RESEARCH

ADELAIDE OFFICE MARKET OVERVIEW AUGUST 2017

HIGHLIGHTS Average Prime incentives in the Offshore purchasers are having an Owners of secondary buildings CBD Core now average 36.3% and increasingly larger role within the face growing impetus to reposition typically range between 35% to market, accounting for all their assets through refurbishment 40%, compared with 30% to 35% prime grade transactions that have and upgrades in order to maintain in the second half of 2016. settled in the year to date. relevance in the leasing market.

KEY FINDINGS SUPPLY & DEVELOPMENT New office supply is anticipated to be minimal until late CBD prime yields firmed by 10 2019, providing the opportunity for the market to basis points from an average of 7.23% to 7.13%, while secondary absorb existing stock. yields remained unchanged at Gross supply for the Adelaide CBD completed in December 2016, is 8.50% totalled just 5,227m² in the six months to marketing some 2,500m² following the July 2017, approximately 62% below the initial 38% pre-commitment from Year to date investment volumes 25 year average. The next significant accounting group Grant Thornton. stand at approximately $240 source of supply will be in Q3 2019, with Elsewhere, the 23 level speculatively built million, headlined by the sale of 45 Pirie Street and the MAC the expected completion of Charter Hall’s 115 King William Street (6,775m²), which Portfolio. Sales volumes totalled 21 level GPO Exchange development was completed in October 2016, is being $545.3 million at the same last (25,000m²) located at 2-10 Franklin offered to tenants as co-working space year. Street. Construction is expected to and is also seeking tenants to fill commence in Q3 this year following a remaining vacancies. Average prime incentives in the 49% tenant pre-commitment from the SA CBD Core increased from 34.8% Attorney General’s Department. The Future projects include the new head to 36.3% over the previous six development will provide floor plates of quarters for hospitality training school Le months and now typically range circa 1,480m², incorporating the existing Cordon Bleu at 200 North Terrace, which between 35% to 40%. heritage component on the lower levels. has recently been revived. This is Tenant’s flight to quality has proposed to be a 19 storey mixed use placed pressure on secondary With the exception of 2-10 Franklin tower (26,000m²) above the existing buildings, highlighted by prime net Street, there are no other significant heritage listed building. Walker absorption of 6,138m² and office developments or refurbishments Corporation’s Festival Plaza development secondary net absorption of under construction in the Adelaide CBD (40,000m²) has no firm starting date. -1,514m² in the six months to July as the market absorbs existing stock and 2017. attempts to reign in the vacancy level. FIGURE 1 Smaller office supply will arise from Adelaide Gross Supply Additions CBD Office (000’s m²) Uniting Communities’ 19 storey mixed

use development located on Pitt Street, 60 offering retail, office (6,600m²), retirement Projection

living and disability respite 50 accommodation. Construction is expected to be completed in Q3 2018, 40 with 66% of the office space to be owner Update 30 occupied by Uniting Communities and

the remainder (4,350m²) seeking tenant 20 commitment. Additionally, 74 Pirie Street (1,500m²), a 7 storey building being 10

refurbished by Maras Group is expected 0 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 HENRY MATHEWS to commence construction shortly and be completed by circa Q3 2018. Research SA CBD GROSS SUPPLY 6 MONTHS TO... ('000m²) 25 YEAR AVERAGE The four level 170 Frome Street (3,900m²) Source: Knight Frank Research/PCA

TABLE 1

Total Vacancy Annual Net Annual Net Average Gross Average Average Core Grade Market Stock (m²) Rate (%) Absorption Additions Face Rent ($/ Incentive Market Yield

Prime CBD 594,887 13.8 5,195 3,800 503 34.9 6.75—8.00 Fringe 39,297 7.8 -260 2,000 442 20.0 7.25—8.00 Secondary CBD 829,546 17.8 821 17,711 371 34.1 8.00—9.25 Fringe 176,553 10.6 2,305 -1,559 345 20.0 8.00—8.50 Total Precinct CBD 1,424,433 16.1 6,016 21,511 Fringe 215,850 10.1 2,045 441 Total Market Adelaide 1,640,283 15.3 8,061 21,952 Source: Knight Frank Research/PCA NB. CBD includes the Core & the Frame precincts

2 ADELAIDE OFFICE MARKET AUGUST 2017 RESEARCH

MAJOR OFFICE SUPPLY

115 King William Street - 6,775m² 1 Local Private Developer - October 2016 - 15% committed

170 Frome Street - 3,900m² [Grant Thornton] 2 Emmett Properties - December 2016 - 38% committed 2

74 Pirie Street # - 1,500m² 3 Maras Group - Q2 2018 12

Pitt Street* - 6,600m² 4 Uniting Communities - Q3 2018 - 66% owner occupied 10 GPO Exchange, 2-10 Franklin Street - 25,000m² [SA Govt] 7 5 Charter Hall - Q3 2019 - 49% committed 13 3 Festival Plaza / Riverbank Precinct - 40,000m² 6 Walker Corp / SA Government - 2020 9

200 North Terrace - 26,000m² [Le Cordon Bleu] 7 8 Commercial & General - H2 2020 - N/A 1 6 5 8 Echelon, 322 King William Street^ - 12,482m² Karidis - 2020 Riverbank 4 Precinct 11 Gawler Chambers, 186-190 North Terrace - 5,500m² 9 Adelaide Development Company - 2020+

102-120 Wakefield Street - 16,500m² 10 Kyren Group - 2020+

42-56 Franklin Street - 21,000m² 11 Kyren Group - 2020+

185 Pirie Street - 6,000m² 12 Palumbo - 2020+

57-61 Wyatt Street - 4,180m² 13 Private - 2020+

Worldpark (Stage B & C) - Richmond Road, Keswick - 22,600m² 14 Axiom - 2020+ Worldpark, Source of Map: Property Council 14 Keswick

Under Construction / Complete NB. Dates are Knight Frank Research estimates Major tenant pre-commitment in [brackets] next to NLA DA Approved / Confirmed # Refurbishment

Mooted / Early Feasibility * Mixed use development comprising retirement living, respite accommodation, retail and office

^ Mixed use development comprising residential, hotel, retail and office 15

3

TENANT DEMAND & RENTS

Vacancy privately and has seen minimal capital FIGURE 3 upgrades from owners conscious of the Adelaide CBD Net Absorption (‘000m² LHS) vs Total Vacancy Rate (% RHS) The headline vacancy rate in the Adelaide bottom line and in a more difficult

CBD was largely unchanged in the six position to access funding for upgrades. Further complicating this is the lack of 50 18 months to July 2017, decreasing from 16 conversion demand more readily seen in 40 16.2% to 16.1% and remaining above the 14 markets such as Sydney and Melbourne 10 year average of 9.9%. 30 12 to reposition assets for residential and 10 20 hotel use. The lower cost of development 8 In the six months to July 2017, Prime 6 sites and construction in Adelaide limits 10 CBD vacancy decreased from 14.9% to 4 13.8% (see Table 2), with a decrease in feasibility, leaving some buildings both 0 2 unattractive to potential office tenants 0 total vacant prime stock from 88,390m² -10 and for conversion. -2 to 82,252m². Over the same six month -20 -4 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 period, vacancy in CBD secondary grade space increased from 17.2% to 17.8%, Net Absorption an increase in total vacant stock from NET ABSORPTION 6 MTHS TO…('000m²) LHS 142,469m² to 147,543m². With the The Adelaide CBD recorded positive net CBD TOTAL VACANCY - RHS (%) Adelaide market particularly reliant on the absorption of 4,624m² in the six months Source: Knight Frank Research/PCA movement of existing tenants, the to July 2017 and 6,016m² over the attractive incentives on offer and previous 12 month period. Highlighting population growth and rising electricity efficiency gains from higher quality space the flight to quality occurring within the costs. has seen a multitude of tenants upgrade market, prime stock recorded absorption from secondary to prime space. of 6,138m² over the previous six months, White collar employment growth in the while secondary stock experienced CBD has continued to remain slow after The Adelaide CBD contains a notable negative net absorption of -1,514m². recording an increase of 0.7% over the proportion of ageing C and D grade office previous financial year. By sector, space, accounting for 30.6% of total economy has seen increases in ‘Administrative and Support stock. This is coupled with one of the positives arising from high retail sales, a Services’ and ‘Health Care and Social lowest proportions of Premium and A strengthening tourism industry and an Assistance’ were offset by decreases in grade stock in , accounting for increase in defence spending as a result ‘Public Administration and Safety’ and 41.8%. While high vacancy in secondary of the $50 billion Federal Government ‘Professional, Scientific and Technical stock has been a factor for some time, submarine contract. Despite these Services’. White collar employment is there is a growing impetus for landlords positives, the South Australian forecast to increase marginally over the to refurbish to remain competitive, unemployment rate stands at 6.2% as at next financial year with the expectation of illustrated by the divergence in vacancy July 2017, one of the highest in the annual growth of approximately 1.1% in rates shown in Figure 2. Much of nation, and the state continues to face 2018/19, maintaining a similar level over Adelaide’s C and D grade stock is held challenges in regards to sluggish the subsequent 2-3 year period.

FIGURE 2 TABLE 2 TABLE 3 Adelaide CBD Vacancy Rates Adelaide CBD Vacancy Rates (%) Vacancy Rates (%) Prime vs. Secondary Grade (%) Jul Jan Jul Jul Jan Jul 20.0% Grade Grade 2016 2017 2017 2016 2017 2017 18.0% 16.0% Premium 8.3 8.3 10.2 Premium - - 14.0%

12.0% A Grade 15.9 15.4 14.1 A Grade 2.1 4.7 7.8 10.0% Prime 15.4 14.9 13.8 Prime 2.1 4.7 7.8 8.0%

6.0% B Grade 14.2 15.6 16.7 B Grade 7.6 16.9 12.8 4.0% C Grade 16.8 18.1 18.4 C Grade 12.8 11.4 10.0 2.0% D Grade 21.5 7.4 7.4 0.0% D Grade 20.0 20.2 19.5 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Secondary 16.2 17.2 17.8 Secondary 11.9 12.6 10.6 PRIME SECONDARY Total 15.8 16.2 16.1 Total 10.2 11.3 10.1 PRIME 10 YR AVERAGE SECONDARY 10 YR AVERAGE

Source: Knight Frank Research/PCA Source: Knight Frank Research/PCA Source: Knight Frank Research/PCA

4 ADELAIDE OFFICE MARKET AUGUST 2017 RESEARCH

Tenant Demand Rental Levels to $371/m² and incentives increase from 33.3% to 34.1% over the previous six Noteworthy tenant requirements in the Increases in incentives and unchanged or months. As a result, gross effective rents market include the SA State Government, reduced gross face rents has resulted in decreased from $254/m² to $245/m². BHP and Suncorp. The SA State a further reduction in effective rents in the Government’s requirement was for office CBD (Figure 4 and 5). The reduction in face rents in the accommodation in the Adelaide CBD secondary market is a result of both Core or Frame and closed on the 30th of Average prime CBD gross face rents strong competition among landlords and June. This was a call to seek either new remained unchanged at $503/m² in the building ownership being largely privately or refurbished space, with one six months to July 2017, while incentives owned. The prevalence of private requirement for approximately increased from 32.5% to 34.9%. As a ownership results in reduced capacity to 9,000m² - 12,000m² from late 2019, and result, gross effective rents decreased pay out up front capital incentives, the second for between 13,000m² - from $339/m² to $328/m². Notably, instead decreasing face rents to remain 16,000m² from late 2020. It’s understood incentives in the Core now average attractive to tenants. the SA State Government, BHP and 36.3% and typically range between 35% Suncorp’s options are currently in to 40%, compared with 30% to 35% in In the Fringe, prime and secondary gross deliberation. the second half of 2016. face rents were unchanged at $442/m² and $345/m² respectively. Major tenant movements over the In the secondary market, the impact of Incentives were also unchanged, previous six months include Great the flight to quality has seen average standing at approximately 20% for both Southern Rail relocating from a Fringe gross face rents decrease from $381/m² grades. location to 233 North Terrace, taking up 1,234m² for a 5 year term. First Mortgage FIGURE 4 FIGURE 5 Services has also relocated, shifting from Adelaide CBD Gross Effective Rent Adelaide CBD Prime Incentives vs. the Frame to a Core location after Growth Gross Effective Rents Prime vs. Secondary Grade (%) p.a. 2007 - 2017 ($/m² LHS, % RHS) committing to a 5 year term at 115 Grenfell Street. 20.00% 500 40 450 Looking forward, the most significant 35 15.00% 400 prime tenant movement is the SA 350 30 10.00% Attorney General’s Department, following 300

250 25 their pre-commitment to the GPO 5.00% Exchange Development for 12+5+5 200 20 years. The SA Attorney General’s 0.00% 150 100 15 Department recently agreed to a 5 year -5.00% 50 extension on their current lease at 45 0 10 -10.00% Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Pirie Street, resulting in a lease tail of Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 approximately two years once they have PRIME EFFECTIVE RENT - LHS ($/m²) PRIME SECONDARY relocated to the GPO development. PRIME INCENTIVE - RHS (%) Source: Knight Frank Research Source: Knight Frank Research

TABLE 4 Recent Leasing Activity Adelaide CBD and Fringe

NLA Face Rent Term Incentive Address Precinct Tenant Start Date (m²) ($/m²) (Yrs) (%)*

115 Grenfell Street Core 1,297 405g 5 # First Mortgage Services Nov-17 1 Richmond Road Fringe 2,337 405g 8 # SA Power Networks Nov-17 233 North Terrace Core 1,234 425g 5 27 Great Southern Rail Oct-17 60 Light Square Frame 905 455g 5 # UniSA Sep-17 45 Pirie Street Core 15,000 545g 5 # SA Govt (AGD) Sep-17 108 North Terrace Core 2,800 480g 5 35 Optus Jul-17 75 Core 830 495g 8 10 Nat. Rail Safety Regulator Jul-17 169 Pirie Street Frame 380 440g 7 # Nat. Heavy Vehicle Regulator Jul-17 121 King William Street Core 660 515g 10 40 Colliers International May-17

*estimated incentive calculated on a straight line basis g Gross # Undisclosed AGD refers SA Attorney General’s Department Source: Knight Frank Research

5

INVESTMENT ACTIVITY & YIELDS

Sales activity in 2017 has seen offshore historical peak for transaction volumes. parking but offering future development purchasers playing an increasingly larger potential. role within the Adelaide market, The first significant transaction of 2017 accounting for all prime grade was the sale of 45 Pirie Street by CorVal Also in August, US based Blackstone transactions that have settled in the year to Singapore based AEP Investment purchased the SA Motor Accident to date. CBD sales currently stand at Management in August. The building Commission’s national property portfolio $240 million (for assets greater than $10 transacted for $105 million and reflected containing a mixture of office and million), down from $545.3 million at the a WALE of approximately 4.0 years industrial assets. The portfolio included same time last year and expected to be (income) and a core market yield of 7.8%, the Adelaide based 121 King William below the total of $1.18 billion recorded influenced by major tenant the SA Street and 99 Gawler Place, which in 2016. Unsurprisingly, Adelaide’s Attorney General’s Department (76% transacted for $58.4 million and $34.6 record transaction volumes came NLA) relocating to the GPO Development. million respectively. approximately one year after the eastern The sale included an additional 952m² seaboard and this is expected to be a site fronting Gawler Place used for car Other assets to transact included the leasehold interest in the mixed use 141 FIGURE 6 FIGURE 7 (Citi Centre) for circa $42.0 Adelaide CBD Sales $10 million+ Adelaide CBD vs East Coast Yields million. The 8 storey office tower By Purchaser Type ($m) Prime Core Market Yields component is fully leased to SA Health and the sale reflected a core market yield

$1,400 9.0% of 10.0% and a WALE of 4.0 years. 8.5% $1,200 8.0% In the lead up to the end of the financial $1,000 7.5% year, the second reduction in Stamp Duty 7.0% $800 that occurred on 1 July 2017 saw some 6.5%

$600 6.0% sales campaigns temporarily put on hold

5.5% as purchasers waited to take advantage $400 5.0% of the savings on offer. Despite causing a YTD $200 4.5% brief interval in sales activity, this initiative 4.0% $0 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 has been a positive point of difference for . AREIT DEVELOPER SYDNEY BRISBANE OFFSHORE OWNER OCCUPIER PRIVATE INVESTOR UNLISTED/SYNDICATE MELBOURNE ADELAIDE

Source: Knight Frank Research Source: Knight Frank Research

TABLE 5 Recent Sales Activity Adelaide

Core Price Mkt NLA NLA WALE Sale Address Vendor Purchaser ($ mil) Yield (M²) ($/m²) (yrs) Date (%)

45 Pirie Street 105.00 7.80 19,854 7,555 4.0 CorVal^ AEP Aug-17

121 King William Street ± 58.40 # 12,558 4,650 # SA Government (MAC) Blackstone Aug-17

99 Gawler Place ± 34.60 # 11,158 3,101 # SA Government (MAC) Blackstone Aug-17

Citi Centre, 141 Rundle Mall < c42.00 c10.0 16,375 2,534 c4.0 Private Private Aug-17

191 Fullarton Road* 9.43 7.61 2,326 4,053 2.8 Private Private Jan-17

25 Grenfell Street 125.10 7.48 25,544 4,929 5.0 GDI Funds Management Credit Suisse Dec-16

91 King William Street (50%) 88.50 7.00 31,399 5,638 3.1 Abacus Property Group ICAM Dec-16

97 King William Street 29.00 6.62 15,115 1,919 4.8 Charter Hall CPOF Private Dec-16

233 North Terrace 21.00 6.81 4,102 5,119 9.5 Australian Fashion Labels Private Dec-16

^ as responsible entity for the Value Active Fund AEP refers AEP Investment Management ± Part of a national portfolio # Undisclosed c Circa MAC refers Motor Accident Commission < leasehold interest * Fringe ICAM refers Inheritance Capital Asset Management CPOF refers Charter Hall Prime Office Fund Source: Knight Frank Research

6 ADELAIDE OFFICE MARKET AUGUST 2017 RESEARCH

Prime CBD yields compressed by 10 FIGURE 8 FIGURE 9 basis points in the six months to July Adelaide CBD Core Market Yields Adelaide CBD Yields & Spreads 2017, decreasing from 7.23% to 7.13%. Yields and Averages by Grade Core Market Yields vs 10 Yr Govt Bond Rate This is 26 basis points lower than the same time last year. 10.0% 650 11% 600 9.0% 550 Prime yields remain approximately 200 10% 8.0% 500 basis points softer than that of Sydney, 450 7.0% 9% and Melbourne (see Figure 7), enhancing 400 6.0% 350 Adelaide’s value proposition and 8% 5.0% 300 reputation as a more affordable 250 4.0% investment opportunity. Adelaide 7% 200 provides the opportunity for a reduction 3.0% 150 6% 100 2.0% in portfolio risk due to reduced volatility 50 1.0% 0 and low correlation with rental growth 5% Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 and vacancy to that of Melbourne and

Sydney. PRIME YIELD (LHS) SECONDARY YIELD SPREAD (RHS) PRIME YIELD (LHS) SECONDARY 10 YR AVG PRIME 10 YR AVG 10 YR GOVT BOND RATE (LHS) SPREAD 10 YR AVG (RHS) In the CBD secondary market, yields did Source: Knight Frank Research Source: Knight Frank Research/RBA not indicate any firming, remaining at an average of 8.50%. As they stand, secondary yields are 18 basis points lower than the same time last year. The secondary market did not follow trend with the prime market over the previous six months due to the heightened Outlook prevalence of tenant’s flight to quality, which has placed pressure on secondary  The next significant source of  Tenant demand is likely to buildings. This has resulted in the supply in the Adelaide CBD will remain inconsistent in the short necessity to price in increased let up not be until Q3 2019, following term, with movements led by periods, incentives and capital the expected completion of existing tenants relocating, improvements to retain leasing appeal. Charter Hall’s GPO Exchange taking advantage of efficiency development (25,000m²). Other gains in prime grade buildings Like the CBD secondary market, projects such as 200 North and enticing incentives. Investment yields in the Fringe have also Terrace (26,000m²) may progress remained unchanged in the six months to depending on further tenant pre-  Offshore purchasers will July 2017. Average prime yields remained commitment. continue to expand their activity at 7.60%, while secondary yields within the Adelaide market as remained at 8.40%.  Secondary building owners face investors follow suit to the likes amplifying requirements to of Blackstone and Credit Suisse It would appear less likely that the reposition their assets through and interest grows in the value aggressive yield compression refurbishment and upgrades in proposition on offer. experienced across the market over the order to retain appeal.  The firming bias of yields within past 24 months will continue, as  Limited growth in face rents and the prime market is expected to purchasers weigh the cost of finance and expanding incentives will persevere in the short term, tighter lending criteria into decision continue to place pressure on however will be driven by capital making. Nevertheless, demand for prime effective rents. market trends rather than investments with secure and stable improvements in office market tenancy profiles remains strong. Given  The lack of supply over the short fundamentals. Adelaide's value proposition and term provides the opportunity for increased interest from overseas and the market to absorb existing institutional investors, there is potential stock and stabilise the vacancy for the firming bias of yields to continue rate. in the short term within the prime market, particularly for core assets without exposure to leasing risk.

7

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