Australia: What next for property?

Transcription

1 March 212 Australia: What next for property? What now? What next?

2 Australia: What next for property? 3 The Global Financial Crisis (GFC) that commenced in late-27 accelerated some real estate investment flows and led to a reversal of others. The GFC has stimulated a major portfolio shift between countries, sectors and investment vehicles. The Australian real estate sector has been, broadly, a beneficiary of this shift. The volume of funds seeking exposure to the Australian market from offshore and from domestic sources has increased substantially over the past three years. Introduction: The great portfolio switch In 28, Jones Lang LaSalle Research published a report The Investment Case for Australia. The report profiled the attractions of the Australian economy and commercial real estate market for offshore and domestic investors. The report was timely. Between 28 to 211 Australia attracted AUD 1.7 billion in direct offshore investment into the commercial real estate markets 1, accounting by value for 24.7% of total transactions in the domestic market (>AUD 5 million). a) Offshore investment flows During 211 alone, offshore investors purchased AUD 3.7 billion of Australian commercial real estate assets which is equivalent to 29.5% of transactions by value (>AUD 5 mill), the largest percentage on record and just below the record dollar value of AUD 3.8 billion achieved in 21. Purchases by offshore investors are only part of the cross-border capital flow story. Offshore participants in the Australian market are invariably active on both sides; as sellers as well The questions are how sustainable is this portfolio shift and how will it play out in the future in terms of values, investment performance and ownership trends? Figure 1: Commercial Real Estate Transactions * AUD Billions Industrial Office Retail Hotels *Sales >AUD 5 million 1 Commercial markets defined as office, industrial, retail and hotel sectors (transactions > AUD 5 million)

3 4 Advance Australia: What next for property? 5 Figure 2: Offshore Investor Activity in the Australian Market AUD Millions 4, 3, 2, 1, -1, -2, -3, Offshore Buyers Offshore Sellers *Office, industrial and retail sectors only, sales >AUD 5 mill, RBA as buyers. Figure 2 demonstrates that while crossborder activity by offshore investors has been fairly volatile over the past 25 years, the broad tendency has been for the volume of flows to increase. Two other features are evident: Firstly, trans-border direct investment moves in long waves the overhead costs of entering or leaving offshore real estate markets are relatively high when compared with, say, equities or foreign currency. Offshore investors were net buyers in the Australian market for eight years, from 1988 to They were net sellers for eight years, from 1998 to 26. They have again been net buyers for five years, from 27 to 211. Secondly, offshore investors are conditional participants in the Australian market. They are the marginal or price-setting investor, which implies that cross-border investment flows are heavily influenced by perceived discrepancies in asset valuations and relative cost of capital across borders. One prediction of this rising flow of activity would be a growing convergence of values and yields between the Australian and offshore markets. Currently, the disparity is wide. In addition to purchases captured in Figure 2, offshore investors have sought access to the Australian real estate market in recent years through a variety of other avenues such as: acquisition of funds management platforms; participation in development projects; partnering with Australian institutional investors; portfolio acquisitions. Offshore capital flows into the Australian real estate sector are part of a larger theme. Foreign ownership of Australian government bonds has risen from around 25% to 75% over the past ten years. Foreign ownership of listed equity has risen from 32% at the end of 27 to around 45% by the end of 211, a fifteen-year peak 2. Notably, cross-border inflows into all three asset classes bonds, equities and real estate commenced prior to 27 (Figure 3), suggesting that the GFC may have accelerated the inflow of investment into Australia, but did not initiate it. This suggests that the post-gfc attractions of investment in Australia high yield, stable GDP growth and market transparency are not the only reasons for the investment flows. Figure 3 shows that real estate investment flows are a very small component of a much larger capital flow trend. However globally, real estate is attracting growing attention against a backdrop of persistent financial market volatility and very low interest rates. For example, a number of important global investors have recently indicated their intention to increase their portfolio exposure to real estate. From March 21, the Government Pension Fund (Norway) allowed for a maximum of 5% allocation to real estate (previously zero). The Canadian Pension Plan Investment Board (CPPIB), which has been active in the Australian retail and industrial sectors, had also increased its allocation to real estate from 4.3% in 27 to 9.1% as of September 211. A number of other funds, including the NPS and CIC, have also increased their allocation to alternative investments, including real estate. Private equity firms have been successful in securing mandates and raising capital from Sovereign Wealth Funds and global pension funds over the past 12 months. As a result, they will be looking to deploy a proportion into the Australian market in 212. Figure 3: Capital Inflows Equity, Debt and Real Estate 4, AUD Millions 3, 1, -1, -3, Equity Debt Property Source: ABS, Jones Lang LaSalle Research 2 Reserve Bank estimate: On Europe s Effects on Australian Financial Markets, 14 February 212, p.7; ABS estimate of equity flows.

4 6 Advance Australia: What next for property? 7 Australia is receiving a disproportionate share of global capital. The true test of the investment case is revealed in the data for crossborder capital flows. It appears that a number of global funds are subscribers to the Australian story. LaSalle Investment Management estimates Australia accounts for 3.% of the global public and private universe. This figure is therefore the benchmark for analysing of product in the retail sector has been concentrated in the neighbourhood and sub-regional centre sector of the market. There has been less offshore interest in the smaller end of the retail shopping centre spectrum. As a result, Australia received only 2.2% of cross-border capital in the retail sector between 28 and 211. capital flows into Australia. Between 28 and 211, Real Capital In contrast, the Australian industrial sector is being re-rated by Analytics recorded USD 292. billion of cross-border capital flows offshore funds. Between 1994 and 211, the industrial sector across the office, retail, industrial and hotels sectors. Australia s delivered higher returns with lower volatility than office markets. A share was 4.6%. There are however interesting sector-by-sector number of large industrial portfolios have been acquired by offshore trends. funds enabling them to build scale within the sector. Real Capital The Australian retail sector is heavily institutionalised. Regional centres are tightly held and rarely trade. However, when a 5% share of Northlands Shopping Centre was offered to the market, Analytics recorded USD billion of cross-border capital flows in the industrial sector between 28 and 211 wherein Australia accounted for 7.9% of the volume. CPPIB acquired the asset for AUD 45 million. The availability Sector Capital Flows to Australia (USD billion) Total Cross Border Capital Flows (USD billion) % Share Office Retail Industrial Hotels Total Source: RCA, Jones Lang LaSalle Research b) Domestic investment flows Participation by offshore investors in the domestic market through multiple avenues is one strand of a more complicated series of portfolio adjustments that have emerged post-gfc. A complete capital flow analysis of the Australian market would identify at least two other sources of capital for investment in domestic real estate that are both significantly larger than the net inflow of offshore capital. Firstly, although the Australian market is small by global standards, Australian investors divested around AUD 21.6 billion of offshore assets (including hotels) between 28 and 211. Over the past two years (21 and 211), the USD 12.8 billion (approximately AUD 14.9 billion) that Australians have divested offshore has been, by a big margin, the largest offshore liquidation of any country, equivalent to sales of the next two countries (UK and Ireland) combined (Figure 4). On the other side of the ledger, the largest cross-border investors (21 to 211) have been Singapore (USD 13 billion), Canada (USD 7 billion) and Hong Kong (USD 4 billion).the refocus on the domestic market and repatriation of capital freed up from asset sales represents an additional source of investment funds to be deployed domestically. Secondly, the growth in domestic superannuation funds over the past four years (28 211) implies an increased demand for real estate over this period. Assume a constant 1% target exposure to real estate by superannuation funds and a breakdown of 7% direct and 3% listed investments. Adjust for the changing valuations of direct assets and A-REITs over the period. Then, over the period from 28 to 211, the required net annual average addition to superannuation funds real estate exposure (assuming a constant 1% target weighting) has been around AUD 13.8 billion; significantly exceeding the total net investment of AUD 6.9 billion by offshore investors over the same period (Figure 5). Figure 4: Cross Border Transactions (21 and 211) Largest Buyers and Sellers USD Billions Australia UK Ireland Denmark Netherlands USA Germany France Japan South Korea Malaysia Hong Kong Canada Singapore Global Figure 5: Shifting Portfolios: Offshore and Domestic Investors, Supperanuation Funds AUD Billions Net Offshore buyers Superannuation Australian Offshore Transactions Source: APRA, Jones Lang LaSalle Research

5 8 Advance Australia: What next for property? 9 The question is how the relative abundance of capital will resolve itself in the Australian market. Consider key investment drivers: Key Investment Drivers a) The economy: Outlook for 212 The short-term outlook is for a recovery in growth in 212, although the forecast GDP growth rate has been adjusted downward in recent quarters. The pace of economic growth is forecast to accelerate through 212 (Table 1). On the other hand, as has been the pattern in recent years, the performance will be uneven. Deloitte Access Economics forecasts GDP growth of 3.6% in 212 and an average growth rate of 3.4% from 212 to 216. As Figure 7 shows, the lead in 212 will be taken by the commodity-based economies of Queensland (bouncing back from the natural disasters that marred 211) and Western Australia. Beyond 212, some convergence of inter-state growth rates is forecast. The economic recovery in 212, combined with a limited construction pipeline outlined in the sector summaries later in the report suggests a continuation of the recovery in rents and capital values recorded over the past two years. b) The economy longer-term attributes Figure 7, which highlights strong growth in the commodity-based economies of Queensland and Western Australia, reinforces the perception that Australia is predominantly a play on commodities and more broadly, exposure to the robust Asia- Pacific growth outlook. However it is notable that the investors who have been active in Australia over the past three years Canadians, Singaporeans and Malaysians, for example are presumably not looking for a commodity or an Asia-Pacific play, which they can achieve as well, if not better, in their domestic markets (Figure 8). In fact, the Australian economy is highly diversified with a sector profile not dissimilar to the US. Table 1: Key Australian Economic Indicators Indicator Last 5 Years^ (actual) (forecast) Next 5 Years (forecast) GDP Growth (% p.a) * CPI Growth (% p.a) Day Bill Rate (% p.a) ** 4.4** 5.7** Employment Growth (% p.a) 2.8.** Unemployment Rate (% p.a) ** ** Exchange Rate (AUD/USD average) ^ Average 25 to 21 * Estimate ** Year end Source: ABS, Deloitte Access Economics Figure 6: Quarterly GDP Growth Percent Q-o-Q Sep-91 Sep-95 Source: ABS, Jones Lang LaSalle Research ** 1.**.8** Sep-99 Figure 7: Gross State Product Growth Forecasts % per annum NSW VIC QLD SA WA ACT to 216 (average) Sep-3, Deloitte Access Economics Sep-7 Sep-11 In the US, the four largest sector contributors to GDP in 211 were: Finance Manufacturing Healthcare Professional services In Australia the four largest sectors were: Finance Mining Manufacturing Construction In comparison to the US, Australia has a larger mining sector and a smaller financial sector. Both have relatively large manufacturing sectors (Figure 9). Suppose we adopt the traditional economic definition of the concentration ratio as the share of a market accounted for by the largest four producers. In the US the four largest sectors account for 55.3% of GDP which is much higher than the 41.8% that applies in Australia s four leading sectors. Figure 8: Leading Sources of Offshore Investment in Real Estate in Australia (27 211) AUD millions Figure 9: Comparison of Two Economies Sector Shares Finance* Information Transport Retail United States - Economic Profile Wholesale Manufacturing Construction Utilities Mining Agriculture Other Services Accommodation 3, 2,5 2, 1,5 1, Canada USA Switerland China Australia - Economic Profile Arts Healthcare Education Administration Malaysia Singapore Management Professional Services Germany

6 1 Advance Australia: What next for property? 11 While the mining sector has clearly been the locomotive of growth in the recent past, from a longer term perspective, it is the service sectors that have been the strong performers. Over the past five, ten and 2 years for example, the Finance and Insurance sector has consistently grown faster than the Mining sector as measured by constant price Gross Value Add. Finance and Insurance is 33% larger in terms of its contribution to real GDP growth and 72% larger in terms of employment. Manufacturing, by contrast, has declined steadily as a portion of Australia s output over the past two decades. This now accounts for 9.1% of national output, down from 13.6% in 27; but on a sector basis, manufacturing is still the third largest contributor to 211 GDP output after Mining and Finance and Insurance 3. The diversity of the economy, rather than its dependence on a few high growth sectors, accounts in large measure for the relative stability of performance as demonstrated in Figure 6. It is this diversity and relative stability that probably attracts many offshore investors. are a desirable attribute. In an environment where regulatory requirements are growing and investors are risk averse, transparency is a highly valued attribute for cross-border investors. In addition, as Figure 1 shows, there is a broad positive correlation between transparency and prosperity. For long term investors, transparency translates into sustainable growth. Figure 1: Transparency Rating and GDP Per Capita 9, 8, GDP per capita (USD) 7, 6, 5, 4, 3, 2, Norway Australia Macau Canada Switzerland South Korea Portugal d) The global hunt for yield The global hunt for yield is on. Australia s relatively high interest rate structure supports high yields in commercial real estate and makes the country attractive for offshore investors with a lower cost of capital. We would expect some pressure towards convergence of yields under the impact of cross border capital flows, as several transactions during 211 demonstrated. Our forecasts anticipate some further moderate yield tightening in the Australian markets over the next few years but not to levels currently recorded in many offshore markets, nor to levels achieved in 27. The spread to other markets is expected to remain relatively wide. While yield is highly valued, growth in the current environment is uncertain and often heavily discounted. Nevertheless, according to the 212 Annual Foreign Investment Survey published by the Association of Foreign Investors in Real Estate (AFIRE), Australia rated fourth (after the US, Brazil and China) for the countries providing the best opportunity for capital appreciation. Figure 11: International Comparison Prime Office Market Yields 8% 7% 6% 5% 4% 3% New York Paris Frankfurt London Tokyo Sydney Melbourne Brisbane c) Transparency and the regulatory environment Australia was rated No. 1 globally in the 21 Jones Lang LaSalle Transparency Index analysis. Clearly in the current environment with increased focus on regulation, high levels of transparency 1, South Africa Transparency Index Rating, OECD 3 Constant price comparisons of the growth of industry sectors will tend to under-state the contribution of the mining sector to GDP, which has been strongly boosted by terms of trade effects in recent years. From a real estate perspective, however, chain volume growth measures provide a proxy for underlying space requirements (office and industrial) by different sectors and therefore an appropriate metric. Measures of the actual contribution of different sectors to GDP are best viewed in current price terms, which is the basis for Figure 9.

7 12 Advance Australia: What next for property? 13 Pricing in Australia s commercial property markets appears attractive. In Table 2, we look at two separate ways of benchmarking yields. The first section of Table 2 considers the current yield setting in 4Q11 compared with the 1-year average. For the national industrial market, we have adjusted the average to a seven-year average to account for the re-rating of the sector that occurred in the early 2s. The yield spread relative to the long-term average ranges from nine basis points (regional shopping centres) to 2 basis points (prime-grade industrial). The long-term average for property yields provides an insight into the absolute value of commercial property. However, according to the Capital Asset Pricing Model, valuations are determined in relation to a risk-free rate. Therefore, a more satisfactory way to assess asset values is to benchmark them to Treasury bonds. Yields on commercial property similar to those on corporate equities are real and should be benchmarked against inflationindexed bond rates. Table 2 shows the risk premium for commercial property. For example, the risk premium for moving up the risk curve and investing in sub-regional shopping centres is 475 basis points above the real risk-free rate. The benchmark yield is, therefore, the inflation-indexed bond rate (2.85%) plus 475 basis points. Table 2: Yields versus Benchmarks Yield Relativity Sector Average Yield 1-Year Average Spread (bp) Risk Premium Current Spread (bp) Valuation Benchmark Spread Over Risk Premium (bp) Spread on Mean Reversion* (bp) Office (Prime-Grade) 7.44% 7.3% Retail (Regional Retail Centres) 6.41% 6.5% Retail (Sub-Regional Centres) 7.71% 7.6% Industrial (Prime-Grade) 8.23% 8.3% Mean Reversion of reference rate to 2.85% The inflation-indexed bond rate is inversely related to investor risk aversion. It has declined from 2.55% at end-june to 1.54% at the end of 211. The inflation-indexed bond rate is now 131 basis points below the long-term average of 2.85%. As a result, the spread over the historical risk premium has blown out to between 137 basis points for regional shopping centres and 165 basis points for prime-grade office buildings. The spread recorded for prime-grade office assets is the widest on record above the spread recorded in the early 199s when Sydney, Melbourne and Perth CBDs had vacancy in excess of 22%. Investors should retain a degree of caution in their pricing models. Robust pricing models should assume a mean reversion in the reference rate in this case the inflation-indexed bond rate. Adjusting the reference rate will reduce the current spread by 131 basis points. Nevertheless, Table 2 highlights that a positive spread still exists in all sectors of commercial property. It would appear that Australian commercial property has a genuine, rather than artificial, cheap side of fair value story. e) The currency hurdle The strength of the AUD against the USD, the Euro and Sterling, is frequently cited as a deterrent to offshore investors entering the Australian market. Historically, the reverse has been the case. Australia is a price-taker in global capital markets. Therefore the AUD and domestic asset values tend to be positively correlated. A strong AUD/USD cross rate has been associated with net capital inflows into real estate because the strong AUD is a symptom of the attractiveness of Australian assets to offshore investors, including real estate investors. Focus on the AUD/USD cross rate offers only a partial analysis of the impact of the AUD on investment flows. Over the four years (28 211) the AUD has moved only 1.3% on a trade weighted basis, which is a remarkably stable performance through a period of massive capital and commodity market volatility. Significantly, through 21 and 211, a high proportion of offshore investment has been sourced from countries with currencies as strong or even stronger than the AUD Canada, Singapore and China for example (Table 3). Property Market Outlook Clearly, a threshold issue for prospective investors in the Australian real estate market is the short and long term performance outlook. In the section below, we provide a brief summary of the prospects for the major sectors. Broadly, capital values have staged a partial recovery from trough levels recorded at the end of 29. Capital values are forecast to regain peak 4Q7 levels in nominal terms in 3Q18 (CBD prime office), 1Q13 (regional retail) and 4Q14 (prime industrial), although there are substantial differences between individual markets. For example, the Melbourne CBD market is forecast to regain its peak CV level in 3Q12, while Adelaide CBD had already regained this level by 4Q1. From the investment perspective, the high correlation between markets that was a feature of market performance during the downturn Table 3: AUD Cross Rate Changes 31 Dec 27 to 3 Dec 211 AUD Change 31 Dec 27 to 3 Dec 211 Gold 88.9% Singapore Dollar 4.% UK Pound Sterling 49.3% Chinese Renminbi -.5% Euro 31.2% Swiss Franc -3.5% US Dollar 15.2% Canadian Dollar -8.7% Trade Weighted Index 1.3% Japanese Yen -2.3% Figure 12: Capital Values Index Sector Averages Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 (28 29) is breaking down and there is growing diversity between sectors and markets, sharpening the importance of timing, grade and location selection. As growth rates diverge, the relative importance of markets is shifting. For example, on a value-weighted basis, a balanced CBD office portfolio would include 11.9% exposure to Perth today versus 6.1% in 21. After strong rental growth through 211 in many office markets, a slowdown is forecast for 212. In contrast, rents are forecast to accelerate in the industrial market as rising demand encounters a limited supply pipeline. Increased momentum in retail spending will support retail rental growth, which was subdued through 211. While further yield compression is anticipated, Australia will remain a high yield market by international standards. Capital Value Index - National Averages Dec 26 = 1 Regional Shopping Centres Prime CBD Office Prime Industrial

8 14 Advance Australia: What next for property? 15 Sector Outlook Market Outlook: Office Market Rental Clock Perth Adelaide Melbourne Sydney Brisbane Canberra The Australian office markets shrugged off the macro concerns in 211 Net absorption of 337,1 sqm was recorded. This figure was 2.% above the 1-year average. As a result, the national CBD office market vacancy rate fell by.7 percentage points to 7.2% in 211. Vacancy is at the lower end of equilibrium, assumed to be between 7.% and 9.% for office markets. Following a four-year period with few major commencements, the delivery of new space will be low over the medium-term. The exception is 212, where supply additions are forecast to total 459,6 sqm. The inflated completions figure for 212 partly reflects the tail-end of the development cycles. A number of large developments will complete in Perth and Brisbane and a number of Federal Government-led precommitments in Canberra. Supply additions are projected to fall to 283,5 sqm in 213 and 251,2 sqm in 214. The pace of recovery is slowing While office markets will continue to recover through 212, the pace of recovery is slowing, partly due to the persistent financial volatility (Average) Supply Additions sqm Net Absorption sqm Gross Effective Rental Growth % p.a Prime Yield % ^ Vacancy % ^ Incentive months % Capital Value Growth % p.a ^ Year end emanating from Europe and increasing reports of job losses across the financial sector. Sub-lease availability will be the transmission mechanism for any potential downsizing in the Finance and Insurance sector. Sub-lease availability showed a marginal increase in late-211 but remains in line with the long-term average and well below the level recorded in mid-29. The markets most at risk of a demand-side slowdown Sydney and Melbourne have a relatively moderate medium supply outlook. In the Sydney CBD, the development pipeline equates to 1.8% of total stock to complete by end-213. Assuming a lead time of 24 to 36 months for a new development, it is unlikely that additional supply will complete before the end of 214 in the Sydney CBD. In fact, the development outlook in the Sydney CBD over the next two years (212 and 213) is the fourth lowest since 197 when adjusted for the size of the market. The Melbourne CBD development pipeline equates to 5.9% of total stock, however the bulk of the space is pre-committed (75%) and there are moves from tenants currently based outside of the CBD and an expansionary element contained within a number of pre-commitments. Jones Lang LaSalle forecasts a three-year period of above-trend rental growth ( ) Over this period, our weighted-average prime gross effective rent series is projected to grow by 5.% per annum. The outlook for rental growth is firm and the spread between the yield and the inflation indexed bond rate is the widest on record for a number of office markets. However, we are unlikely to see a significant yield compression cycle in 212. Investors are applying higher hurdle rates to investment in office markets to account for the low treasury yield environment and uncertainty in the global economy. Nevertheless, there is scope for some moderate yield compression for prime-grade assets in CBD office markets. In contrast, for secondary grade assets with short WALEs or upcoming capex requirements, there is the potential for yields to increase. Five thematic issues for office markets How to forecast future demand for quality and quantity of space due to: --Flexible use of workspaces; -- Rising proportion of part-time/casual workers; -- Changing metrics $ per sqm or total occupancy cost? Sustainability and reduced office life cycle what options for owners? Rental incentives will normal levels be re-established? Scarce development finance who will finance development in fringe and suburban locations? Will the yield gap between Australian and offshore assets be arbitraged away?

9 16 Advance Australia: What next for property? 17 Market Outlook - Industrial Market Rental Clock Perth Sydney Adelaide Melbourne Brisbane Tenant demand has been steady Recent activity indicates businesses became more cautious during the latter half of 211. This (Average) Supply Additions sqm N/A Rental Growth % p.a Prime Yield % ^ Capital Value Growth % p.a ^ Year end New development project starts are expected to continue to be demand-led in the next few years as finance for commercial development remains constrained and developers are broadly riskaverse. These conditions are having a dampening effect on supply and new construction is expected to remain below the 1-year average in 212 nationally. The average sale price recorded in 211 increased to the highest level since 27 This indicates good depth of purchasers in the national industrial market. Also, there is greater appetite for larger lots sizes than there has been in previous years. The slowdown in the pre-lease market may increase competition for assets that offer modern facilities with above average WALEs, if and when they are offered to the market for sale. In combination, these rent and yield trends imply that capital growth will be slightly above average and in most cases above CPI over the period to 214. Capital value growth thereafter is assumed to be driven by market rental growth, which will have reverted to around the pace of expected inflation. Five thematic issues for industrial markets Does the re-rating of prime industrial assets have further to go? The next wave of containerisation: which locations will be the winners? Will industrial real estate continue to set the pace for cross-border investment? How will on-line retailing impact industrial development and demand? Which locations are most prospective for the manufacturing sector in Australia? is evident in the lack of pre-lease commitments during 211 although this was not unexpected given that pre-lease activity by the major retail and logistics groups drove much of the demand in 21. Leasing activity in existing space has been subdued partly due to a lack of available existing stock as well as tenant retention strategies by landlords and general occupier caution. However, back-fill space that is becoming available as a result of major tenants moving into their newly constructed purpose built premises over the next year may provide small and medium-sized businesses with the expansion space they require, without the commitment of a pre-lease or D&C deal. The GFC has led to a marked reduction in supply under construction New industrial supply in 21 was the lowest in over a decade. New supply in 211 was only around 18% higher and was the second lowest on record since 21. While there has The primary driver of rental growth will be the balance between subdued supply and a volatile, but broadly positive, demand environment. Conditions for rental growth have improved and many markets have recorded above trend net face rental growth in both prime grade and secondary grade existing stock in the last year. From the investment perspective, the major participants remain private investors, offshore groups looking to build their presence in the market and existing domestic institutional funds with a focus on the industrial sector as a core mandate. This diverse, but extensive, pool of potential buyers will support further moderate yield compression over the next few years especially in light of the expected growth in market rents. been a pick-up in construction activity due to pre-lease developments for major tenants, the forward pipeline remains fairly subdued and speculative development has been minimal. While further speculative development activity is likely, we expect it to be fairly limited overall.

10 18 Advance Australia: What next for property? 19 Market Outlook - Retail Market Rental Clock Brisbane (CBD) Sydney (CBD) Melbourne (CBD) Melbourne (Regional) Sydney (Regional) SE Queensland (Regional) Regional Centres (Average) Supply sqm N/A Rental Growth % Yield % ^ Capital Value Growth % Sub-Regional Centres Rents flat-lined through the latter half of 211 After tracking sideways through 211, the outlook for 212 is for a moderate recovery in rental growth. Anecdotally, leasing incentives have also risen not only to attract new tenants to vacant space but also in many cases on lease renewals in order to maintain occupancy. Nevertheless, the news is not all negative for centre owners and the weakness seen in areas of discretionary spending With the arrival of the GFC, construction and refurbishment activity was cut back sharply. However, developers appear to be slowly gaining more confidence. A growing number of regional and sub-regional projects, mostly extensions of existing centres, are going through the various pre-construction phases of development. Retail spending growth has been below trend With the exception of the temporary impact of the fiscal stimulus in 29, retail turnover growth has been running below trend continuously since 28. Discretionary spending categories have been most affected by current consumer caution. This is evident in a 3.5% decline in fashion, footwear and accessories retailing over the year to November, and a 4.% decline in department store turnover. Retail vacancy has remained resilient, although at a cost to landlords of more generous rental terms. Analysis of vacancy rates by region shows Supply sqm N/A Rental Growth % Yield % ^ Capital Value Growth % ^ Year end that tenant demand in South East Queensland and Perth continued to soften with the average vacancy rate increasing in both markets in the second half of the year. Interestingly, it is Western Australia and Queensland which have been driving the increase in retail turnover growth. This will be supportive of an improvement in tenant demand and a limited supply pipeline will likely see vacancy rates stabilise or decline. has largely been avoided by food-based retailers and also by many retail services providers. There are also specific larger major and mini-major tenants that have continued to perform strongly despite the weak environment. Further modest yield compression is forecast over the next few years A return to rental growth during 212 will support modest further yield compression. The yield spread among regional, sub-regional and neighbourhood centres appears to have stabilised. The regional/sub-regional yield spread has remained relatively stable at around 13 bp since 3Q9 while the regional/neighbourhood spread remains at 2 to 22 bp. Our interpretation of these spreads is that they represent a reasonable risk-adjusted assessment of the outlook for the three retail formats. Five thematic issues for retail markets Is the current retail spending downturn cyclical or structural? How will on-line shopping and more conservative consumers influence retailer mix and leasing structures? Are neighbourhood centres the next retail format to attract portfolio investors? Will the forecast housing construction recovery in 213 revitalise bulky goods retailing? What long term impact will offshore retailers have on the domestic retail scene?

11 2 Advance Australia: What next for property? 21 Market Outlook - Hotels Market (Average) Transaction volumes remain above the long term average Four thematic issues for hotel markets Perth Brisbane RevPAR growth slowing Sydney Melbourne Adelaide RevPAR rising RevPAR falling RevPAR decline slowing Many markets are trading above the previous peak Despite continued uncertainty surrounding the global economic outlook, the road ahead for Australia s city hotel markets is positive with all major markets expected to record continued growth in 212. Resource-driven states continue to thrive with strong growth in key accommodation markets, as closely followed by major corporate centres. Most prime CBD accommodation markets have now surpassed the previous nominal RevPAR trading peak with Adelaide being the exception. On the whole, growth rates are expected to accelerate over the next three years as markets reach capacity and debt market constraints restrict the flow of funds for new accommodation development. Strong ADR growth is therefore projected to be the primary driver of investment returns. Supply Additions Rooms 82 1,62 1,124 1,41 Occupancy % ADR $ ADR CAAG % RevPAR $ ^ RevPAR CAAG % Initial Yield % 7.5* 7.9* * N/A Capital Value Growth % N/A Note: All data includes Adelaide, Brisbane, Canberra, Melbourne, Perth and Sydney Note: ^ Year End * Weighted average yield based on transactions occurring or likely to occur in the market Source: Jones Lang LaSalle Hotels Increased developer interest in hotel projects, but few are progressing The strong trading recovery which has been evident in Australia s hotel sector over the past couple of years has resulted in increased interest from developers with a doubling of mooted accommodation rooms through 211. With so many established hotel investment opportunities available globally, investor appetite for hotel development projects is likely to remain low given the higher degree of associated risk and size of the capital commitment required before the cash flow becomes stabilised, which is typically after three years. Based on current market momentum, the exceptions are most likely to be the key strategic locations; notably prime sites in Sydney, Brisbane and Perth. Having recorded the fifth highest year on record in 21, with AUD 1.3 billion, transaction volumes moderated slightly in 211 to record AUD 1. billion. Deal pace slowed through the mid part of the year as the macro environment softened. The Australian hotel market also witnessed three major corporate transactions in 211 for an estimated $275 million excluding real estate which involved high profile national operating companies and their brands (Mirvac Hotels & Resorts, Oaks Hotels & Resorts and Constellation Hotel Group) bought by overseas investors. The high proportion of domestic brands as well as strong trading environment has increased Australia s appeal for M&A activity over the past year. Transaction volume is expected to reach around $1.2 billion in 212, slightly above the long term trend. More owners are expected to take advantage of the trading upswing and exit over the next couple of years. Asian buyers are expected to continue to dominate although competition is increasing with a number of Middle Eastern sovereign wealth funds targeting acquisitions. Will Asian investors continue to be the primary source of offshore capital or will Middle Eastern investors take this mantle? Australian CBD hotels have been a prime target for Asian companies amassing portfolios in anticipation of REIT formation or IPOs will this continue to underpin offshore investment demand through 212? Markets are reaching capacity but given the lack of development finance, when will new supply emerge? Room rate differential for Sydney and Melbourne is reducing as Perth and Brisbane record stronger ADR growth impact on the investment market?

12 22 Advance Australia: What next for property? 23 Conclusion The 28 Jones Lang LaSalle research report: The Investment Case for Australia highlighted the reasons why investment would be attracted to the local market. Offshore investors appear to agree, based on the transactions flow over the past four years. The strength of the appeal of investment in the Australian property market does not rest on a single or even a small number of attributes although different investors may well attach different weightings to different market features. Many attractions for investment in Australia are long-term such as the transparency of the regulatory environment, the diversity of the economy and the sophistication of financial markets. Other attractions such as the yield spread, rapid growth in the resource-based states and the changing cross rates of the AUD against a range of other currencies can be expected to vary over time. As a result, sources of capital will also be subject to change. From a long-term valuation perspective, prime grade real estate assets in Australia are still discounting an uncertain global outlook and volatile financial markets. In contrast to some offshore markets, valuations are not dependent on unsustainably low interest rates nor are investors betting on sharp increases in the pace of GDP growth. The outlook through 212 is that commercial real estate will remain on the path of recovery and offshore investors will continue to participate actively in the domestic market. Dr. David Rees Head of Research and Consulting, Australasia david.rees@ap.jll.com As Head of Research and Consulting, Australasia, David is responsible for the preparation and dissemination of research market data, forecasts and strategic analysis relating to commercial real estate markets in the region. David is an economist and statistician by training. Prior to joining Jones Lang LaSalle David was Director of Research at Mirvac Group. In addition to real estate, David has wide experience across all asset markets. As Head of Research at Commonwealth Bank he led a team of researchers covering economics, credit and foreign exchange markets, as well as equity research. At Bankers Trust he held the position of Chief Equity Strategist in the investment banking division. Andrew Ballantyne Head of Capital Markets Research, Australia andrew.ballantyne@ap.jll.com Andrew is the Head of Capital Markets Research at Jones Lang LaSalle. Andrew has in excess of 12 years experience in industry research in the commercial and residential property and transportation and logistics sectors. Andrew is a well-respected industry commentator and is regularly quoted in the national press and property journals. Andrew is responsible for the production of thought leadership papers, office market research portfolio and management of the overall Strategic Research team. He holds an MA in Market Research and BA (Hons) in Business Economics. Karen Wales Senior Vice President Hotel Marketing & Research karen.wales@ap.jll.com Karen is responsible for the firm s hotel investment research in the Asia Pacific region and has been involved in several major global research assignments and the provision of strategic advisory services including market and demand studies, financial feasibilities and consultancy in the hotel and tourism sector. Karen has an in-depth understanding of the hotel and tourism industry, with previous experience in advisory and asset management, as well as strong operational experience. Karen possesses a Bachelor of Arts (majoring in history, politics and economics) from University of Newcastle-upon-Tyne as well as a Masters of Business Administration (MBA) from AGSM, University of New South Wales.

13 Adelaide Level 22, Grenfell Centre 25 Grenfell Street Adelaide SA 5 tel Brisbane Level 33, Central Plaza One 345 Queen Street Brisbane QLD 4 tel Brookvale 1 Dale Street Brookvale NSW 21 tel Canberra Level 7, 121 Marcus Clarke Street Canberra, ACT, 261 tel Glen Waverley Building 2 54 Springvale Road Glen Waverley VIC 315 tel Liverpool Level Northumberland Street Liverpool NSW 217 tel Mascot Level 3, Sydney Airport Centre 15 Bourke Road Mascot, NSW, 22 tel Melbourne Level 21, Bourke Place 6 Bourke Street Melbourne VIC 3 tel North Sydney Level 27, North Point 1 Miller Street North Sydney NSW 26 tel Parramatta Level 8, 79 George Street Parramatta NSW 215 tel Perth Level 29, Central Park St Georges Terrace Perth WA 6 tel Sydney Level 25, 42 George Street Sydney NSW 2 tel COPYRIGHT JONES LANG LASALLE 212 All rights reserved. No part of this publication may be published without prior written permission from Jones Lang LaSalle. The information in this publication should be regarded solely as a general guide. Whilst care has been taken in its preparation no representation is made or responsibility accepted for the accuracy of the whole or any part. We stress that forecasting is a problematical exercise which at best should be regarded as an indicative assessment of possibilities rather than absolute certainties. The process of making forward projections involves assumptions regarding numerous variables which are acutely sensitive to changing conditions, variations in any one of which may significantly affect the outcome, and we draw your attention to this factor.