1 SPRING 2015 MARKET TRENDS Leasing demand strengthened in the year to July 2015, led by take up from the Government and regulatory authorities and Utilities, Mining and resources sectors. Supply additions and withdrawals moderate. Prime net rental growth rises. Sales activity solid and yields firm as investment demand strengthens. IN THIS REPORT Adelaide CBD Office Market Adelaide s CBD office market saw vacancy stabilise in the first half of Strong supply in the second half of 2015 and early 2016 is expected to see vacancy peak mid-2016 before moderate net absorption and easing supply sees vacancy track down over the remainder of the five year outlook. The Adelaide CBD office market witnessed low levels of new supply, positive demand, moderate rental growth and a solid investment market over the past six months. There was moderate tenant demand over the first half of Demand came from expansion of existing tenants such as the Department of Social Services and Australian Institute of Business as well as tenants moving from suburban locations to the CBD such as Channel Nine moving from North Adelaide. Supply was moderate over the first half of This, combined with withdrawals of stock and positive demand resulted in stable vacancy at 13.5%. Investment activity was solid over the year to August and yields firmed over the year to September 2015 due to investor demand. Market overview 1 Key Office Influences 2 Demand, Supply, Vacancy 3 Rental market 6 Investment market 7 Outlook 9 Demand is likely to remain moderate over the second half of Due to solid levels of recent leases signed, demand from firms benefiting from low interest rates, strong property and construction markets and forecast positive economic conditions. Prime rents rose in the year to September 2015, while secondary rents stabilised. 81 Flinders Street sold in February 2015 KEY INDICATORS ADELAIDE CBD OFFICE MARKET Stock (m 2 ) Vacancy (%) Net face rents ($/m 2 ) Outlook (1year) Incentives (%) Yields (%) Outlook (1year) CBD 1,379, % Prime 569, % Secondary 809, % Source: Property Council of Australia (July 2015) and m3property (September 2015).
2 Employment annual change (%) KEY OFFICE INFLUENCES Economy is transitioning from mining sectors to interest rate driven sectors. ECONOMIC GROWTH While economic challenges remain, headed by global uncertainty, falling exchange rates and volatile equities markets, there are still positives for the SA economy. According to the SA Treasury gross state product (GSP) is forecast to grow by 2.0% in and This is up from 1.75% over The Australian economy continues to transition away from growth driven by investment in the mining and resources sector towards other interest rate sensitive sectors. This transition is already starting to become evident with mining employment slowing by 32.1% over the year to May 2015 from 67.9% growth the year prior. Whereas white collar sectors grew by 5.3% in the year to May 2015 compared to falling by 2.0% the year prior. Nationally unemployment remains a major challenge. Employment and population growth is expected, but likely to be slow. EMPLOYMENT Unemployment continues to be a major challenge for the Australian economy. Although the unemployment rate remains below long term averages it is above the five year average rate and is having a negative impact on sentiment. Many of the job losses have been in the mining, manufacturing and agriculture sectors, however the finance and insurance sector has also seen falls. Looking forward employment and population growth is expected to be slow. Employment growth is expected to be around 1.0% for in each of the next three financial years in SA. Mixed employment results for SA with Information, media and telecommunications services and finance and insurance performing the best over the year to May % 60.0% 40.0% 20.0% 0.0% -20.0% -40.0% -60.0% SA employment by selected industry group Info, Media & Telecommuns. Rental, Hiring & Real Estate Public Admin. m3property Research Source: ABS (July 2015) Finance & Insurance Admin. & Support Slowing job ads growth suggests employment growth is likely to slow looking forward. JOB ADVERTISEMENTS Job ads data from ANZ Bank has been volatile since the end of the nine month run of positive growth in February Over the month of August job advertisements rose by 1.0%. This followed a fall of 0.5% in July 2015 and a rise in July. Over the year to August 2015 job advertisements rose by 8.7%. Business confidence below long run averages. BUSINESS CONFIDENCE After strong growth in May and June 2015 the National Australia Bank s index of business confidence saw the index fall from 8.0 in June to a net balance of 4.0 in July and 1.0 in August Confidence is expected to remain below long term averages over the short term due to the combination of resource sector investment slowing, global economic and political uncertainty, volatile equities markets and a falling Australian dollar. Comm3ntary Spring 2015 P2
3 SUPPLY DEMAND AND VACANCY STOCK AND SUPPLY Stock in the Adelaide CBD office market totalled 1,379,345 square metres as at July The total breakdown of space by grade is shown below. Adelaide CBD Office Market - July 2015 Grade A accounts for 38% of space in the Adelaide CBD. There continues to be a higher rate of secondary space at 58.7% of the total. C 21% D 11% Premium 3% A 38% B 27% Source: Property Council of Australia OMR, m3property Research Net supply additions were moderate in the year to July However, a pick-up is expected over the next six months. Supply is set to rise in the second half of 2015 and withdrawals are expected to decrease. Approximately 11,626 square metres of gross supply including the refurbishment of 7,920 square metres at 169 Pirie Street (committed by Nine Entertainment and Lucid Consulting Australia) was added to stock during the year to July Withdrawals, over the same time frame, totalled over 17,600 square metres. The building withdrawn during the past six months was North Terrace, for retail conversion (2,722 square metres). In the second half of 2015 supply is expected to rise significantly to levels more than double the long term six monthly average. The main new projects in the second half of 2015 are expected to include the new development at Flinders Street, the full refurbishments of Wakefield Street and Flinders Street and the partial refurbishment of 1 King William Street. MAJOR ADELAIDE CBD OFFICE SUPPLY PROJECTS Project address Comp date Project type NLA (m 2 ) Stage Large Commitments Flinders Street 2015 New 20,470 Construction Peoples Choice C.U., Santos 1 King William Street 2015 Refurb 12,628 Construction Most new projects are waiting for pre-commitments before proceeding with the main exception being King William Street which has commenced speculatively Wakefield Street 2015 Refurb 4,000 Construction Flinders Street 2015 Refurb 3,095 Construction King William Street 2016 New 6,900 Construction 170 Frome Street 2016 New 3,800 Construction Grant Thornton Franklin Street 2018 New 21,000 DA Approved Source: m3property (August 2015) New and refurbishment projects due , over 3,000 square metres in size. Comm3ntary Spring 2015 P3
4 Net Absorption (m 2 ) DEMAND, SUPPLY AND VACANCY Net absorption was moderate over the first half of Grade B performed the best of the grades over the past 18 months. Gross absorption stronger in the first half of 2015 compared to the previous six months. Government and Regulatory Authority tenants accounted for the most moves in terms of square metres signed over the year to July TENANT DEMAND Tenant demand was positive 4,443 square metres in the first half of 2015 after falling by 5,697 in the six months prior. This took net absorption over the year to July 2015 to -1,254 square metres, according to the Property Council of Australia. This represents an improvement compared to the previous two financial years. Due to the strength of grade B demand, net absorption for prime stock was similar to secondary stock over the six months to July In fact grade B has been the best performing grade, in terms of net absorption over the past 18 months. This is consistent with firms looking to upgrade space due to affordable rents and high incentives being offered for grade B buildings in the CBD, with rents having been stable since March 2013 and incentives blowing out to between 20% and 35%. Gross absorption in terms of leases signed over the year to July 2015 was estimated by m3property to be around 73,000 square metres, with demand strengthening over the first half of 2015 compared to the previous half year. The slowdown of the second half of 2014 resulted in a reduction in activity looking on an annual basis. The leases reported as signed is a leading indicator of net absorption. This indicates that net absorption is likely to continue to grow over the short term and should bring net absorption back to around the six monthly long term average of 5,237 square metres over the second half of Government and Regulatory Authority tenants accounted for the most moves (in terms of square metres of space signed) over the year to July 2015, representing 36.5% of the total. The next two most active sectors where the Utilities, Mining and Resources sector which accounted for 12.4% of activity and the Business Services sector (which includes business consultants, accountants, recruitment companies, etc) with 11.3% of leases signed. Net absorption was positive over the first half of 2015, however, not strong enough to counteract the negative second half of ,000 60,000 50,000 40,000 30,000 20,000 10, ,000-20,000-30,000 Long term average Adelaide CBD Office: Net Absorption Financial year Source: Property Council of Australia OMR (July 2015), m3property Research Net absorption forecast to be positive in the CBD over the short to medium term. Looking forward, net absorption is expected to be positive over the short to medium term outlook. This is based on moderate levels of current leases signed which is a leading indicator of net absorption and positive forecasts for South Australian Gross State Product and employment growth, which are likely to peak in 2017 at 2.3% and 1.0% growth respectively. Comm3ntary Spring 2015 P4
5 Vacancy rate DEMAND, SUPPLY AND VACANCY 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Adelaide CBD vacancy forecasts Source: PCA Office Market Report (July 2015) and m3property Research (September 2015) Total vacancy was stable in the Adelaide CBD over the year to July 2015 at 13.5%. Vacancy is set to rise over the second half of 2015 before falling over 2016 and 2017 due to moderate demand and weak net supply forecasts. VACANCY The vacancy rate, driven by moderate demand and supply levels, was stable over the six months to July 2015 at 13.5% according to the Property Council of Australia (July 2015). This vacancy rate lies above the long term (26 year) average for the CBD of 12.1%. Premium and grade A vacancy decreased over the first half of 2015 resulting in prime vacancy falling from 12.0% to 11.6%. Secondary vacancy, however, increased to 14.9% despite the withdrawal of 2,722 square metres of grade D stock. Tenants appear to be taking advantage of the high incentives still on offer in the higher graded buildings. Supply is expected to increase in the second half of 2015 with the completion of 50 Flinders Street and a number of refurbishments. Approximately 40,193 square metres of space is set to complete in the second half of 2015, which is likely to see an increase in the already high vacancy rate if demand for office space does not improve significantly. Known future supply, following 2015, is limited. With only two small new developments due in 2016 and no major projects currently likely to complete in 2017, unless a significant pre-commitment is received in the short term. SELECTED MAJOR TENANT MOVES Tenant Address Start date NLA (m 2 ) Est Net rent ($/m 2 ) Grant Thornton 170 Frome Street Oct-16 1,473 $400 g People s Choice Credit Union Flinders Street Oct-15 9,794 High $400s Santos Flinders Street Oct-15 5,295 High $400s SKM Flinders Street Dec-15 1,065 $425 n APIA 400 King William Street Jun-15 3,029 Mid $400s Regus Serviced Offices Level 21, 25 Grenfell Street, Adelaide May-15 1,077 $500 g SA Government 173 Wakefield Street May-15 1,225 $325 g Department of Social Services 55 Currie Street Mar-15 3,079 Mid $400s Comm3ntary Spring 2015 P5
6 Prime incentives (%) Prime net face rents ($/m 2 ) RENTAL MARKET Prime face rents increased over the year to September 2015 but effective rentals fell due to increasing incentives. Secondary face rents were stable over the year to September RENTAL GROWTH Prime face rentals have risen over the 12 months to September 2015, however effective rentals have decreased due to incentives increasing from the 15%-25% range, to the 20%-35% range. Net face rentals for prime grade accommodation ranged from $365 to $420 per square metre as at September By comparison, secondary grade accommodation was stable over the year to September 2015 and is attracting face rentals in the order of $225 to $350 per square metre net. Outgoings can vary significantly, depending on a number of factors, but generally lie between $95 and $125 per square metre for prime grade buildings in the Adelaide CBD and from $75 to $100 per square metre for secondary grade accommodation. $450 $400 $350 $300 $250 $200 $150 $100 $50 $- Secondary Prime Adelaide net face rents Source: m3property Research Incentives are likely to remain high over the year to June 2016 before falling in late 2016 and over Climbing vacancy rates, as new supply and backfill space enters the market, is expected to result in limited rental growth over the next 6-12 months. This will continue to place downward pressure on effective rentals, as incentives are anticipated to remain high, whilst landlords and leasing agents seek to entice tenants into vacant space. 35.0% 30.0% Prime Adelaide prime incentives Secondary 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Source: m3property Research Comm3ntary Spring 2015 P6
7 Sales volume ($millions) Sales volume ($millions) INVESTMENT MARKET INVESTMENT MARKET Sales volumes reached record levels in 2014 and are therefore expected to moderate in Recent transaction activity in Adelaide has moderated, after reaching record levels in 2014, with approximately $160,810,900 worth of office stock traded in the Adelaide CBD market over the first eight months of The largest sale over 2015 to date was for 81 Flinders Street which sold in February for $41,333,897. Norelco Holdings sold the recently upgraded and refurbished building to the 81 Flinders Street Pty Ltd syndicate at a market yield of 8.2%. 600 Adelaide CBD office sales volume * Source: m3property Research *National Office Sales over $5 million to end August Private investors were the most active purchaser group in the Adelaide CBD over the first eight months of Over the first eight months of 2015 private investors have been the most active purchaser type for CBD office buildings, over $5,000,000 in value, with Syndicates the next largest group. This contrasts with the 2014 profile which saw A-REITs dominate activity. It appears that owners of larger prime buildings are currently looking to hold onto assets rather than sell whereas holders of secondary assets or sites particularly with development potential are still actively looking to sell due to the strength of the residential market. The number of CBD office investment grade assets being marketed for sale has reduced over the past six months with very few prime buildings being actively marketed. Larger investment opportunities currently on the market include the Viterra Property Portfolio, which contains three office buildings ( South Terrace, Stafford Street and Stafford Street) and three development sites and King William Street, which has recently undergone an upgrade including energy saving initiatives, floor and entrance lobby refurbishment. 600 Adelaide CBD sales volume, by purchaser type * A-Reit Developer Foreign Investor Government Owner Occupier Private Investor Syndicate Undisclosed Unlisted Fund Source: m3property Research *National Office Sales over $5 million to end August * Comm3ntary Spring 2015 P7
8 Prime yields (%) INVESTMENT MARKET Investment yields tightened due to low interest rates and investor demand for property due to volatility of other asset classes. Yield levels within the Adelaide CBD have firmed over the year to September 2015, and were trending in the range between 7.00% and 8.00% for prime investments. Secondary properties were typically achieving yields of between 8.00% and 9.5% at the end of September 2015 having also firmed over the past 12 months % Adelaide yields 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Prime Secondary Source: m3property Research Investment yields are set to tighten further over the year to September 2016, albeit at a slower rate compared to the year prior. This is likely to be driven by continued low interest rates and investor demand particularly for prime well located buildings or secondary buildings that offer future development opportunities. SELECTED ADELAIDE CBD OFFICE SALES Property address Date Price (millions) Rate $/m 2 Market yield IRR Purchaser Selected sales over the first eight months of 2015, sold for over $5,000, Flinders Street Feb-15 $41.33 $4, % 9.27% 60 Wakefield Street and 21 Divett Place 81 Flinders Street Syndicate Mar-15 $37.50 $2, % 8.55% Ascot Capital Grenfell Street Apr-15 $20.00 $4, %* 9.60% Centuria Metropolitan REIT Pirie Street Jan15 $13.00 $2, % 10.94% Pirie Investments North Terrace Mar-15 $7.00 $1,695 NA NA 233 North Terrace Pty Ltd Source: m3property (September 2015). *Initial yield Comm3ntary Spring 2015 P8
9 Net supply and absorption (m 2 ) Vacancy rate m3property Research For more information please contact: OUTLOOK The outlook for the Adelaide CBD office market is for volatility. Research Contacts Jennifer Williams P M ,000 40,000 Adelaide CBD market balance 20% 16% Key Valuation Contacts Kym Dreyer P ,000 12% M ,000 8% 10, ,000-20,000-30,000 Net supply Net Absorption Vacancy Rate 4% 0% -4% -8% -12% Simon Hickin P M Neil Bradford Source: PCA Office Market Report July 2015, m3property Research Net supply is expected to increase over the second half of 2015 before falling substantially in 2016 and no new supply is expected in Tenant demand is forecast to be moderate, over the next few years driven by a strengthening growth in the education and training and health and personal services sectors. The balance between net supply and net absorption is likely to result in vacancy rates falling by the end of 2016 after rising in the second half of 2015 and first half of Vacancy is then forecast to fall again in 2017 before stabilising. Face rents are forecast to be fairly stable over OFFICES Adelaide Brisbane Melbourne Level 3 44 Waymouth Street Adelaide South Australia 5000 T 61 (8) F 61 (8) Level 2 15 James Street Fortitude Valley Queensland 4006 T 61 (7) F 61 (7) Level Bourke Street Melbourne Victoria 3000 T 61 (3) F 61 (3) Perth Sydney Disclaimer Unit Stirling Highway Nedlands Western Australia 6009 T 61 (8) F 61 (8) Level 23, MLC Centre 19 Martin Place Sydney New South Wales 2000 T 61 (2) F 61 (2) the year to June 2016 on the back of high and increasing vacancy and only moderate tenant demand for CBD office space. Incentive levels are also likely to remain high over the year. After achieving record sales volume in 2014 sales activity is expected to moderate over While demand is expected to be solid owners are likely to look to hold onto CBD and, in particular prime, well located assets. Investment yields are set to tighten, albeit at a slower rate than over the year to September 2015, over the year to September 2016 driven by continued demand for assets and low interest rates. This report has been derived, in part, from sources other than m3property. In passing on this information, m3property makes no representation that any information or assumption contained in this material is accurate or complete. To the extent that this material contains any statement as to the future, it is simply an estimate or opinion based on information currently available to m3property and contains assumptions which may be incorrect. m3property makes no representation that any such statements are, or will be, accurate. P M Definitions A-REIT: ASX listed Australian Real Estate Investment Trust Completion date: determined by issue of a Certificate of Occupancy Grade: is determined using the PCA report A Guide to Office Building Quality. Net absorption: is the change in occupied stock within a market over a specified period of time. Net lettable area (NLA): defined in accordance with the PCA Method of Measurement Pre-commitment: contract signed to occupy space in new or refurbished space prior to construction commencing. Prime: Combination of premium and grade A. Secondary: Combination of grades B, C and D. WALE: Weighted average lease expiry.