OFFICE RENOVATION IN GLOBAL CITIES:

Imagine the result OFFICE RENOVATION IN GLOBAL CITIES: Which city provides the highest return?

ARCADIS Office renovation in global cities 03 Our research estimates the expected return on Capital Expenditure (CAPEX) generated from office renovation projects in 15 cities across the world. Our research found that in the U.S., with many large buildings in multi-occupation, the best return to investors will come from investment in maintenance strategies which sustain a building s competitive position. SCOPE OF THE RESEARCH This research considers both major and minor renovation projects and ranks them by best return from CAPEX. In addition, we consider influential factors, such as renovation costs per square foot, different CAPEX investment strategies, the status of rental cycles and recommendations for investors to enhance asset performance through renovation. Our focus is on 20- to 30-year-old buildings that, in their previous state, no longer met the criteria for Class A space. Our research focuses on the following 15 cities: Amsterdam, Brussels, Chicago, Dubai, Frankfurt, Hamburg, Hong Kong, London, Madrid, Milan, New York, Paris, Shanghai, Singapore and Warsaw. EXECUTIVE SUMMARY Office renovation is the most effective way to improve the income from older buildings in most locations; it also allows investors to gain an advantage more quickly in rapidly changing rental growth cycles. New York, which is dominated by large multi-tenant buildings, offers a relatively better return to investors if CAPEX is spent on maintenance strategies that sustain the building s competitive position. Recovering markets in Europe offer the best return overall; London is ranked number one for major renovation, and Madrid ranks number one for minor renovation. Frankfurt, London, Milan and Warsaw are among the cities that deliver a significant increase in rental income and quick CAPEX payback. Asian financial centers, including Shanghai, Singapore and Hong Kong, offer relatively high returns on CAPEX, but with increased risk due to the increasing competition resulting from the high volume of new office supply coming to market.

ARCADIS Office renovation in global cities 04 THE FINDINGS This research focuses on the increase in rental income following renovation and is based on full occupancy. Rental income is expressed as a percentage of CAPEX (or total development cost), and the research reviews both major and minor renovation projects based on the definitions presented on pages 5 and 6. In the case of major renovation, locations in the early stages of the business cycle (in terms or rental and capital growth), such as the European financial centers, including London, Frankfurt, Hamburg and Milan, offer a significant increase in income and a relatively quick payback period. London offers the highest return nearly 10% as a result of substantial rental growth in the past year. It is important to note that these locations tend to be in regions where the planning and regulatory environment is most favorable to improving floor plates and increasing floor area. The returns on CAPEX varied from 6% to 10% in these locations. Although we are seeing an increase in major CAPEX projects for renovation in Asia, we conclude that this is partly justified from a financial perspective due to an expectant yield compression through local market trends rather than from an asset competitiveness perspective. The impact of yield compression due to market sentiment is outside the scope of this research. New York offers a relatively lower return on CAPEX due to more expensive construction costs and the nature of the tenant market. This is a result of the relatively low supply of office space and the multi-tenant nature of office buildings. Therefore, owners do not have as much of an incentive to invest in their assets to keep tenants. The Asian financial sector offers a level of return for minor renovation of approximately 7%. This level of return invariably occurs where there are opportunities to reposition the tenant profile. However, the risk is higher due to the competitive nature of the office market in terms of the volume of new-build supply and shorter real estate cycles. Madrid offers the highest return from minor renovation, primarily due to the legacy of underinvestment in office assets. It appears that a small asset enhancement project will make a relative difference in terms of rental income. This is not sustained for major renovations in this market due to relatively lower rental levels than those of other global cities.

ARCADIS Office renovation in global cities 05 Minor renovation Analysis of return on investment post minor renovation Rank Location Return % 1 Madrid 9.59% 2 London 8.46% 3 Shanghai 7.89% 4 Singapore 7.53% 5 Warsaw 7.47% 6 Milan 7.35% 7 Hong Kong 7.00% 8 Paris 6.99% 9 Frankfurt 6.02% 10 New York 5.43% 11 Hamburg 4.91% 12 Amsterdam 3.78% 13 Chicago 3.77% 14 Brussels 2.67% 15 Dubai 0.00% Minor Renovation: the primary objective of minor renovation is to prolong the economic life of the asset by up to five years and to keep existing tenants. Typical work includes upgrades to entrance halls, common and reception and reception areas, areas, toilets, toilets, and elevators, and elevators, and any and superficial any re-branding superficial re-branding work, such work, as façade such as lighting façade lighting and landscaping. and landscaping. No major No planning major is planning required, is required, and all work and is carried all work out is carried with tenants out with in place. tenants The in place. average The project average duration project duration of a minor of a project minor is project six months. is six months. Indicative minor renovation construction New York Singapore Paris London Chicago Amsterdam Brussels Milan Shanghai Hong Kong Dubai Warsaw Madrid Frankfurt Hamburg 0 10 20 30 40 50 60 70 80 90 100 110 ( $ / ft² Gross internal floor area ) Return on investment: our assessment of return on investment is based on a comparison of the increase in annual rental income (based on full occupancy) as a result of renovation. This assessment does not take into account the impact of reducing voids. Return on investment is expressed as a percentage of total development costs. The rental calculation excludes tenant incentives, loss factor, and other local market nuances. The assessment of development costs excludes finance costs and sales taxes (VAT). Costs represent all-in build cost for each renovation option, including alterations and temporary works, base build construction, developer s fit out and contractor s management and profit. Professional fees, sales tax and finance charges are excluded.

ARCADIS Office renovation in global cities 06 Major renovation Analysis of return on investment post major renovation Rank Location Return % 1 London 9.86% 2 Warsaw 7.53% 3 Milan 6.03% 4 Frankfurt 5.78% 5 Amsterdam 5.46% 6 Madrid 5.18% 7 Hong Kong 5.15% 8 Paris 4.29% 9 Hamburg 4.26% Indicative major renovation construction costs Hong Kong Paris London Amsterdam Milan Brussels Warsaw Major renovation: the primary objective of major renovation is to extend the life of the asset by as much as 15 to 20 years and to enhance the office environment for tenants. There are likely significant structural changes, upgrades to all areas, and replacement of the external fabric and major mechanical, electrical and fire protection systems and machinery. Major renovation that increases floor area through the replanning or extension of floor plates or the addition of extra floors will generate the greatest additional return. All work is carried out when the structure is vacant. The average duration of a major project is 24 months. Frankfurt Hamburg Madrid 0 50 100 150 200 250 300 350 ( $ / ft² Gross internal floor area ) Sources of variation in construction costs: ARCADIS has compiled international construction costs for many years. Our analysis has demonstrated that there are substantial differences in the costs of constructing functionally identical spaces. These differences are the result of variations in specification standards, labor costs, productivity and so on. Renovation costs have the potential for even greater variation associated with the quality and condition of the base build and the amount of improvement work required. Costs of the renovation of offices in Paris and Hamburg illustrate this trend, with older buildings in Paris core being more difficult to bring to modern standards than the post-war office stock common in Germany.

ARCADIS Office renovation in global cities 07 DIFFERENT LOCATIONS, DIFFERENT STRATEGIES Different market locations offer different dynamics. Therefore, to maximize the return on CAPEX, different strategies must be tailored according to local circumstances. We offer four strategies that should be considered to enhance the potential return from an office building. Each potential return is determined by a combination of factors, including the design, age and condition of the existing building, as well as the presence or absence of constraints, such as planning controls. These four strategies are summarized below and illustrated in the typical case studies that follow: 1. TRANSFORM revenues through major renovation 2. MAINTAIN revenues through minor renovation 3. DEFEND revenues through minor renovation 4. RE-PURPOSE where existing revenues are at risk due to obsolescence The table below plots opportunities to improve asset performance along the axes of building performance and tenant quality. In New York, for example, there is little opportunity to increase actual floor area in multi-tenant buildings, and the objective of renovation is to maintain the position of the asset in its marketplace, benefitting from general upward movement in rent levels. By contrast, in London, opportunities exist to improve values through CAPEX renovation by increasing the quality and quantum of space and by shifting the market position of the building. HIGH BUILDING MAINTAIN TRANSFORM New York London (major) LOW HIGH Dubai Amsterdam RE-PURPOSE DEFEND LOW BUILDING

08 ARCADIS Office renovation in global cities The Four Investment Strategies 1. TRANSFORM These are locations that reach their desired potential when investment is made in major renovation. The transform strategy typically requires fully vacant space to enable major work to be carried out. Benefits include: increased rental income as a result of delivery of Class A space increased floor area enhanced capital value driven by tenant covenant Strong markets for the transform strategy include London, Hamburg and Frankfurt because these are locations where many older buildings have the potential for extension and increased efficiency through the replanning of the floor plate. These buildings may benefit from character that attracts tenants and a planning agreement that is better than could be obtained in the current market. A typical case study of major renovation in London The building: A 1960s office building with approximately 155,000 square feet of gross internal floor area in a fringe location in the City of London with the potential to re-plan and extend floor plates. The approach: A major renovation strategy to deliver a 25% increase in net floor area to approximately 134,500 square feet of Class A space and updates in all building services. The expected outcome: The improvement in the quality of space drives a 25% increase in base rent to $107/ft² Renovation costs include the loss of rental income during a 22-month construction period. Analysis of renovation costs and returns: Performance Metric Value Development expenditure $65.2 M Development expenditure ($/ft² gifa) $390/ft² Increase in rental income $6.4 M pa Increase in asset value $101.6 M Return on expenditure 9.9% Total return per $ million of development expenditure $1.15 M Payback 10.1 years The key to success in this renovation project has been the reorganization of circulation cores and the infill of sections of the floor slab to improve the efficiency of the floor plate, increase overall floor area and improve the overall quality of space. Older office buildings that are organized around light-wells present many opportunities to maximize development value. Renovation on this scale enables the developer to create office space that meets all modern expectations with regard to comfort and energy efficiency. This case study demonstrates that investment in a major renovation delivers significantly better long-term returns in markets where there is the potential to extend and reposition the asset in its marketplace. HIGH BUILDING MAINTAIN MAINTAIN TRANSFORM New York London (major) LOW HIGH Dubai Amsterdam DEFEND DEFEND RE-PURPOSE RE-PURPOSE LOW BUILDING

ARCADIS Office renovation in global cities 09 The Four Investment Strategies 2. MAINTAIN These are locations that benefit from investment in minor renovation to retain a position in a diverse and competitive market that presents plenty of options for tenants. The maintain strategy is essential for large, multi-tenant buildings in good locations, where rental growth will be influenced by general market dynamics as well as the condition of the buildings. Benefits include: Improved tenant retention as part of a wider asset management initiative Minimization of the loss of rental income associated with renovation Strong markets for this strategy include cities in the U.S., such as Chicago and New York, where periodic renovation to meet tenant expectation could be considered a cost of business rather than a major investment. A typical case study of minor renovation in New York The building: Floor-by-floor renovation of a multi-tenant 1960s office building located in central Manhattan. The approach: Minor renovation focused on improvement work to tenant space with some upgrade work to landlord areas on the affected floor only. The expected outcome: The renovation helps to secure a 13% increase in rent, to $80/ft². The tenant remains in situ during renovation work, and there is no loss of rental income. Analysis of renovation costs and returns: Performance Metric Development expenditure Development expenditure ($/ft² gifa) Increase in rental income Increase in asset value Value $3.7 M $140/ft² $0.20 M pa $0.31 M Return on expenditure 5.4% Total return per $ million of development expenditure $70,000 Payback 18.4 years This case study illustrates the need to invest in minor renovation work as part of an asset management strategy to sustain the attraction of an older asset in an attractive location. To succeed, it is vital to focus on aspects of renovation that contribute directly to securing an increase in rent and to effectively work around tenants in situ. HIGH BUILDING MAINTAIN TRANSFORM New York London (major) LOW HIGH Dubai Amsterdam RE-PURPOSE DEFEND LOW BUILDING

ARCADIS Office renovation in global cities 10 The Four Investment Strategies 3. DEFEND In many cities, modern office space is being delivered in new city quarters, providing corporate tenants with the high-quality space they now expect in attractive, accessible locations. This is encouraging tenants to relocate away from established City Business Districts (CBD) to new city centers. Examples include Amsterdam-Zuid, London s Canary Wharf and Kings Cross, and Singapore s Marina Bay. If vacancy levels increase as a result of competing development, then office space in the older CBD will need to be repositioned both to retain existing tenants and to attract a new target market. Benefits include: Avoidance of obsolescence Protection of existing revenue streams Attraction of new tenant classes into existing office locations Many of the markets for the defend strategy are suffering from oversupply, including Amsterdam, Brussels, Singapore, Hong Kong and Shanghai. A case study of minor renovation in Amsterdam The building: A 1970s office building with approximately 46,000 square feet of gross internal floor area located in the established city center. The building is vacant because the tenant (a public-sector organization) moved into a larger, more modern office building. The building needs to be modernized to compete in its existing, over-supplied market. The approach: A minor renovation of the entire building, together with updates to some of the outmoded central building services plant, is designed to improve the attractiveness of the building and to make its running costs comparable with peer buildings. Rents are stable at about $18/ft² with little opportunity for demand-driven escalation in the short to medium term. The success of the renovation will be determined by the extent to which the modernization will differentiate the scheme enabling it to compete for tenants in the established city center. Analysis of renovation costs and returns: Performance Metric Development expenditure Development expenditure ($/ft² gifa) Increase in rental income Increase in asset value Value $3.4 M $76/ft² $0.35 M pa 2.59 M Return on expenditure 10.7% Total return per $ million development expenditure $578,000 Payback 9.3 years In this case study, the business case for renovation is based on the ability to secure leases in a competitive, over-supplied market. However, the impact of the renovation can be high, generating income from an otherwise underutilized asset. This case study illustrates the results of leasing 50% of the available space generating a 10.7% return on the total renovation cost and paying back all expenditures in nine years. Clearly, with the vacancy hurdle set so low, there is plenty of room for improved performance. However, given that increased occupancy levels are likely to be the only route to increased income, this should be considered a high-risk option. HIGH BUILDING MAINTAIN TRANSFORM New York London (major) LOW HIGH Dubai Amsterdam RE-PURPOSE DEFEND LOW BUILDING

11 ARCADIS Office renovation in global cities The Four Investment Strategies 4. RE-PURPOSE These are locations where further investment in an asset is not appropriate because the asset is already considered obsolete in terms of location, layout or performance. This trend can be seen in city economies that have undergone a dramatic change in the quality and location of office stock as a result of significant economic growth prior to 2008. Dubai is a good example of a city with a stock of poorly located, sub-standard office buildings. In these circumstances, there will not be an investment case for additional expenditure. Disposal or conversion into alternative-use structure may be a better option to maximize asset value. A typical case study of minor renovation in Dubai The building: A 1990s office building of approximately 320,000 square feet GFA located outside the core commercial area. This building is in an older location, is inefficient (with a net-to-gross ratio of 0.65) and is underspecified compared to modern office buildings. The approach: Significant investment is required to bring the building up to standard. Repurposing of the asset should be considered. The expected outcome: A minor renovation of the entire building will cost approximately $14.4 million and is unlikely to deliver a positive return. In this situation, a better investment strategy might be to re-purpose the asset. Analysis of renovation costs and returns: Performance Metric Value Development expenditure $/ft² $14.4 M Development expenditure ($/ft² gifa) $33/ft² Increase in rental income $0.00/ft² pa Increase in asset value -$10.48 M Return on expenditure nil% Total return per $ million development expenditure $0 Payback N/A HIGH BUILDING TRANSFORM MAINTAIN London New York LOW HIGH Dubai Amsterdam DEFEND RE-PURPOSE LOW BUILDING Notes on performance criteria used in all case studies. Development expenditure includes all costs associated with refurbishment including construction, professional fees and statutory costs. For major refurbishment, loss of rental income and letting fees are also included. Cost of finance and sales tax is excluded. Increase in annual rental income is for a full year and is based on headline rent, excluding adjustments for tenant incentives Improvement in asset value is calculated on the basis of capital values for the unimproved and refurbished asset and development expenditure. Values are calculated using headline rents and typical investment yields for primary and secondary office space in appropriate locations % of expenditure returned by annual income is based on development expenditure and the annual increase in income Payback is calculated on the basis of total development expenditure and the annual increase in income.

12 ARCADIS Office renovation in global cities TIMING IS CRUCIAL As with any investment strategy, timing is absolutely critical. One of the advantages of renovation is that an asset can be turned around at speed, which means that investors can respond to opportunities in recovering markets ahead of new-build development. Our office renovation cycle (see diagram below) shows the stage that a city is at according to the cycle of demand for space and rising rents. FRANKFURT / HAMBURG AMSTERDAM LONDON RENTAL GROWTH MILAN WARSAW PARIS MADRID / HONG KONG / SINGAPORE / SHANGHAI NEW YORK CHICAGO BRUSSELS DUBAI TIME *Market conditions data has been taken from multiple sources and is indicative of market potential only. As outlined in the diagram, many European office markets are currently entering a rental growth phase. This is driven by a general recovery in developed economies that has extended to the Eurozone. London, Milan and Frankfurt, for example, offer superior returns on major renovation because they are entering the rental growth phase of their letting cycle. Amsterdam and Brussels both represent markets suffering from oversupply, leading to lower returns. Nonetheless, as shown, Brussels is likely to see rental growth over the next two to three years as it re-enters a growth phase, while Amsterdam has already reached the peak of its cycle, and returns may take longer to materialize. New York and Chicago are also positioned at the start of a rental growth phase which will benefit investors in well positioned and well maintained office stock. While the Dubai office market is recovering, obsolete space outside prime locations is unlikely to deliver a positive return on investment in renovation in the near future.

ARCADIS Office renovation in global cities 13 WHY RENOVATE? Renovation will continue to remain popular due to its inherent advantages over new build. These advantages are summarized as follows: The carbon cost is lower. A shorter development period reduces exposure to rental market risk. Owners can squeeze more value from original planning agreements. There is opportunity to improve tenant business performance by tailoring upgrades to their changing workplace needs. The CAPEX is lower and easier to finance. Renovation / Investment Projects completed within occupied buildings Faster procurement to increase speed to market Scope of work tailored to suit tenant sector user requirements Establishing metric of Return of CAPEX investment Flexible layouts and density for tenants Future proofing as set against asset depreciation Create Asset / Portfolio Brand Public Relations Strategy for asset Create visual brand e.g. Façade / Lighting / Reception / Elevator cores / Landscaping / Signage Create performance brand e.g. elevator specs and elevator cores / Premium technologies for mobility services Create tenant community Leasing and Management Strategy Active tenant management Lower OPEX through energy efficiencies Renegotiate leases Enhanced tenant mix New lease structure short-term vs. long-term Shared amenities strategy Improved Infrastructure Accessibility plan for tenants / occupiers re: public transport Parking improvements Security improvements Link to public transport including public bicycles Extend Asset Life by 20 years 8 WAYS TO ENHANCE ASSET VALUE Pro-active maintenance plan to enhance building value Excellent reputation for estate / building management driving rental growth High LEED and BREEAM ratings Reduced vacancy Value through Planning Gain More productive workers (less sick leave) Zoning changes through lobbying Zoning rules relaxation Re-categorize net revenue areas Change of use New masterplan for area in collaboration with neighbors Signature Designs and Designers Signature architects Signature lighting and landscape solutions and speciality designers Use of innovative / non-conventional materials Add Value through Sustainability

ARCADIS Office renovation in global cities 14 CONCLUSION Office renovation offers an excellent opportunity to improve the income and performance of an older office building in key global cities. To achieve the best performance, investment projects should be tailored to local market requirements. This approach can be summarized into four different strategies. We believe that a more scientific approach to the assessment of relevant returns on CAPEX investment is required globally. This will help investors decide where to prioritize their asset management cash and pre-acquisition investment strategies. From our research, high returns on CAPEX can be obtained from both major and minor renovation strategies in European cities where such projects can easily take place and where there is good quality-tenant demand. Major renovations offer the greatest opportunity to drive long-term capital value appreciation as well as an immediate return on CAPEX. METHODOLOGY Project data were provided by colleagues from ARCADIS in Europe and the U.S., EC Harris in London and Asia, and Langdon & Seah across Asia. Rental income data were sourced from local agents. Calculations were based on standard metrics (Office NIA, GIA, efficiency, rents, construction costs and professional fees), and common and standard assumptions were used for all locations. In addition, we have undertaken desktop research to review all information and ensure that, where possible, it reflects the reality of the chosen locations. The information provided in this report is indicative and should not be relied on for investment purposes.

ARCADIS Office renovation in global cities Contact us Global Market Sector Leader, Financial Institutions Matthew Cutts Email matthew.cutts@arcadis.com Tel +44 (0)7913 307 749 Simon Rawlinson Email simon.rawlinson@echarris.com Tel +44 (0)7715 759 997 US Karl Stumpf Email kstumpf@rtkl.com Tel +1 202 912 8242 John Braley Email john.braley@arcadis-us.com Tel +1 212 682 9271 ASIA Simon Baxter Email simon.baxter@echarris.com Tel +65 9112 2438 Frank Kwok Email frankkwok@hk.langdonseah.com Tel +852 2830 3500 Weibin Xu Email weibin.xu@echarris.com Tel +86 136 1012 3648 MIDDLE EAST Terry Tommason Email terry.tommason@echarris.com Tel +971 56 216 3143 EUROPE Markus Reppenhagen Email m.reppenhagen@arcadis.com Tel +49 172 2461 612 UK Keith Perry Email keith.perry@echarris.com Tel +44 (0)7714 064 815 www.arcadis-us.com 20140814-V01