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Office Investment Outlook United States | Q3 2016 OFFICE Office asset pricing exhibiting signs of plateauing U.S. Office property market U.S. Office investment -60 1.3% $101.4 -1.5% 12-month change in total vacancy (bps) 12-month net absorption (as % of inventory) Investment sales (YTD, billions of $US) YTD investment sale growth 1.3% 5.8% 4.4% -30 12-month comple tio ns (as % of inventory) 12-month rent growth (p.s.f.) Average cap rate 12-month change in cap rate (bps) Stable and growing office leasing markets during the third quarter. Despite increased labor market volatility over the past six months, there was no evidence of a summer slowdown, with leasing volumes up 4.4 percent compared to the four-quarter trailing average. With this, markets are keeping pace and have absorbed space at nearly 100 percent the rate of new deliveries. However, primary markets welcoming new supply are nearing an inflection point as supply begins to catch up to demand. Year-to-date volume declines moderating with a strong third quarter. While up relative to the third quarter of last year by 5.7 percent, $35.5 billion of quarterly office investment sale activity brought year-todate volumes to $101.4 billion, 1.5 percent below prior-year levels. This comes on the heels of calming yet still uncertain investor sentiment following sustained levels of heightened macro market volatility. However, if looking at market conditions today, real estate markets are well positioned to normalize this year, supporting a return in 2017 from lagging deal flow experienced in 2016. Office pricing showing signs of plateauing. The overall pricing landscape nationally for office product remains steady, with cap rates across primary and secondary markets averaging 4.4 percent. This is stable compared to the last two quarters while showing a 30-basis-point compression compared to this time last year. Pricing will be a key factor to watch heading into 2017, and those markets with higher barriers to Offshore office investment remains elevated and outperforming peer sectors. Following a year of sector diversification, offshore capital remains active and at sustained, structurally higher levels within the office sector. Preliminary metrics indicate office has captured more than 60.0 percent of inbound capital year-to-date—beyond long-term average metrics. As a result, nearly 15.0 percent of year-to-date acquisitions were by offshore investors. This represents a consistent increase when compared to leading volume years from the prior cycle, which saw offshore participation between 5.0 and 9.0 percent. This capital continues to focus on primary office markets—led by New York, San Francisco and Boston—with selective diversification. 10.0% Q4 8.0% 10-year Treasury (%) Primary cap rates (%) Secondary cap rates (%) 5.2% 6.0% 4.0% 4.1% 2.0% 0.0% 1.6% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD Source: JLL Research, Real Capital Analytics (transactions larger than $5.0M) Secondary market diversification normalizes; risk sensitivities sustained at the submarket level. After a pullback in secondary market transactions in the second quarter, momentum returned this quarter. This activity was driven by Dallas–Fort Worth, Atlanta and Northern New Jersey, which collectively drove seven of the ten largest secondary market transactions of the quarter. With this, however, we have seen a sustained sensitivity to submarket risk, with non-CBD liquidity reverting to late-2014 levels. As a result, CBDs are now driving over 55.0 percent of quarterly deal flow. Despite year-over-year compression, office cap rates plateauing 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Office investment sale volumes (billions of $US) While up 5.7 percent in the third quarter, year-to-date office investment sales down 1.5 percent at close of third quarter $250.0 Q1 Q2 Q3 $200.0 $150.0 $100.0 $50.0 $0.0 entry will be more resilient in sustaining current pricing levels. Source: JLL Research, NCREIF, Board of Governors of Federal Reserve JLL | United States | Office Investment Outlook | Q3 2016 2 TOP 1 5 OFFICE THEMES Stable and growing office leasing markets during the third quarter Despite increased labor market volatility over the past six months, there was no evidence of a summer slowdown in the office leasing markets in the third quarter. U.S. leasing volumes totaled nearly 60 million square feet—4.4 percent higher than the four-quarter trailing average—and expansionary leases composed the largest share of 20,000-square-foot-and-larger leases at 47.1 percent. As a result of more broad-based growth across industries and sectors, the top-performing leasing markets year-to-date have ranged from major diversified metros such as Atlanta (+33.5 percent YTD) to industry- and corporate-driven secondary markets such as Salt Lake City (+136.2 percent YTD), Columbus (+70.6 percent YTD) and Orlando (+68.3 percent YTD), all of which have benefited from a combination of large-block office users in professional services, finance and even tech, as well as non-office users such as leisure, hospitality, education and health. With this, total vacancy edged downward by 10 basis points as markets absorbed 12.8 million square feet compared to the 12.5 million square feet that were delivered. While markets are keeping pace and have absorbed space at nearly 100 percent the rate of new deliveries—totaling nearly 35.5 million square feet year-to-date, some markets are beginning to see vacancy creep as new supply hits the market. Looking ahead, as long as employment continues to grow, occupancy in the office market should continue to expand. That said, primary markets welcoming new supply are nearing an inflection point as supply begins to catch up to demand. With more than 60.0 percent of the 105 million-square-foot development pipeline expected to deliver by the end of 2017, leasing conditions will become much more balanced by 2018, with a shift to more tenant-favorable conditions by 2019. Leasing volume by market Completions Primary markets remain leaders, although Silicon Valley is disproportionately contributing to volume The remainder of the groundbreaking wave has boosted 2018 completions to 25.1 m.s.f. 60,000,000 11% 7% 3% 3% Source: JLL Research (volumes based on total activity) 30,000,000 20,000,000 10,000,000 0 2019 5% 3% 4% Preleased Available 40,000,000 2018 6% 6,665,424 4,379,517 3,549,945 3,497,458 3,350,427 2,693,694 2,600,042 1,931,398 1,906,676 1,744,264 27,567,367 59,886,212 2017 6% New York Washington, DC Boston New Jersey Chicago Seattle Los Angeles Atlanta Dallas Silicon Valley All other markets Total leasing activity 2016 6% 46% Leasing activity(s.f.) Completions (s.f.) 50,000,000 Market Source: JLL Research JLL | United States | Office Investment Outlook | Q3 2016 3 2 Year-to-date volume declines moderating with a strong third quarter While up relative to the third quarter of last year by 5.7 percent, $35.5 billion of quarterly office investment sale activity brought year-to-date volumes to $101.4 billion, 1.5 percent below prior-year levels. This comes on the heels of calming yet still uncertain investor sentiment following a sustained level of heightened macro market volatility and thus perceptions of elevated downside risks in markets. This volatility, heightened sensitivities to cyclical risks and current pricing levels are now increasing investor selectivity on office investment opportunities, especially for higher-risk, less-liquid submarkets and core opportunities. With this, the majority of markets are seeing annual activity declines, with the exception of those most active markets: Los Angeles, San Diego, Northern New Jersey and Philadelphia. However, liquidity remains strong in coastal primary markets such as New York, Boston and Los Angeles, as well as high-growth secondary markets such as Denver and Philadelphia. New York remains the most active market domestically and globally, accounting for the three largest office transactions of the quarter —all of which were partial interest transactions, with two being to offshore buyers. In the largest trade of the quarter, Hong Kong Monetary Authority acquired a 49.0 percent interest in 1095 Avenue of the Americas for nearly $1.2 billion from Ivanhoe Cambridge and Callahan Capital Partners. Uncertainty has calmed but likely is not yet over. Upcoming elections abroad, slowing job gains and pending Federal Reserve d ecisions are expected to spur near-term bumpiness. However, if looking at market conditions today, real estate markets are well positioned to normalize this year, supporting a return in 2017 from lagging deal flow experienced in 2016. Office investment sales by market As the majority of markets continue to see year-to-date declines, New York, Boston and Los Angeles lead office investment sale activity; Los Angeles, San Diego and Northern New Jersey lead gains New York Boston Los Angeles San Francisco Seattle-Bellevue Chicago Atlanta Northern New Jersey San Diego Philadelphia Washington, DC Dallas-Fort Worth Silicon Valley Northern Virginia San Francisco Peninsula $0.0 -47.7% -15.9% 24.8% -17.4% -25.8% -65.9% -39.7% -47.1% -34.7% -29.8% -47.4% -47.7% $5.0 $10.0 $15.0 $20.0 $25.0 $30.0 $35.0 $40.0 2016 YTD 2015 YTD -100.0% -50.0% 9.2% 23.5% 4.0% 0.0% 50.0% Percentage change (YTD) Source: JLL Research (assets larger than 50,000 s.f.) 3 Office pricing showing signs of plateauing The overall pricing landscape nationally for office product remains steady, with cap rates across major primary and secondary markets averaging 4.4 percent. This is stable compared to the last two quarters while showing a 30-basis-point compression compared to this time last year. 65.6 percent of the 32 largest office markets are seeing cap rates compress year-over-year, but primary markets continue to drive annual cap rate declines, with all of these markets seeing further compression, on average by 34 basis points. However, there has been an uptick in those markets which are softening, a trend evidenced in 22.0 percent of markets. All of these are secondary office markets. With this, the overall pace of cap rate compression is declining as well, most notably and similarly in secondary markets. Softening cap rates have been most evident in Sacramento, Houston, Raleigh-Durham and Oakland–East Bay. On the other end of the spectrum, compression remains strong and at leading paces in Salt Lake City, Philadelphia and Portland, as well as in Boston and Washington, DC—all of which have seen annual declines greater than 50 basis points, sustaining those primary markets at sub4.5 percent levels and those secondary between 5.0 and 6.0 percent. As a result of these dynamics, the yield discount for secondary relative to JLL | United States | Office Investment Outlook | Q3 2016 4 primary markets remains at historically elevated levels of 110+ basis points, nearly 40 basis points wider than expansionary cycle norms. With cap rates below prior peak levels—notably, in the primary markets—yet liquid real estate capital markets across debt and equity, pricing will be a key factor to watch heading into 2017, with select markets seeing pricing disconnects emerge between buyers and sellers. Those markets with higher barriers to entry will be more resilient in sustaining current pricing levels. Overall office annual cap rate fluctuations While 65.6 percent of markets are seeing cap rates compress, signs of plateauing begin to emerge, with 22.0 percent of markets seeing a yearto-date softening of cap rates 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD 16% 19% 3% 9% 56% 97% 34% 9% 22% 22% 16% 6% 22% 0% 20% 40% Compressing 60% Stable 80% 100% Softening Source: JLL Research, NCREIF (includes 32 major office markets; stable defined as markets seeing fluctuations within 10 basis points year-over-year) Primary-to-secondary market cap rate differential 120 105 With this, however, we have seen a sustained sensitivity to submarket risk. Since early 2014, there has been a continued expansion of liquidity for non-CBD assets, whether those fall within urban or suburban submarkets. This peaked in the first quarter of 2016, in which nearly 60.0 percent of transactions fell within non-CBD submarkets—71.8 percent of which fell within suburban submarkets. This was the highest level of this activity seen in the current cycle. However, with uncertainty in early 2016, non-CBD liquidity has reverted to late-2014 levels, with CBDs now driving over 55.0 percent of quarterly deal flow. Despite this pullback, best-in-class assets in suburban-centric markets such as New Jersey, Atlanta and Dallas continue to see strong suburban transaction volumes, with buyers primarily being private equity investors or local/regional players and institutional players less active. Looking ahead, liquidity is expected to remain intact for secondary markets. However, current investor selectivity is expected to limit liquidity for inferior, outlying suburban product due to an increased focus on cycle assurance and longer-term repositioning strategies. Investment sale volumes by market type Secondary investment volumes normalize after an atypical slowdown last quarter; as a result, these markets have now driven > 41.0 percent of quarterly deal flow in three of the last four quarters 80% 60 15-year expansionary cycle average 40 20% 27% 31% 23% 34% 37% 37% 29% 34% 35% 41% 41% 41% 60% 40% Source: JLL Research, NCREIF (includes 32 major office markets) Primary markets 2016 Q3 2016 Q2 2016 Q1 2015 Q4 2015 Q3 2015 Q2 2015 Q1 2014 Q4 2014 Q3 2014 Q2 2014 Q1 0% 2013 Q4 20% 20 0 After a pullback in secondary market transactions in the second quarter at a level we had not seen since 2014, momentum in secondary markets returned this quarter, with 41.4 percent of transaction volumes in this market set. In the third quarter, this activity was driven by Dallas–Fort Worth, Atlanta and Northern New Jersey, all of which saw over $500 million of quarterly deal flow and drove seven of the ten largest secondary market transactions of the quarter. This is a return to levels experienced in two of the last three quarters and reflective of a strong and sustained appetite for higher-yielding opportunities outside of expensive primary markets from Core-plus and even more so valueadd capital. In the largest value-add, secondary market transactions of the quarter, Fortis acquired the Chase Tower in the Dallas CBD for $273 million, or $219 per square foot, from Hines, and Rubenstein Partners acquired Sanctuary Park in the North Fulton submarket of Atlanta from JP Morgan. Both furthermore represent transactions of 1.0 million+ square feet. 100% 80 Secondary market diversification normalizes; risk sensitivities sustained at the submarket level 2013 Q3 100 111 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD Secondary market yield discount (basis points) Secondary market cap rates at an atypically high discount relative to primary markets, having reached 111 basis points this quarter and now beyond levels seen at the prior peak 4 Secondary markets Source: JLL Research (assets larger than 50,000 s.f.) JLL | United States | Office Investment Outlook | Q3 2016 5 Foreign office investment activity Submarket selectivity continues with heightened levels of activity in urban CBD submarkets for the second consecutive quarter—the highest relative level of activity in these submarkets since 2014 Office continues to outperform peer sectors and at a sustained, structural pace relative to prior cycle: nearly 15.0 percent of year -to-date acquisitions by offshore investors 18.0% 36% 37% 34% 35% 32% 36% 44% 37% 43% 78% CBD—Suburban Non-CBD—Suburban 63% 56% 2016 Q3 2016 Q2 39% 2016 Q1 2015 Q4 2015 Q3 2015 Q2 55% 50% 54% 50% 2015 Q1 2014 Q4 2014 Q3 59% 57% 2014 Q2 2014 Q1 59% 62% 57% CBD—Urban Non-CBD—Urban Foreign office investment (billions of $US) 20% 37% 33% 37% 15.6% 14.9% $25.0 13.5% 13.6% $20.0 11.0% 11.1% 10.5% 8.5% 10.6% 11.0% 8.4% 7.4% $10.0 Following a year of sector diversification, offshore capital remains active and at sustained, structurally higher levels within the office sector. At the close of the third quarter, preliminary metrics indicate office has captured more than 60.0 percent of inbound capital year-to-date—in line with and in fact beyond long-term average metrics. Largely the result of significant global capital flows into the industrial sector in 2015, the office sector captured a minor 27.0 percent of this capital in full-year 2015. However, as foreign participation metrics across sectors have normalized in 2016 to levels seen in the prior cycle, the office sector continues to see growth in participation both in dollars and in relative terms: at the close of the third quarter, nearly 15.0 percent of year-to-date acquisitions were by offshore investors. This represents a consistent increase when compared to leading volume years from the prior cycle, which saw offshore participation between 5.0 and 9.0 percent. This capital continues to focus on the primary office markets with selective diversification: New York has captured 45.5 percent of this capital year-to-date, followed by San Francisco (8.4 percent), Boston (7.1 percent) and Washington, DC (6.8 percent). Canadian, German and Chinese investors continue to lead inbound volumes, accounting for 57.3 percent of year -to-date offshore office acquisitions. As we move to year-end and into 2017, the foreign buyer pool remains active yet selective overall, with office investment levels expected to remain high relative to peer sectors given the global, institutional nature of the asset class. 8.0% 6.0% 4.0% $5.0 2.0% 0.0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 $0.0 Offshore office investment remains elevated and outperforming peer sectors 10.0% 5.2% Source: JLL Research (assets larger than 50,000 s.f.) 5 14.0% 12.0% 11.7% $15.0 16.0% Foreign participation (as a % of total office volumes) $30.0 2013 Q4 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2013 Q3 Transaction volumes by submarket characteristics Investment sale volumes by submarket characteristics Source: JLL Research, Real Capital Analytics (transactions larger than $5.0M) Foreign investment by destination market (as a percentage of total, 2016 YTD) Primary markets continue to capture the lion’s share of inbound capital, receiving 78.2 percent of this capital year-to-date, with selective diversification evidenced San Diego Philadelphia Austin Atlanta Chicago Northern New Jersey Miami Seattle-Bellevue Los Angeles Dallas–Fort Worth Washington, DC Boston San Francisco New York 1.1% 1.1% 1.4% 1.6% 1.9% 2.1% 2.8% 4.8% 4.8% 5.6% 6.8% 7.1% 8.4% 45.5% Source: JLL Research, Real Capital Analytics (transactions larger than $5.0M; includes all office markets which received > 1.0 percent of offshore capital as of Q3 2016) JLL | United States | Office Investment Outlook | Q3 2016 6 Notable primary market transactions, Q3 2016 Market Property Buyer New York 1095 Avenue of the Americas Hong Kong Monetary Authority (49.0% interest) New York 11 Madison Avenue PGIM (40.0% interest) New York 10 Hudson Yards Allianz (44.0% interest) San Francisco 2-property portfolio (303 2nd Street; 100 1st Street) San Francisco Chicago Chicago Boston Price ($) Size (s.f.) Price (p.s.f.) $1,152,970,000 1,036,534 $2,270 $1,040,000,000 2,285,846 $1,137 Coach Inc. $946,000,000 1,809,073 $1,188 Norges Bank Investment Management (44.0% interest) Kilroy Realty $452,900,000 1,213,000 $849 760 Market Street Confidential Thor Equities $374,000,000 298,124 $1,200 321 N Clark Street Diversified Real Estate Capital (95% interest) Hines $358,000,000 896,000 $400 American Realty Advisors Sterling Bay $305,000,000 531,190 $574 Clarion Partners Jamestown $295,000,000 278,212 $1,060 Conway Capital Brickman/Allied $295,000,000 172,000 $1,715 Google $285,961,215 397,510 $719 1K Fulton (1000 W Fulton Street) Riverview Center (245 First Street) Seller New York 1619 Broadway Silicon Valley 1101 W Maude Ave LinkedIn Ivanhoe Cambridge/ Callahan Capital Partners SL Green Realty Corp. Notable secondary market transactions, Q3 2016 Market Property Buyer Seller Price ($) Size (s.f.) Price (p.s.f.) Northern New Jersey 800 Scudders Mill Rd Hana Asset Management LCOR/Ivy Equities $305,000,000 761,824 $400 Dallas–Fort Worth Chase Tower Fortis Hines $273,000,000 1,248,230 $219 Atlanta Sanctuary Park Rubenstein Partners JP Morgan Asset Management $265,000,000 1,541,723 $172 Clarion Partners DivcoWest $235,500,000 535,253 $440 Mack-Cali Realty Corp. Equity Commonwealth $235,000,000 521,410 $451 Mesirow Financial Verizon $231,168,605 1,150,000 $299 Lake Merritt Plaza (1999 Harrison Street) Waterfront Corporate Northern New Jersey Center I (111 River Street) Verizon Irving Regional Dallas–Fort Worth Headquarters (600 Hidden Ridge) Oakland–East Bay Dallas–Fort Worth 2000 McKinney Ave Union Investment ADIA/Lincoln Property/Corrigan $225,836,000 442,355 $511 Fort Lauderdale Bank of America Plaza Deutsche Bank JPMorgan Chase $219,946,496 408,064 $539 Minneapolis Ameriprise Financial Center HQ Morning Calm Founders Management/Axar Capital Properties Management $200,000,000 848,000 $236 Atlanta 2475 Northwinds Pky Brookdale Group $186,900,000 1,037,678 $180 Blackstone JLL | United States | Office Investment Outlook | Q3 2016 7 For more information, please contact: Investor Sean Coghlan Director, Investor Research [email protected] Office Julia Georgules Director, Office Research [email protected] Click for more research on: Lodging, Industrial, Multifamily, Office & Retail. About JLL JLL (NYSE: JLL) is a professional services and investment management firm offering specialized real estate services to clients seeking increased value by owning, occupying and investing in real estate. A Fortune 500 company with annual fee revenue of $4.7 billion and gr oss revenue of $5.4 billion, JLL has more than 230 corporate offices, operates in 80 countries and has a global workforce of approximately 58,000. On behalf of its clients, the firm provides management and real estate outsourcing services for a property portfolio of 3.4 billion square feet, or 316 million square meters, and completed $118 billion in sales, acquisitions and finance transactions in 2014. Its investment management business, LaSalle I nvestment Management, has $57.2 billion of real estate assets under management. JLL is the brand name, and a registered trademark, of Jones Lang LaSalle Incorporated. For further information, visit www.jll.com. About JLL Research JLL’s research team delivers intelligence, analysis and insight through market-leading reports and services that illuminate today’s commercial real estate dynamics and identify tomorrow’s challenges and opportunities. Our more than 400 global research professionals track and analyze economic and property trends and forecast future conditions in over 60 countries, producing unrivalled local and global perspectives. Our research and expertise, fueled by real-time information and innovative thinking around the world, creates a competitive advantage for our clients and dr ives successful strategies and optimal real estate decisions. © 2016 Jones Lang LaSalle IP, Inc. All rights reserved. All information contained herein is from sources deemed reliable; however, no representation or warranty is made to the accuracy thereof.