dtz commercial office leasing market report 2014

Property Times Greater Toronto Area Office Q3 2013

Sublet space continues to rise

DTZ Research

30 October 2013 Contents

Executive summary 1

Greater Toronto Area 2

Downtown 4

Midtown 5

GTA North 6

GTA East 7

GTA West 8

Statistics summary 9

Definitions 11

Author

Warren D’Souza

Research Manager

+ 1 905 804 3559

[email protected]

Contacts

John Wickes

Head of Americas Research

+ 1 312 424 8087

[email protected]

Hans Vrensen

Global Head of Research

+ 44 (0) 20 3296 2159

[email protected]

The vacancy rate in the Greater Toronto Area (GTA) increased to 8.8% in Q3 2013 from 8.5% at the end of Q2 2013. Sublet space is on the rise in most markets in Class A buildings.

30 office buildings, representing 7.7 million square feet of new inventory were under construction. The majority of new construction is concentrated in the Downtown and GTA West markets.

The Globe and Mail and Samsung penned significant deals over the quarter. The Globe and Mail will occupy 125,000 square feet of the 500,000 square foot building at 351 King Street E in Downtown East, construction will start shortly. Samsung will occupy 125,000 square feet at 2050 Derry Road West in Meadowvale.

Two buildings reached completion over Q3 2013 totalling 133, 600 square feet. 30 buildings were under construction totalling 7.7 million square feet and 79 buildings are in the pre-leasing state with the opportunity to add 13.1 million square feet to the inventory.

The GTA West possessed the greatest amount of vacant space for lease (5.8 million sq ft) while Midtown had the least amount of vacant options (840,177 sq ft).

Figure 1

GTA Under Construction Comparison, Under construction (000s sq ft) and vacancy rate (%)

Source: Altus InSite and DTZ Research

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Downtown GTA East GTA North

GTA West Midtown Vacancy Rate

Greater Toronto Area Q3 2013

www.dtz.com Property Times 2

Greater Toronto Area Although demand for office space continues to remain strong in the GTA, a significant amount of space came to market over the quarter. The vacancy rate increased to 8.8% from 8.5% in Q2 2013. Net absorption was negative as 179,190 square feet came to market (Figure 2). Three out of five nodes experienced negative net absorption in Q3 2013. Figure 2

Quarterly GTA Absorption by Market, sq ft


GTA North experienced 128,147 square feet of positive net absorption resulting in a 6.3% vacancy rate. This was the second lowest vacancy rate in the GTA. The GTA West market had the highest vacancy rate at 14.0%. The overall GTA vacancy rate was 8.8% (Figure 3). GTA West had over 5.7 million square feet of vacancy followed by Downtown with over 3.9 million square feet of vacancy. The GTA East (3.5 million sq ft), Midtown (1.3 million sq ft) and GTA North (840,177 sq ft) made up the balance of vacancy in the GTA in Q3 2013. Two buildings reached completion over Q3 2013, both in the GTA West market, totalling 133,600 square feet. 7685 Hurontario Street in Brampton is a seven story LEED Gold registered building that totals 73,600 square feet. 5135 Creekbank Road, Mississsauga is 60,000 square feet of office space in a larger flex building, it is fully leased.

Figure 3

GTA Market Vacancy Rate Comparison


7.7 million square feet of office space, spread across 30 buildings, were under construction in Q3 2013. The majority of office space under construction is located within nine buildings Downtown (5.7 million sq ft), followed by 16 buildings in the GTA West (1.4 million sq ft), and five buildings in the GTA North (514,869 sq ft). Midtown and GTA East had no office buildings under construction in Q3 2013. Total vacant space increased by 449,456 square feet in Q3 2013, a 3.1% change in square feet since Q2 2013. Vacant sublet space increased by 144,467 square feet over the quarter, a 5.3% change in square feet since Q2 2013. Sublet vacancy was at the highest level since Q3 2010 at over 2.8 million square feet in Q3 2013 (Figure 4). Figure 4

GTA Direct and Sublet Vacancy, 000s sq ft


-600,000

-400,000

-200,000

0

200,000

400,000

600,000

800,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Downtown Midtown GTA East GTA North GTA West

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Downtown Midtown GTA East

GTA North GTA West GTA Total

2,400

2,500

2,600

2,700

2,800

2,900

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Direct Vacant Space (lhs) Total Vacant Space (lhs)

Sublet Vacant Space (rhs)



Greater Toronto Area Average asking gross rents for the GTA were $29.95 per square foot in Q3 2013 and continue to hover around the $26.00 to $36.00 per square foot range (Figure 5). Rents for the most part have remained fairly stable in nodes with high vacancy rates and have increased in nodes with low vacancy rates. Figure 5

GTA Rent Trends All Classes


For all classes of office in the GTA, the Downtown node maintained the highest average asking net rent of $27.62 per square foot in Q3 2013 whereas the GTA East averaged the lowest net rent of $12.79 per square foot (Figure 6). Table 1

GTA Vacancy Rate and Net Absorption

GTA Node Q3 2013 Vacancy Rate (%)

Net Absorption (Sq Ft)

Downtown 5.6% -210,492

Midtown 6.4% -137,223

GTA East 11.6% -126,663

GTA North 6.3% 128,147

GTA West 14.0% 160,246

GTA Total 8.8% -179,190


Figure 6

GTA Average Gross Rent Comparison


Table 2

Select Lease Transactions in Q3 2013

Tenant Size (Sq Ft)

Address Market Node

The Globe and Mail 125,000 351 King Street E DT East

Samsung 125,000 2050 Derry Road W Meadowvale

LinkedIn 46,000 250 Yonge Street DT North

Shepell FGI 46,000 800 Bay Street DT North

Mercatus 39,500 545 King Street W DT West

Catalyst Capital 32,700 181 Bay Street Financial Core

Zurich 24,066 901 King Street W DT West

Cogent Communications

22,789 245 Consumers Road

Consumers Road

Epsilon 17,519 111 Gordon Baker Road

Hwy 404 & Steeles

Regus 16,557 50 Bay Street DT South

Office Clouds 16,000 25 Sheppard Avenue W

North Yonge


$20.00

$25.00

$30.00

$35.00

$40.00

$45.00

$50.00

$55.00

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Ave

rage

Gro

ss R

ents

($

/psf

)

Downtown GTA East GTA North GTA Total GTA West Midtown

$12.79

$14.66

$15.61

$16.99

$17.01

$27.62

$13.10

$12.43

$14.34

$15.63

$18.42

$26.33

$0.00 $10.00 $20.00 $30.00 $40.00 $50.00 $60.00

GTA East

GTA West

GTA Total

GTA North

Midtown

Downtown

Net Rent Additional Rent



Downtown Market Vacancy increased from 5.3% in Q2 2013 to 5.6% in Q3 2013 due mainly to negative net absorption. Negative absorption was recorded in Downtown North (66,474 sq ft), Financial Core (208,450 sq ft) and Liberty Village (37,386 sq ft). Downtown West recorded the most positive absorption (96,183 sq ft). Figure 7

Downtown Direct and Sublet Vacancy


79.5% of vacant space was available direct with the landlord while sublet space made up 20.5% (Figure 7). The majority of space that came to market over the quarter was for sublease. Despite a negative absorption rate for Q3 2013, we expect the surplus space that came to market to be absorbed in the coming months due to strong demand and low vacancy rates (Figure 8). Table 3

Vacancy Rate and Net Absorption



DT East 6.8% 5,690

DT North 4.8% -66,474

DT South 3.2% -55

DT West 4.8% 96,183

Financial Core 6.1% -208,450

Liberty Village 9.9% -37,386

Downtown 5.6% -210,492


Figure 8

Downtown Absorption by Node


Significant transactions in Q3 include The Globe and Mail taking 125,000 square feet at 351 King Street East and LinkedIn taking 46,000 square feet at 250 Yonge Street. Currently there are nine buildings under construction totalling over 5.8 million square feet. This represents 74.0% of the total square feet under construction in the GTA. Two buildings, 60 Atlantic Avenue and 661 University Avenue the MaRS Discover Centre (Phase II) (46.2% pre-leased) are scheduled for completion in 2013. The remainder of the buildings are scheduled for completion between 2014 to 2017. Financial Core gross asking rents continue to be the highest in the GTA at $55.81 per square foot. The average gross rent for the Downtown node was $53.95 per square foot (Figure 9). Figure 9

Downtown Average Asking Rent Comparison


Direct, 3,125,428,

79.5%

Sublet, 805,832,

20.5%

4.2%

4.4%

4.6%

4.8%

5.0%

5.2%

5.4%

5.6%

5.8%

-600,000

-400,000

-200,000

0

200,000

400,000

600,000

800,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Vac

ancy

Rat

e (%

)

Net

Ab

sorp

tio

n (

Sq f

t)

DT East DT North DT South

DT West Financial Core Liberty Village

$18.23

$19.58

$20.69

$19.98

$23.60

$30.26

$14.27

$17.40

$16.67

$19.47

$19.24

$25.55

Liberty Village

DT East

DT West

DT North

DT South

Financial Core

$0.00 $20.00 $40.00 $60.00




Midtown Market Midtown experienced negative absorption of 137,223 square feet. The Eglinton node accounted for the largest segment of negative absorption, with 100,776 square feet followed by Bloor with negative 46,722 square feet. St. Clair recorded a positive 10,315 square feet. Midtown’s vacancy rate increased by 0.7% in Q3 2013 to 6.4%. This node’s vacancy continues to range between 4.0% and 8.0%. Figure 10

Midtown Direct and Sublet Vacancy


74.2% of space was directly available for lease from the landlord while 25.8% of space was available for sublet. (Figure 10). The majority of negative absorption occurred in Class B buildings with space coming to market for sublease. There were 18 available blocks of space 10,000 square feet and up in this market offering many options to larger users (Figure 11). Table 4




Bloor 4.8% -46,772

Eglinton 9.0% -100,766

St. Clair 7.3% 10,315

Midtown 6.4% -137,223


Figure 11

Midtown Absorption by Node


Average gross asking rents increased from $35.26 per square foot in Q2 2013 to $35.43 per square foot in Q3 2013. Increasing by $0.37 from Q2 2013, Bloor remains the most expensive node in Midtown with an average gross rent of $38.86 per square foot. Eglinton continues to be the most economical node within Midtown with average gross rent of $32.12 per square foot in Q3 2013 (Figure 12). Figure 12

Midtown Average Asking Rent Comparison


Direct, 770,388,

74.2%

Sublet, 267,374,

25.8%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

-200,000

-150,000

-100,000

-50,000

0

50,000

100,000

150,000

200,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Vac

ancy

Rat

e (%

)

Net

Ab

sorp

tio

n (

Sq F

t)

Bloor Eglinton St. Clair Vacancy Rate

$14.66

$17.58

$19.74

$17.46

$19.28

$19.12

Eglinton

St. Clair

Bloor

$0.00 $10.00 $20.00 $30.00 $40.00 $50.00




North Market The GTA North market’s vacancy rate decreased from 6.6% in Q2 2013 to 6.3% in Q3 2013. Vaughan recorded negative absorption of 25,163 square feet. Dufferin and Finch remained relatively unchanged recording 32 square feet of negative absorption. The majority of positive absorption was in North Yonge (74,571 sq ft) and Richmond Hill (64,328 sq ft). Figure 13

GTA North Direct and Sublet Vacancy


74.6% of vacant space in the GTA North market was for lease whereas 25.4% of space was for sublease (Figure 13). This market experienced positive net absorption in Q3. The majority of this growth was experienced in Class B buildings in North Yonge and Class A buildings in Richmond Hill (Figure 14). Table 5




Downsview 5.0% 1,803

Dufferin and Finch 10.4% -32

North Yonge 5.7% 74,571

Richmond Hill 5.9% 64,328

Vaughan 10.1% -25,163

Yorkdale 1.6% 12,640

GTA North 6.3% 128,147


Figure 14

GTA North Absorption by Node


A significant transaction in Q3 included Office Clouds taking 16,000 square feet at 25 Sheppard Avenue West in North Yonge. GTA North’s gross asking rents averaged $32.62 in Q3 2013. The most expensive node continued to be North Yonge with an average gross rent of $37.62 per square foot. Yorkdale continued to be the most affordable area with average gross rents remaining at $21.01 per square foot (Figure 15). Figure 15

GTA North Average Asking Rent Comparison


Direct, 626,675,

74.6%

Sublet, 213,502,

25.4%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

-300,000

-200,000

-100,000

0

100,000

200,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Vac

ancy

Rat

e (%

)

Net

Ab

sorp

tio

n (

Sq F

t)

Downsview Dufferin and Finch North Yonge

Richmond Hill Vaughan Yorkdale

Vacancy Rate

$9.50

$10.13

$14.20

$16.71

$12.50

$18.44

$11.51

$13.32

$11.14

$10.56

$17.25

$19.18

Yorkdale

Dufferin and Finch

Richmond Hill

Vaughan

Downsview

North Yonge

$0.00 $10.00 $20.00 $30.00 $40.00




East Market The GTA East recorded 124,663 square feet of negative net absorption in Q3 2013. The vacancy rate increased to 11.6% from 11.3% in Q2 2013. Five nodes within the GTA East recorded positive absorption this quarter, Consumers Road (10,857 sq ft), Don Mills and Eglinton (4,926 sq ft), Duncan Mill (10,674 sq ft), Markham (3,978 sq ft) and Scarborough (18,381 sq ft). Highway 404 and Steeles (-166,389 sq ft) and Pickering (-7,090 sq ft) both recorded negative net absorption. The majority of negative net absorption can be attributed to ING Bank of Canada vacating their space at 111 Gordon Baker Road. Figure 16

GTA East Direct and Sublet Vacancy


83.2% of vacant space was directly available with the landlord while sublet space comprised 16.8% (Figure 16). Net absorption over the past five quarters has averaged negative 89,136 sq ft (Figure 17). Table 6




Consumers Road 15.8% 10,857

Don Mills & Eglinton 7.8% 4,926

Duncan Mill 8.9% 10,674

Hwy 404 & Steeles 13.4% -166,389

Markham 10.5% 3,978

Pickering 9.9% -7,090

Scarborough 16.0% 18,381

GTA East 11.6% -124,663


Figure 17

GTA East Absorption by Node


There are 19 buildings in the pre-leasing stage ranging from 24,000 square feet to over 500,000 square feet with the possibility of adding over 3.1 million square feet to the inventory if completed. GTA East gross asking rents averaged $25.89 per square foot in Q3 2013. Consumers Road posted the highest average asking gross rent at $26.90. Pickering posted the lowest average gross rent this quarter at $22.80 (Figure 18). Figure 18

GTA East Average Asking Rent Comparison


Direct, 2,916,586,

83.2%

Sublet, 589,500,

16.8%

10.4%

10.6%

10.8%

11.0%

11.2%

11.4%

11.6%

11.8%

12.0%

-400,000

-300,000

-200,000

-100,000

0

100,000

200,000

300,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Vacancy

Rate

(%

)

Net A

bsorp

tion (

Sq F

t)

Consumers Road Don Mills Corridor

Hwy. 404 & Steeles Markham

Pickering Scarborough

Vacancy Rate

$12.14

$12.14

$10.72

$11.69

$12.15

$14.26

$11.45

$10.66

$11.38

$14.52

$14.48

$14.24

$12.18

$15.45

Pickering

Highway 404 and Steeles

Scarborough

Duncan Mill

Don Mills and Eglinton

Markham

Consumers Road

$0.00 $10.00 $20.00 $30.00




West Market GTA West performed the best in the GTA with the highest positive net absorption rate in the GTA in Q3 2013 of 160,246 square feet. Brampton (67,452 sq ft) and Dixie and Eglinton (71,693 sq ft) recorded the highest positive net absorption. GTA West vacancy increased to 14.0 % in Q3 2013 from 13.6% at the end of Q2 2013. This is due to a significant increase in inventory and sublet space on the market. Figure 19

GTA West Direct and Sublet Vacancy


82.7% of direct vacant space was available with the landlord while sublet space comprised 17.3% (Figure 19). Absorption over the past five quarters has averaged positive 48,024 square feet (Figure 20). Currently there are 16 buildings under construction that will add 1.5 million square feet to the market between 2013 and 2015. Also, there are 45 buildings in the pre-leasing stage totalling over 5.6 million square feet. Table 7




Airport 14.4% 96,042

Brampton 13.0% 67,452

Burlington 16.3% -76,458

Highway 427 Corridor 13.0% 24,539

Hurontario North 10.0% 27,263

Meadowvale 12.8% -15,138

Mississauga City Centre 14.9% 5,955

Mississauga South 13.8% 28,957

Oakville 17.6% 1,634

GTA West 14.0% 160,246


Figure 20

GTA West Absorption by Node


Over the quarter two buildings reached completion within the GTA West totalling 133,600 square feet. 7685 Hurontario Street in Brampton is a seven story LEED Gold registered building that totals 73,600 square feet. 5135 Creekbank Road, Mississsauga is 60,000 square feet of office space in a larger flex building, it is fully leased. GTA West gross asking rents averaged $27.09 in Q3. The Mississauga City Centre posted the highest gross rent at $32.01. Mississauga South continues to be the most affordable area with an average gross rent of $22.45 (Figure 21). Figure 21

GTA West Average Asking Rent Comparison


Direct, 4,793,627,

82.7%

Sublet, 1,000,315,

17.3%

11.0%

12.0%

13.0%

14.0%

15.0%

-400,000

-200,000

0

200,000

400,000

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

Vac

ancy

Rat

e (%

)

Net

Ab

sorp

tio

n (

Sq F

t)

Airport Brampton Burlington Highway 427 Corridor Hurontario North Meadowvale Mississauga City Centre Mississauga South Oakville Vacancy Rate

$10.75

$11.94

$13.95

$15.02

$14.75

$16.06

$18.08

$14.27

$16.34

$11.71

$11.98

$11.32

$10.44

$12.17

$12.09

$10.82

$16.19

$15.67

Mississauga South

Airport

Hurontario North

Burlington

Brampton

Meadowvale

Oakville

Highway 427 Corridor

Mississauga City Centre

$0.00 $10.00 $20.00 $30.00




Statistics Summary Table 8

Quarterly data

Q3 2013 Total

Inventory (Sq Ft)

Under Construction

(Sq Ft)

Change in Occupied

Area (Sq Ft)

Vacancy Rate (%)

Average Net Rent ($/psf)

Average Additional Rent

($/psf)

Average Gross Rent ($/psf)

Downtown Toronto

DT East 4,080,172 455,000 5,690 6.8% $19.58 $17.40 $36.98

DT North 12,391,831 746,898 -66,474 4.8% $19.98 $19.47 $39.46

DT South 4,382,790 2,355,843 -55 3.2% $23.60 $19.24 $42.84

DT West 13,576,221 284,405 96,183 4.8% $20.69 $16.67 $37.37

Financial Core 32,836,276 1,911,452 -208,450 6.1% $30.26 $25.55 $55.81

Liberty Village 2,573,143 27,834 -37,386 9.9% $18.23 $14.27 $32.50

Downtown 69,840,433 5,781,432 -210,492 5.6% $27.62 $26.33 $53.95

GTA East

Consumers Road 4,008,828 0 10,857 15.8% $11.45 $15.45 $26.90

Don Mills and Eglinton 3,506,276 0 4,926 7.8% $12.15 $14.24 $26.39

Duncan Mill 2,120,533 0 10,674 8.9% $11.69 $14.48 $26.17

Highway 404 and Steeles 6,026,442 0 -166,389 13.4% $12.14 $11.38 $23.52

Markham 6,702,187 0 3,978 10.5% $14.26 $12.18 $26.44

Pickering 944,064 0 -7,090 9.9% $12.14 $10.66 $22.80

Scarborough 4,062,454 0 18,381 16.0% $10.72 $14.52 $25.24

GTA East 30,117,691 0 -124,663 11.6% $12.79 $13.10 $25.89

Midtown

Bloor 9,184,953 0 -46,772 4.8% $19.74 $19.12 $38.86

Eglinton 4,796,205 0 -100,766 9.0% $14.66 $17.46 $32.12

St. Clair 2,268,507 0 10,315 7.3% $17.58 $19.28 $36.86

Midtown 16,249,665 0 -137,223 6.4% $17.01 $18.42 $35.43

GTA North

Downsview 445,556 0 1,803 5.0% $12.50 $17.25 $29.75

Dufferin and Finch 760,209 0 -32 10.4% $10.13 $13.32 $23.45

North Yonge 8,498,333 0 74,571 5.7% $18.44 $19.18 $37.62

Richmond Hill 2,746,907 0 64,328 5.9% $14.20 $11.14 $25.34

Vaughan 2,307,379 514,869 -25,163 10.1% $16.71 $10.56 $27.27

Yorkdale 1,246,820 0 12,640 1.6% $9.50 $11.51 $21.01

GTA North 13,408,184 514,869 128,147 6.3% $16.99 $15.63 $32.62



Table 9

Quarterly data, continued

Q3 2013 Total

Inventory (Sq Ft)

Under Construction

(Sq Ft)

Change in Occupied Area

(Sq Ft)

Vacancy Rate (%)

Average Net Rent ($/psf)

Average Additional

Rent ($/psf)

Average Gross Rent

($/psf)

GTA West

Airport Corp. Centre 4,914,300 180,722 12,167 13.3% $15.24 $12.77 $28.01

Airport East 2,301,946 0 -25,517 22.5% $12.58 $12.51 $25.09

Airport North 1,043,350 0 32,849 13.8% $10.94 $11.63 $22.57

Airport West 460,619 0 -2,554 20.7% $8.80 $10.78 $19.58

Bloor and Islington 1,041,370 0 716 12.1% $15.25 $17.05 $32.30

Brampton 3,104,863 190,000 67,452 13.0% $14.75 $12.17 $26.92

Burlington 3,459,670 0 -76,458 16.3% $15.02 $10.44 $25.46

Cooksville 852,464 0 36,927 24.9% $11.11 $11.82 $22.93

Dixie and Eglinton 2,764,531 60,000 71,693 5.7% $12.10 $9.51 $21.61

Etobicoke North 974,260 0 7,404 22.9% $11.96 $14.66 $26.62

Etobicoke South 555,542 0 8,701 23.7% $12.88 $14.80 $27.68

Highway 427 Corridor 2,144,028 0 15,122 10.7% $14.69 $16.72 $31.41

Hurontario North 3,702,159 567,131 27,263 10.0% $13.95 $11.32 $25.27

Meadowvale 5,959,072 92,778 -15,138 12.8% $16.06 $12.09 $28.15

Mississauga City Centre 3,730,278 56,324 5,955 14.9% $16.34 $15.67 $32.01

Oakville 3,373,271 191,436 1,634 17.6% $18.08 $10.82 $28.90

Sheridan 1,076,325 0 -7,970 4.9% $10.38 $11.59 $21.97

GTA West 41,458,048 1,480,391 160,246 14.0% $14.66 $12.43 $27.09

GTA Total 171,074,021 7,776,692 -179,190 8.8% $15.61 $14.34 $29.95



Definitions

Absorption: Difference (positive or negative) between total Occupied Area for current quarter/year and total Occupied Area from previous quarter/year.

Asking Rate: Posted rental rate, in dollars per sq. ft. per annum, for a specific available space. This rate is typically a negotiable cost.

Available Area: The area contained within a building that is currently being marketed as available for lease with an immediate or future possession date.

Building Class: Class A: Higher quality combination of design, materials, tenant mix, age, size and location. Class B: Lower quality combination of design, materials, tenant mix, age, size and location. Class C: remaining poorer quality properties

Building Completion: A development in which the main contract has been completed, whether this be to shell and core or developer’s finish. Also the tenant has taken occupancy of the space.

Direct Available: Space available for lease directly from the landlord.

Speculative Development: A newly developed or comprehensively refurbished building undertaken without the benefit of a secured tenant.

Sublet Available: Space available for lease from one of the tenants in the building for the remaining portion of their lease term.

Sublet Vacant: The portion of Sublet Available that is physically unoccupied or unoccupied by a tenant.

Total Additional Rent: The sum of additional costs (realty taxes, operating costs, in-suite power) for all spaces in a building. This amount is typically not negotiable.

Total Available: Sum of Direct Available Area and Sublet Available Area.

Total Available Rate: Total of Direct and Sublet Available Area divided by Total Office Area and expressed as a percentage.

Total Vacant: Sum of Direct Vacant Area and Sublet Vacant Area.

Total Vacant Rate: Total of Direct and Sublet Vacant Area divided by Total Office Area and expressed as a percentage.

Under Construction: A development in which work has started on the main contract. This usually excludes demolition and site clearance contracts.

Vacant and Leased: Space that is both physically unoccupied and leased but not currently being marketed as available. Most often describes leased area in properties under construction.

Vacant Area: The area contained within a building that is currently physically unoccupied by a tenant.



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Occupier Perspective Updates on occupational markets from an occupier perspective, with commentary, analysis, charts and data. Global Occupancy Costs Offices Global Occupancy Costs Logistics Obligations of Occupation Americas Obligations of Occupation Asia Pacific Obligations of Occupation EMEA Global Office Review India Office Demand and Trends Survey 2012-13 Poland Banking Sector - January 2013 Motorways of the Sea - January 2013 The TMT Sector - October 2012

Property Times Regular updates on occupational markets from a landlord perspective, with commentary, charts, data and forecasts. Coverage includes Asia Pacific, Bangkok, Beijing, Berlin, Brisbane, Bristol, Brussels, Budapest, Central London, Chengdu, Chongqing, Dalian, Edinburgh, Europe, Frankfurt, Glasgow, Guangzhou, Hangzhou, Ho Chi Minh City, Hong Kong, India, Jakarta, Japan, Kuala Lumpur, Luxembourg, Madrid, Manchester, Melbourne, Milan, Nanjing, Newcastle, Paris, Poland, Prague, Qingdao, Rome, Seoul, Shanghai, Shenyang, Shenzhen, Singapore, Stockholm, Sydney, Taipei, Tianjin, Ukraine, Warsaw, Wuhan, Xian.

Investment Market Update Regular updates on investment market activity, with commentary, significant deals, charts, data and forecasts. Coverage includes Asia Pacific, Australia, Belgium, Czech Republic, Europe, France, Germany, Italy, Japan, Mainland China, South East Asia, Spain, Sweden, UK.

Money into Property For more than 35 years, this has been DTZ's flagship research report, analysing invested stock and capital flows into real estate markets across the world. It measures the development and structure of the global investment market. Available for Global, Asia Pacific, Europe, North America and UK.

Foresight Quarterly commentary, analysis and insight into our in-house data forecasts, including the DTZ Fair Value Index™. Available for Global, Asia Pacific, Europe, UK and China. In addition we publish an annual outlook report.

Insight Thematic, ad hoc, topical and thought leading reports on areas and issues of specific interest and relevance to real estate markets. Great Wall of Money - October 2013 Quantitative Easing - UK Regions - September 2013 Singapore Government Land Sales - September 2013 UK lending market -September 2013 Quantitative Easing - August 2013 Property Investment Guide Asia Pacific 2013-2014 Singapore Insight – Residential – July 2013 Net Debt Funding Gap - June 2013 China Insight - The Healthcare Sector - April 2013 City of London occupier demand - April 2013 European Sustainability Guide - April 2013

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Investment Transaction Database Aggregated overview of investment activity in Asia Pacific and Europe.

Money into Property DTZ’s flagship research product for over 35 years providing capital markets data covering capital flows, size, structure, ownership, developments and trends, and findings of annual investor and lender intention surveys.

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DTZ Foresight 2014 Annual Outlook

Time for occupiers and investors to boldly go…

DTZ Research

5 December 2013

Contents

Introduction 2

Section 1: Global Outlook 3

Section 2: Regional Outlooks 10

Authors Hans Vrensen


[email protected]

Magali Marton

Head of CEMEA Research

[email protected]

Richard Yorke

Head of UK Research

[email protected]

Dominic Brown

Head of SEA / ANZ Research

[email protected]

Andrew Ness

Head of North Asia Research

[email protected]

John Wickes


[email protected]

Nigel Almond

Head of Strategy Research

[email protected]

Fergus Hicks

Global Head of Forecasting

[email protected]

Dennis Fung

Head of Asia Pacific Forecasting

[email protected]

Economic sentiment has improved markedly, with risk aversion no longer in focus. In fact, the outlook has now improved so much that many central banks are looking to unwind their supportive monetary policies. Therefore, bond yields and interest rate are projected to increase in 2014 and beyond.

Occupiers will benefit from below-inflation cost increases over the next few years. But, in Asia Pacific we do forecast the highest regional average cost increase. This is despite vacancy projected to increase across the region as inflation pushes up rents (Figure 1). The pipeline of new space for 2014-15 is limited and vacancy across the US and Europe is projected to be stable.

As far as space use efficiency, there is little room for improvement across most Asian markets and larger European and US markets. Therefore, occupiers need to be bold about improving their operational flexibility. Across European markets, we consider corporate affordability for the first time. Our analysis shows that highly productive cities are typically least affordable, confirming price signals work. This does leave some smaller markets with low costs and high productivity for corporate expansion.

Investors will benefit from good relative value across most markets, especially in the US. But, lack of attractive prime opportunities has already led investors to re-focus on non-core and non-prime opportunities. Together with improved availability of debt and equity capital, investment volumes have been breaking post-crisis records. But, unfortunately the opportunity is limited in time. We forecast relative value to reduce as interest rates rise. This means that investors need to move ahead boldly, before relative value is no longer available.

With limited time available, market-level liquidity is expected to become more relevant in the next few years. Based on our initial analysis across 26 key markets, London and some of the key US markets come out particularly strong. London ranks top for cross-border liquidity also.

Figure 1

Average office stock growth (as % of existing stock) and vacancy rate

Source: DTZ Research

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2014 Annual Outlook

www.dtz.com DTZ Foresight 2

Introduction 2014 promises to be another eventful year for occupiers and investors across global property markets. If we take stock, we note that many markets have already turned. Occupiers consider their individual businesses and industries in the context of a sustained global macro economic recovery, which appears to be experiencing a temporary slowing. Many occupiers are still focused on achieving costs efficiencies across their portfolios, while a small but increasing number of occupiers are getting ready for their first expansion in years. Many investors are still looking for distressed opportunities, while the recovery in most core markets has already run its course. An increasing number of investors are taking more risk and actively looking at non-core markets, partly because of lack of core opportunities. Even new development is back on the agenda in selected markets. Investors are further encouraged by a normalisation of the lending markets. This has brought investment volumes back to historical levels in the US and Europe while setting new records in Asia Pacific.

There has been a gradual shift towards a more positive market sentiment, as most occupiers and investors have shifted away from their focus on possible downside scenarios. This does not mean that we have become blind to the remaining challenges on the regulatory, policy and political fronts. But, one of the biggest challenges might now come from better than expected economic growth, which is likely to trigger the unwinding of accommodating central bank policies in the US and Europe. This will trigger an increase in interest rates, which have been at record lows for some time. Interest rate increases have traditionally proven to be challenging for property investors. But, they are also likely to slow economic growth and dampen occupiers’ plans for expansion.

Despite these potential headwinds, we find ourselves for the first time in a long while focusing on an increased probability for upside surprises. As in previous Outlooks, we start with a global economic and market review followed by the three regional sections covering occupiers and investors separately. Our key views are summarised on the front page. Finally, I thank my senior research team in assisting me with our fourth DTZ Research annual outlook.

With warmest regards and best wishes for 2014,

Hans Vrensen Global Head of Research DTZ

2014 Annual Outlook


Section 1: Global Outlook

Economic and policy context

Economic growth projected to improve As we look ahead into 2014, we note a significantly better forecast for GDP growth for the next five years (Figure 2). It has taken a longer time for this latest recovery to take hold after the unprecedented global financial crisis, when compared to previous rebounds. However, growth across all regions is now projected to be positive. Southern European countries drag down the regional average, but most will return to growth. The US and China are returning as the main engines of global economic growth. Accommodating monetary policies in the US, Europe and Japan have worked well to kick-start this recovery. But, these will have to be reversed to avoid inflationary impact.

Figure 2

Average per annum GDP growth

Source: Oxford Economics

Downside scenarios have faded into the background The improved sentiment is further evidenced by the disappearance of the infamous euro-zone breakdown scenario. Most of our clients are no longer asking about this happening. The key risk the euro-zone now faces is actually deflation. Upside and base case scenarios have become more probable (Figure 3). However, we do note that most of the systemic and structural impediments to effective crisis management remain, such as the lack of a federal EU government and the inability to compromise on key policy decisions across US political parties. These have been the key factors for sovereign rating downgrades and need to be addressed to avoid future problems. In the mean time, accommodating monetary policies have worked well and many newly proposed regulatory controls have been delayed to dampen their short term impact.

Sustained recovery to trigger bond yield widening As a result of quantitative easing, government bond yields fell to historical lows in early 2013 (Figure 4). Initial talk of tapering in the US triggered a significant widening in the first half of 2013. With the economic recovery gaining momentum, we anticipate that bond yields will widen in 2014 and beyond. Our economic forecasters and market forward rates support this view. This will have significant repercussions for our property markets, as we will see later. However, we do need to bear in mind that central banks will only reverse their accommodating policies if they are concerned about inflation. This will happen if the economic recovery remains on track. Of course, this in turn will provide a strong positive for both corporate occupiers’ profitability and investors’ expectations for income growth. Both would be a welcome reversal from the recent past.

Figure 3

Estimated scenario probabilities

Source: Oxford Economics

Figure 4

Government bond yields and forward rates

Source: Bloomberg

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2014 Annual Outlook


Global occupier outlook Asia Pacific vacancy to increase, offering wider choice With most corporations focused on costs savings during the global financial crisis, vacancy rates across European and US markets have held steady on average, due to existing leases and the small amount of new space delivered. With a limited pipeline of future new supply, this is not expected to change significantly going forward (Figure 5). However, the situation in Asia Pacific is very different. Of course, it is not unreasonable to expect higher office vacancy rates for markets that add nearly 10% of space to existing inventory every single year. However, the recent (temporary) slowdown in economic growth and the very strong pipeline of new supply is triggering a significant increase in vacancy rates across this region. This vacancy provides a wider range of choice for occupiers across the Asia Pacific region. These trends are further confirmed when we consider individual markets across regions on Map 1 on pages 8 & 9.

Asia Pacific occupancy costs increase most and are now above US, with Europe remaining least affordable Despite the increase in vacancy rates, we forecast the highest increase in occupancy costs for the Asia Pacific region, when compared to the US and Europe (Figure 6). Higher inflation will push up Asia Pacific rents. Regardless of this projected increase, many Asian markets remain more affordable on an absolute basis. However, on average Asia Pacific average occupancy costs have now become less affordable than the US national average. Europe remains the most expensive region on average, offering low costs only in CEE and Baltic markets. Regional differences aside, we forecast average global occupancy cost increases at just below inflation for the next two years, which should be an acceptable result for most corporate occupiers.

Little room for efficiency gains to offset cost increases across Asia Pacific markets, but plenty left elsewhere If we next consider space efficiency in combination with cost increases, we note some interesting patterns (Figure 7). Most Asia Pacific markets (except Australia) show high space efficiency and a wide range around the highest average regional cost increase. Europe and US show similar regional average space efficiency, but US markets are in a tighter range. This outlook leaves occupiers with little room for efficiency gains in Asian markets. Across Europe and the US, there is more room left for space efficiencies, especially in some of the smaller markets. Therefore, we think that occupiers need to move more boldly on improving their operational flexibility. Our global occupier metrics tool can help in that respect. We highlight its features in Box 1.

Figure 5

Average office stock growth (as % of existing stock) and vacancy rate by region


Figure 6

Top five most affordable markets by region and growth rates of occupancy costs per workstation


Figure 7

Change in Global occupancy costs and space efficiency


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2014 Annual Outlook


Box 1: Global Occupier Metrics Tool

New DTZ analytical tool offers occupiers tailored solutions In November 2013, DTZ launched its Global Occupier Metrics Tool (GOMT) giving occupiers easy online access to relevant market information across 130 global markets. GOMT allows occupiers to calculate occupancy costs and identify potential cost savings by considering their own space utilisation against the local markets’ best practice. By combining workplace strategy with the most up-to-date and forecasted market information, DTZ is helping occupiers to make informed choices.

New workplace practices trigger lower space density Workplace practices have evolved rapidly in recent times with companies needing fewer employees present in the office at all times. Technology and low-cost mobile phone and widespread wi-fi access have lead to a much more fluid way of working for many workers across industry sectors. This has had a knock-on effect on workplace density and corporate occupiers often retain more space than they actually need. Taking time to re-examine the amount of space allocated to each employee can therefore prove a worthwhile exercise for occupiers.

Focusing on lower cost locations can lead to false savings Corporations looking to realise savings from their property portfolio usually target rents and can therefore end up moving to less desirable areas in pursuit of reduced operating expenses. However, the biggest cost savings are not necessarily through changing location – in fact, quite the contrary. Focusing instead on workplace density allows corporate real estate managers to find the right solution to the traditional trade off between costs and talent. It means that corporations can in fact save money, while staying in or moving to a prime location to retain and attract the best available talent, as long as they reduce the space per worker. Typical costs savings of up to 30%, when following local best practice Companies with a typical portfolio of offices across major European capitals can save up to 30% by adjusting their space utilisation to local market best practice, according to data from DTZ Research. This assumes a typical services company occupying offices in the ten major European capitals for 1,000 employees can save up to €1.5m a year – which, given cost-to-revenue ratio. This equates to an EBITDA increase of around three per cent.

http://occupiermetrics.dtz.com

Environmental regulation

Prevailing certification systems

Local energy costs

Typical office access modal split.

(Currently EU. only)

Head count projections

Workplace strategy

Location and building type.

Provides visuals of lease area components

Converts Net Internal Area (NIA) into local Gross Lease Area (GLA).

Total occupancy cost benchmarks

Workplace density best practice

Typical fit-out costs

Tenant obligations of occupation.

Converts and visualises net and lease area:

Total occupancy cost simulation based on:

Includes environmental regulation and best practice information:

Provides latest market research on:

Global Occupier Metrics Tool

2014 Annual Outlook


Global investor outlook

Good relative value, with US top and APAC least attractive Most property markets are now attractively priced based on our Fair Value Index (“FVI”) approach (Figure 8). This has been partly driven by an improved outlook for rental and capital growth. However, the improvement in the relative attractiveness of property is mostly due to historically low government bond yields. This has resulted in a global FVI-index score of 75, which identifies over 200 markets in the attractive categories of hot and warm. Regionally, the US remains most attractive, with Asia Pacific re-pricing leaving it at below the global average. Some core global markets, like Paris and Hong Kong, have seen yield tightening to such extent as to now render them unattractive.

Record equity capital availability combines with normalisation of the lending markets Apart from an improving macro outlook and good relative value, investors have benefitted from a normalisation in the lending markets. This is evidenced by a continued decline in the net debt funding gap in both Japan and Europe. Figure 9 illustrates the size of the debt related problems around the world, now solely concentrated in Europe. With the strong uplift in non-bank lending activity the net debt funding gap has reduced strongly. Loan portfolio sales are occurring nearly weekly now, partly fuelled by the large volume of available opportunistic or non-core equity capital. In fact, there is more capital available for commercial property than ever before. We expect this record to be broken as the fundraising environment should improve further.

Investors need to act boldly before relative value disappears due to interest rate increases With good relative value and improved debt and equity capital availability, it is no wonder that investment volumes have been breaking post-crisis records (Figure 10). But, as our forecast of the global FVI-index shows, we expect relative value to come down as soon as interest rates start rising. Of course, this does not mean there are no longer any attractive opportunities available. However, we do expect that new capital commitment growth will slow as a result, especially from mixed-asset investors. With some delay, we would expect volumes to also come down as a consequence. In other words, investors should move boldly ahead with their execution, before relative value is no longer available across a broad range of markets. With time running out we think investors should carefully consider liquidity on a market-level. Box 2 further looks into liquidity.

Figure 8

Global Fair Value IndexTM

, Q3 2013


Figure 9

Global debt funding gap and available equity 2013-14


Figure 10

Investment volumes (USD bn) and Fair Value Index score

Source: DTZ Research, RCA, RealNet

88 74 65 75

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2014 Annual Outlook


Box 2: City-level liquidity ratio analysis

Liquidity becomes more relevant when time is limited Going forward we believe liquidity will become an even more critical factor for global investors. Especially as real estate’s relative attractiveness reduces in future and available capital remains strong. Liquidity is an important factor for investors wishing to both enter and exit markets through the cycle. We have now extended our analysis of liquidity from a country level to drill down to the 26 key office markets globally.

London top for overall and cross border liquidity Overall, we find higher liquidity ratios in the US (8%) compared to Asia Pacific (6%) and Europe (5%). See Figure 11. Even when comparing inter-regional flows (capital invested from outside a region) there is a similar hierarchy, albeit with wide variations. Globally, London is the most liquid market over the last ten years (11.5%) followed by San Francisco (11%). The most liquid city in Asia is Sydney at 9% and it is ranked fourth globally. Paris and Frankfurt show significantly lower ratios compared to their peers. Based on inter-regional activity, London is again the most liquid market, underscoring the diverse range of investors attracted to this market.

New York’s liquidity more volatile, Tokyo and Paris least For investors, it is important to understand these trends through the cycle and the market position today. Figure 12 outlines the range through the cycle for key cities ranked by their ten year average. This shows a wider range in San Francisco and New York and above the global average. Paris and Tokyo show far less volatility. In New York, Paris, Singapore and Tokyo we see the 2012 ratio at or below the ten year average. These leave some room to grow, in contrast to London and San Francisco, where the ratio is close to its ten year high.

Market size and liquidity key for investors For cross border investors we believe absolute market size, as well as liquidity is critical. In Figure 13 we compare the average liquidity scores at both the country and city level, together with the invested stock of a city shown by the size of the bubble. On this basis London and New York stand out as having critical mass and above average liquidity scores. Both Paris and Washington are sizable markets with close to average liquidity ratios. Of the Asian markets Singapore stands out with the highest liquidity, but lacks relative size. Comparatively larger markets Tokyo and Hong Kong show lower liquidity levels.

Figure 11

City liquidity by source of capital 10 year average 2003-12


Figure 12

Tends in City liquidity across key gateway cities


Figure 13

Country and city level liquidity (10 year average) and 2012 market size USD bn


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2014 Annual Outlook


Map 1: New 2014-15 supply as % of stock and average 2014-15 rent growth


AMS Amsterdam BOS Boston DEL Delhi HKG Hong Kong

ANT Antwerp BRU Brussels DEN Denver HOU Houston

ATL Atlanta BUC Bucharest DUB Dublin HYD Hyderabad

BCN Barcelona BUD Budapest EDI Edinburgh JKT Jakarta

BEJ Beijing CHE Chennai FRA Frankfurt KOL Kolkata

BER Berlin CHG Chengdu GEN Geneva KUL Kuala Lumpur

BGL Bengaluru CHI Chicago GLA Glasgow LAX Los Angeles

BKK Bangkok COP Copenhagen GOT Gothenburg LON London

BNE Brisbane DAL Dallas HGH Hangzhou LUX Luxembourg

2014 Annual Outlook


LYN Lyon MUM Mumbai QIN Qingdao SYD Sydney

MAD Madrid NAN Nanjing RIG Riga SZX Shenzhen

MEL Melbourne NYC New York ROM Rome TAL Tallinn

MIA Miami PAR Paris SEA Seattle TKO Tokyo

MIL Milan PER Perth SEO Seoul WAR Warsaw

MIN Minneapolis PHL Philadelphia SFO San Francisco WDC Washington DC

MOS Moscow PHX Phoenix SHA Shanghai ZUR Zurich

MRS Marseille PRG Prague SIN Singapore

MUC Munich PUN Pune STO Stockholm

2014 Annual Outlook


Section 2: Regional Outlooks

EMEA occupier outlook

Demand will push up average rents more than prime The emerging economic recovery will feed into improved job growth and increased occupational. The biggest employment gains in 2014 are forecasted for office-based service sectors such as business, information & communication and financial services. This improved demand and limited new supply will push up both prime and average rents (Figure 14). It should be noted that we forecast average rents to increase more rapidly than prime, during 2014-15. This reflects a ‘catch-up’ effect as secondary rents recover from their current low base. But, the expansion of small and medium sized enterprises will also be a contributory factor, as they take up non-prime office space. Highest productivity cities are typically the most expensive We have, for the first time, assessed affordability at the city level (Figure 15). When we analyse corporate affordability of property, we calculate affordability as the occupational cost per workstation divided by economic output per employee. This reveals that many of the highest productivity cities, including London, Paris and Frankfurt also have high occupancy costs. This is expected given that all three cities are large internationally important centres for finance and commerce. Conversely, Moscow is by far the least affordable market. This is mainly due to high occupancy costs and relatively low productivity. Markets such as Copenhagen, Brussels and Rome are especially appealing based on these metrics. All three are more productive and affordable than the European average, providing a good alternative for occupiers looking for expansion. Most efficient cities likely to see fastest cost increases Space efficiency, defined as space per workstation, ranges from a low of 8 sq m in Moscow to 23 sq m in Helsinki (about twice the sq m European average). Looking forward, many of the most efficient cities are also likely to see the fastest increases in occupational costs, as indicated by the fitted line in Figure 16. Consequently, occupiers might find it difficult to increase space efficiency in order to offset these higher costs. Munich and Frankfurt, however, stand out as exceptions. Here space efficiency is below the European average, and occupiers therefore have the opportunity to increase efficiencies in the face of rising costs. Similarly, occupiers in less efficient cities such as Dusseldorf, Helsinki, Amsterdam and Stockholm have the opportunity to make efficiency gains, despite lower cost increases.

Figure 14

Inflation, prime and average rent forecasts

Source: DTZ Research, Oxford Economics

Figure 15

Occupancy costs per workstation vs output per worker


Figure 16

Space efficiency and future occupancy costs


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2014 Annual Outlook


EMEA investor outlook Record high attractiveness across Europe, with UK top The European FVI score at Q3 2013 stood at 74, meaning that Europe continues to offer a wide range of attractively priced markets with the UK ranking as the most attractive with a FVI score of 85 (Figure 17). The CEE markets should also draw investors with a score of 81. Similarly, Italy and Spain have become more attractive since the last quarter with a combined score of 67. Here bond yields have fallen, which has led to a corresponding fall in required returns. Conversely, Germany, usually considered as a safe haven in Europe, has lost some of its appeal on the back of higher bond yields, but remains fairly priced. The French market, however, is relatively over priced despite a majority of markets considered as warm or hot.

Secondary opportunities increasingly attractive Investor appetite for commercial real estate remains very strong. However, the opportunity to acquire prime product has been diminishing, with pricing also getting less attractive. Consequently, investors are moving up the risk curve in terms of country focus and non-prime assets. As more investors struggle to source prime product, the appetite for secondary assets will continue to grow. Based on our analysis of transaction yields, we have already seen the gap between prime and secondary yields stabilise at historically highs in the UK, whilst across the rest of Europe we have seen signs of this gap narrowing (Figure 18). With growing investor interest for European property and attractive pricing, we expect these gaps to narrow further over the next 12-18 months.

Investors should take advantage of current pricing quickly, as attractiveness will start to deteriorate The current attractiveness of property combined with the emerging economic recovery is likely to encourage further inflows of equity into commercial real estate. Consequently, we have upgraded our forecasts of investment volume to increase by 10% to EUR 150bn in 2014. Investment volume will increase by a further EUR 10bn in 2015 (Figure 19). While we expect domestic investors will continue to account for the majority of investment, non domestic investors are projected to account for an increasing share of investment. This increased weight of investment will coincide with the expected fall in the FVI. This decline in attractiveness, triggered by increased interest rates, should ultimately result in reduced investor interest and lower volumes. But the strong current momentum is expected to carry through until at least 2015. Finally, we highlight the need for proper benchmarking for investors going forward and introduce our transaction-based index for Europe in Box 3 next.

Figure 17

European Fair Value IndexTM

, Q3 2013


Figure 18

Gap between prime and secondary transaction yields


Figure 19

European investment volume (EUR bn) and Fair Value Index

TM


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2014 Annual Outlook


Box 3: A European transaction-based index

Transaction-based index is leading performance indicator DTZ Research introduces for the first time a transaction based index (TBI) for Europe to measure price performance of the European real estate market. The main advantage of a TBI is that it reflects actual price changes in a timelier manner than a valuation-based index. This brings property more in line with other asset classes, like stocks and bonds. Valuation based indices tend to smooth price volatility and lag behind transaction based indices in price movements. Due to lack of a quarterly pan-European valuation-based index going back far enough, we compare the UK indices. Such a comparison between the UK all property capital growth in both transaction and valuation-based indices shows higher volatility and the leading nature inherent in TBIs. This suggests TBIs have the capability to provide earlier signals in major market turning points (Figure 20). In other words, they can function as a leading indicator for market pricing and performance.

Europe and UK TBIs show improvement in 2013Q3 According to our TBI, both UK and European capital values improved last quarter. This represents a reversal from the decline since mid-2011. Both have partly recovered following the boom and bust of the global financial and sovereign debt crisis. The lacklustre recovery in European capital values mirrored economic conditions across Europe during the last few years (Figure 21). We expect the TBI to further improve, as more investors commit an increasing amount of capital to the sector.

Rigorous methodology adjusting for lack of data in Continental Europe Our TBI is constructed by using actual paired sales transactions from the Investment Transaction Database (ITD). The DTZ TBIs are constructed following rigorous procedures and checks, combining the ITD and a robust econometric model built in-house by DTZ Research, based on repeat sales regression (RSR) and enhancement techniques introduced by S.Bokhari and D.Geltner (2012)

1.

These methodologies have been used by other providers of TBIs, particularly in the US. RSR is at the core of constructing the TBIs, in which the price changes of individual properties are used to estimate price changes for the market as a whole over time. The Europe all property TBI is constructed as a combination of the UK and Europe ex-UK all property TBIs, weighted by invested stock (Figure 22). 1 Bokhari, Sheharyar and David Geltner. (2012). Estimating Real Estate Price Movement for High Frequency Tradable Indexes in a Scarce Data Environment. Journal of Real Estate Finance and Economics 45(2)

Figure 20

DTZ UK TBI and IPD UK all property capital values, %y/y

Source: DTZ Research, IPD

Figure 21

DTZ Europe and UK all property TBIs, Q1 2002 = 100


Figure 22

DTZ UK TBI Indices construction process overview


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Estimate four annual indexes based at each quarter Using Weighted Least Square Regression (WLSR)

Convert the four annual indexes into quarterly index using approach introduced by S.Bokhari and D.Geltner (2012)1

DTZ Transaction Based Quarterly Index

2014 Annual Outlook


Asia Pacific occupier outlook Office rent growth to slow as absorption trails new supply

2013 was a year of consolidation in Asia Pacific. Weakening economic conditions over the year have impacted tenant demand, leading to the second consecutive year of decline in net absorption (Figure 23). Consequently, rental growth was largely suppressed, as tenants became more concerned about controlling office operating costs. We expect a marginal improvement in conditions in 2014. Net absorption is forecast to bounce back by 25% as new supply in the emerging markets of the region will broadly act to increase the availability of quality space there. Meanwhile, most mature markets will continue to receive support as new supply is limited. Given the highly diverse supply-side condition in Asia Pacific, the rental outlook varies across the region. But, in general we expect moderate rental increases in the next two years. Average occupancy costs up by 7% over the next two years

In light of the improving economic outlook, the window of opportunity for occupiers to secure preferential deals appears to be closing, with the majority of markets forecast to experience an increase in occupancy costs in the near term (Figure 24). Tokyo is expected to lead the increase in absolute and relative levels as its economic recovery gains momentum and rents are further bolstered by a limited development supply pipeline. Beijing is also expected to show strong growth in occupancy costs, underpinned by tight vacancy and limited new supply. In contrast, a large pipeline of new completions will continue to suppress cost growth in many Tier 2 Chinese cities. Despite registering rental decline over 2013, Hong Kong is expected to return to rental growth over the next two years, further reinforcing its position as the most expensive office market in the region. Cost mitigation still possible in Tokyo and Australia

Rental growth is the primary driver of increases in occupancy costs. However, there are opportunities to mitigate this in some markets. Cost increase is the largest in Tokyo, but space utilisation in this market is still above the Asia Pacific average (Figure 25). Aligning space efficiency to the average would reduce the costs of occupancy per workstation by over 15%. Although rental growth is slower in the Australian markets, they offer more potential for increased space efficiency. Indeed, space consolidation has already been underway for much of 2013, resulting in an increase in sublease vacancy. Opportunities for cost saving are more limited in the main Indian and Tier I Chinese markets as both already display high levels of space efficiency. In these cities, opportunities for cost reduction may be achieved via decentralisation strategies.

Figure 23

Office net absorption, new supply (m sq m) and change in prime rents


Figure 24

Prime office occupancy cost USD per workstation


Figure 25

Asia Pacific occupancy costs and space efficiency


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2014 Annual Outlook


Asia Pacific investor outlook

Emerging markets drag down Asia Pacific attractiveness At a score of 65, the Asia Pacific FVI remains in positive territory, with more attractive markets than unattractive markets (Figure 26). Within the region, Australia and China offer the most opportunities to investors with a majority of markets considered warm or hot. But, the regional score has now begun a downward trajectory since reaching its recent peak of 71 in Q2 2013. The reduction has been led by the region’s emerging markets. Although these markets still offer many attractive opportunities, structural deficits in markets like India and an oversupply in China’s tier 2 cities have weakened investor confidence, resulting in the downgrade of many emerging markets from hot to warm over Q3 2013.

Interest rates to erode attractiveness & limit volumes In light of the overall attractiveness of the Asia Pacific region, investment volumes (excluding land sales) in 2013 are forecast to hit USD88bn (Figure 27), up by 9% year-on-year and representing the fourth consecutive year of increase. However, we expect volumes to moderate slightly over the next two years. Rising interest rates combined with weaker economic growth will erode market attractiveness of the region, while the on-going lack of available prime stock in some locations limits market liquidity. However, this stock shortage will provide good opportunities for vendors to lock in capital value growth in prime locations. Furthermore, quality assets in off-CBD, secondary locations or development opportunities in CBD areas that offer attractive yield spreads will become more sought after.

Despite yield widening in some markets, rental growth is projected to stimulate capital growth In light of declining market attractiveness, investors need to more carefully assess drivers of investment performance. The expected winding down of QE will increase bond yields and interest rates, thereby placing upward pressure on property yields. This is especially the case in markets that are currently at or near record lows such as Hong Kong and Seoul (Figure 28). Investors therefore need to consider the extent to which rental growth will offset these negative impacts on total returns. Core markets like Tokyo, Beijing and Shanghai will offer steady rental growth going forward. Although Australian markets such as Sydney and Melbourne offer limited rental growth, the continuing high spread between property yields and bond yields provides a buffer to any potential upward yield movement and so they remain attractive investment destinations for now.

Figure 26

Asia Pacific Fair Value IndexTM

, Q3 2013


Figure 27

Asia Pacific investment volumes (USD bn) and Fair Value Index

TM


Figure 28

Prime office capital value growth forecast by component (2014-18 pa)


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2014 Annual Outlook


North American occupier outlook

Job growth and limited new supply lowers vacancy Business confidence remains high about future economic conditions. But, this has not yet triggered many new hires, with political uncertainty and reduced government spending making businesses pause. But, there are several industries that will grow headcount including technology, healthcare, energy, mining, and professional and business services. As a result, office requirements are expected to grow, especially in San Francisco and New York. Consumer confidence, however, continues to trend down, which impacts retail sales. So far, developers have largely remained on the sidelines. Also, we forecast only modest growth in space inventories across all property types. This additional space will be absorbed causing vacancy to trend down (Figure 29). Occupiers will continue to receive concessions in most markets, as rental growth remains at inflation As a result, we project moderate rental growth for most US office markets, with a few notable exceptions (Figure 30). Most landlords are expected to increase occupancy through concessions, which in some cases offset higher rents. San Francisco and New York are notable exceptions to the slow rent growth projected. Demand by the technology and professional and business services sectors will drive up occupancy and rental rates. Landlords will be more selective about tenants, sometimes extending discounts only to more creditworthy tenants. They are also trying to diversify their tenant mix to reduce risk. Little room for efficiency savings in high cost markets San Francisco and New York will have the highest occupier costs growth throughout our forecast period. With many tenants opting for more efficient floor plans (Figure 31), there is more room for further efficiencies in New York, Chicago and Dallas when compared to San Francisco and Los Angeles. In Canada, the economy is also under performing. But, the labour market is healthier than in the US Job growth is forecast to be moderate in 2014, triggering slow demand for space. Vacancy is projected to rise in 2014 due to more sub-lease space and tenants right size their space. Rents are expected to hold steady in most markets, but will increase in prime CBD buildings with low vacancy rates, such as Toronto. With this exception, we expect that Canadian occupiers will remain in strong bargaining positions in 2014.

Figure 29

US vacancy rate and growth in stock


Figure 30

Prime office rental growth by year


Figure 31

US occupancy costs and space efficiency


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2014 Annual Outlook


North American investor outlook

US remain a good destination for investment With its high transparency and property law that promotes the facile buying and selling of commercial real estate, the US has always been popular with investors. Add large markets with many investment opportunities, high liquidity, and good pricing and it is easy to understand why the US remains top-ranked globally. Record-low US government bond yields are an advantage for mixed asset investors - our Fair Value Index (FVI) categorises most U.S. markets as attractive (Figure 32). One of the impacts of the many investment opportunities has been the growth of opportunistic funds, which tend to look for higher yields in secondary and tertiary markets (defined here as smaller markets). Buildings with creditworthy clients in smaller markets are gaining appeal. Most Canadian markets also remain popular with investors, but the inventory is much smaller than the US hence the lower amount of investment. This is partly why Canadian investors have been so active in cross-border investing. Investors look for retail and industrial as prime offices have partly re-priced The increased competition to place capital in the larger US metros in prime office has produced lower yields; so many investors have started to turn their attention to other property types. This is reflected in the larger amount of hot retail and industrial opportunities (Figure 33). The re-emergence of retail as an attractively priced property type is surprising, given the negative impact from the recession and the changes in US consumer buying habits and increase internet shopping. Relative value to come down with higher rates, but momentum on investment volumes expected to last Despite an expected increase in bond and mortgage rates, we believe volumes will increase for the next two years (Figure 34). Our base case assumes no geo-political or global financial events. Part of this increased volume will come from Asian investors, who have been steadily growing their market share in many US markets. REITs are also expected to be active buyers. Cap rates will certainly rise over our forecast but not significantly so. The weight of equity capital looking to be invested in property will continue to drive growth in volumes. However, with lower relative value, we do expect a delayed impact on investor appetite and volume momentum after 2015.

Figure 32

US Fair Value IndexTM


Figure 33

US Fair Value IndexTM

by sector, Q3 2013


Figure 34

North American investment volumes (USD bn) and US Fair Value Index

TM

Source: DTZ Research, RCA, RealNet

10 4 4 4 52 88 79 86 88

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2014 Annual Outlook


Other DTZ Research Reports Other research reports can be downloaded from www.dtz.com/research. These include:

Occupier Perspective Updates on occupational markets from an occupier perspective, with commentary, analysis, charts and data. Global Occupancy Costs Offices Global Occupancy Costs Logistics Obligations of Occupation Americas Obligations of Occupation Asia Pacific Obligations of Occupation EMEA Global Office Review India Office Demand and Trends Survey 2012-13 Regional Headquarters Asia Pacific November 2013 Poland Banking Sector - January 2013 Motorways of the Sea - January 2013

Property Times Regular updates on occupational markets from a landlord perspective, with commentary, charts, data and forecasts. Coverage includes Asia Pacific, Bangkok, Beijing, Berlin, Brisbane, Bristol, Brussels, Budapest, Central London, Chengdu, Chongqing, Dalian, Edinburgh, Europe, Frankfurt, Glasgow, Guangzhou, Hangzhou, Ho Chi Minh City, Hong Kong, India, Jakarta, Japan, Kuala Lumpur, Luxembourg, Madrid, Manchester, Melbourne, Milan, Nanjing, Newcastle, Paris, Poland, Prague, Qingdao, Rome, Seoul, Shanghai, Shenyang, Shenzhen, Singapore, Stockholm, Sydney, Taipei, Tianjin, Ukraine, Warsaw, Wuhan, Xian.

Investment Market Update Regular updates on investment market activity, with commentary, significant deals, charts, data and forecasts. Coverage includes Asia Pacific, Australia, Belgium, Czech Republic, Europe, France, Germany, Italy, Japan, Mainland China, South East Asia, Spain, Sweden, UK.

Money into Property For more than 35 years, this has been DTZ's flagship research report, analysing invested stock and capital flows into real estate markets across the world. It measures the development and structure of the global investment market. Available for Global, Asia Pacific, Europe, North America and UK.

Foresight Quarterly commentary, analysis and insight into our in-house data forecasts, including the DTZ Fair Value Index™. Available for Global, Asia Pacific, Europe, UK and China. In addition we publish an annual outlook report.

Insight Thematic, ad hoc, topical and thought leading reports on areas and issues of specific interest and relevance to real estate markets. Net Debt Funding Gap - November 2013 UK secondary market pricing October 2013 Great Wall of Money - October 2013 Quantitative Easing - UK Regions - September 2013 Singapore Government Land Sales - September 2013 UK lending market -September 2013 Quantitative Easing - August 2013 Property Investment Guide Asia Pacific 2013-2014 Singapore Insight – Residential – July 2013 China Insight - The Healthcare Sector - April 2013 City of London occupier demand - April 2013

DTZ Research Data Services

For more detailed data and information, the following are available for subscription. Please contact [email protected] for more information.

Property Market Indicators Time series of commercial and industrial market data in Asia Pacific and Europe.

Real Estate Forecasts, including the DTZ Fair Value Index

TM

Five-year rolling forecasts of commercial and industrial markets in Asia Pacific, Europe and the USA.

Investment Transaction Database Aggregated overview of investment activity in Asia Pacific and Europe.

Money into Property DTZ’s flagship research product for over 35 years providing capital markets data covering capital flows, size, structure, ownership, developments and trends, and findings of annual investor and lender intention surveys.

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DTZ Research

DTZ Research Contacts


Hans Vrensen

Phone: +44 (0)20 3296 2159


Head of Forecasting

Fergus Hicks

Phone: +44 (0)20 3296 2307


Head of Strategy Research

Nigel Almond

Phone: +44 (0)20 3296 2328


Head of UK Research

Richard Yorke

Phone: +44 (0)20 3296 2319

Email: [email protected] Head of CEMEA Research

Magali Marton

Phone: +33 1 49 64 49 54


Head of North Asia Research

Andrew Ness

Phone: +852 2507 0507


Head of South East Asia / Australia New Zealand Research

Dominic Brown

Phone: +61 (0)2 8243 9999



John Wickes

Phone: +1 312 424 8087


Head of Asia Pacific Forecasting

Dennis Fung

Phone: +852 2250 8864


DTZ Business Contacts

Global Chief Executive Officer

Tod Lickerman


Chief Executive, EMEA

John Forrester

Phone: + 44 (0)20 3296 2002


Chief Executive, North Asia

Edward Cheung

Phone: + 86 21 2208 0088


Chief Executive, APAC

Henry Arundel

Phone: +61 (0)2 9492 8818


DISCLAIMER

This report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, DTZ can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within this report. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. Any such reproduction should be credited to DTZ.

© DTZ December 2013

