SYDNEY CBD OFFICE - m3property Strategists | P3 The Sydney CBD office market is in the growth phase of the property cycle. Low vacancy and hence reduced availability of space resulted

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Key Research Contacts:

m3commentary SYDNEY CBD OFFICE

Spring | 2017

m3property.com.au

Jennifer WilliamsNational Director | NSW

(02)8234 8116

Casey RobinsonResearch Manager | QLD

(07) 3620 7906

Zoe HaskettResearch Manager | SA

(08) 7099 1807

Amita MehrotraResearch Director | VIC

(02) 9605 1075


m3property Research

Market Overview 3

Key Retail Influences 4

Key Indicators 5

Key Sales 7

Outlook 8

CONTENTS

VACANCY TO FALL

AND EFFECTIVE

RENTS TO GROW

Grade: is determined using the PCA report

“A Guide to Office Building Quality”.

Prime: Combination of premium and grade

A.

Secondary: Combination of grades B, C

and D.

Net lettable area (NLA): defined in

accordance with the PCA “Method of

Measurement”.

Net absorption: is the change in occupied

stock within a market over a specified period

of time.

Completion date: determined by issue of a

“Certificate of Occupancy”.

Pre-commitment: contract signed to

occupy space in new or refurbished space

prior to construction commencing.

WALE: Weighted average lease expiry.

A-REIT: ASX listed Australian Real Estate

Investment Trust

DEFINITIONS

•Prime leasing demand continues to be strong, but net

absorption is likely to be low over the short- to medium-

term due to reduced availability of contiguous office space.

•Gross supply levels decreased slightly in the year to June

2017, after reaching a cyclical peak in the 2016 financial

year. Gross supply is forecast to continue to reduce over

the next two financial years.

•Stock withdrawals are expected to peak in the current cycle

over the year to June 2018, despite having seen elevated

levels of withdrawals over the previous two years.

•There was solid rental growth and falling incentives

recorded over the year to June 2017.

•Sales activity was solid over the year to June 2017, albeit

lower than the level achieved over the 2016 financial year.

•Yields across prime and secondary offices continued to

tighten over the year to June 2017 driven by strong

demand from overseas and domestic investors and

developers, combined with limited acquisition opportunities.

•Emergency Services Property Levy changes were

abandoned by the government.

m3commentary Spring 2017


The Sydney CBD office market is in the growth phase of the property cycle. Low vacancy

and hence reduced availability of space resulted in a reduction in net absorption over the

year to July 2017. Tenant demand, however, remains strong and is driving solid rental

growth. With opportunities becoming increasingly limited in the CBD, tenants are

reviewing opportunities in fringe and other suburban locations.

The Sydney CBD office market experienced high levels of

supply, positive tenant demand, strengthening rental

growth and solid investment demand over the 2017

financial year, making it one of the best performing office

markets in Australia.

Tenant take-up in the CBD was strong for prime stock

over the year to July 2017, but weaker in secondary stock

as reduced available space and rising rents began to

impact tenant occupation decisions. Net absorption is

expected to be below the long-term average over the next

few years, in line with the general decline in available

space. In terms of leasing activity over the year to July

2017, gross absorption increased in the CBD compared to

the same time last year, indicating that tenant demand

remains positive for CBD space.

Demand from firms benefiting from low interest rates,

strong property markets and a strengthening US economy

including engineering and construction, education and

training, business services and finance and insurance

firms are likely to drive CBD office demand in the short-

term. The market is, therefore likely to continue to expand.

Gross supply was strong over the year to June 2017 at

205,794m2. While, stock withdrawals (201,480m2) and

positive tenant demand, offset most of the supply, vacancy

rose slightly from 5.6% in July 2016 to 5.9% in July 2017.

Looking over the next two years, high levels of stock

withdrawals are forecast to continue to reduce supply, with

conversion to residential, hotel and mixed uses, and

redevelopments being the main reasons for withdrawal of

space.

Investment activity was solid and yields firmed over the

year to June 2017 due to continued investment demand

and strengthening market fundamentals.

MARKET OVERVIEW

m3property Research

m3property Investment Sale:

MLC Centre, 19 Martin Place



ECONOMIC GROWTH

Business investment continues to be restrained, although measures of business sentiment

remain positive. Labour market indicators are mixed and inflation low. While a low official

interest rate is supporting domestic demand, rising rates from the major banks and a

fluctuating exchange rate continue to reduce its effectiveness. According to the Australian

Treasury, in real terms Gross Domestic Product is forecast to grow by 2.50% in 2016-17

and improve to 3.0% in 2017-18.

EMPLOYMENTWhile employment is expanding overall in Australia, under-employment and significant

differences between States continue to be an issue. In New South Wales as at July

2017 employment totalled 3,857,253 people, a rise of 1.2% over the past 12 months.

More significantly full-time employment in New South Wales rose by 3.5% over the

same period, however, this was offset slightly by a fall in the participation rate from

64.0% to 63.6%, indicating that under-employment still exists within the state. The

unemployment rate due to increased employment and the fall in participation reduced

to 5.0% as at July 2017 from 5.2% a year prior. In core white collar sector industries

employment increased by 4.5% in New South Wales over the year to May 2017, which

bodes well for the office sector within the State.

JOB ADVERTISEMENTSOverall job advertisements data from ANZ (a forward-looking indicator of labour

demand) indicates an increase in employment in the short-term. This is consistent

with the slow transition in the labour market and the economy, more generally,

towards service based industries and sectors which benefit from a lower Australian

dollar and low interest rate. Job advertisements increased over the year to July by

12.8%.

BUSINESS CONFIDENCENational Australia Bank’s (NAB) index of business confidence rose to 12.0 index

points in July 2017 from 4.0 points in July 2016. This is twice the long-term average

for the index and is back around its pre-GFC levels. Business conditions (which is a

combination of trading, profitability and employment conditions) also increased over

the year to July 2017, to 15.0 index points. This is three times the long-term average

level and the highest it has been since early 2008.

$

KEY INFLUENCES

m3property Research


66 Goulburn Street


320 Pitt Street



STOCK AND SUPPLY

Stock in the Sydney CBD office market totalled 5,086,316m2

according to the Property Council of Australia as at July 2017.

This is expected to be supplemented by 112,332m2 of new

gross supply over the 2018 financial year, including the

completion of Barangaroo C2 International House (6,720m2)

and the refurbishments of 10 Shelley Street (27,720m2) and

140 Sussex Street (12,040m2). New supply is expected to be

fully offset by over 200,000m2 of stock withdrawals, resulting in

a reduction in office stock of -92,290m2. Financial year 2019 is

expected to see a moderation of gross supply, to total around

73,000m2. The level of withdrawals is expected to reach almost

100,000m2, resulting in net supply falling by over 26,000m2.

Looking further forward there a number of large redevelopment

projects that will be undertaken over the next few years

including Wynyard Place (due 2019-2020), CQ Tower (2020)

and Quay Quarter (2019-2021). These are set to change the

way people access transport within the city, to activate and

reinvent laneways and add new shopping, leisure and dining

options for residents and worker in the CBD.

Brookfield’s Wynyard Place contains three buildings. The main

premium grade tower (59,000m2) will incorporate Wynyard

station. It is expected to have office floor plates of up to

2,500m2 and contain over 5,000m2 of retail space. NAB has

pre-committed to 31,000m2 within this tower. The project also

includes restoration of Shell House, which will create 7,700m2

of boutique office accommodation and 1,500m2 of retail space

and 285 George Street, which will be around 1,500m2 in area.

Lendlease’s Circular Quay (CQ) Tower is expected to be

Sydney’s tallest office tower on completion at 263m high and is

set to contain around 55,500m2 of NLA. The development will

contain a public bike hub, public plazas with dining options,

shopping, entertainment and leisure facilities.

AMP Capital’s Quay Quarter is set to redesign the area within

Bridge, Alfred, Young and Loftus Streets. It has stage 2 DA

approval to contain five buildings, including three largely office

towers, retail, residential, heritage and pubic domain space.

AMP have pre-committed to the 50 Bridge Street tower.

GROSS ABSORPTION

Gross absorption is a leading indicator of net absorption.

Based on reported signed leases gross absorption was

estimated by m3property to be 314,200m2 over the year to July

2017. This represents an increase of 9.5% compared to the

year prior. The number of tenant moves increased over the

year with this being reflected in the average size of leases

signed falling to 1,277m2 from 1,927m2 a year prior. Gross

absorption is expected to be fairly stable over the short-term as

available space contracts and tenants move from older stock to

newer, more efficient space. This should result in low positive

net absorption over the next few years.

KEY INDICATORS

m3property Research

To end 2018 Projects over 10,000m2 NLA

New International House C2

151 Clarence Street

275-281 George Street

35,082

Refurbishments 10 Shelley Street

167 Phillip Street

140 Sussex Street

201 Sussex Street

259 George Street

2 Bligh Street

104,620

Withdrawal –

Redevelopment

Change of use

Quay Quarter

CQ Tower

Refurbishment

54,081

116,962

13,277

59,043

081624324048566472

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

Nu

mb

er

leases r

ep

ort

ed

as

sig

ned

NL

A (

m2)

Sydney CBD Leases Signed

Southern The Rocks WesternWalsh Bay Midtown CoreNo lease signed

Source: Property Daily and m3property

-160,000-120,000

-80,000-40,000

040,00080,000

120,000160,000200,000240,000280,000320,000

Su

pp

ly

(m2)

Sydney CBD supply

Gross supplyNet supply

Source: Property Council of Australia OMR m3property Research (August 2017)



NET ABSORPTION

Tenant demand was positive in the Sydney CBD, despite the

Property Council of Australia recording negative net absorption

of 7,727m2 over the year to June 2017. The entire loss was in

secondary stock, with prime net absorption totalling 151,840m2.

Looking forward, net absorption is forecast to be weak but

positive in financial year 2018 due to increased cost of

occupancy and reduced availability of space. Over the

remainder of the five year outlook net absorption is expected to

be positive but below the long term average due to rising rents

in the CBD compared to other markets. In particular back

offices of large firms and government tenants may consider

exiting the CBD over the period.

VACANCY

Over financial year 2017 the Sydney CBD vacancy rate rose

from 5.6% to 5.9%. This was due to positive net supply

combined with negative net absorption over the year. The

vacancy rate is still below the 20-year CBD average of 7.4%.

Secondary stock accounted for 62.9% of stock withdrawals

over the financial year at 148,657m2 and only accounted for

21,750m2 of new supply. However, net absorption decreased

by 159,567m2, as tenants were displaced from buildings that

are to be withdrawn from the market. Vacancy, therefore, rose

from 4.1% to 5.9% over the year. Prime vacancy fell, due to

strong net absorption of 151,840m2, despite strong net supply

of 131,221m2.

Looking forward the vacancy rate is forecast to continue to fall

until the end of 2019. This is due to continued high levels of

stock withdrawals with around 305,245m2 due to be removed

from the market for refurbishment and redevelopment. From

2020 increases to supply from projects such as Quay Quarter,

Wynyard Place, CQ Tower at 176-182 George Street and 33-

35 Pitt Street and 388 George Street are likely to result in

vacancy gradually increasing.

RENTS

Prime gross face rents in the Sydney CBD increased over the

year to June 2017 with growth of around 5.3% being recorded

for prime and 4.9% for secondary office space. Stronger rental

growth is expected for both grades over the year to June 2018,

due to forecast low vacancy and continued positive demand.

Affordability of space is likely to increasingly become a factor

over the next few years where vacancy is expected to

decrease to 4.0% by June 2018 and lower in 2019. Higher

rents are expected to result in the displacement of some

tenants from the CBD to fringe and other metropolitan

locations. Rents are expected to grow from 2017 to 2019,

before moderating when new supply starts to push up vacancy

from 2020.

KEY INDICATORS

m3property Research

$-

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

Gro

ss f

ace r

en

ts (

$/m

2)

Sydney CBD Average Gross Rents

Prime

Secondary

Source: m3property Research

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Vacan

cy

Rate

(%

)

Sydney CBD Office: Vacancy

SecondaryPrimeTotal

Source: Property Council of Australia OMR July 2017, m3property Research

Average

-200,000

-150,000

-100,000

-50,000

0

50,000

100,000

150,000

200,000

Net

ab

so

rpti

on

(m

2)

Sydney CBD Office: Annual Net Absorption

Source: Property Council of Australia OMR, m3property Research (August 2017)

Long term average



INCENTIVES

Incentives have fallen in the Sydney CBD to range from 21.0%

to 24.0% for prime stock and between 12% and 18% for

secondary stock as at June 2017. With current prime vacancy

lower than secondary and the rental differential having reduced

over recent years between the grades, it is expected that prime

incentives will fall by further than secondary incentives over the

2018 financial year. This is likely to continue over 2019, before

supply pressures start to push up vacancy again in 2020.

INVESTMENT MARKET

Transaction activity while remaining strong has slowed over the

year to June 2017 compared to the 2016 financial year. The

majority of deals have been for secondary grade assets with

prime assets remaining tightly held, although more prime grade

assets have come to the market over 2017. Sales over the

year to June 2017 were approximately $3,527,241,888,

compared to $4,290,152,620 over the year prior. Some of the

larger sales were 50% of MLC Centre for $722,500,000, 66

Goulburn Street ($228,000,000), 320 Pitt Street ($275,000,000)

and 20 Bridge Street ($335,000,000).

Overseas investors reduced investment activity in the CBD

accounting for 42.4% of sales over the year to June 2017

compared to 66.6% of sales the year prior. Unlisted trusts

have increased activity to account for 28.5% of sales over the

year to June 2017.

A-REITs (12.7%) and developers (8.4%) accounted for the

next largest proportions of sales over the 12 months to June

2017 with both these groups increasing their exposure

compared to the same time last year.

YIELDS

Prime yields tightened by 50 basis points over the 12 months

to June 2017, to range between 4.63% and 5.50%. Over the

same time frame secondary yields tightened by around 63

basis points to range from 5.25% to 6.25%.

Low interest rates, strengthening market fundamentals and

strong capital flows into property have largely driven this

tightening in yields in the CBD.

Looking forward, while bond rates have started to rise, yields

are likely to continue firming in the short-term due to strong

rental growth, which should drive continued investment

demand in the Sydney market.

KEY INDICATORS

m3property Research

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Sale

s v

olu

me (

$m

illio

ns)

Sydney CBD Office Sales Volume

Source: m3property Research *Office Sales over $5 million to end of July 2017

*

5.63%

7.25%

5.06%

6.38%

8.50%

5.75%

4.00%

4.50%

5.00%

5.50%

6.00%

6.50%

7.00%

7.50%

8.00%

8.50%

9.00%

Av

era

ge y

ield

s

Sydney CBD Prime and Secondary Yields

Prime

Secondary


0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Incen

tiv

es (

%)

Sydney CBD Incentives

Prime

Secondary




Property Date PricePassing

Yield

Market

YieldIRR $/m2 Purchaser Type

66 Goulburn Street Aug 17 $252,000,000 NA NA NA $10,897 Overseas Investor

MLC Centre (2x25%) Jun 17 $722,500,000 4.50% 5.6% NA $18,669 A-REIT and Unlisted Fund

320 Pitt Street Jun 17 $275,000,000 6.27% 6.45% 6.90% $9,431 Overseas Investor

275 George Street Jun 17 $82,000,000 DS DS DS $11,232 Developer

59 Goulburn Street May 17 $158,000,000 5.20% 5.97% 7.15% $8,141 Unlisted Fund

20 Bridge Street Apr 17 $335,000,000 3.86% 4.23% 5.63% $16,465 Overseas Investor

183-185 Clarence Street Jan 17 $22,750,000 DS DS DS $6,319 Developer

56 Clarence Street Jan 17 $64,000,000 5.15% 5.78% 5.99% $12,473 Private Investor

55 Clarence Street Jan 17 $169,000,000 5.70% 6.26% 7.66% $11,345 Overseas Investor

SIGNIFICANT SALES TO DATE

m3property Research


20 Bridge Street


DS - Development site, NA - Not available

[email protected]

Andrew Duguid

Managing Director | NSW

(02) 8234 8101

Don Semken

Senior Valuer | NSW

(02) 8234 8102

Simon Hickin

Director | SA

(08) 7099 1812

Gary Longden

Director | VIC

(02) 8234 1040

Ross Perkins

Managing Director | QLD

(07) 3620 7901

KEY COMMERCIAL VALUATION

CONTACTS

Net supply is expected to reduce over financial year

2018 to -92,288m2 and remain negative in financial year

2019 before increasing again from 2020.

Net absorption is forecast to be moderate, over the next

few years in part due to the lack of available contiguous

space. This is likely to pressure tenants to consider

fringe and suburban markets for larger and back office

space requirements.

Vacancy rates are expected to fall over financial year

2018 until the end of 2019. Positive demand should

result in pre-lease activity rising over the next few years,

driving new development completions in 2020 and 2021.

Forecast development activity in this period is expected

to result in an increase in vacancy over those years.

Prime gross face rents are forecast to increase by

around 5.8% over the year to June 2018. Secondary

space is expected to see similar growth over the year.

Incentive levels are also likely to reduce across both

grades.

Sales activity is expected to be solid in 2017 with some

prime stock already coming to the market. Overseas

investors and domestic trusts continue to pursue

investment opportunities in the Sydney CBD.

Investment yields are set to tighten further over 2017

driven by strengthening fundamentals and continuing

investor demand. However, with 10 year bonds starting

to rise the rate of firming has already slowed and this is

expected to continue to be the case over the short-term.

OUTLOOKSYDNEY CBD OFFICE

m3property Research

m3property provides national

coverage in all States and

Territories.

DISCLAIMER

© m3property Australia. This report is for information purposes only, it has been derived, in part, from sources other than m3property and does not constitute

advice. 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 available to m3property at that time

and contains assumptions, which may be incorrect. m3property makes no representation that any such statements are, or will be, accurate. Any unauthorised use

or redistribution of part or all of this report is prohibited.

Documents

SYDNEY CBD OFFICE - m3property Strategists | P3 The Sydney CBD office market is in the growth phase of the property cycle. Low vacancy and hence reduced availability of space resulted