Is there a disconnection between property pricing and fundamentals? What is happening in the capital markets? What is happening in the leasing markets? Where do we go from here?

1. MAY 2015
AUSTRALIA PROPERTY
MARKET OUTLOOK
Cushman and Wakefield Research
PFA ANNUAL CONFERENCE 2015
EXPLORING THE NEXUS BETWEEN
PROPERTY VALUE AND FUNDAMENTALS
Alex Pham PhD AAPI
National Research Manager
Cushman and Wakefield Australia
Alex.Pham@ap.cushwake.com

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OVERVIEW
1. THE NEXUS BETWEEN CAPITAL VALUE AND FUNDAMENTALS
2. WHAT IS HAPPENING IN THE CAPITAL MARKETS?
3. WHAT IS HAPPENING IN THE LEASING MARKETS?
4. WHAT’S NEXT?

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The nexus between capital value and fundamentals

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THE TAIL OF TWO PROPERTY MARKETS
Asset
Market
(Capital values, cap
rates)
Space
Market
(Rents, vacancy
rates)
Vendors Purchasers
Landlords Tenants
Rents Construction

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100
200
300
400
500
600
700
2010 2011 2012 2013 2014 2015
A$psqmpa
Average Grade A Face Rent
Average Grade A Rent
100
110
120
130
140
150
160
170
2010 2011 2012 2013 2014 2015
Index
Australia CBD Office Capital Return Index
CBD Office Capital Return Index
THE (DIS)CONNECTION BETWEEN ASSET PRICES AND LEASING
CONDITIONS…
Source: C&W, IPD
Asset prices have risen
significantly…
… despite the subdued
leasing conditions.

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…HAS BEEN DRIVEN BY A STRUCTURAL SHIFT IN THE
PROPERTY ASSET PRICING FUNCTION
Rent ($)
Construction (sqm)
Capital Market
(Asset)
Leasing Market
(Space)
Stock
(sqm)
Asset Price
($)
…and put a
downward
pressure on
rents.
Sources: C&W, Wheaton & DiPasquale (1992)
…has resulted
in an upward
shift in asset
prices…
This has created the
new price-rent
equilibrium.
“The new normal”
A structural
shift in the
asset pricing
function…

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What is happening in the capital market?

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A STRUCTURAL DECLINE IN LONG-TERM INTEREST RATES
GLOBALLY…
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Policy Interest Rates in Major Economies
US Japan EU UK Canada Australia
Pre-GFC
Average (ex JP)
= ~4%
The rate disparity between
Aus and the rest of the
world have widen post GFC.
Post-GFC
Average (ex
AU) = ~0.5%
Structural break in
interest rates
Sources: C&W, ABS

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0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
A$Million
Foreign Capital into Australian Property
Office Industrial Retail Others
…HAS PARTIALLY RESULTED IN SURGING DEMAND FOR
AUSTRALIAN PROPERTY….
Low offshore
interest Pre-
GFC
Rising foreign
investment
Post-GFC…
Speculative
investment in
2007 despite the
high interest
rates. … As a result of
a rational
investor
response to a
lower cost base
and return
disparity.
Sources: C&W, RCA

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6.0%
6.5%
7.0%
7.5%
8.0%
8.5%
9.0%
9.5%
10.0%
2008 2009 2010 2011 2012 2013 2014 2015
Australian Property Capitalisation Rates
All Property Cap Rate Office Cap Rate Industrial Cap Rate Retail Cap Rate
… WHICH LED TO A CONTINUAL COMPRESSION OF CAP
RATES.
Continual
compression of cap
rates across all sub-
classes.
Sources: C&W, RCA

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Are we heading for a crash?

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THE TWO EPISODES OF CAP RATE COMPRESSION
-200
-100
0
100
200
300
400
500
600
-3.50%
0.00%
3.50%
7.00%
10.50%
2008 2009 2010 2011 2012 2013 2014 2015
bp
Australian Property Pricing Trends
Yield spread (bp) All Property Cap rate (%) Bond yield (%) YoY Change in cap rate (bp)
Cap rates are compressing
while yield spreads widen...
...in response to falling
bond yields.
1st phase of
compression is largely
a result of lower risk
expectation
2nd phase of
compression is
mainly driven by
falling risk-free rates
Sources: C&W, RCA

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-20
-15
-10
-5
0
5
10
15
20
25
30
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
All Property Capital Return Index
All Property
CAPITAL VALUES ARE GROWING AT THE “LONG-TERM”
TREND PACE
Capital values have
grown at a normal
pace since the GFC.
100
120
140
160
180
200
220
240
260
280
300
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Index
All Property Capital Return Index
All Property
1989
Crisis
2007
GFC
Long-term trend
growth = 2.66%
Sources: C&W, IPD

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KEY TAKEAWAYS
• Capital values are determined by the asset market, while rentals are determined by the space
market.
• A structural shift in capital asset demand has resulted in the increase in capital values while
rentals are subdued.
• The low interest rate environment globally was the main cause of the structural shift in asset
demand.
• Australian interest rate (and return) disparity with the rest of the world has driven strong
interest from offshore investors…
• …leading to a gradual compression in the capitalisation rates,
• …however, property values are growing at a pace consistent with the long-term trend.
• Strong investor demand post-GFC is a rational response to lower interest rate environment.
• Interest rates are expected to remain low going forward as the world economies transitioning
into a low-growth (low inflation) period (“the new normal”).

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What is happening in the leasing market?

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OFFICE MARKET CONDITIONS
0%
5%
10%
15%
20%
25%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Grade A OfficeVacancy Rates
Sydney Melbourne Brisbane Perth Adelaide
Forecast
Lower vacancies in
Sydney and
Melbourne
Rising vacancies in
Perth and Brisbane.
Source: C&W

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• Improving consumer spending
• Low interest rates
• Weaker domestic currency
• Strong interest from international fashion
brands
• Australian institutional investors and A-REITs
have been the net buyers
• Engagement of institutional investors in
regional towns and non-metro locations
• Super-regional shopping centres have been in
high demand as retail investors seek higher
yields
AUSTRALIAN RETAIL LANDSCAPE

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RETAIL SALES PICKING UP
Sources: C&W, ABS
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
%
Quarterly sales Non-discretionary Discretionary Year-ended sales
10-year trend
Retail sales have picked up …
...supported by strong
growth in
discretionary spending
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
%
Quarterly sales Non-discretionary Discretionary Year-ended sales
10-year trend
Retail sales have picked up …
...supported by strong
growth in
discretionary spending

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Supply
• Low vacancy
• Limited new construction – prime industrial
accommodation
• Strong precommitment
• Rezoning and residential conversions
INDUSTRIAL PROPERTY MARKETS
Demand
• Construction, retail, transport & logistics &
food industries drive demand
• Tenants looking for flexibility and efficiency
• Location, infrastructure and design remain
the key features

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RESIDENTIAL MARKETS – IT’S ALL ABOUT SYDNEY
0
100
200
300
400
500
600
700
800
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
A$'000
Median Price of Established HouseTransfers
Sydney Melbourne Brisbane Perth Adelaide Hobart Darwin Canberra
Sydney house prices
have risen significantly
in the past two years.
Sources: C&W, ABS

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KEY TAKEAWAYS
• Office – The tail of two extremes
• Improving office demand in Sydney and Melbourne - Incentives for prime and grade A stock
slowly decrease
• Leasing conditions remain soft in Perth and Brisbane - Flight to quality trend continues –
vacancies are expected to rise
• Retail – Improving consumer spending and low interest rates will drive retail sales forward
• Industrial – Construction, retail, transport & logistics & food industries compensate the
declining demand from the manufacturing sector
• Residential – Overheating in Sydney – Increase in home building activity will limit the rapid rise
in house prices

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What’s next?

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OUTLOOK
• Strong investor demand, particularly from offshore investors, will continue to drive yields
lower and prices higher
• There is still room for further compression as the rate premium is still above long-term average
and capital growth is consistent with the long-term trend
• While the core assets remain attractive to both local and offshore investors, strong competition
will drive demand for secondary locations and alternative asset classes as investors seek for
higher yield
• Pockets of value remain available in regional locations and alternative assets – increasing
institutional engagement in “regional cities”
• The two-speed economy will remain the key feature of the market
• Leasing conditions are expected to improve in Sydney and Melbourne while falling mining
activity poses a drag on Perth and Brisbane