m3commentary SYDNEY INDUSTRIAL

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1 m3commentary SYDNEY INDUSTRIAL Autumn 2017 Key Research Contacts: Jennifer Williams National Director NSW (02) Casey Robinson Research Manager QLD (07) Zoe Haskett Research Manager SA (08) m3property.com.au P1

2 CONTENTS Market Overview 3 Key Influences 4 Sector Changes 5 Market Fundamentals 6 Submarkets 7 Investment Indicators 9 Key Sales 10 Outlook 11 ARE YIELDS AT THEIR LOWEST POINT? Rents and incentives largely stable. DEFINITIONS Submarket Inner West Central West Outer West North North West South South West Outer South West Suburbs include: Campsie Five Dock Kingsgrove Petersham Marrickville Fairfield East Greystanes Lidcombe Rydalmere Silverwater Smithfield Wetherill Park Arndell Park Eastern Creek Erskine Park Glendenning Huntingwood Mount Druitt Brookvale Frenchs Forest Gladesville Gore Hill Lane Cove Macquarie Park Blacktown Castle Hill Kings Park Norwest Seven Hills South Windsor Alexandria Botany Mascot Rockdale Taren Point Chullora Milperra Moorebank Prestons Regents Park Campbelltown Ingleburn Minto Smeaton Grange Land values rise due to competition for sites. Demand for industrial space slowed slightly, over the past year, with the South and Central West leaking tenants due to stock withdrawals and the South West and North West increasing take-up compared to the year prior. Supply remains largely demand driven. Acquisition activity continues to slow, despite investor demand remaining for quality space. Yields across prime and secondary assets have continued to tighten over the year to March Forecasts indicate that yields are likely to reach cyclical lows in the Sydney submarkets over varying time frames starting from 1.5 years. Across all submarkets yield tightening has already started to slow. m3commentary Autumn 2017 P2

3 MARKET OVERVIEW Industrial supply and vacancy have decreased over the past 12 months in the majority of submarkets in Sydney. Rents have largely been stable and yields have firmed over the year to March 2017 across most of the submarkets. Sales activity outside of portfolio purchases has been only moderate and this, combined with rising bond rates is resulting in a slowing of yield compression. Key drivers of the industrial market in Sydney at current are changing infrastructure, zoning and planning changes, international retailers looking to expand or enter into the Australian market and low interest rates. Demand for Sydney industrial space is changing in both composition and location. While many tenants still have a preference to locate in the South and Inner West due to their proximity to major road, sea and air transport, the improvement of infrastructure in other submarkets, comparable cost and availability of space is driving a movement of tenants towards the Western precincts. Activity levels were strongest in the Outer West, Central West and South West submarkets over the year to March 2017 while the South and Inner West saw the lowest level of take up across the submarkets. Prime and secondary net face rents were largely stable across most submarkets over the year to March 2017, with the exception of the South and Outer South West submarkets which experienced growth. Incentives remained stable across most submarkets over the same period, except for a slight decrease in the Outer South West and the South submarkets. Yields firmed and land values rose over the year to March 2017 on the back of reduced supply and positive, albeit slowing, demand for industrial sites and buildings. m3property Valuation 24 Lockwood Road, Erskine Park m3property Valuation 6 Macdonald Road, Ingleburn m3property Valuation Bourke Road, Alexandria m3commentary Autumn 2017 P3

4 KEY INFLUENCES $ ECONOMIC GROWTH Business investment continues to be restrained, although measures of business sentiment remain above average. Labour market indicators continue to be mixed and inflation low. While a low official interest rate is supporting domestic demand, rising rates from the major banks and a fluctuating exchange rate continue to reduce its effectiveness. According to the Australian Treasury, in real terms Gross Domestic Product is forecast to grow by 2.50% in and improve to 3.0% in TRANSPORT INFRASTRUCTURE Sydney has a number of infrastructure projects currently underway or in planning. These include: WestConnex, which integrates the expansion of the M5 East to the M4 extension; the Western Harbour Tunnel; NorthConnex M1-M2 project; the Moorebank intermodal Terminal and Western Sydney Inland Container Intermodal Terminal at St Marys; the Western Sydney Freight Line; Sydney Metro Rail and Parramatta light rail developments; and Badgerys Creek Airport. FREIGHT ACTIVITY Container trade is a leading indicator of demand for the logistics sector. There has been positive annual growth in container trade activity through Sydney s Port for the past 14 financial years (NSW Ports, February 2017). The year to February 2017 saw 1.9% growth which bodes well for positive growth in the 2017 financial year. Estimates of around 4.0% to 5.0% growth per annum in twenty foot equivalent units (TEUs) are forecast to This is likely to result in continued positive demand for logistics and storage facilities over the period. INTEREST RATES Interest rates have a dual impact on the industrial sector, firstly indirectly through other sectors and secondly through the investment market. Record low official interest rates (currently at 1.50%) stimulated residential sales and construction and retail trade over 2015 and into This had positive flow-on-effects to demand for industrial space to supply these industries and store and transport goods. With Banks not passing on the full interest rate cut to customers over the past 12 months, rising bond rates and increased restrictions on lending to investors, this has resulted in a slowing of yield compression over the past 12 months compared to the year prior. 2 Glendenning Road, Glendenning Cumberland Industrial Estate, Smithfield m3commentary Autumn 2017 P4

5 SECTOR CHANGES LOGISTICS Retailers continue to be the main users of the logistics sector in Australia, contributing 36.8% of revenue, according to IbisWorld (July 2016). Retailers use the full range of logistics services although the focus is now more on transport and storage, than handling and distribution, due largely to just-in-time inventory management. The retail sector has gone through major changes over the past few years, which has led to inventory reduction, outsourcing of non-core activities and retailers expanding or creating online services to increase their customer base and compete with overseas firms and hence increasing demand for logistics services. Retail trade growth has been positive in NSW. From February 2016 to February 2017 growth was 3.1%, down from 5.1% over the same time last year. The continuing low cash rate combined with strong residential prices has kept spending positive, despite global uncertainty and low wages growth over the period. Inventory levels have seen a reducing growth rate over recent years. The four largest inventory holding industries are wholesale trade, manufacturing, retail trade and mining. According to the ABS over the year to December 2016, manufacturers (-4.6%) and miners ( 7.9%) ran down inventory levels, while retailers (1.8%) and wholesale traders (9.8%) increased levels. The demand for logistics services by wholesalers has remained strong, as goods need to be readily available in a positive retail market and imports from overseas although having slowed with the reduced Australian dollar have substituted for the reduced level of domestically manufactured goods. This has helped make wholesalers the second largest contributor to the logistics sector in , accounting for 31.9% of revenue, according to IBISWorld. The third largest contributor to logistics revenue is the manufacturing sector (25.4% of revenue). Although it has been generally on the decline in Australia over the past 40 years it still contributed around 5.9% of gross value add at current prices to GDP over 2016 (seasonally adjusted). This is due to the overall trend towards off-shoring to countries with cheaper labour and other costs. While the reduction in the Australian dollar over the past few years has helped shift the cost imbalance back towards manufacturing of products here, in some cases, such as the car industry, this has occurred too late and wages costs continue to impact our competitiveness despite only growing by 1.6% over the year to November TECHNOLOGY New technology not only creates new products, which need to be transported and stored but it also influences the way goods are transported and stored. Mobile applications and solutions are impacting the manufacturing sector, including: communications, data collection, onsite visualisation, databases, control equipment, remote access, scheduling, safety applications and employee tracking. These applications and solutions reduce order status calls and can increase sales. Storage solutions including automated storage systems save time, space requirements and costs in logistics. The latest automation systems, include: high-speed unit picking, voice picking and intelligent conveyor systems. Integrated transport and warehouse systems can be complemented by energy-efficient initiatives including rain water harvesting and energy monitoring. Driverless logistics, holographic teleportation and drone delivery are other technologies, which are likely to result in major changes in the industrial markets around the world. The key benefits are cost reductions and a lower environmental impact of logistics, increased efficiencies and cost savings within warehouses and increased demand for storage space as showrooms become less relevant. Gateway Industrial Estate Arndell Park m3commentary Autumn 2017 P5

6 Vacancy rate (%) Value of building approvals ($millions) Number of building approvals m3property Research MARKET FUNDAMENTALS NSW Industrial Building Approvals Number of approvals Other industrial Warehouses Source: m3property and ABS (May 2017) SUPPLY AND TENANT DEMAND NSW building approvals, by value, increased over the year to March This is likely to result in industrial building supply levels, especially warehouses, remaining robust in the short term, as many of these planned projects complete. Looking forward, strong competition with other land uses in the southern and inner precincts is resulting in a reduction of available industrial stock and therefore increased supply in the Western precincts, which have seen an increasing number of projects to accommodate displaced tenants. Gross tenant demand, in terms of leases signed, decreased over the year to March 2017, compared to the year prior (for deals over 1,000 square metres in size). The decrease was driven by reduced activity in the South and Central West submarkets where competition with other land uses is resulting in tenant displacement. Tenant demand was still strongest overall in the Central West over the year, accounting for 26.9% of the metropolitan total. Gross absorption was also high inthe Outer West (24.8%) and South West (20.0%) submarkets. Agriculture & aquaculture blg The North, South West and Inner West submarkets witnessed Factories increasing demand over the year to March 2017, compared to the year prior. Large leases signed in Macquarie Park and Brookvale in the North; Horsley Park, Chullora, Revesby and Prestons in the South West and Enfield and Ashbury in the Inner West helped drive this result. Many tenants in, or looking to enter, the Sydney industrial market are still looking for efficiencies through consolidation of activities, choosing the optimal location for supply chain efficiencies and/or automation of processes. VACANCY AND RENTS 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Industrial Vacancy Rate Source: Various industrial A-REIT annual reports Vacancy rates fell in the Sydney metropolitan area over the second half of 2016 due to a slowing of supply over the period. Based on our sample of prime properties in Australia s major industrial A-REITs, the vacancy rate reduced to 3.6% at December This was down from 4.9% in December The forecast is for vacancy to increase slightly over 2017 with supply likely to be slightly higher than net demand. It is likely that overall vacancy is higher in the wider market. Prime net face rents were largely stable but increased over the year to March 2017 in the South and Outer South West submarkets. Withdrawal of stock for change of use saw vacancy fall and building quality improve over the past year in the South submarket and resulted in some upward pressure on rentals. The Outer South West submarket has largely been driven by demand for space in Ingleburn and Smeaton Grange, which are some of the only areas still offering large blocks along transport corridors. m3commentary Autumn 2017 P6

7 SUBMARKETS INNER WEST Net face rents were stable over the past year for prime stock ranging from $115-$135 per square metre, secondary rents were also stable ranging from $85-$105 per square metre at March This submarket is likely to continue to see decreasing stock levels over the next six months due to many secondary buildings being withdrawn for change of use. This may place some upward pressure on rents in the short term. Stock in this submarket largely consists of small older workshops, ex-manufacturing facilities and warehouses of less than 3,000 square metres. Enfield is an exception with some larger premises available in close proximity to the intermodal terminal. Vacancy is low in the area, keeping rents steady. In terms of demand, Enfield, Ashbury and Kingsgrove have been the most active suburbs in the precinct over the year to March CENTRAL WEST Rents were stable ranging from $105-$140 per square metre for prime and $60-$95 per square metre for secondary stock over the year to March Rents may increase marginally over the next six months as supply is fairly low and demand is expected to remain robust. Low supply and moderate demand has resulted in modern, multi-unit complexes having low vacancy and short letting up periods in this precinct. Wetherill Park followed by Yennora have been the suburbs of strongest tenant demand over the past 12 months to March Silverwater, Smithfield and Lidcombe also remained popular with tenants with a range of deal sizes from larger facilities of over 10,000 square metres down to office/warehouses of less than 5,000 square metres in size. OUTER WEST Prime rents have been stable ranging from $95-$115 per square metre over the 12 months to March 2017 Secondary rents were also stable ranging from $65-$85 per square metre over the year to March Rental growth is expected to rise slightly over the next six months as demand continues to strengthen from tenants moving from inner submarkets where vacancy is being pushed down by supply withdrawals. The Eastern Creek submarket dominated tenant demand with the strongest demand of any suburb in Sydney over the past 12 months. Huntingwood and Arndell Park have also been active over the 12 months to March NORTH Rents in the North submarket remained in the range from $140- $160 per square metre for prime stock and $110-$130 per square metre for secondary space over the year to March Demand has increased but was fairly low in this submarket over the year to March Deals have been largely less than 2,000 square metres in size. Macquarie Park, Brookvale and Artarmon saw the strongest gross absorption in the submarket over the past 12 months. Incentives continued to be higher than most other submarkets due to the higher office components in buildings in this market. Prime incentives ranged from 15%-20%, while secondary incentives ranged from 15%-25% over the year to March This compared to a range of 8%-10% for prime stock and 8%-15% for secondary stock generally across the other submarkets. Tenant demand is expected to continue to rise in the North. Conversion of sites to mixed use or multi-unit residential in St Leonards, Artarmon, Macquarie Park and other suburbs continues in this submarket. Combined, this should result in vacancy decreasing in the North submarket in the short term Templar Road, Erskine Park m3commentary Autumn 2017 P7

8 SUBMARKETS NORTH WEST Rents have been stable ranging from $105-$120 per square metre for prime stock and from $80-$95 per square metre for secondary stock over the 12 months to March This submarket is forecast to see rental growth over the next few years as leasing activity improves, with tenants looking to take advantage of improving infrastructure and growing employment pools in the area. Tenant demand has slowed in Marsden Park (Sydney Business Park) over the past nine months but it remains the strongest suburb in terms of tenant demand over the past year in the North West submarket. Demand has started to pick-up for smaller space within the North West submarket which has benefited areas such as Seven Hills and Kings Park. SOUTH Prime rents increased in the South submarket over the year to March 2017 and continue to be the highest across the Sydney industrial submarkets, ranging from $150-$190 per square metre. Secondary rents were also stable over the past 12 months ranging from $80-$110 per square metre to March Continued conversion of older style industrial facilities to residential or mixed use, and a lack of new industrial development has assisted to keep the South vacancy rate low over the past 12 months. It has also, however, resulted in a number of tenants having to vacate the submarket to find appropriate space for their requirements. Banksmeadow, followed by Alexandria saw the most leasing activity over the past 12 months in the submarket. While Taren Point/Caringbah witnessed an increase in take up due to some newly created subdivisions within the suburb. SOUTH WEST Prime rents were stable over the year to March 2017 ranging from $95- $110 per square metre while secondary rents ranged from $70- $85 per square metre. Rents may rise slightly over the next six months due to decreasing vacancy generally. The South West submarket has witnessed increasing demand over the year to March 2017 compared to the year prior. Horsley Park, Chullora, Revesby and Prestons were the most active suburbs in the submarket in terms of leasing demand over the past 12 months. Demand for space in Horsley Park and Chullora has mainly come from larger tenants while Revesby and Prestons saw demand from a range of space users over the period. OUTER SOUTH WEST Rents are lowest in the Outer South West submarket despite having increased over the past 12 months to be in the range from $90-$110 per square metre for prime stock. Secondary rents remained in a range from $60-$80 per square metre over the year to March Leasing activity has slowed in the Outer South West submarket over the year to March 2017, after a very strong 12 months prior. Activity remained solid in Ingleburn which accounted for over half the deals reported in the submarket for the year. Smeaton Grange and Campbelltown accounted for the next strongest level of gross absorption for the submarket over the year to March Pine Road, Yennora m3commentary Autumn 2017 P8

9 1-2 ha serviced lots ($/m 2 ) Yield (%) Sales volume ($millions) m3property Research INVESTMENT INDICATORS $2,500 $2,000 $1,500 $1,000 $500 $- NSW sales by price range >$20 mill $10 mill -$20 mill $5 mill-$10 mill Source: m3property Research (*to April 2017). Sales over $5 million INVESTMENT DEMAND Industrial sales activity (above $5,000,000) in NSW decreased significantly over 2016 compared to This excludes the NSW assets incorporated in the Goodman, Charter Hall and Denison Funds Management portfolio sales that occurred in Over the year to April 2017 there was approximately $1,582,396,900 worth of properties traded in 81 transactions, down from $2,000,009,000 (102 deals) over the year prior. Larger sales, over $20,000,000, have continued to dominate total value of NSW sales since Unlisted funds with 34.0% of sales, by value, accounted for the largest portion of industrial sales in NSW over the year to the March quarter 2017 (in sales over $5,000,000 in value). Foreign Investors (17.1%) and private investors (12.7%) were the next largest purchaser groups, over the same period in NSW % 9.50% 9.00% 8.50% 8.00% 7.50% 7.00% 6.50% 6.00% m3property Research $1,400 $1,200 $1,000 $800 $600 $400 $200 $- Sydney Industrial Yields Prime Secondary Sydney Land Values North West North South South West Inner West Central West Outer West Outer South West m3property Research YIELDS Prime investment yields for industrial property in Sydney are now approaching their pre-gfc lows. While secondary yields are still lagging prime considerably, the gap is now starting to reduce. While value was previously being seen in secondary assets, largely for its redevelopment potential, rather than its value as an industrial asset, there are now many investors looking at this market as a stock of future industrial land as well as for its current potential in a market with tight vacancy. That said, secondary space is still going to remain higher on the risk scale perpetuated by tenants desire to lease the most efficient space possible. It is usually the case that rents rise in prime space as vacancy contracts and land values rise, this prices existing secondary space back into the market, lowering its risk. While land values have risen, rent growth has been fairly benign and is yet to occur in many submarkets resulting in the continued perceived risk differential between the grades. LAND VALUES The Sydney industrial land market is more prominent within the outer suburban ring. Inner metropolitan precincts have limited sites available and larger redevelopment options that come to the market are often converted to alternative uses, such as residential or mixed-use where planning regulations permit. Land values have started to see some increases over the past two years after previously being largely flat since the trough of the market in The average land value across Sydney, for one to two hectare allotments, as at March 2017 was $466 per square metre, this represents an increase of 8.1% over the past year. Land values currently range from an average of $275 per square metre in the Outer South West up to $900 per square metre in the South, where land is in short supply and alternative use is more likely. m3commentary Autumn 2017 P9

10 SIGNIFICANT SALES Property sales Qtr Price Rate/m 2 Market Yield Purchaser Simonson Properties Portfolio (Sydney Six) Q2/17 $71,000,000 $1, %* Leda Holdings Bourke Road, Alexandria** Q2/17 $13,400,000 $3, % Undisclosed 69 Sargents Road, Minchinbury Q1/17 $161,000,000 $1, % LOGOS and Ivanhoe Cambridge 36 Gow Street, Padstow Q1/17 $30,175,000 $1, % Mirvac Property Group 43 Newton Road, Wetherill Park Q4/16 $16,667,500 $1, % Fabcot Holdings Pty Ltd O Riordan Street, Alexandria Q4/16 $14,500,000 $3, % San Tiea Investment Australia Pty Ltd Bowden Street, Alexandria Q3/16 $7,450,000 $3, % Krumpet No 10 Pty Ltd McCauley Street, Alexandria Q3/16 $5,308,888 $2, % Private Investor Green Street, Banksmeadow Q3/16 $12,600,000 $2, % Private Investor 6A Wonderland Drive, Eastern Creek Q3/16 $8,600,000 $1, % Private Investor 1 Huntingwood Drive, Huntingwood Q3/16 $31,500,000 $1, % GPT Land Sales Qtr Price Site Area Land rate/m 2 Purchaser 36 Huntingwood Drive, Huntingwood Q1/17 $29,762,250 56,690 $525 Charter Hall Victoria Street, Wetherill Park Q4/16 $10,300,000 35,100 $293*** Private Developer Hollingsworth Road, Marsden Park Q4/16 $40,000,000 ~210,000 $190 LOGOS Property Group Augusta Street, Huntingwood East Q3/16 $68,000, ,600 $315 Lesso Mall Developments 727 The Horsley Drive, Smithfield Q3/16 $4,250,000 8,048 $528 Private Developer NA Not available. *Initial yield. **Exchanged, awaiting settlement. ***Excluding $50-$70 servicing Harcourt Business Park, Botany Road, Alexandria m3commentary Autumn 2017 P10

11 OUTLOOK SYDNEY INDUSTRIAL Sydney s industrial property market is expected to continue to be positive over the short term. Growth is likely to largely be driven by the high volume of export and import sales. Retail trade growth continued to reduce and is likely to slow demand for storage and distribution space in the medium term. Supply of industrial stock increased over the year to March Supply mainly relies on owners obtaining pre-commitments, although speculation has increased in some locations. This has largely been matched by demand prior to completion, however, it has resulted in a rise in available backfill space. Supply is set to continue at solid levels in the short term with approval of industrial space remaining high over the year to March Demand for industrial property should continue to be positive over the short term. In particular the merchandise trade, construction and logistics sectors are likely to drive growth in demand for processing, distribution and storage facilities within Sydney. While expected to remain subdued, in line with historical averages, rental growth should improve slightly over the short term, in selected submarkets particularly for prime assets. Investment market activity is expected to be moderate over the short term with many landlords looking to hold assets. There is scope for investment yields to tighten by up to 25 basis points on selected assets across the Sydney submarkets over the next 6-12 months. This represents a slowdown compared to recent years. KEY INDUSTRIAL VALUATION CONTACTS James Farrugia Director NSW (02) Joel Ducey Associate Director NSW (02) John Rasaku Senior Valuer NSW (02) Gary Longden Director VIC (03) m3property provides national coverage in all States and Territories. info@m3property.com.au Basil Simitci Director QLD (07) Neil Bradford Director SA (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.