Office Views. Residential Luxury? Sydney s North Shore Market. How vendors are adjusting to demand. Commercial Overview November 2015

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1 CI RESEARCH SYDNEY NORTH SHORE NOV 2015 Office Views or Residential Luxury? How vendors are adjusting to demand Sydney s North Shore Market Commercial Overview November 2015

2 CI Team The Sydney North Shore Team at CI comprises of professional individuals, devoted to ensuring all client needs are met with precision and efficiency. Please contact our office to discuss the potential of your assets and we will endeavour to make sure your key drivers are achieved. Name : Bevan Kenny Title : Managing Director, North Sydney Sales Mobile : bkenny@ciaustralia.com.au Name : Michael Lochtenberg Title : Director, Commercial Leasing & Development Mobile : mlochtenberg@ciaustralia.com.au Name : Georgia Hundt Title : Director, Tenant Representation Services Mobile : ghundt@ciaustralia.com.au Page 2 of 16

3 Contents Office Views or Residential Luxury... 4 The North Shore Market... 6 Market Summary... 7 Commercial Stock... 8 Conditions & Patterns... 8 Current Trends... 9 Key Drivers... 9 Commercial Sales Sales Activity Investor Demand CI Outlook Commercial Leasing Leasing Activity Tenant Demand CI Outlook North Shore Development Development Activity Key Updates CI Research Page 3 of 16

4 Office Views or Residential Luxury Over the past year, Sydney s North Shore market has experienced an exceptional decrease in vacancy rates from 10.9% to 8.5% which is a positive reduction of 2.4% overall. There are a number of reasons as to why this decrease has occurred, the foremost reason being an increase in demand from office users particularly those outside the Sydney CBD and secondly the extraction of stock through change of use to residential. How did this occur and what does this mean for the future? 1. The increase in demand particularly from the IT and communications sector has led to an increased take up in high demand, well serviced commercial locations 2. A substantial increase in the value of residential and lack of available redevelopment sites fuelled with increasing demand from foreign investment for development opportunities Due to the increasing value of residential stock which has exceeded current commercial values, there has been a strong demand for commercial to residential conversion opportunities. This has placed pressure on current commercial supply in the market and as a result has further increased demand and consequent values. This is particularly relevant in locations that allow high density mixed use accommodation and high rise developments (i.e. commercial cores on public transport routes). This has been aided by State Government s DRAFT Metropolitan Plan 2031 which, amongst other items, states it will: Work with councils to identify suitable locations for housing and employment growth coordinated with infrastructure delivery (urban renewal) and train services, including around Priority Precincts, established and new centres, and along key public transport corridors Page 4 of 16

5 This unexpected increase has encouraged property owners to assess their properties, particularly older secondary assets that are in need of substantial capital expenditure to maintain desirability in the commercial office market. Following this assessment, a number of properties have been placed on the market to take advantage of this capital increase and satisfy the development demand. Our belief is that whilst the residential market continues to show strong demand, the opportunity for redevelopment of commercial buildings to convert to residential will continue to be at the forefront and therefore maintaining pressure on commercial building values through this change which, together with the regression of office space and increasing demand from the office sector, will ad upward pressure to pricing. This is giving vendors the opportunity to sell into a strong residential market or look to take advantage of the reduction in stock and maintain their commercial use at improving rental levels. NORTH SHORE (AGGREGATE) KEY MARKET INDICATORS Based on figures at July 2015 (Source PCA/CI Research) Grade Vacancy July 2015 (%) Vacancy July 2014 (%) Net Absorption, 6 months July 2015 (sqm) Net Absorption, 12 months to July 2015 (sqm) Premium 1.3% A 6.5% 10.0% 5,289 15,592 B 9.8% 10.8% 7, C 9.6% 13.0% ,653 D 9.7% 9.6% 180-1,968 Total Average 8.5% 10.9% 11,498 11,468 Page 5 of 16

6 The North Shore Market Macquarie Park Crows Nest/ St Leonards Chatswood North Sydney The Sydney North Shore The North Shore office market begins at the northern side of the Sydney Harbour Bridge, otherwise known as the dynamic commercial centre of North Sydney, and extends through to major northern metropolitan areas. North Sydney is the main business hub for the North Shore, offering a high quality CBD environment with extensive transport and retail amenities. An impressive tenant profile including Coca-Cola, NSW Health, Transfield Services, Cisco, Genworth, Leightons (arriving 2016), MLC, SAP, Sony, Worley Parsons and Zurich positions North Sydney as a strong alternative to the Sydney CBD. The North Shore locality consists of 2,322,045sqm of commercial office space and includes the following four key commercial precincts: North Sydney (823,351sqm) Crows Nest/St Leonards (346,934sqm) Chatswood (284,465sqm) Macquarie Park (868,295sqm) Page 6 of 16

7 Market Summary Commercial Stock Period : July 2015 Total Commercial Stock : 2,323,045 sqm Total Vacancy : 123,874 sqm Vacancy Factor : 8.5% Net Absorption : 11,468 sqm (12 months to July 2015) Commercial Sales Market Activity : Strong demand for residential conversion has led to increased residential developments, ultimately tightening the amount of commercial stock available. Market Yields : A Grade 6.58% % Secondary Grades 7.75% -8.25% Continued strong demand from domestic and offshore investors with low costs of capital coupled with stock withdrawal for residential development is driving the current market cycle of yield compression - Bevan Kenny Commercial Leasing Market Activity : Significant withdrawal of stock due to residential conversion has led to rise in rental levels and increased demand as a result of tightening supply. Market Rents : $ Net psmpa Face for A Grade $ Net psmpa Face for B Grade Market Incentives : 25%-30% (Excluding Macquarie Park) One of the latter areas to enjoy positive net absorption due the lifting of capital constraints placed on US and European based corporations. Throughout the GFC period, The North Shore has recently enjoyed a significant resurgence in demand with particular emphasis on the commercial centres of North Sydney and Chatswood - Michael Lochtenberg Page 7 of 16

8 Commercial Stock Sydney s North Shore market contains a variety of commercial stock, with 45% Prime (Premium and A-Grade) office accommodation. NORTH SHORE TOTAL COMMERCIAL STOCK (sqm) Based on figures at July 2015 (Source PCA/CI Research) Total Stock Premium A Grade B Grade C Grade D Grade North Sydney 823,351 36, , , ,957 12,932 St Leonards/Crows Nest 346, ,699 66, ,814 13,646 Chatswood 284, ,412 81,146 45, Macquarie Park 868, , ,941 16,917 2,721 Total 2,323,045 36,500 1,062, , ,141 29,753 Conditions & Patterns The North Shore remains a cost effective option for businesses who desire prime accommodation whilst remaining in proximity to the CBD. Macquarie Park holds a greater supply of Prime stock due to the continued development of new assets on land inherently available for development. Residential conversion of Secondary stock within all precincts has led an upward push of existing tenants to Primary assets. North Shore demand is evidenced through a decline in vacancy and movement of high profile company headquarters. NORTH SYDNEY MARKET FORECASTING Based on figures at September 2015 (Source PCA/CI Research) Current 12 Month 24 Month Vacancy Factor 8.0% 8.0% 7.3% Gross Face Rent (prime) $713 $728 $748 Gross Face Rent (Secondary) $595 $608 $625 Rental Growth (Prime) 3.3% 2.1% 2.7% Incentives (Prime) 28.0% 27.0% 25.0% Incentives (Secondary) 29.0% 28.0% 27.0% Yields (Prime) 6.9% 6.8% 6.9% Yields (Secondary) 7.7% 7.6% 7.7% Page 8 of 16

9 Current Trends Currently, the commercial market for the North Shore has experienced a compression in vacancy rates from 10.9% in July 2014 to 8.5% in July this year. This can be attributed to a growth in demand for varied stock ranging from residential conversion opportunities to commercial office space. Environmentally friendly green spaces are high on the list of tenant preferences along with quality end of trip facilities and mixed use tenancies, allowing retail exposure to the ground floor as well cafes and other food premises to service the tenancies. Green Spaces EOT Facilities Mixed Use Recent spikes in residential conversion have caused strong demand from developers seeking opportunities within secondary lower grade stock to purchase for conversion. As a result there has been a shift amongst several Local Planning instruments which have been altered to allow mixed use zonings in historically commercial locations. Key Drivers The North Shore market is currently experiencing a reduction in supply, declining vacancy rates and upward pressure on rents. Key drivers for these are as follows: Withdrawal of stock for residential development Minimal DA approved office development deliverable before 2018, leading to lack of new supply. Increased residential amenity to St. Leonards and Chatswood markets North Sydney and Macquarie Park enhanced as mixed used commercial markets to take advantage of existing and improving infrastructure. Sydney Metro City and South-West railway link will connect the North West suburbs of Chatswood, St Leonard s and Victoria Cross (North Sydney).. Page 9 of 16

10 Commercial Sales Sales Activity In the last 12 months sales within the North Shore commercial market have totalled an estimated $1.55 billion, a dramatic increase from the 5 year average of $457 million. This boom can be attributed to the significant weight of domestic and offshore capital chasing a limited amount of stock, as well as the opportunity to invest in capital that is speculated to increase rapidly. Investors have observed the reduction in vacancy rates and consequent rise in rental figures, solidifying speculation that the leasing market is set to improve in months. This improvement will further exert downward pressure on incentives whilst increasing net effective rentals, overall resulting in the improvement of capital values. NORTH SHORE SALES ACTIVITY Based on figures at September 2015 (Source CI Research) Date Jun-15 Jun-15 Feb 15 Feb-15 Sep 14 Jun 14 Apr 14 Apr 14 Apr 14 Dec 14 Mar-14 Property Area Sqm (Approx) $M Yield (Fully Leased) Rate Psm Wale By Income (Yrs) 140 Arthur Street NORTH SYDNEY 8, % 6, Pacific Hwy St Leonards 5, % 2,687-2 Elizabeth Plaza NORTH SYDNEY 7, % 5, &7 Eden Park MACQUARIE PARK 18, % Arthur Street NORTH SYDNEY 7, % 4, Albert Avenue CHATSWOOD 15, % 5, Miller Street NORTH SYDNEY 10, % 5, Christie Street ST LEONARDS 18, % 5, Mount Street NORTH SYDNEY 10, % 4, Miller Street NORTH SYDNEY 14, % 7, Herbert St ST LEONARDS 6, % 3,957 - Page 10 of 16

11 Investor Demand Investor demand is anticipated to remain strong over the next 24 months given the current interest in North Shore assets from local institutions, funds and offshore groups, particularly investors based in Singapore, Hong Kong and mainland China Capital values and yields along Sydney s North Shore vary on the basis of building grades. Prime assets such as A Grade have a capital value of approximately $7,600- $11,150/sqm Secondary assets buildings such a B, C or D Grade have capital values of approximately $4,500-$7,600/sqm Prime assets yield a range of 6.50% to 7.50% Secondary assets yield a range of 7.75% to 8.85% North Shore Investor Profile Foreign Purchaser Fund Developer Private 2% 18% 5% 75% CI Outlook The demand for investment grade properties on the North Shore has continued to increase, with a number of recent taking places. This is a function of increasing investor demand for quality stock in supply constrained market. As Sydney s premier metropolitan market, yields across the lower North Shore have firmed strongly as investors intensify their search for genuine investment opportunities. However in comparison to the Sydney CBD market, North Shore assets continue to provide relatively good returns and remain an attractive investment proposition. Recent sales of prime commercial office in North Sydney suggest yields are firming, with the most recent transactions reflecting returns well below 8% as the benchmark. This situation is set to continue, with ongoing yield compression in the CBD and continued stock withdrawals across the lower North Shore due to residential development driving the supply/demand equation. - Bevan Kenny Managing Director, CI Australia North Shore Page 11 of 16

12 Commercial Leasing Leasing Activity The North Shore commercial market is currently seeing an increase in leasing activity with areas such as North Sydney, Chatswood and Macquarie Park make up the largest proportion of these deals. NORTH SHORE COMMERCIAL LEASING ACTIVITY Based on figures at September 2015 (Source CI Research) Property Area (Approx) $/sqm Date Level 10, 2 Elizabeth Plaza 350 sqm $560N June 2015 Level 6, 41 Mclaren Street 920 sqm $462N August 2015 Level 8, 2 Elizabeth Plaza 604 sqm $433N September Talavera Rd, Macquarie Park 2000 sqm $360N November 2014 Suite 14.01, 132 Arthur Street 258 sqm $455N June 2015 Levels 18 & 19,40 Mount Street 2,259 sqm $750N September 2015 Level 5, 90 Arthur Street 816 sqm $495N October 2015 Level 14,90 Arthur Street 515 sqm $694N September Pacific Hwy 1008 sqm $623N August Mclaren Street 920 sqm $570N August Mount street 2259 sqm $515N September 2015 Rental benchmarks are said to hit record levels in North Sydney as listings with net face rents of $650 (60 Miller St) and $760 (40 Mount St) enter the market. This confidence is a result of increased leasing activity which can be attributed to: Growing business confidence within the economy Improving availability of high quality accommodation Increased presence of large scale tenants such as attaché Software and Steinhoff in Macquarie Park, escalating the net absorption rate to approximately 25,000 qm Heightened activity in commercial to residential conversion leading to a tightening of available commercial space Page 12 of 16

13 Tenant Demand Gross face rents have been maintained over the past 12 months as incentive levels have pressure to drop, but it is now estimated that incentives will gradually diminish as the leasing market improves and once a level of approximately 20% incentives is achieved, growth will then occur in face rents. It is thought that incentives will remain at this level (approximately 20%) as it allows sufficient capital for fit-outs to be funded by the landlord, an integral part of leasing transactions that has developed over more recent years. The Macquarie Park region will benefit from this growth as a developing trend in larger tenants relocating to the area takes place. Other more dense regions will benefit from a reduced availability of leasing stock as a result of commercial to residential conversions, increasing demand and further escalating face rents. CI Outlook Overall the commercial office leasing market on the North Shore reflects the overall positive economic outlook for NSW, with a good level of confidence, relatively low net supply and improving demand. We anticipate the supply that is on course for delivery will provide leasing activity and a flight to quality. At this stage each vacancy in a good quality building that has arrived over 2014/15 has been keenly sought especially in the North Sydney market. Impending vacancies at 177 Pacific Highway, 40 Miller Street, 101 Miller Street and 80 Pacific Highway will provide leasing opportunities and activity. (Lower A grade stock may remain relatively soft over the short to medium term). Again, both Chatswood and Macquarie Park have very limited supply, and with recent rise in economic confidence tenants appear to be on the move, as illustrated by the strong recent movements in vacancy rates in all markets. At this stage we anticipate this to continue in the short to medium term as an early indication of this has been the tapping out of incentive levels. - Michael Lochtenberg Director Commercial Sales & Development, CI Australia North Shore Page 13 of 16

14 North Shore Development Development Activity The North Shore has limited new supply presently under construction. In terms of A Grade office towers, the North Shore market has the ability to attain the economic rents required to sustain development profitability, however any development requires significant precommitment to obtain debt funding. This recent circumstance will create a positive outcome for the North Shore market given the recent lack of new developments and an improving leasing market. COMMERCIAL DEVELOPMENT ACTIVITY Based on Figures at July 2015 (Source CI Research) Market Status Completion Project Address NLA (sqm) St Leonards DA Approved Mooted 88 Christie St 28,000 Macquarie Park Construction Thomas Hold Dr 11,400 Macquarie Park DA Pending Mooted Epping Rd 14,477 Macquarie Park DA Approved Mooted 8 Julius Ave 34,194 Macquarie Park Construction Waterloo Rd 10,000 Macquarie Park DA Approved Mooted 1 Rivett Rd 11,380 Macquarie Park DA Approved Mooted Waterloo Rd 40,030 North Sydney Construction Pacific Hwy 39,383 North Sydney DA Approved Mount St 48, 000 North Sydney DA Approved Denison Place 45,720 North Sydney DA Approved Mooted 100 Mount St 40,100 Most of the developments within the North Shore region are mooted, a result of lower demand for commercial spaces due to stock withdrawals for the purpose of conversion into residential or mixed use, this is developing into a trend where future supply is dependant on demand through higher pre-commitment rates. This trend for residential is set to continue due to the higher use value for conversion and redevelopment. The following table highlights a number of future commercial sites that are prime candidates. Page 14 of 16

15 FUTURE POTENTIAL COMMERCIAL TO RESIDENTIAL/SE5RVICED APT. Conversion DEVELOPMENT ACTIVITY Based on Figures at September 2015 (Source CI Research) Address Commercial NLA Timing Owner/Purchaser 52 Alfred St, Milsons Point 9, ? Bridgehill 118 Mount St, North Sydney 4,034 - Zurich 5 Blue St, North Sydney 8,079 Mooted Zurich 564 Pacific Hwy, St. Leonards 1, Leightons 100 Christie St, St Leonards 9, Altis 600 Wiloughby Rd, Willoughby 4, For Sale 486 Pacific Highway 11, Leightons Albany St Crows Nest 4, Warner Music Key Updates Construction of large scale development projects such as 1 Thomas Holt Drive Macquarie Park (11,400sqm) and Pacific Highway North Sydney (39,383sqm) has increased High level pre-commitments rates amongst new developments such as a 75% precommitment by Leighton holdings for Pacific Highway North Sydney Macquarie Park showing the highest level of developments completed with offices such as 5 Talavera Road and 118 Talavera Road making up for 12,975sqm and 12,000sqm respectively Page 15 of 16

16 CI Research CI Australia is widely regarded as a market leader within the property and real estate industry, specialising in the areas of: Commercial Leasing Tenant Representation Services Investment Sales Asset Management Engineering & Facilities Management Valuations & Advisory Marketing & Research The CI Research department benefits from a vast network of industry connections and the inherent resource of property knowledge that accompanies. The teams at CI work ambitiously and thrive in ensuring your interests are successfully protected and your key drivers achieved through high-performance and superior results. For more information on any of our research items, or to request a personalised research document specific to a certain market or asset, please contact our offices: North Sydney Office Level 7, 2 Elizabeth Plaza North Sydney, NSW, 2060 T: F: northsydney@ciaustralia.com.au Sydney CBD Office Level 4, 35 Clarence Street Sydney, NSW, 2000 T: F: sydney@ciaustralia.com.au Disclaimer: This report has been prepared by CI Australia Pty Limited ( CI ) concerning information on the North Shore Market. This report is given for information purposes only. CI does not give any warranty of reliability, accuracy, currency or completeness of any of the information supplied nor does it accept any responsibility arising in any way (including by reason of negligence) for any errors or omissions in the information provided. The information in this report is subject to change without notice and may include certain statements, estimates and projections with respect to anticipated future performance. No representations or warranties are made as to the validity of those assumptions or the accuracy of those statements, estimates or projections. Any interested party should form its own views as to what information is relevant to any decisions it makes and make its own independent investigations and obtain its own independent advice. This report does not form part of or constitute an offer or contract. The information in this report must not be copied, reproduced or distributed without the prior written approval of CI. Page 16 of 16