Brisbane CBD Office Market: the 1990s Vs Now

September 2013 Brisbane CBD Office Market: the 1990s Vs Now Key Points Figure 1: Brisbane CBD Sub-lease Vacancy % of Total Stock 3.0 2.5 2.0 1.5 1.0 1993 2002 2009 2013 Total market vacancy in Q2/2013 was 14.2%, only slightly below the record 14.8% the market reached in the early- 1990s after Australia s last recession. 0.5 0.0 Brisbane CBD sub-lease vacancy is 2.6% of total stock, the highest on record (although data is only available from 1993). Despite similarities in the statistics, Jones Lang LaSalle s analysis leads us to conclude that current market conditions are not as bad as they were in the early-1990s. In the 1990s occupiers carried significant hidden vacancy due to relatively low rents and little prospect of leasing surplus space. Economic conditions, and hence underlying tenant demand, were also weaker in the 1990s than currently. Consequently, while the market is experiencing challenging conditions and there will be further upward pressure on leasing incentives, we do not expect average incentives to reach the 4 level seen in the 1990s. Vacancy should reach a peak in 2013 and steadily decline over 2014 and 2015 as tenant demand recovers. Vacancy near record highs Sub-lease vacancy is the most responsive indicator of office markets to changing economic conditions. Brisbane CBD sub-lease availability has risen very rapidly over recent quarters and, while it fell slightly from the previous quarter, was 2.6% of total stock in Q2/2013 or around 56,560 sqm (Figure 1). The level of sub-lease remains higher than in any previous cycles going back to 1993, when the data was first collected. However, anecdotal evidence from Jones Lang LaSalle leasing agents active in the market at that time suggests that it may have in fact been higher in the very early 1990s, immediately after a very large wave of construction completed. Brisbane overall CBD vacancy has similarly risen sharply in recent quarters. Since reaching a trough of 6.1% in Q1/2012, vacancy has more than doubled to 14.2% in Q2/2013. Figure 2 indexes total vacancy to the period in each cycle that sub-lease vacancy peaked. It illustrates that vacancy in the Brisbane CBD is now only slightly below historic peaks reached in the early-1990s. It also shows how total vacancy has generally peaked one or two quarters after sublease vacancy has peaked. Figure 2: Brisbane CBD Vacancy % of Total Stock 16% 14% 12% 1 8% 6% 4% 2% * Peak based on peak in sub lease 1993 2002 2009 2013 The recent rapid rise in Brisbane vacancy has been due largely to contraction in the market s two largest demand drivers: the public sector and resource-related entities. A weak state fiscal position prompted a reduction of the Queensland state public service of around 14,000 positions during 2012. Job cuts have flowed through to office demand over recent quarters, reaching a peak in Q1/2013. This contraction has coincided with the end of the resource investment boom, which has seen some job reductions, particularly in the coal sector. Project space has been relinquished as older projects reach completion.

Pulse Brisbane CBD Office: the 1990s Vs Now September 2013 2 Are conditions as bad as the 1990s? Our assessment is that current market conditions are not as bad as the early-1990s, despite the similarity in market metrics. The main rationales for this conclusion are that: There was significant hidden vacancy in the early 1990s; and Economic conditions now are more favourable than in the early 1990s. Hidden Vacancy Brisbane seemingly did not experience the same level of downturn in the 1990s as other Australian markets. Brisbane CBD vacancy reached a peak of 14.8% in Q3/1993 (just 0.6% above the current level), which compares to an average of 25.3% across the other four major capital cities (Table 1). Table 1: CBD Office Market 1990s Troughs Average Leasing Vacancy Incentive Market % Qtr % Qtr Brisbane 14.8 Q3/1993 41 Q2/1994 Sydney 23.3 Q3/1993 49 Q3/1993 Melbourne 26.1 Q2/1993 49 Q4/1992 Perth 31.8 Q4/1992 50 Q1/1992 Adelaide 19.9 Q2/1993 30 Q2/1993 Average (excl. Brisbane) 25.3 45 The relatively strong performance of the Brisbane CBD in the early 1990s reflected a proportionally smaller (albeit still large) construction pipeline in Brisbane CBD, as well as the comparatively strong performance of the Queensland economy. In contrast to the current situation, the Queensland government also entered the economic downturn of the 1990s with a strong budgetary position. Nevertheless, the experience of Jones Lang LaSalle in the Brisbane leasing market through the early 1990s period suggests that the market was much weaker than the headline vacancy figure suggested. Anecdotally, the level of hidden vacancy was very high, with many firms carrying significant space that was surplus to their real space requirements. This hidden vacancy was certainly evident in other office markets as well at the time. The large supply pipeline of the early 1990s and the severity of the economic recession that hit the country accentuated the situation. That is, many tenants optimistically pre-committed to growth space in the end of the 1980s economic boom, but by the time supply completed, not only did they no longer need expansion space, but they also needed much less space due to significantly reduced staff levels. This left many large tenants carrying surplus floors in new developments and/or lease tails on previous addresses that they had thought would be easier to dispose of when conditions were stronger. In all markets, it quickly became apparent that it would be difficult to dispose of this surplus space. However, for Brisbane, a lower rental structure at the peak of the boom meant there was less incentive for tenants to keep attempting to sublease surplus space and the decision to just carry this extra space was easier. For example, average prime gross effective rents in Brisbane at their peak in the very late-1980s only reached $264 per sqm, compared to $602 per sqm in Sydney, $391 per sqm in Melbourne and $322 per sqm in Perth. Some evidence of this hidden vacancy can also be found in data on leasing incentives. Despite the fact that vacancy in Brisbane was much lower than the national average, the peak in average Brisbane CBD leasing incentives (41%) was much closer to the average of the other major markets (45%) and indicative of the underlying excess space in the market at the time. In the current market, there is certainly not the same volume of hidden vacancy. Indeed, a much higher rental structure currently, with prime gross effective rents comparable to Sydney and Perth and much higher than Melbourne, means that tenants are keen to dispose of surplus space as a significant cost saving. Economic conditions The 1990s economic downturn was severe. National GDP growth contracted in three out of four quarters from September 1990, with the annualised growth rate reaching a trough of -1.6% in June 1991. GDP took over two years to regain its peak level during this period. In contrast, the trough in annualised GDP growth post-gfc was a relatively mild 0.9% in September 2009 and there have only been two quarters of negative growth recorded since the onset of the GFC, which were more than two years apart. While growth has been slower than trend (typically seen as between 3% and 3.5%) in the post-gfc environment, it has still averaged a relatively healthy 2.5% per annum. From a labour market perspective, the differences between the two periods are also stark. In the period when the Brisbane CBD vacancy rate was above 14% in the early 1990s, the state unemployment rate was hovering around 11%. In contrast, the state unemployment rate is currently slightly below 6% (Figure 3). While this level of unemployment is well above the trough level of 3.3% the state recorded in 2008, the current rate remains below the 30-year average of 7.6%.

Pulse Brisbane CBD Office: the 1990s Vs Now September 2013 3 Figure 3: Brisbane CBD Vacancy and Unemployment 16. 14. 12. 10. 8. 6. 4. 2. 0. Outlook Jun 85 Sep 86 Dec 87 Mar 89 Jun 90 Sep 91 Dec 92 Mar 94 Jun 95 Sep 96 Dec 97 Mar 99 Jun 00 Sep 01 Dec 02 Mar 04 Jun 05 Sep 06 Dec 07 Mar 09 Jun 10 Sep 11 Dec 12 CBD Vacancy Rate QLD Unemployment Rate There is a currently concern about the Brisbane CBD outlook due to the weak demand environment and the relatively large supply pipeline, with three major projects all due to complete around 2016 480 Queen Street (55,000 sqm), 180 Ann Street (58,000 sqm) and 1 William Street (75,000 sqm) equating to 6.8% of the current market stock. However, in assessing the outlook it is important to note: The entire supply pipeline is more than two and half years away - which is sufficient time for demand to recover and absorb some of the current excess vacancy; Queensland s economic outlook remains favourable there is potential for strong rebounds in the local housing and tourism markets, while resource projects still under way will significantly boost state exports over the next few years. Deloitte Access Economics forecasts the Queensland economy to grow by an average of 4.3% per annum over the next five years; While other sectors (such as mining) are more recognisable as drivers of office demand, there is a strong correlation between housing investment and Brisbane office market demand. This is likely to reflect not only the direct impact from stronger housing activity, but the indirect boost to consumer confidence and spending. It now appears that lower interest rates are taking affect and that a strong rebound in the local housing market is likely to emerge over the next few years. The impact of state government staffing reductions on the office market is largely over. The Federal Government is a comparatively small occupier in the Brisbane CBD and mostly comprises core services, therefore the risk of contraction from this source is fairly low. At the state level, we expect that the state will slowly return to a demand positive status over the next few years; Resource sector prospects have improved recently, which is likely to prevent further contraction. In particular, coal prices have improved and a lower AUD is supporting US dollar export revenues. Further decline in the AUD and/or improvement in prices could even see a rebound in the coal sector and an unexpected rebound in demand in the Brisbane office market; Sublease vacancy does generally turnaround quickly with business sentiment. Around two thirds of the current sublease vacancy in Brisbane is resource-related, so a recovery in that sector could see an even quicker than anticipated turnaround in the sublease market. While Brisbane s current vacancy rate is high, it is disproportionately skewed towards certain segments of the market. Vacancy in Prime (Premium and A-grade) stock is currently 9.9%, while vacancy in secondary stock is a particularly high 17.8%. Even within prime stock, vacancy is low in modern stock and skewed by higher vacancy in the older prime stock. There is also a strong negative correlation between floorplate size and vacancy. Figure 4 shows that vacancy in prime buildings with a floorplate of over 1,000 sqm is still around 6%, with prime stock with a floorplate under 1,000 sqm approaching 18% vacancy Figure 4: Brisbane CBD Vacancy by Floorplate Size (% of Total Stock) As at Q2/2013 25% Stock (proportion of Total Stock) 6.1% 23.6% 15.5% 43.8% 9.3% 1.8% 2 15% 1 5% 1,500 sqm + 1,000 to 1,499 sqm Prime Stock sub 1,000 sqm B C D Secondary Stock Jones Lang LaSalle s house view is that vacancy in the Brisbane CBD will peak in 2013 and we expect a very moderate reduction in vacancy by year-end. Nevertheless, part of this improvement will be the reduction in sublease vacancy, while new demand requirements will remain modest through the latter half of 2013. In 2014, we expect that business sentiment will improve and a more general recovery will begin as the Queensland domestic economy accelerates again. Vacancy is expected to fall below 1 by the end of 2015, before rising once more in 2016 to just below its current level when the three large projects complete.

Pulse Brisbane CBD Office: the 1990s Vs Now September 2013 4 While the new supply that completes around 2016 will push up the headline vacancy to around its current level, a stronger economy means this supply is likely to be met by a much stronger demand environment than what currently exists. We also anticipate that there will remain a somewhat two-tiered vacancy rate with the best prime stock (particularly with larger floorplates) a relatively balanced market, but much higher vacancy in older stock (especially with smaller floorplates). While not alternative forecasts, Figure 4 offers two demand scenarios to illustrate how the market would track in a much weaker demand environment (we have taken 5 off our demand forecasts from 2013 to 2016) and a stronger demand environment (we have added 25% to demand forecasts from 2013 to 2016): Authors: Leigh Warner Director, Research and Consulting Jones Lang LaSalle tel: +61 7 3231 1445 leigh.warner@ap.jll.com www.joneslanglasalle.com.au Adam Barrett Director, Leasing Jones Lang LaSalle tel: +61 7 3231 1315 adam.barrett@ap.jll.com www.joneslanglasalle.com.au Under the weak demand scenario, vacancy still falls over the next few years, before rising to a peak of 16.5% when the new supply enters in 2016. This weak case scenario is not as adverse as the conditions experienced in most CBD markets in the 1990s, and shows the very important role of overbuilding in generating the kind of extreme vacancy reached in the 1990s; The stronger demand scenario which we see as representing an above expectations rebound in the resources sector has vacancy falling back to around 7.5% by 2015, before rising to slightly above 1 by the end of 2016. Figure 4: Brisbane CBD Vacancy Outlook 18% 16% 14% 12% 1 8% 6% 4% 2% 03 04 05 06 07 08 09 10 11 12 13* 14 15 16 17 CBD Base Case Low Demand Scenario High Demand Scenario * As at June 2013

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