New South Wales. Month in Review June 2015

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2 New South Wales Overview The office sector throughout Australia has seen mixed performances this year. There was a feeling of increased confidence in some industries, while others have probably been hit harder than expected. This month, our offices are going to give details on how they feel the first half of 2015 has panned out in their specific service areas. It s an invaluable set of opinions for anyone with a stake in office space. Sydney Short term market expectations appear fairly positive for the Sydney office market. Total office space in Sydney has tightened over the past year, supporting a fall in total vacancy, which has also been helped by a moderate recovery in office demand. Previously forecast sharp supply driven increases to vacancy levels for the 2015 to 2016 period appear to have been scaled back, with increased certainty around the amount of stock withdrawals likely to occur in the years to come. The expected level of stock withdrawals over the short to medium term has grown increasingly significant, largely driven by the current strength of demand for new high density residential development. To put this into perspective, the Property Council of Australia (PCA) has identified a pipeline of around 530,000 square metres of office projects (new builds and full refurbishments) at either construction, plans approved or plans submitted stages as at January 2015, with the vast majority of these projects expected to be completed within the next five years. On the other hand, industry sources are predicting as much as 360,000 square metres of office stock to become withdrawn in the next five years in the Sydney CBD office market alone. The offsetting effect of stock withdrawals to new supply is expected to be positive news for office landlords in Sydney, as it should help maintain space market fundamentals which are supportive of rental growth. Recent figures are already showing an improvement in Sydney s physical office market from a landlord s perspective. The headline vacancy rate across the Sydney office market as monitored by the PCA fell to 8% in January 2015 from its previous peak of 9.3% twelve months prior. The headline vacancy rate fell not just as a result of office demand which undoubtedly increased in the year to January 2015 (around 86,500 square metres of net absorption) but also as a result of stock withdrawals (135,600 square metres) exceeding new completions (114,300 square metres). Based on PCA s Consensus Forecasts (Autumn 2015), all monitored markets apart from the Sydney CBD are expected to record falls in vacancy rates between January 2015 and January In the Sydney CBD, market expectations are generally for only moderate growth in prime and secondary gross face rents over the next two years (ranging from 2% to 3.8%), with rental incentives expected to reduce most significantly in the second forecast year. On the other hand, non-cbd markets appear to hold greater prospects for rental growth coinciding with falling vacancy levels, particularly for Sydney s North Shore office markets (North Ryde, Crows Nest/St Leonards and Chatswood). In terms of buyer demand, we are seeing more investment into commercial property coming from private investors seeking returns higher than currently being offered in the residential market. Sitting tenants in offices transitioning into owner occupiers of their business premises continue to be a common theme in Sydney, driven by the narrowing of the gap between costs of owning premises outright versus renting, as well as the popularity of purchasing business premises through self-managed super funds. Additionally, buyer interest from offshore investors is also driving a portion of demand for smaller office assets across Sydney, spreading outside of submarkets which are traditionally hotspots for these types of buyers. Canberra The budget has just been handed down and it appears on first reading that the reduction in the Public Service has been stalled and indeed some 6

3 growth is anticipated. The overall market is heavily into over supply and we quote from the Property Council of Australia figures as released in February 2015 (all measurements are in square metres): Total Office Stock: 2,393,674 However the major tenant in the ACT is government. Currently it is mooted that the Department of Finance will consolidate its operation in a recently completed development in Forrest although there is no certainty that this move will occur as the cost to government is being questioned in Parliament. Direct Vacancy % Sub-lease 39, % We then look at some of the individual centres and realise where the space in over supply is located: Vacancy by location in square metres: Airport 81,384 City 100,900 Barton and Forrest 62,158 Woden 28,329 Belconnen 11,759 Remaining Office Locations 83,966 Currently we are seeing some strong private sector leasing activity particularly in the Deakin area RSM Bird Cameron, SAP and ASG each have taken in excess of 1,000 square metres in 70 Kent Street and CSG has secured circa 2,000 square metres at the airport. The amalgamated departments of Immigration and Customs would like to consolidate under one roof and an opportunity for this to occur has been identified at the airport. However Immigration is one of the keystones of the Belconnen Town Centre and strong debate at a local and national level is occurring. The whole ethos and structure of the design of the ACT assumes decentralisation and is dependent on the strength of town centres. Office space and waste is being hotly pursued by government and the Australian Government Property Data Collection (PRODAC) unit of the Department of Finance is charged with ensuring that there is no waste. The Australian Taxation Office is purported to have 6,500 empty desks across the nation. This could amount to 65,000 square metres of excess space under lease. The Department of Human Services in Canberra is understood to be trying to off load substantial space in leased buildings. It is important that government is seen as an efficient space user and to that end the surplus space will impact on vacancy rates across the nation, not just in the ACT. The budget papers indicate that smaller agencies will be encouraged to occupy space held by government under lease. Wollongong The Illawarra commercial property market has shown clear signs of improvement over the past 12 months with an increase in sales volumes, demonstrating improved confidence after a prolonged period of static conditions. Investment transactions have increased as investors (private and second tier funds) are enticed back to the market by yield arbitrage and a common view that the market has bottomed. However, these investors are still primarily motivated by good quality assets, strong lease covenants and rental security 7

4 although the gap between prime and non-prime assets appears to be closing somewhat. Price point is also a factor with demand reducing for higher valued assets in the plus circa $2 million to $3 million range. Low interest rates, a recovery in the development site market and the increased buyer depth has resulted in yield compression despite rents largely remaining stagnant. Low interest rates are a significant driver in the local market and prices may be adversely affected if interest rates increase. Tenant demand at present for large suites in the Wollongong CBD appears to be primarily from government departments and is concentrated on the higher quality A grade space with reduced interest in lower quality stock. There is a trend amongst select large corporations of reducing space as exhibited by the downsizing of AHM/Medibank, Illawarra Mercury, Hatch and One Path and unconfirmed media speculation of Illawarra Coal downsizing its premises at the Innovation Campus. There is limited corporate head office demand with most companies requiring tenancy sizes of less than 500 square metres. Conversely, supply of large functional floor plates within the highest grade office stock is limited. Given the overall vacancy rate and the market primarily being driven by affordability, it is our opinion that there will be no upward pressure placed on rents in the foreseeable future, despite the fact that there is no significant supply proposed in the market. Newcastle The over riding factors hanging over the A and B grade Newcastle office markets have been the continued low vacancy rates and lack of any new stock of significant size in the pipeline. The development market has now responded to this need for new stock and as at January 2015, there was a total of 20,800 square metres of new CBD office property in the construction pipeline. Of this space, 3,700 square metres is currently under construction on the corner of Parry Street and Stewart Avenue in Newcastle West. Completion is due in late The remaining office property to be constructed is situated at the Doma Group owned Edition mixed use development in Honeysuckle as well as four stories of office property to be constructed over Civic West Carpark. Neither of these developments will be completed until after 2017 and we can expect tight vacancy rates in the upper end of the local office market to continue until this time. Local agency advice indicates tenant demand remains firm in the A grade sector, however larger users are becoming more difficult to secure. Office rental rates are staying firm at the top end of the market. In fact, there is an interesting observation on a two level mixed use property in the Hunter Street Mall. The market indicates that for large, older style upper level offices, the market rent is actually on par (on a rate per square metre of gross rent basis) with the lower level, much smaller retail spaces. This is a very unusual situation and indicative of the relative strength of the office market against the weak state of the retail market in that particular location. 8

5 Victoria Melbourne The Melbourne CBD office market has observed a marginal increase in vacancy rates over the past 12 months, with the Property Council of Australia reporting in the January 2015 office market report a total vacancy of 9.1%. This represents an overall increase of 0.6% from the total vacancy of 8.5% observed in July The overall vacancy rate for the Melbourne CBD market is currently lower than the national January 2015 average of 10.8% and is also notably lower than the overall Australian CBD vacancy rate of 11.2%. The PCA reports that during the 2015 calendar year a significant amount of space will be added to the market with a high level of precommitment (121,335 square metres with 71% precommitted) and again in 2016 with a further 55,000 square metres or so to be absorbed (undisclosed level of pre-commitment). The leasing incentives currently remain relatively high with incentives of approximately 25% to 30% being offered for office space within A and B grade buildings and reports of up to 40% for buildings with relatively high levels of existing vacancy. The city fringe market has observed a decrease in the vacancy rate from 8.6% to 7%. The outer east suburban vacancy rate remains relatively high having increased from March to September 2014 from 11.4% to 12.9% following the relocation of the ATO to new premises at 913 Whitehorse Road, Box Hill. In the south-east, the vacancy rates have improved somewhat, reducing from 5.3% to 3.4%, primarily due to the conversion of a number of older commercial buildings into residential development opportunities. Strong overseas investor demand is continuing for good quality office properties within the Melbourne CBD, St Kilda Road and city fringe / inner suburban office markets. This is primarily due to the lack of suitable stock on the market and the sheer weight of local and international capital seeking limited investment opportunities in this segment. Assets in the $15 million to $50 million price point typically appeal to a broad range of private investors, syndicates and Self Managed Super Funds (SMSF). The primary overseas demand is from Singaporean, Malaysian and Chinese private investors with local investors now required to pay a premium in order to secure suitable investment grade assets. Due to the current economic climate, both locally and internationally, the Melbourne CBD is currently an attractive destination for Asia Pacific investors. This is primarily predicated by the relatively high returns on offer and the generally low risk fundamentals of these CBD assets compared to competing cities in the region. It is predicted that prime A and B grade CBD office buildings will continue to attract strong demand from both local and overseas institutional investors, syndicates and sovereign wealth funds. We predict that overseas interest will continue to grow in the short term as the next wave of demand comes from Chinese sovereign wealth and pension funds. Recent sales activity suggests that market yields are continuing to firm for well located investment grade assets exhibiting sound fundamentals, such as a strong WALE and limited capital expenditure requirements in the short term. As an example of this we note the recent sale of 520 Collins Street, Melbourne which was reportedly purchased by an undisclosed private investor for $52 million. This is a B grade 17 level freehold office building, incorporating additional retail and car parking, which was constructed in 1975 and subsequently refurbished over time. The property has a net lettable area of 8,554 square metres, a 2.5 9

6 Star NABERS rating and is situated on an allotment of 836 square metres. The property was sold via an EOI campaign subject to a net passing income of approximately $3,469,142 per annum which reflects a passing yield of 6.67%. Our enquiries indicate that there was considerable depth of interest in this property with multiple competitive bids received from prospective local and international purchasers. Overseas developers in particular continue to remain extremely active within this market segment and, in many cases, are appearing to be pricing local developers out of the market. Given the relatively weak leasing conditions and the potentially substantial re-leasing and refurbishment costs for older office buildings, in some cases we are witnessing a number of overseas developers secure quite substantial office buildings with the view to convert or redevelop for residential purposes. Our overall observations however are that due to limited opportunities and substantial capital inflows, many purchasers are disregarding basic property fundamentals to secure well located assets by paying what can be considered a premium for assets with relatively weak lease profiles and significant capital expenditure requirements. Murray Riverina market activity, including smaller scale owner occupiers and larger development sites, has spiked in recent times. Several smaller sales at or around the $500,000 to $600,000 mark have been complemented by development sites including Victracks Ten Pin Bowling Site and the adjoining Bella Cibo site along with a former service station site on High Street and though dated the childcare site in Ogilvie Avenue. While levels of value have not been racing ahead this activity appears to demonstrate improved confidence and a desire to take advantage of current interest rate conditions. Mildura The office market remains quiet, with owner occupiers and tenants generally reluctant to move. Several older style buildings have sold during the past six months in the sub $500,000 bracket. In both cases, the buyers intend to refurbish and occupy. Buyers are generally seeking buildings with good natural light and on site carparking. Rental rates and values have remained static during the past two years and we don t see this trend changing in the near term. Vacancy rates remain slightly above long term average levels. One of Mildura s larger office buildings, currently subject to a lease to a national accounting firm, is currently being advertised for sale and will be a good litmus test of the investor market. 10

7 South Australia Adelaide The South Australian commercial property sector appears to be facing an extended period of consolidation that is expected to continue. While recent interest rate reductions may have contributed to agents reporting improvement buyer sentiment, this appears to be predominantly from owner-occupiers with rental rates still in decline or at best stagnant. Many properties with strong fundamentals still require incentives to secure tenants, making speculative investment office purchases less attractive despite reduced borrowing costs. strong yields, the underlying demand from owneroccupiers and opportunity for capital growth offers secure investment opportunities. In particular properties on main arterial routes are currently in strong demand due to recent Urban Corridor Zoning changes allowing for higher density mixed use developments. This has come at a time of reduced borrowing cost which is stimulating the market; however, the market demand for the end products remains unclear for office and retail space but if coupled with good car parking and lower overall occupation costs compared to the CBD there is likely to be reasonable demand. Strata office accommodation within the CBD has been notably subdued for some time, but the State Governments ambitious targets to increase the population within the CBD will eventually have flow on effects to retail and office accommodation. Additionally the conversation of out-dated and underutilised office buildings to mixed use residential /office/retail will in time remove the lower grade properties and equalise the market. Although this will take time, the policy directives are in place to strengthen the CBD market and current weak conditions may present opportunities for a brave investor. Currently city fringe offices are a popular investment opportunity. While these don t typically provide 11

8 Queensland Brisbane Throughout the first half of 2015, economic global growth has continued to improve, although it has been uneven, with the threat of deflation and collapsing commodity prices ever present. Australia has experienced two reductions of the official cash rate, in an attempt to offset the high Australian dollar and jump start the broader economy that continues to grow at a glacial pace, with business confidence remaining low. The latest reserve bank cash rate cut of 25 basis points, in May 2015 has lowered the official cash rate to 2.00% and has left the economy at a cross road, with a great deal of uncertainty overall, stemming from factors such as the collapse of the iron ore price and rising government debt. With regards to the Brisbane office market, sales of prime CBD office accommodation continues to support the overall poorly performing office market. Interest does remain strong for prime investment grade office properties with good leasing profiles, however secondary office accommodation continues to experience a softening in demand as a result of increasing vacancy rates. At odds with the overall state of the office market, yields have remained relatively stable with the prime office market reflecting yields of circa 7.50% to 8.00% and the secondary market reflecting yields circa 8.50% to 9.00%. Of greater concern appears to be the softening of sales activity with the year to March 2015 down 72% and almost 59% below the five year average. From a leasing perspective, the remainder of the year and looking towards 2016 appears to be patchy with Lessors forced to offer large rental incentives in an extremely competitive leasing market. While this offers good value for prospective new tenants providing for affordable rents, demand for office space in the Brisbane CBD is expected to remain low. This will be further exacerbated by the completion of 180 Brisbane on Ann Street in the fourth quarter of 2015, 480 Queen Street in the first quarter of 2016 and 1 William Street in the third quarter of Combined, this will provide an additional 188,966 square metres of Net Lettable Area and will result in the relocation of many tenants throughout the Brisbane CBD who look to move to high quality, brand new tenancy areas, all the while locking in highly competitive gross effective rents as a result of the subdued market overall. While this will represent a shift in the market as tenants relocate across the Brisbane CBD, vacancy rates will continue to remain high as older office accommodation is vacated which in turn will increase rental incentives as these tenancy areas attempt to be re-leased. Accordingly, the overall vacancy rate is likely to not have yet peaked as new stock enters the market and older stock becomes available. Unless significant stock withdrawals occur the high office vacancy rate is anticipated to continue until at least Overall, the Brisbane office market has the distinction of the poorest performing sector of the property industry and this is highly unlikely to change within the foreseeable future. While yields of prime CBD assets continue to remain relatively stable, investors are advised to use caution when considering the purchase of assets, given the stubbornly high overall vacancy rate and falling face rents as a result of high rental incentives with the condition to remain unchanged for some time. Toowomba Leasing demand for commercial office accommodation in Toowoomba has been moderate to date in Office rentals have remained 12

9 relatively static with some lease incentives available for properties with longer term vacancies. Car parking fees within the CBD have increased over the past six to twelve months. Car park rents are mostly influenced by fees charged by Toowoomba Council for their public car parks and metered street parking. The parking fees charged by Council were increased for the 2014/2015 budget period, which has resulted in an increase in fees achieved in private car parks and car parking attached to commercial office buildings. There have been no new major office building developments in Toowoomba to date in 2015, with only a small development currently under construction on the corner of Herries and Phillip Streets, however there is a current requirement by the Department of Transport and Main Roads for a 2,500 square metre office tenancy within the Toowoomba CBD or CBD fringe. It is believed that this requirement will be fulfilled by the development of a new building. The low interest rates have resulted in strong demand for commercial properties by investors, however the lack of supply of quality, fully leased properties has limited the number of investment sales. The largest sale of note was the new Toowoomba Chronicle building in Neil Street which sold in late 2014 for $5,975,000 at a net yield of 8.36%. Gold Coast Reiterating our review of the Gold Coast office market earlier this year, there would appear to be continuing general improvement in both buyer and tenant demand. Again, this sentiment would appear to be riding on the back of reducing vacancy levels and the historically low interest rates, the latter influence providing investors with superior real net investment returns. There were a number of larger office building sale transactions reported in late 2014, Including 183 Varsity Parade, Varsity Lakes for $8.9 million and the Dascom Building at 165 Varsity Parade, Varsity Lakes for $6.25 million. The Department of Child Services occupied a building at 24 White Street, Nerang which sold in March 2015 for $3.35 million. We are also aware of an off market transaction of an office building within one of the beachside suburbs above the level of the Varsity Lakes sales. Collectively, these sales reflect yields ranging from 7% to 8.5%, with the trend being a compression of yields. Further tests of the strength of the Gold Coast office market are several current sale campaigns for properties of the calibre of the Foxtel Building at 35 Robina Town Centre Drive, Robina (reported net income of circa $3.6 million per annum), The Rocket at 203 Robina Town Centre Drive, Robina (reported net income of circa $6.24 million per annum) and potentially for the private investor/owner occupier sector, the far smaller Coral Homes building at 36 Laver Drive, Robina of 1,487 square metres lettable area being offered with vacant possession (and also available for lease). Activity within the strata office sector would also appear to be improving. This asset class is most prolific in the main Gold Coast office precincts of Southport, Bundall, Surfers Paradise and Robina/ Varsity Lakes. Sale prices certainly appear to have stabilised, but there is plenty of evidence of price increases. Value rates for this asset class in our market would broadly range from $2,000 to $4,000 per square metre of surveyed floor area. The lower level being applicable for older, lower quality buildings within Bundall and Surfers Paradise, while the higher rates are being achieved for newer, better quality buildings within areas such as Robina. 13

10 Yields will vary significantly depending on whether purchased for owner occupation (7% to 7.5%) or for investment (8% to 8.75%). The strata office market continues to offer good opportunities, particularly for owner occupiers who can capitalise on the low interest rate environment where it makes more economic sense to pay interest than rent. An example of a good owner occupation opportunity is the Westlawn Groups Lakehouse project at Robina. There are two existing buildings on a lake setting that are being progressively refurbished and strata titled. The first building will provide up to 18 suites with open car parking. List prices range from $471,000 to $683,000. Rental levels appear to have well and truly stabilised and are now at the point where landlords are reducing incentives and anticipating rental growth. B and C grade stock is ranging from $250 to $375 per square metre per annum gross, with A grade space at $400 to $500 per square metre per annum gross. With an across the board PCA vacancy level of 15.2% in January 2015 and an expectation that the level at July 2015 will move downward, leasing agent optimism is starting to permeate the marketplace. Office areas with a better ratio of car parking and are readily accessible to the light rail would appear to be attracting a higher level of leasing interest. The office precinct of Southport falls into this category. Tenants are also attracted to more modern buildings with competitive rental rates such as Varsity Lakes. In an overview sense, based on our observations, the middle tier rental rate range is attracting the higher incidence of tenant enquiry. Inferior, older quality floor space remains more difficult to lease, possibly due to perceived uncertainty in future business conditions being a hindrance for businesses to commit to more expensive floor space at this time. Overall, there is a general sentiment that the Gold Coast office market is improving. We anticipate that this should build further moving through Hervey Bay Generally, the commercial office market in Hervey Bay remains unchanged and slow with little indication of any change in the short term. However, the variation in leasing rates between primary and secondary property appears to be expanding. Continued high levels of supply and anxious vendors have resulted in a general softening in leasing rates for older properties or spaces lacking exposure. Current asking rates are as low as $160 per square metre net for secondary space while primary space is still asking in excess of $300 per square metre net. Buyers continue to lack urgency in making a decision and very few properties have sold over the past six months. Some sales with good tenancy profiles are achieving yields in the 8% to 8.75% range. Owner occupier rates per square metre appear steady in the range of $2,000 to $3,500 in older buildings and up to $3,800 per square metre in the newer buildings. Leasing rates are likely to remain very competitive until stock is absorbed. Incentives are common and tenants remain cautious, with most local operators negotiating initial one year lease terms with options. Gladstone Continuing into mid 2015 we consider market conditions will remain volatile in Gladstone s office sector, with potential for continued market correction on the back of the downturn in local mining industries and reduced local workforce numbers. Demand for office accommodation is weak and there is currently an oversupply of accommodation. 14

11 Tenants that have leases approaching market review are taking the opportunity to renegotiate down from the peak rental levels they were paying throughout 2011 and It is likely that incentives will be required as part of any new lease negotiations to secure a tenant. There have been very few investment sales for office accommodation over the past two years, which is reflective of investor sentiment around the current supply and demand in this sector. To appeal to an investor, the property will need to have a solid tenant and strong unexpired lease term. Vacant office accommodation does not appeal to investors in the current market as securing a tenant is problematic with long letting up periods, especially for older properties in secondary locations. Interest rate cuts are likely to also see more tenants across this sector opt out of renting and purchase their own premises. This has been seen across the board in nearby Central Queensland towns over the past 12 to 24 months and we anticipate this will continue pace while the interest rate remains low. Rockhampton The Rockhampton office market has been behaving much like the retail and industrial property markets where tenant demand is moderate and incentives are necessary to attract new tenants. Vacancy rates are stable although with little new office space being produced there has been a slight reduction in available space. We are seeing a growing trend for many tenants to down size as business practices change and modern work forces embrace a wider use of mobile technologies. Agents report most interest from new tenants is for office space below 100 square metres and a small but growing demand for office space that is lettable on an hourly rate. Rockhampton is somewhat oversupplied with older buildings that have not been updated and in some cases not well maintained. Tenants are not attracted to these older buildings that no longer meet tenant requirements of a modern office. This is an issue for some of the older buildings in Rockhampton, some of which are heritage listed. Some of the older heritage listed buildings within the city centre which have been used as office space over recent years are now reverting back to their original designs of 100 years ago with residential uses in upper levels and commercial or retail uses on the ground floors. Two buildings within the CBD in this category which also enjoy river views have recently sold at about $1.1 million each to owner occupiers. We consider the recent interest rate reduction will continue to encourage tenants to purchase and occupy their own premises. This will be a continuation of the owner occupier activity we have seen in the local office market over the past 24 months, with most activity below $750,000, but with price points to about $1.1 million as noted above. Townsville Office activity into the start of 2015 has remained sporadic and mostly within the sub $5 million price range and not CBD centric, but rather includes suburban locations along major distribution roads. Unemployment in the region remains higher than the state average, while business confidence in Townsville during the second quarter of 2015 has continued to improve with a slight uplift in the index according to the PwC Townsville Business Confidence Survey. Anecdotal evidence suggests that the sub $2 million price bracket is a more realistic range for mum and dad investors at this time as this is seen as more affordable and less risky due to smaller floor plates and single tenancy configurations. Our CBD office survey for the six months from July 2014 to January 2015 indicates that the vacancy rate for A grade office space reduced during this period, however increases in the B and C grade vacancies 15

12 meant that there was an increase in the office vacancy rate overall from 24.5% to 26.3%. Current conditions are consistent with weak overall demand for office space. Rental rates have suffered downward pressure as a result of the continuing weakness, triggering increases in leasing incentives in order to attract tenants. There is a concern that current incentives are simply attracting opportunistic tenants or new first time businesses into the market that will have little commitment to the longer term. 16

13 Northern Territory Darwin A recent inspection of the new Charles Darwin Centre at the corner of the Smith Street Mall and Bennett Street revealed a well planned functional shell which is already an ornament to the CBD skyline. Fitout works for the NT Government (NTG) tenancy have commenced and it is expected to be occupied before the end of the year. This building is already a game changer within the Greater Darwin office market. The NTG (the dominant tenant in this market) is already allowing leases to expire in some of its older tenanted buildings in anticipation of relocating to the Charles Darwin Centre. On a brighter note, demand for smaller scale strata title office space has remained steady. Owner occupiers and their related superannuation funds are purchasing this type of product, taking advantage of the low interest rate environment to buy rather than rent. The Avenue development at Parap is a prime example of this with its proponents now pursuing a similar although smaller scale development at Alice Springs. View from Charles Darwin Centre 19th floor looking south east over the waterfront The twin cutbacks in the NTG office staff numbers and the reduced area required per staff member (due to more efficient building and workplace design) mean that demand for office space is dwindling. We are forecasting a negative net absorption rate for CBD office space over the next couple of years. This does not bode well for owners of buildings with large floor plates designed for NTG occupation, especially buildings that require significant investment to upgrade. It appears inevitable that vacancy rates will rise further. View from Charles Darwin Centre 19th floor looking west over the city and Esplanade 17

14 Western Australia Perth Since mid-2012, CBD office rents have been subject to downward pressure as increasing vacancy and low enquiry levels impacted the market. The downturn in the market coincided with the beginning of the end of inflated iron ore prices. Office vacancy in the Perth CBD increased 5.8 percentage points over 2014 to 14.8% at January Vacancy increased as a result of subdued tenant demand and a number of businesses re-evaluating their staffing and accommodation needs. The rise in vacancy was experienced in both prime and secondary assets; indeed all grades of office accommodation experienced an increase in vacant space over the year, albeit with the lower grades experiencing the largest increases demonstrating the flight to quality that is resulting from the market turning in favour of tenants. Subdued rents and rising incentives are providing a number of favourable options for tenants in the current market. While vacancy seems high for Perth, it is only marginally higher than the national CBD vacancy rate of 11.2%. The increase in vacancy has come almost entirely from direct vacancy, with sublease vacancy only increasing by 0.1 percentage points in the 12 months to January. New supply due in 2015 is expected to further increase vacancy which is expected to peak in late 2015 before the new supply is gradually absorbed by the market (beyond 2016). Demand conditions are likely to improve as the effects of reduced interest rates and depreciating Australian dollar are felt in the market and while lease terms continue to favour tenants. After a record year of transactions in 2013, office sales in 2014 were somewhat restrained. Approximately $133 million worth of office transactions were recorded in the 12 months to March 2015 in the Perth CBD area. This is down 91% from the acute high of $1,541 million in the previous 12 months and down on the five year average of $704 million. Over the past twelve months three properties were reported sold, down from the previous year of 13 and down on the five year average of 11. There were only two transactions of great significance in 2014: the $35 million sale of 220 St Georges Terrace in November and the $91 million sale of 256 Adelaide Terrace in April. Perth office stock has traditionally been purchased by domestic investors, yet is rapidly growing in esteem with offshore buyers as demonstrated by two major transactions in Offshore capital continues to look for opportunities in Perth due to its countercyclical nature with the eastern states allowing a level of diversification. Perth assets also tend to be higher-yielding than those on the eastern seaboard. As a result, both domestic and foreign capital should continue to seek Perth assets with solid lease expiry profiles, however transactional activity is limited by a dearth of stock being presented for sale. Market yields have gone through a prolonged period of stagnation. Market yields in the Perth CBD as at March 2015 are estimated to range between 7.5% and 8.75% for A grade buildings and between 8.75% and 10.25% for secondary grade buildings. The average yield for A grade office buildings in the quarter to March 2015 is 8.13%, no change over the year. Capital values have generally eased over the past 12 months especially in secondary grade space predominantly as a function of a fall in effective rents but also a rise in vacancy. Capital values in the Perth CBD as at March 2015 are estimated to range from $6,600 per square metre to $10,000 per square metre for A grade buildings and between $4,150 per square metre and $6,000 per square metre for secondary grade buildings. Average capital values for A grade properties are $8,300 per square metre, no change over the year. Vacancy rates are at a five-year high and the substantial amount of stock additions due in

15 should result in the vacancy rate increasing further. As a result of this increasing vacancy, effective rents are expected to remain under pressure, although to a lesser degree than what was seen over Incentives may also increase a little further. They currently sit at around 30%, however deals have been done with 50% incentives, mainly for nonpremium and A grade stock. The Perth market is closely correlated with the resources sector, which is known for its rapid changes. It would take several resources projects to be moved into the committed phase or a sustained increase in the iron ore price to spark interest in office space. Perth s capital transactions market is anticipated to continue to be popular with both foreign and domestic investors over the medium term, as comparatively high yields persist in attracting capital. However actual transaction volumes are severely hindered by the lack of suitable stock being presented for sale. South West WA The commercial property market in South West WA remains subdued with business cautious due to the broader economic uncertainty and global economic volatility. A limited number of office sales transactions in the South West makes it difficult to gauge a clear pattern of values, however weak demand in this segment indicates price softening. Most properties are tightly held which is helping to balance the market but extended selling periods are required. There has been an increase in demand for good quality office space particularly from government departments within many towns in the South West. This demand has been brought about by the lack of speculative development in this area over the past few years. The result is upward pressure on the rental value of quality office space. Although there have been few sales of quality office space, it is considered likely that values will also increase. Due to increased banking regulations and tightening margins, speculative developers have been very quiet. The majority of developments undertaken and properties purchased now appear to be by those that already have a use for the property. There are high levels of owner occupation in the area with the majority of sales activity relating to established property for use by owner occupiers. The equivalent yield range identified from these type sales is usually lower than that of investment sales. Overall the quality office market can be seen as coming off the bottom of the cycle and is showing initial signs of growth. Due to population growth and the broad economic diversity of the South West WA region, it stands poised to deliver strong economic growth in the long term which should underpin long term demand for commercial property in the area. 19