Sydney CBD Investment Market Review and 2013 Outlook

Sydney CBD Investment Market Review and 2013 Outlook

Introduction and 2012 review Investment in the Sydney CBD reached $4.29Bn in 2012, the highest level on record (since JLL began recording in 1988) and significantly above the $2.0Bn of sales in 2011. This number was inflated by the $2Bn of capital commitment to International Towers Sydney at Barangaroo South as well as the deals recorded as part of the de-listing of CQO. Outside of these transactions interest in Sydney was from offshore groups and the return of Super Funds and A-REITs. These record investment volumes were set against the background of the first year of negative net absorption since 2009. In a year with no new supply entering, negative net absorption had a negligible impact on vacancy. Nonetheless, landlords reacted to this weakening tenant demand by providing competitive proposals to retain existing tenants. Throughout the report we will cover the major themes of the Sydney CBD in 2012, including: Rising Investment levels and a number of sub 7% deals Tenants centralising offsetting weak demand Although economic growth for both Australia and NSW will be below trend in 2013 we expect capital markets to drive yield compression for prime grade assets in Sydney. The main themes we will cover for the Sydney CBD in 2013 are: Continued dichotomy between the investment and physical markets Scarcity of prime product and why buyers will have to move faster Pricing metrics in the Western Corridor Tenants Centralising in the CBD Despite the global economic concerns that weighed heavily on tenant demand in 2012, Sydney CBD vacancy held steady. Headline vacancy reached 8.4% in Q4/2012, relatively unchanged from the 8.5% vacancy recorded 12 months earlier. Downsizing in the financial sector was counter-balanced by an increase in tenants centralising their business operations in the CBD from non-cbd locations and a reduction in total stock (due to building withdrawals). There were seven major tenant moves from non-cbd markets into the CBD in 2012. It appears that businesses are taking advantage of attractive rental incentives to relocate to the CBD. Centralisation accounted for a total of 23,500 sqm in gross take-up in 2012. 2 Jones Lang LaSalle

Tower Australia Limited moved their head office from 80 Alfred Street, North Sydney to 363 George Street in June (10,500 sqm). British American Tobacco relocated several office functions to 405 Sussex Street (3,200 sqm) after moving out of their owner-occupied combined production and office space at Eastgardens in January. Adobe Systems centralised from Chatswood, sub-leasing 2,800 sqm at Darling Park Tower 2, 201 Sussex Street. And the Australian Institute of Management relocated from North Sydney, taking 2,700 sqm at 7 Macquarie Place in December. In 2012, the Professional Services sector and the Education sector drove positive net absorption. Major leasing deals by Tower Australia Limited, Atlassian, Middletons Lawyers and Adobe Systems pushed Professional Services net absorption to 10,800 sqm, while numerous small deals from educational organisations including Australian Institute of Management, Academies Australasia and University of Sydney Business School boosted absorption by the Education sector to 10,200 sqm for the year. Chart 1: Market Balance Sydney CBD Office Square Metres ('000s) 200 150 100 50-50 100 * as at Q4/2011 Jones Lang LaSalle Research Total Vacancy Rate 07 09 10 11 12 13* 14* Completed Net Absorption Under Construction Vacancy Rate [RHS] 12% 10% 8% 6% 4% 2% 0% Sydney CBD Investment Market Review and 2013 Outlook 3

Table 1: Offshore Purchases in 2012 Asset Date Price (AUD) Millions Buyer Country International Towers 2 & 3 3Q12 1,000.0 Lend Lease CPPIB Canada 2 Park Street 2Q12 306.0 Charter Hall REIT GIC/PSP Singapore/Canada 1 Martin Place 2Q12 191.2 Charter Hall REIT GIC/PSP Singapore/Canada 2 Market Street 2Q12 145.3 Charter Hall REIT GIC/PSP Singapore/Canada 6 O Connell Street 3Q12 105.1 Colonial MGPA Singapore 59 Goulburn Street 2Q12 75.2 Charter Hall REIT GIC/PSP Singapore/Canada 10 Barrack Street 4Q12 62.5 BlackRock Property Trust Bright Ruby Singapore 333 Kent Street 1Q12 47.7 AMB Property Maville Group China 149 Castlereagh Street 1Q12 40.6 Record Realty Trust Blackstone Funds Mgmt USA 40 King Street 3Q12 7.2 Margarethe Holdings Pty Ltd Torallo New Zealand Offshore Investment Reaches the Highest Level on Record Australia s market transparency, stable GDP growth and high yielding property market have been a major drawcard for cross-border capital into Australia over the last few years. Offshore sovereign wealth funds, international investment trusts and global pension funds are all active within the commercial property sector. Since 2010, the Sydney CBD has accounted for 47% of all offshore investment into Australia, totalling AUD 4.1 billion. Previous perceived barriers to offshore investment, such as the high Australian dollar and the 2012 tax increase on returns paid to overseas investors of managed investment trusts, have not stifled investment inflows. In fact, offshore investment has been building over the last three years. Since 2010, offshore investment volumes in Sydney have averaged AUD 1.36 billion annually, compared to the AUD 48.6 million averaged through 2008-2009 when cross-border investors were focused more on the Canberra and Melbourne CBD markets. Singaporean and Korean funds were the early movers throughout 2010 and 2011 with National Pension Service of Korea (NPS) and Keppel REIT Asia making forays into the Sydney CBD investment sphere. However in 2012, it was Canadian pension funds, along with Singaporean sovereign fund, Government of Singapore Investment Corporation (GIC) that that led global capital coming into the city. The Canada Pension Plan Investment Board (CPPIB) invested AUD 1.0 billion into the first two stages of the International Towers Sydney at Barangaroo South, while the Public Sector Pension Investment Board (PSP) invested an estimated AUD 358.9 million as Charter Hall privatised their Charter Hall Office REIT (CQO) in April. This investment entitled the fund Chart 2: Domestic and offshore Investment Sydney CBD AUD (Billion) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 2008 2009 2010 2011 2012 Domestic Investors Offshore Investment Source: Jones Lang LaSalle Research (as at Q4/2012) to a 42.5% share of four Sydney CBD office towers. This investment was matched by GIC who also invested AUD 358.9 million for another 42.5%. Investment Levels Rise with the Return of Wealth Funds Investment in the Sydney CBD office market reached AUD 4.3 billion in 2012, anchored by the AUD 2.0 billion investment in the International Towers Sydney project at Barangaraoo. This was a significant increase in transaction volumes recorded in 2011 (AUD 2.0 billion), boosted by the continuation of superannuation and sovereign wealth funds readjusting their portfolio allocations back into direct property. Throughout the Global Financial Crisis, superannuation and sovereign wealth funds were inactive as both buyers and sellers in Sydney. However, since 2010, there has been a re-emergence of both domestic and offshore funds in the investment sphere, hunting for yield and stability against a 4 Jones Lang LaSalle

more volatile equities market and the lowering of cash rates. Over the past three years, superannuation funds have invested more in Sydney commercial property than any other investor category, accounting for 28% of total, or AUD 2.4 billion. In 2012, superannuation funds accounted for 38.8% of annual sales volume, totalling AUD 1.7 billion. Along with the aforementioned Canada Pension Plan Investment Board (CPPB) AUD 1.0 billion investment in the International Towers Sydney 2 & 3 at Barangaroo and the Public Sector Pension Investment Board (PSP) investment in the Charter Hall CQO portfolio, many other funds were active in 2012. Two domestic super funds, Telstra Super and First State Super Further invested a further AUD 250.0 into International Towers Sydney 2 & 3 at Barangaroo, acquiring AUD 125.0 million each. While the higher education and research superannuation fund, Unisuper paid AUD 55.0 million for the remaining half share of Stockland s 7 Macquarie Place from in April. Investor Appetite In a year of financial sector downsizing and general weakening of tenant demand, prime yields in the Sydney CBD held firm. Investor appetite for modern, prime-grade office buildings saw a total of 17 assets transact over the course of the year. While the number of transactions was down from the 22 recorded in 2011, the value of the transactions recorded was up 116%, reflecting the improved quality of stock put to market. In 2012, six assets transacted with sub-7.0% equivalent yields. Investa Property Group s internal transfer of ownership of a 25% share of Deutsche Bank Place, 126 Phillip Street to Investa Commercial Property Fund (ICPF) and Investa Office Fund (IOF) in March 2012 sold on an equivalent yield of 6.35%. While in December, DEXUS purchased a 25% share of Grosvenor Place at 225 George Street from Colonial s Direct Property Investment Fund for AUD 271.2 million on an equivalent yield of 6.50%. An estimated equivalent yield of 6.20% recorded for Allianz Centre at 2 Market Street which was sold as part of the privatisation of Charter Hall Office REIT (CQO) to GIC, Public Sector Pension Investment Board (PSP) and Charter Hall Group. Also included in the assets privatised by Charter Hall REIT were 50% of 2 Park Street and 50% of 1 Martin Place which sold on estimated equivalent yields of 6.80% and 6.70%. While the Sydney CBD prime yield band remained unchanged in 2012 at between 6.25% and 7.50%, there has been a marked increase in assets transacting toward the tighter end of the yield range as increased competition between potential buyers and favourable real estate fundamentals attract more global capital into Sydney. Chart 3: Investor Types 2012 & 2011-11 Sydney CBD Unlisted Property Trust Other Syndicates Superannuation Funds State Government Private Companies & Investors Listed Property Trust Institution Government Finance Companies Developers/ Property Companies Corporates 0% 5% 10% 15% 20% 25% 30% 35% 40% 2010-2011(% of Investment) 2012 (% of Investment) Source: Jones Lang LaSalle Research (as at Q4/2012) Chart 4: Transaction Totals in 2012 National Office AUD (Billion) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 Sydney Brisbane Melbourne Perth Adelaide Source: Jones Lang LaSalle Research (as at Q4/2012) Sydney CBD Investment Market Review and 2013 Outlook 5

Themes for Sydney CBD in 2013 Where will product come from? Paul Noonan, Head of Sales and Investments, NSW Investors seeking product in the Sydney CBD will have a variety of sources in 2013. Whilst off market approaches will continue, the major sources of on market campaigns in the Sydney CBD in 2013 will come from: Fixed term funds expiring. This will include: PIF (AMP), PPS (Colonial) and, DPIF (Colonial) which has almost wound up with only 25% in 207 Kent St remaining in Sydney. Offshore groups who engaged in opportunistic buying in 2008 / 2009 that can hit their return hurdles. These hurdles will be met due to both currency appreciation against the Euro and USD, and capital growth since purchase. Continuation of mergers and acquisitions resulting in new owners divesting out of non core product. This was evidenced in 2012 with asset recycling by CHOT and could potentially continue with any entity level deal involving Australand. The dichotomy between the investment market and physical market Rob Sewell, Head of Office Investments, Australia Historically, property yields are very sensitive to movements in vacancy rates. The path to tightening yields in a property market recovery is typically led by an improving leasing market. The -15,400 sqm of net absorption in Sydney in 2012 has resulted in incentives remaining elevated and minimal rental growth. The normal route to yield compression in 2013 is unlikely to be taken. Pricing tension and ultimately yield compression will be a function of global investment market conditions and credit markets. Specific factors include: Low interest rates. Global search for yield Sydney prime-grade yields are significantly higher than other gateway cities Current REIT business conditions means many groups are in acquisition mode (low WACC, funds repatriated to Australia from overseas, post GFC restructuring is complete) Large volume of passive capital (A-REITS; offshore; unlisted funds and super funds) with limited product availability. New buildings aren t for sale Simon Storry, Head of International Investments, Australia Sydney is Australia s largest and oldest office market, approximately 50% of Sydney CBD stock is more than 30 years old. The appetite for product in Sydney as Australia s most desired office location is intensified for new buildings. Sydney will experience extreme competitive tension for any new or pre lease assets should they become available. Most of the planned or known development opportunities are already tied up in capital partnerships prior to completion. These 6 Jones Lang LaSalle

include: 8 Chifley Square with Keppel REIT, 161 Castlereagh St; GPT, LIM and ISPT, Mirvac and AMP at 190-200 George Street, CBus and CPA at 5 Martin Place. The opportunities to invest in a new building that will be via a market process are extremely limited for the Sydney market. Western Fringe Opportunities How are they priced? Ben Schubert, Director, Sales and Investments, NSW Barangaroo s longer term effect on the Western Corridor is accepted as being positive. However, there remains a distinct disconnect between what level of premium is required for vendors to transact. Most vendors are commenting that they want to receive the future upside themselves instead of receiving a premium for the building today. Purchasers are prepared to pay a premium however they are still falling short of vendor expectations. The key metrics where purchasers are unable to meet vendors expectations in our experience are; Market Rent estimates for buildings similar to the as yet to be confirmed Barangaroo Central style buildings, Market Rent Growth in years 2-4, Incentive rates applied on single tenant expiries in years 2-4 as distinct from the broader Sydney CBD market. Even if buyers are able to bridge this price premium to vendor expectations it remains to be seen if A-REIT owners are willing to part with assets with upside potential. Buyers will move faster this year Ben Hunter, Director, International Investments, Australia 2012 on market campaigns were characterised with longer times to reach an agreement on price. By year end 2012 we experienced buyers displaying a greater sense of urgency in campaigns, particularly on prime opportunities. We expect this to be a continuing trend in 2013. The competition for prime stock and the volume of capital some buyers have to place will lead to buyers responding faster than year end 2012. This could lead to some offshore groups running into resourcing issues if there is a large volume of product available nationally. Where have all the privates gone? James Aroney, Director, Sales and Investments, NSW Privates accounted for 1.4% of purchases in the Sydney CBD in 2012 and 0.0% in 2011 compared with 11.6% in 2010. This situation will develop further in 2013 for multiple reasons: Private buyers prefer higher yielding assets in suburban markets Whilst private investors desire repositioning plays in the Sydney CBD if they require finance and have significant leasing risk, banks are reluctant to lend at competitive rates. Additionally, A-REITs are seeing the potential for medium term value gain from secondary repositioning in this point of the cycle. The competition from this investor group is pricing private investors out of the market. There will be minimal participation from traditional retail investor syndicate deals, however club style investors will continue to operate on smaller core opportunities. Private investors will only participate on select high yielding Sydney CBD opportunities. Sydney CBD Investment Market Review and 2013 Outlook 7

Property transactions 2012 Sydney CBD Grosvenor Place, 225 George Street, Sydney (25%) Price $271,250,000 Date of sale December 2012 Initial Yield 5.64% Equivalent Yield 6.46% 11,859 sqm (approx.) Site Area 85,343 sqm Rate per sqm $12,713 (approx.) Purchaser DEXUS Property Group Colonial First State (DPIF) Purchased off market as part of a portfolio of assets acquired by DEXUS Property Group in December 2012 from the Direct Property Investment Fund (DPIF). Upon Settlement in March 2013, the property will be circa 14.5% vacant with a WALE of 5.45 years. Deloitte Services who occupy 33% of the buildings have recently renewed their lease to expire in 2023. Ashurst occupy some 16% of the and will be vacating in March 2015. 39 Martin Place, Sydney Price $143,000,000 Date of sale December 2012 Initial Yield 4.98% Equivalent Yield 7.46% 16,341 sqm (approx.) Site Area 1,884 sqm Rate per sqm $8,751 (approx.) Purchaser DEXUS Property Group & DEXUS Wholesale Property Fund (50% each) Colonial First State (DPIF) Purchased off market as part of a portfolio of assets acquired by Dexus Property Group in December 2012 from the Direct Property Investment Fund (DPIF). The property will settle in March 2013 with a vacancy of 4,417sqm (27% of ) and will have a WALE of 4.07 years. Dexus acquired the Martin Place Shopping Circle for a separate amount as part of the deal. 9 Hunter Street, Sydney Price $79,259,092 Date of sale December 2012 Initial Yield 6.84% Equivalent Yield 8.64% 15,623 sqm (approx.) Site Area 1,662 sqm Rate per sqm $4,625 (approx.) Purchaser CorVal Partners Colonial First State (DPIF & OSF) 9 Hunter Street is part of a freehold stratum that sits above the Hunter Connection retail complex. At the time of sale the property was approximately 9% vacant with a WALE of under 4 years. We understand there to be approximately $7.25m of outstanding incentives, which the purchaser is responsible for. 10 Barrack Street, Sydney Price $62,500,000 Date of sale December 2012 Initial Yield 8.05% Equivalent Yield 7.74% Total 9,540/sqm (approx.) Site Area 1,040/sqm Rate per sqm $6,551 (approx.) Purchaser Glory Property Investment Pty Ltd Blackrock Investment Management The major tenant is Credit Corp Group who occupy 28% of the building. The property has a major exposure in 2015 with 7 tenants expiring for 43% of the building by. 8 Jones Lang LaSalle

107 Pitt Street, Sydney Price $23,600,000 Date of sale December 2012 Initial Yield 7.75% Equivalent Yield 7.65% Total 3,172/sqm (approx.) Site Area 500/sqm Rate per sqm $7,441 (approx.) Purchaser AM Property Plus Blackrock Investment Management At the time of the sale, the property was 100% leased and had a weighted average lease term (WALT) of 3.74 years by income. Major tenant s include Radar Group and Jamie s Italian occupying some 18%, 13% of net lettable area () respectively. 175 Castlereagh, Street, Sydney Price $56,000,000 Date of sale November 2012 Initial Yield 10.02% 11,859 sqm (approx.) Site Area 1,302 sqm Rate per sqm $4,722 (approx.) Purchaser Centuria Stockland Group The property was approximately 7.40% vacant at the time of sale with a WALE of 3 years. This building is in the immediate vicinity of the soon to be completed 161 Castlereagh Street development. 6-10 O Connell Street, Sydney Price $105,100,000 Date of sale September 2012 Initial Yield 8.00% 16,286 sqm (approx.) Site Area 1,767 sqm Rate per sqm $6,454 (approx.) Purchaser MGPA Colonial First State (PPS) Sold via an EOI campaign to an offshore purchaser, the building was approximately 93% occupied at the time of sale. This was the purchasers first acquisition in Sydney. 50 Carrington Street, Sydney Price $58,500,000 Date of sale August 2012 Initial Yield 4.94% 11,291 sqm (approx.) Site Area 980 sqm Rate per sqm $5,181 (approx.) Purchaser DEXUS Property Group Retail Employees Superannuation Trust (REST) 50 Carrington was sold under EOI and at the time of sale had a substantial 35% vacancy. The purchaser is in the process of refurbishing the existing vacant space, along with the ground floor lobby area. Sydney CBD Investment Market Review and 2013 Outlook 9

Property transactions 2012 Sydney CBD International Towers Sydney Barangaroo South, Hickson Road, Sydney Price $2,000,000,000 Date of sale July 2012 16,286 sqm (approx.) Purchaser Canada Pensions Plan Investment Board/Lend Lease Group/ Australian Prime Property Fund/ Telstra Super/ First State Super Lend Lease International Towers consists of three new commercial office towers in the Barangaroo South Precinct. Recently named International Towers Sydney, Tower 3 (82,168sqm) is to become Westpac Bank s new headquarters, while Tower 2 (93,515sqm) is to be occupied by KPMG and Lend Lease. The largest of the three towers, Tower 1 (109,748sqm) is currently available for lease. Towers 2 and 3 are expected to complete in 2015, followed by Tower 1 in 2017. Please note this investment amount is only in towers 2 & 3. Wharf 10, 50-52 Pirrama Road, Pyrmont Price $31,800,000 Date of sale July 2012 Initial Yield 8.60% 7,014 sqm (approx.) Site Area 4,346 sqm Rate per sqm $7,316 (approx.) Purchaser Abacus Property Group and Heitman JV Charter Hall and Private Syndicate The purchaser is Abacas in partnership with Heitman as a joint venture. Leasehold interest with 94 years remaining. 60 Clarence Street, Sydney Price $14,250,000 Date of sale July 2012 Initial Yield 6.57% 1,846/sqm (approx.) Site Area 364/sqm Rate per sqm $7,719 (approx.) Purchaser Karen Loblay (Private Investor) Rex Harbor (Private Investor) 48 Martin Place, Sydney Price $134,000,000 Date of sale April 2012 Initial Yield undisclosed 19,105 sqm (approx.) Site Area 2,719 sqm Rate per sqm $7,014 (approx.) Purchaser Macquarie Group Commonwealth Bank 7 Macquarie Place, Sydney (50%) Price $55,000,000 Date of sale April 2012 Yield 7.95% Initial Yield 7.25% 13,582 sqm (approx.) Site Area 1,459 sqm Rate per sqm $8,099 (approx.) Purchaser UniSuper Stockland Property Group The property was sold through preemptive rights to the existing joint owner, Unisuper. The property is 98% occupied with a WALE of 2.41 years with approximately 70% of the building becoming vacant in the next 3 years. Direct deal competed between Macquarie Group and the Commonwealth Bank. Macquarie Plans to refurbish the building and to occupy it from the expiry of their existing lease at 1 Martin Place. 10 Jones Lang LaSalle

333 Kent Street, Sydney Price $47,750,000 Date of sale March 2012 Initial Yield 8.52% Equivalent Yield 8.38% 8,938 sqm (approx.) Site Area 1,518 sqm Rate per sqm $5,342 (approx.) Purchaser Maville Group Australia Pty Limited AMB Property (All Saints) Pty Limited The property is fully leased to Central Queensland University (CQU) with an expiry date of April 2017. We note that a lease variation was recently executed removing the break clause within the head lease. The building s WALE is now approximately 5.16 years by income. 161 Clarence Street, Sydney Price $28,000,000 Date of sale March 2012 Initial Yield - 5,645 sqm (approx.) Site Area 1,441 sqm Rate per sqm $4,960 (approx.) Purchaser Crown International Brookfield Multiplex 9-19 Elizabeth Street, Sydney Price $16,000,000 Date of sale April 2012 Yield unknown 7,014 sqm (approx.) Site Area 472 sqm Rate per sqm $4,344 (approx.) Purchaser Macquarie Group Commonwealth Bank Direct deal competed between Macquarie group and the Commonwealth Bank. This building formed part of the 48 Martin Place sale. Deustche Bank Place, 126 Phillip Street, Sydney (50%) Price $176,250,000 Date of sale February 2012 Initial Yield 6.17% Equivalent Yield 6.35% 42,256 sqm (approx.) Site Area 3,936 sqm Rate per sqm $16,684 (approx.) Purchaser Investa Commercial Property Fund/Investa Office Fund Investa Property Group In a related party transaction the Investa Property Group sold 50% of it s stake in 126 Phillip Street in two parts to two different arms of Investa. The Investa Office Fund proposed to acquire 50% of the property, however the pre-emptive rights of ICPF were exercised to acquire 25%. IOF simultaneously acquired a 50% interest in 242 Exhibition Street, Melbourne. This was the first acquisition by IOF since change of responsible entity from ING to Investa. 149 Castlereagh Street, Sydney Price $40,600,000 Date of sale March 2012 Initial Yield - 13,056 sqm (approx.) Site Area 1,325 sqm Rate per sqm $3,110 (approx.) Purchaser Blackstone Funds Management Ernst and Young (as Receivers and Managers) The property was sold with only a single retail tenant of approximately 103sqm fronting Castlereagh Street. The office component is 100% vacant. The incoming owner intends to spend significant capital to alter services, street level entry and retail configuration and re-brand the building. Since the time of sale the new owners have changed the street address of the office component to 151 Castlereagh Street. Sydney CBD Investment Market Review and 2013 Outlook 11

Contacts For more information, please contact the following: Paul Noonan Head of Sales and Investments, NSW tel + 61 2 9220 8347 paul.noonan@ap.jll.com James Aroney Director, Sales and Investments, NSW tel +61 2 9220 8591 james.aroney@ap.jll.com Ben Schubert Director, Sales and Investments, NSW tel +61 2 9220 8337 ben.schubert@ap.jll.com Rob Sewell Head of Office Investments Australia tel + 61 9220 8315 rob.sewell@ap.jll.com Simon Storry Head of International Investments Australia tel +61 2 9220 8439 simon.storry@ap.jll.com Ben Hunter Director, International Investments Australia tel +61 2 9220 8769 ben.hunter@ap.jll.com www.joneslanglasalle.com.au COPYRIGHT JONES LANG LASALLE 2013 All rights reserved.