Australian Office Investment Review & Outlook 2019 Table of contents 03 Executive summary 04 What were the key observations from 2018? 09 What industry sectors will contribute to growth in 2019? 16 Should we be concerned by the supply-side of the equation? 18 How do we assess the relative value of office markets? 24 Will AUD volatility have an impact on investment flows? 27 Is it time to allocate more resources to exploring markets outside of Sydney and Melbourne? 28 Outlook 30 Summary of Major Transactions 2 Office Investment Review & Outlook 2019 Executive Summary Transaction volumes surpass AUD 19 billion for New development activity is pre-commitment the first time on record: The Australian office sector led: Developers have remained risk averse and recorded AUD 19.53 billion of transaction volumes in 2018 typically looked to secure healthy levels of pre- – the highest figure on record. Volumes were supported commitment prior to starting construction. We by the acquisition of Investa Office Fund (IOF) by Oxford have observed an inverse relationship between Properties for AUD3.4 billion. However, the number of office prime grade vacancy and the development transactions was lower than previous years with pipeline. Office markets with low prime grade the top 10 office transactions representing 43.9% of total vacancy are experiencing higher levels of new volume in 2018. development activity. AUD volatility could stimulate investment activity: The relative Offshore divestment hit a record value of the AUD is influenced by high: Offshore capital sources interest rate differentials, GDP growth remained active participants in the and commodity prices. A further Australian office sector, acquiring AUD correction in the AUD against the USD 9.46 billion in 2018. However, offshore will influence the decision-making investors are active on both sides of the process of USD denominated funds. ledger and divested AUD 6.57 billion in However, global pension funds 2018 – an all-time record high. and sovereign wealth funds have a natural hedge across their portfolio and will be less impacted by currency movements. Counter-cyclical investment strategies becoming more prevalent: Tangible signs of a leasing market recovery in Pricing is reflective of the rental Brisbane and Perth has increased growth outlook: Prime yields the prevalence of counter-cyclical across most Sydney and Melbourne investors. The depth of investor office markets have reached new demand is more diverse for assets benchmarks in this cycle. The spread in Brisbane, but the acquisition of between yield and the risk-free rate Exchange Tower in Perth by GIC has compressed, but is at a level Real Estate is a sign of confidence in normally associated with above trend Perth’s medium-term rental outlook. rental growth. Office market vacancy is trending lower: The Australian Volumes are expected to be lower in 2019: Office CBD office market vacancy rate trended back into single digit transaction volumes are expected to be 10% to territory in 2018 (8.6%) – the lowest level since 3Q12. The 20% lower in 2019. A high proportion of core assets Sydney CBD (4.1%) and Melbourne CBD (3.7%) are two of have traded, while corporate activity will likely be the tightest office markets in the world. The spread between concentrated in small to mid-cap REITs. However, prime and secondary grade vacancy rates is wider than the emerging development pipeline in some office historical benchmarks outside of Sydney and Melbourne with markets will generate fund-through or take out prime grade vacancy in Canberra (6.2%), Brisbane (7.2%) and opportunities for core capital sources. Adelaide (9.6%) in single digit territory. Office Investment Review & Outlook 2019 3 What were the key observations from 2018? We recorded AUD 19.53 billion worth of office transaction The 2018 result was heavily influenced by Oxford Properties volumes in 2018 – the first time the Australian office sector acquiring the IOF portfolio (AUD 3.4 billion). The number of has surpassed the AUD 19 billion mark (Figure 1). The office transactions was actually lower in 2018 than previous Australian office sector remains desirable for its high level of years with the top 10 transactions representing 43.9% of total transparency, fixed escalations in leases and low volatility volume. In 2017 (26.9% of total volume) and 2016 (24.8% of of returns. Multiple capital sources competed for assets in total volume), the proportion of office transactions accounted 2018 with strong activity from domestic and offshore groups. for by the top 10 transactions was significantly lower. Fig 1: Australian office market transaction volumes $20 $16 $12 $, $, billion $8 $4 $0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: JLL Research Offshore investors accounted for AUD 9.46 billion or 48.4% Offshore activity is occurring on both sides of the ledger with of transactions by value in 2018. The most active offshore 2018 another record year for offshore divestment of Australian buyers in 2018 were from Canada (16.9% of total volume), USA office product (AUD 6.57 billion). Similar to previous years, the (8.7% of total volume) and Singapore (8.6% of total volume). divestment rationale varied by capital source with developers Interestingly, the destination of capital was more diverse with selling down stabilised assets, trading between markets and increased offshore investment activity across non-Sydney and the regulatory led divestment by some Chinese investors. Melbourne office markets. However, it is clear that some offshore groups do believe that Australia is expensive and 2018 represented an opportunity to In 2018, 63.7% of purchases in the Brisbane CBD were made crystalise strong capital gains. by offshore capital sources with M&G Real Estate, Hines, JP Morgan and GIC Real Estate acquiring office product. The depth of offshore buyers in the Perth CBD is lower than Brisbane. However, counter-cyclical offshore investors have started to make significant investments into the Perth CBD with GIC Real Estate acquiring Exchange Tower at 2 The Esplanade. 4 Office Investment Review & Outlook 2019 Fig 2: Offshore buyer and seller activity $12 60% $9 50% $6 40% $3 30% $, $, Billion $0 20% Percentage Share -$3 10% -$6 -$9 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Buyers Sellers Oshore Share (RHS) Source: JLL Research | Allianz Centre (50%) 2 Market Street, Sydney, NSW, 2000 Sale Date June 2018 Sale Price $285,000,000 Office Investment Review & Outlook 2019 5 Office Investment Review & Outlook 2019 5 Investors are confident in under-writing the A diverse range of capital sources have a mandate Sydney rental growth story for the Brisbane CBD The Sydney office markets are characterised by low vacancy, The Queensland economy has moved past the trough and limited new development activity and strong rental growth. we have seen tangible signs of recovery in the Brisbane office The sharp escalation in market rents has led to the potential leasing markets. The recovery has been concentrated in the for positive income reversion and investors have become prime grade sector of the market with the CBD (7.2%) and confident in under-writing the Sydney rental growth story. Near City (10.6%) prime grade vacancy rates trending to the Sydney CBD prime net effective rents have increased by 64.2% lowest level in five years. The leasing market improvement is over the past three years to 2018, with strong rental growth expected to precipitate a recovery in effective rents over 2019 recorded in Parramatta (+47.0%), North Sydney (+31.8%) and and 2020. Macquarie Park (+29.2%) over the same time period. M&G Real Estate purchased a 50% share in the new The acquisition of a one-third stake in Quay Quarter Tower development at 80 Ann Street for AUD 418.0 million, reflecting by REST for AUD 912.0 million, equating to a rate per sqm of a yield of 5.00% and a new benchmark for core product in AUD 31,405 represents a new benchmark for the Sydney CBD. the Brisbane CBD. Multiple capital sources are subscribers to Outside of the Sydney CBD, investment activity was strong in the Brisbane office leasing market recovery with JP Morgan Parramatta with Eclipse Tower at 60 Station Street purchased purchasing 53 Albert Street for AUD 252.0 million, while GIC by GPT for AUD 277.6 million. We believe that the Parramatta Real Estate increased their exposure to Brisbane through the office market will increase to over 1.0 million sqm by 2023 acquisition of 143 Turbot Street for AUD 108.0 million. and it has now become a market with the required scale for institutional investment. The Perth CBD leasing market recovery has been stronger than expected Offshore investors attracted to the Melbourne CBD The Perth CBD office leasing market recovery started in mid- The Melbourne CBD has a similar vacancy profile and prime 2017 and gathered momentum over 2018. We recorded 50,800 grade yield metrics to Sydney. However, lower rents in sqm of net absorption in 2018 – almost three times higher Melbourne are reflected in lower capital values with average than the 25 year average of 17,700 sqm. The reduction in sub- values in Melbourne only two-thirds of the level in Sydney. lease availability from 5.1% of total stock in 2015 to 1.8% of The Melbourne value proposition is attractive to investors total stock in 2018 is a sign that organisations have moved that benchmark rate per sqm between global cities. Part of from consolidation to an expansionary mode. the explanation for lower asset values in Melbourne was site availability. The current development cycle will absorb a high Transaction volumes across the CBD and West Perth increased proportion of well-located sites on Collins Street and Bourke to AUD 781.3 million as counter-cyclical investors started to Street.