Market Commentary Melbourne CBD Office

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1 Market Commentary Melbourne CBD Office July 2015 Executive Summary The Melbourne CBD office market recorded strong net absorption of 26,000 sqm in 2Q15. This is the fifth consecutive quarter of positive net absorption taking the total to 122,900 sqm over the past 12 months. However, an increase in secondary grade backfill space resulted in the headline vacancy rate increasing to 10.1% Two major projects completed in the CBD this quarter. AGL s building at 699 Bourke Street (19,300 sqm fully pre-committed) and the extension to 570 Bourke Street (15,550 sqm vacant). Melbourne CBD Key Indicators CBD prime gross effective rents rose slightly over the quarter, at an average $404 per sq m. Average prime outgoings growth outpaced rental growth, increasing by 3.4% over the quarter. Incentives edged higher to 32.5% (10 year lease). Average gross effective rents and incentives in the secondary market remained unchanged at $296 and 31% (10 year lease) respectively. End-June 2015 Total Stock (million sqm) 4.57 New Supply (sqm net) last 6 months Net Absorption (sqm) last 12 months 62, , Month Outlook Prime equivalent yields tightened by 25 basis points at both the top and bottom end of the range to 5.50% to 7.25% Secondary equivalent yields have tightened at the upper end by 25 basis points and now range from 6.75% to 8.75%. Vacancy 10.1% Prime Gross Effective Rents ($per sqm p.a) Secondary Gross Effective Rents ($per sqm p.a) $404 $273 Prime Yields (prime) 5.5%-7.25% 1 Melbourne CBD Office Market Update 2Q2015

2 Economic Overview State Final Demand, 2014 to % The Australian economy continues to be challenged by global factors. The Chinese economy is slowing and its slowdown has further to go and this has implications for commodity prices and as a result mining related construction. However, there are positives, with interest rates likely to remain lower for longer and the Australian dollar down from its peak in 2014 (parity with the US$) to approximately 78c. Y/Y, % Change 4% 2% 0% -2% -4% The NAB Business Survey in June confirmed the trend of gradually improving near term indicators and recorded the highest level of business confidence since August Westpac Melbourne Institute Index of Consumer Sentiment in July 2015 shows that consumer confidence has taken a step back. This result was expected as consumers were influenced by exogenous factors in China and Greece. Australian GDP increased 0.5% in the June 2015 quarter. Growth is expected to slow with GDP growth forecasts for 2015 expected to be 2.4%. Deloitte Access Economics (DAE) then forecast an improvement in economic activity with growth of 2.8% forecast for 2016 The RBA eased monetary policy in early 2015 to help smooth the transition from mining sector led investment growth to more broad based demand drivers. While the official cash rate is at a historical low (2.00), the RBA retains an easing bias and there is scope for a further easing of monetary policy. The lower Australian dollar has benefited many of Victoria s interest rate sensitive sectors of the economy, improving the operating environment and resulting in a reduction in Victoria s unemployment rate to below the national average. Victoria is also the state that is leading population growth which supports a strong residential sector. Victoria is benefitting from positive net overseas migration and an improvement in net interstate migration as residents are no longer leaving Victoria for the resource-dependent states. Demand VIC NSW QLD WA SA, Deloittte Access Economics The completion of 699 Bourke Street AGL s relocation from two premises into this building contributed 5,960sqm of positive net absorption to Q2 s positive net absorption figure of 25,995 sqm. The fully pre-committed building added 19,300 sqm to the Melbourne CBD. High incentive levels continue to act as pull factor for tenants to centralise. In 2Q15, NEC and VECCI both moved operations from outside the CBD, taking 5,600 sqm and 5,759 sqm respectively. There was also a large amount of activity in the pre-commitment space. Link Financial Services signed to take 25,000 sqm at Walker s Collins Square (Building 4); they will consolidate from a number of tenancies in the CBD. AECOM also pre-committed to 6,000 sqm in this building, and will vacate 4,854 sqm from 8 Exhibition Street and approximately 4,000 sqm in 80 Collins Street. Demand in the CBD is expected to remain positive with centralisation activity a major driver of absorption while CBD incentives are high. Since the beginning of 2015, 114 new tenant briefs have come to the market totaling 170,630 sqm (ranging from 105sqm to 23,500sqm) When broken down into size cohort, 13 occupiers (87,250 sqm) are seeking space in excess of 3,000 sqm. A further 32 occupiers (48,800 sqm) are seeking space between 1,000 3,000 sqm. However, the sub 1,000 sqm cohort continues to be the most active, with 69 tenant briefs totaling 34,580 sqm representing over 60% of requirements. Approximately 49% of tenants are seeking fitted space with the majority of the smaller tenant briefs falling into this category. 2 Melbourne CBD Office Market Update 2Q2015

3 Percentage of stock Square Meters Square Meters Absorption Melbourne CBD 200,000 Under Construction Project Address Size NLA Completion 150, Collins Street 48, ,000 50, Bourke Street Extension, Bourke Street 25, , * The Rialto Extension, 525 Collins Street 6, * As of June 2015 Collins Square Building 2, 735 Collins Street 65, Melbourne CBD market balance, 2006 to 2015 Vacancy % 200,000 12% 160,000 10% 8% 120,000 6% 80,000 4% 40,000 2% 0 0% -40,000-2% -80,000-4% * Completions Construction Net Absorption Vacancy Rate (rhs) * As of June 2015 PWC Southbank, 2 Riverside Quay 21, In Melbourne CBD there are currently four major office projects under construction totalling 141,000 sqm, of which 93,600 sqm is pre-committed. The completion of 567 Collins Street (scheduled for 3Q15) could bring as much as 14,000 sqm of additional vacant space to the Melbourne CBD. The pre-commitment of Link Financial Services in Walker Corp s Collins Square has meant that Building 4 is likely to commence construction in the second half of The medium term vacancy outlook is positive with JLL projecting vacancy will contract back towards 8.4% by Melbourne CBD vacancy, 2005 to 2015 Supply/Vacancy Despite the positive net absorption number, vacancy increased this quarter from 9.6% to 10.1%. The extension to 570 Bourke Street reached practical completion this quarter. The Charter Hall development extends the building by 15,550 sqm on the lower levels and is currently seeking tenant commitment. There were also a number of contractionary moves including: Oz Minerals (1,800 sqm), Melbourne IT (2,567 sqm), Victorian Government (5,638 sqm) and the State Trustees Office (6,140 sqm). 16% 14% 12% 10% 8% 6% 4% 2% 0% * Prime Secondary * As June 2015 The largest increase in vacancy was in the secondary grade sector, which increased by 1.0 percentage point to 10.6%. Prime vacancy recorded a marginal increase from 9.6% to 9.8% over 2Q. The extension to the Rialto building at 525 Collins Street started construction in 2Q15. The development will add additional retail (2,000 sqm) and office space (6,000 sqm). Bank of Melbourne has pre-committed to 3,000 sqm of the additional office space. 3 Melbourne CBD Office Market Update 2Q2015

4 $/square meters p.a. Docklands S&P/ASX 200 dominant tenant mix Docklands is the Melbourne CBD s newest precinct. The first completion occurred in DATE over 600,000 sqm of office space has been added bringing Docklands total office stock to 788,150 sqm. Docklands is now Melbourne s second largest precinct behind the Western Core and represents 17.3% of the CBD s total office stock. Newly constructed buildings with a larger floor plate size have attract a number of big corporate occupiers. Analysis of occupier composition shows that in excess of 27% of Docklands by NLA is occupied by listed S&P/ASX 200 companies and in all cases except for Myer, these companies have improved their ranking (by market capitalisation) Rank By Market Cap 2015 Rank By Market Cap Rents: Melbourne CBD $450 $400 $350 $300 $250 $200 $150 Code Company NLA 2 1 CBA Commonwealth Bank of Australia Australia And New 4 4 ANZ Zealand Banking Group 5 5 NAB National Australia Bank 6 6 TLS Telstra Corporation TCL Transurban Group Stapled AMP AMP AGL AGL Energy MPL Medibank Private Bendigo And BEN Adelaide Bank FXJ Fairfax Media Nine Entertainment NEC Co. Holdings MYR Myer Holdings Total * Prime Gross Effective Secondary Gross Effective * As at June 2015 Rents Prime gross effective rents increased this quarter by 1.2% to $ 403 per sqm p.a. A 3.4% increase in outgoings over the quarter is the main factor in explaining gross effective rental growth. Land tax is having a significant impact on the level of outgoings. With residential property development placing upward pressure on underlying land values the amount of land tax payable increases. To put this in further context, average outgoings in Melbourne s CBD office market have increased 10.1% over the last 12 months. Average prime face rents marginally increased over the quarter by 0.4%. There are a number of large contiguous space options that currently exist in Melbourne s CBD and this has constrained rental growth. Prime incentive has also increased by 1.2% over the quarter, negating the effect of the face rental increases for land lords. Secondary gross effective rents have stablised over the quarter, remaining at $ 296. Incentives still remain at 37 months rent free on a ten year lease. Selected Major Leases Tenant New Address Area Leased (m2) AGL 699 Bourke St 15,000 NEC 720 Bourke St 5,600 Ausnet Serivces 15 Willaim St 3,477 VECCI 150 Collins Street 2,760 Engineers Australia 600 Bourke Street 2,400 Yields / Transaction Volumes Five sales greater than $ 5 million transacted in Q2 totalling $337.3 million, four of which were located on Collins Street. The largest recorded transaction in 2Q15 was 357 Collins Street which was sold by Frasers owned Australand and purchased by the Frasers Commercial Trust for $ million. This sale represents 66% of the total CBD sale value this quarter. Other significant transactions occurring in the CBD in Q2 were: 520 Collins Street which was sold for $ 51 million. The Australian based Mering Corporation sold the building to an undisclosed private investor. ANU House at Collins Street was sold for $ 33.1 million. The Australian National University sold the building to Australian Developer Marks Henderson Collins Street & 175 Flinders Lane transacted between private investors for $ million and $ 9.8 million respectively. 4 Melbourne CBD Office Market Update 2Q2015

5 This quarter the prime yield range compressed by 25 basis points to 5.50%-7.25%. The upper end of the range represents a tightening further than the 2007 peak. Prime Yields: Melbourne CBD There is a healthy competition for assets, including for potential residential conversion, which has led to yields tightening. Investors willing to go further up the risk curve have also lead to the upper end of the secondary yield range compressing by 25 basis points on a range of 6.75%-8.75%. There are a number of large assets on the market that are expected to confirm current yield levels over the coming quarters. Assets that are in the advanced stage of due diligence include: 222 Exhibition Street and 575 Bourke Street % 8.50% 8.00% 7.50% 7.00% 6.50% 6.00% 5.50% 5.00% * Prime and Secondary Yield spread 8.50% 8.00% 7.50% 7.00% 6.50% 6.00% 5.50% * As of June 2015 Office Market Outlook The Victorian economy is expected to gradually improve over the next few years. State final demand is forecast to grow by 3.4% in 2015 and drop back to 2.2% in 2016 before gradually improving in following years (Deloitte Access Economics). Private housing investment will be a major driver of the growth in 2015 along with private consumption. The centralisation trend will continue in the medium term in addition to other demand drivers resulting in a slight tightening vacancy rate by the end of this year. However, in 2016 part pre-committed projects at Collins Square are expected to complete and with some back fill space due to come to market, vacancy will slightly increase again in 2016 before trending lower through to a cyclical low in Face rents have seen some growth and though incentives remain stubbornly high they are expected to start falling towards the end of the year. Prime gross effective rents are expected to show a year on year rise of 3.9% for Solid growth in effective rents is expected to continue through to Australia remains a stable and attractive destination for investment. Melbourne s CBD office market contains the characteristics that institutional investors consider favourable. Robust capital market demand for real assets is projected to continue over the coming quarters and new pricing benchmarks are likely to be achieved this year. The continued recovery of the physical market supports the outlook for effective rental growth through to 2018 and adds weight to the investment thesis. However, there are signs that the investment market is already factoring in this rental growth and risks getting ahead of the physical market fundamental 5.00% * * As at June 2015 Table 1: Selected Major Transactions Address NLA (sqm) sale price (AUD million) Initial yield Date 357 Collins Street 30, ,500, % Apr Collins Street 8,419 50,000,000 May Collins Street 5,350 34,000, % Mar Collins Street 3,357 32,000,000 May Flinders Lane 1,440 9,800, % May Melbourne CBD Office Market Update 2Q2015

6 For further information, please contact Annabel McFarlane Research Manager Victoria Strategic Research tel JLL Melbourne Level 21, Bourke Place 600 Bourke Street Melbourne VIC Follow us Jones Lang LaSalle 2015 Jones Lang LaSalle IP, Inc. All Rights reserved. All information contained herein is from sources deemed reliable; however, no representation or warranty is made to the accuracy thereof.

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