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What is driving the recovery in the Sydney CBD leasing market? May 2015 Summary The recovery in the Sydney CBD office leasing market is starting to gather momentum. We recorded 34,900 sqm of net absorption in 1Q15 and 99,500 sqm over the 12 months to March 2015. However, the demand recovery is uneven. Technology and mid-tier legal firms are increasing their headcount and occupational footprint, while we have recorded consolidation from investment banks and tier 1 legal firms. Five successive quarters of positive net absorption The Sydney CBD is 18 months into a cyclical upturn. The first phase of an upturn is characterised by a reduction in sub-lease vacancy. The most recent peak in sub-lease vacancy was 1.8% of total stock (2Q13) with the current reading at 0.76% of total stock. Sydney recorded its fifth successive quarter of positive net absorption in 1Q15 (34,900 sqm) and 99,500 sqm over the year to March 2015 (Figure 1). To put this figure in context, the 40 year average for net absorption in the Sydney CBD is 57,500 sqm. Figure 1: Sydney CBD net absorption, 2008 to 1Q15 NSW is ranked as the strongest performing state in Australia by CommSec. Moving forward, Deloitte Access Economics projects that NSW will be the engine of the domestic economy, accounting for 40% of real final demand growth between 2014 and 2019. Sqm 60,000 40,000 20,000 0 The domestic banking sector will be a growth sector of the Sydney CBD office market. Banks have absorbed the excess capacity in their workforce and boosted productivity. The next phase of expansion will see an increase in headcount. -20,000 -40,000 -60,000 -80,000 2008 2009 2010 2011 2012 2013 2014 2015 Source: JLL Research One risk to the demand outlook is a weak recovery in non-mining sector business investment spending. While corporate Australia has repaired its balance sheet and is sitting on excess cash reserves, corporates are reticent to commit to new capital investment projects. NSW is the strongest performing economy in Australia NSW is a beneficiary of the transition in the domestic economy from mining sector investment growth to more broad based domestic demand drivers. While the transition has not been seamless, Deloitte Access Economics reported that NSW state final demand increased by 3.8% in 2014 – significantly higher than the 20 year average (3.1%). State final demand is a measure of domestic economic activity and excludes net exports. NSW is ranked as the top performing state in Australia by CommSec1, achieving the top ranking on three of the eight measures – retail spending, population growth and housing investment. Deloitte Access Economics projects the NSW economy will outperform, with state final demand forecast to increase by an average of 3.1% per annum between 2014 and 2019. Over this time period, NSW is forecast to account for 40% of Australia’s real final demand growth – almost 10 percentage points higher than its share of the economy in 2014 (Figure 2). Figure 2: Share of real final demand, 2014 to 2019 WA 1.7% SA 6.4% Figure 3: Computer system design & related services employment, 2007 to 1Q15 2007 = 100 200 180 160 140 120 100 Others 4.4% 80 2007 2008 2009 2010 2011 Australia 2012 2013 2014 2015 New York City Source: JLL Research, ABS, NY State Department of Labor NSW 40.0% QLD 20.5% VIC 27.1% Source: JLL Research, Deloitte Access Economics An uneven demand recovery Historically, a demand recovery in the Sydney CBD is led by the financial services sector and tier 1 legal firms. However, investment banks have consolidated their footprint and Deloitte Access Economics states the number of people employed in the F&I sector in the Sydney CBD is 6.0% lower in 1Q15 than 2007. Professional services are the locomotive of employment growth and the take-up of office space in Sydney. Professional services employment has increased by 7.0% between 2007 and 1Q15. However, it is not the traditional sub-sectors – legal and accounting – which are supporting growth, but computer system design & related services (the technology sector). The trend observed in Sydney is replicated in New York. Figure 3 shows employment growth in the computer system design & related services sub-sector for Australia and New York City. While the numbers in Australia are aggregated to the country level, the ABS reported that 45% of businesses employing in excess of 20 people in computer system design & related services are located in NSW. As a result, the trend in Australia’s number relates to employment growth in Sydney. 1 2 CommSec Research ‘ State of the States, April 2015 What is driving the recovery in the Sydney CBD leasing market? – May 2015 Sydney is benefitting from the expansion of home-grown technology firms and multi-national companies listed on the NASDAQ stock exchange. Recent new entrants into Australia include Twitter and Intuit, while LinkedIn and Adobe Systems have increased their footprint in Sydney over the past 12 months. The ABS provides a breakdown of headcount by industry subsector (Table 1). Based on our assumptions of average headcount and workspace ratios, the underlying demand from the computer system design and related services sub-sector was 81,200 sqm between 2011 and 2014. Table 1: Counts of NSW businesses (Professional services) Sector Computer System Design Legal Services Accounting Underlying Number of People Demand 2011 2014 (sqm) 20-199 200+ 20-199 200+ 260 23 350 25 81,200 95 106 15 9 148 135 16 11 47,300 30,000 Source: JLL Research, ABS The legal services sector has experienced a wave of M&A activity over the past four years. A number of large multi-national firms have emerged in the sector with an aim to increase the geographical diversification of revenue streams and achieve economies of scale across shared services. The consolidation of Tier 1 legal firms has led to a reduction in their overall occupational footprint. However, the number of mid-tier legal firms (employing between 20 and 199 people) has increased across NSW. JLL estimates underlying demand from the legal services sector was 47,300 sqm between 2011 and 2014. Early signs of recovery in the financial services sector Conclusion As mentioned earlier, financial services employment in the Sydney CBD is lower than 2007. Investment banks have consolidated and relinquished excess office space. While the short-term drivers of investment banking revenue – M&A activity, IPOs and trading volumes through equity markets – is firmer, the investment banking sector is not expected to be a major contributor to the recovery of the Sydney CBD office market. The lead indicators for the office sector in the Sydney CBD are firming. The Seek (NSW) new internet job advertisements highlighted a 25% increase in internet job advertisements between mid-2013 and March 2015. Corporate Australia’s hiring intentions are a positive lead indicator for leasing enquiry and the underlying demand for office space. However, sub-sectors of financial services are increasing – the four largest banks by market capitalisation in Australia are recording strong revenue growth and an improvement in operating profit. Retail banking services – the direct execution of transactions between a bank and its customers – is a driver of revenue growth and is linked to the expansion of household balance sheets. The ABS estimates that established dwelling prices in metropolitan Sydney increased by 35.7% between 4Q11 and 4Q14. House price appreciation has stimulated private sector housing investment with NSW private sector housing investment increasing by 11.5% in 2014. Deloitte Access Economics projects above trend private sector housing investment growth of 7.5% per annum between 2014 and 2017. We have observed a strong relationship between NSW private sector household investment and Sydney CBD net absorption between 1991 and 2014 (Figure 4). Historically, the demand for office space has lagged housing investment by two years’. The lag is explained by banking sector profitability precipitating employment growth and the demand for office space. Assuming the recovery in the Sydney CBD office market evolves in a similar way to previous cycles, it supports our prediction of the Sydney CBD office market recording above trend net absorption in 2015 (85,000 sqm) and 2016 (120,000 sqm). Figure 4: NSW private sector housing investment & Sydney CBD net absorption, 1990 to 2018 (Sqm) 300,000 The recovery in leasing demand has occurred prior to an increase in completions over 2015 and 2016. Approximately 375,600 sqm of new and refurbished supply is forecast to complete by the end of 2016, equating to 7.5% of total stock. However, completions and supply additions are different variables. Upon relocation to International Towers Sydney (T2), a high proportion of Westpac’s backfill space will be withdrawn for redevelopment, while a number of office assets with adaptive reuse potential will be converted to residential. As a result, supply additions will be lower at an average of 61,900 sqm in 2015 and 2016, before supply additions are lower than the long-term and average 44,600 sqm between 2016 and 2018. Authors: (Y/Y % Change) 30% 250,000 25% 200,000 20% 150,000 15% 100,000 10% 50,000 5% 0 0% -50,000 -5% -100,000 -10% -150,000 -15% -200,000 -20% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Net Absorption Private Sector Housing Investment (2 years forward) Source: JLL Research, Deloitte Access Economics 3 While the factors outlined in this paper have been broadly positive about the demand-side of the equation, we remain cognisant of risk. Corporate Australia is sitting on excess cash reserves and we expect to see a recovery in business investment spending in the 2015/16 financial year. However, corporate Australia remains cautious about the outlook and is applying conservative assumptions in project appraisals. A weak recovery in business investment spending would, therefore, temper the outlook tenant demand in Sydney over 2015 and 2016. What is driving the recovery in the Sydney CBD leasing market? – May 2015 Andrew Ballantyne Head of Strategic Research JLL tel: +61 2 9220 8412 [email protected] Daniel Kernaghan Head of Office Leasing - NSW JLL tel: +61 2 9220 8721 [email protected] Jones Lang LaSalle offices Adelaide Level 22, Grenfell Centre 25 Grenfell Street Adelaide SA 5000 tel +61 8 8233 8888 Melbourne Level 21, Bourke Place 600 Bourke Street Melbourne VIC 3000 tel +61 3 9672 6666 Brisbane Level 33, Central Plaza One 345 Queen Street Brisbane QLD 4000 tel +61 7 3231 1311 North Sydney Level 27, North Point 100 Miller Street North Sydney NSW 2060 tel +61 2 9936 5888 Canberra Level 7, 121 Marcus Clarke Street Canberra, ACT, 2601 tel +61 2 6274 9888 Parramatta Level 8, 79 George Street Parramatta NSW 2150 tel +61 2 9806 2800 Glen Waverley Building 2 540 Springvale Road Glen Waverley VIC 3150 tel +61 3 9565 6666 Perth Level 29, Central Park 152-158 St George’s Terrace Perth WA 6000 tel +61 8 9322 5111 Mascot Level 3, Sydney Airport Centre 15 Bourke Road Mascot, NSW, 2020 tel +61 2 9693 9800 Sydney Level 25, 420 George Street Sydney NSW 2000 tel +61 2 9220 8500 www.jll.com.au COPYRIGHT © JONES LANG LASALLE 2015. 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