develops and manages a range of properties across Victoria, so a move to a more centralised location allowed easier access to their projects via a more diverse transport infrastructure. 35 Collins Street: Salta Properties IG Markets, previously located at 417 St Kilda Road, recently signed a 10 year lease at 55 Collins Street. The CFD and Forex provider had large back-up power supply requirements, which presented minimal suburban options. 55 Collins Street: IG Markets CBD buildings with better infrastructure, provided greater choice. Improved access to amenity and transport services offered in the CBD supported their business case of securing a CBD location.

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