Themes that shape the U.S. Skyline Infographics from the U.S. Skyline Review | Spring 2014

Collision of the workforce and workplace

“If you build it, they will come” can be thrown out...In the 80s and 90s, supply and demand eventually met and thus filled up office buildings in core and even challenged locations. The millennial generation’s shift into the driver seat of the workforce over the next five years will position buildings and micromarkets with unique offerings, a sense of place and a heartbeat to dominate demand patterns. Ironically, this does not mean Main and Main buildings will be the winner, but in many cases, could be the loser, as owners who bet on location only and not experience are left behind until they can recreate an ideal setting for tomorrow’s tenant.

Reinvented frontiers

A significant shift in demographics and urban in-migration have fueled Skyline population growth to nearly triple the rate of growth of overall cities. Consequently, once derelict or largely ignored urban microsegments will see a renaissance over the next three to five years. Parking lots will be transformed into Trophy office towers; warehouses into multifamily units, rail depots into retail experiences and dim streets into lively blocks. Look for areas like Downtown Atlanta, South Park Los Angeles, Midtown Village in Philadelphia, Middle Market San Francisco, the Arts District in Dallas, Mount Vernon Triangle in Washington, DC and the West Side in New York to lead growth in the years ahead with a more vibrant offering than traditional office corridors.

Flight to the middle

In recent quarters, high-end and value conscious tenant demand have left few space options at the extremes of the Skyline, positioning mid-tier buildings for tightening ahead. This scarcity, particularly in the form of large blocks of space, will position the mighty middle to capture future tenant activity. However, in order for owners of those second- and third-generational buildings to be successful, repositioning and investment will be needed to maximize window line, minimize column spacing and offer more side core opportunities, among other attributes.

Rightsizing overload

Corporates across industries are reevaluating workplace strategies and implementing new solutions to attract and retain talent, improve the workplace culture and wring out cost savings. Law firms are seeing their per attorney space shrink from 900 square feet per attorney to as efficient as 550 square feet per attorney, consulting firms are seeing optimization levels increase by nearly 50.0 percent and 75.0 percent of corporates are proactively solving for future space optimization. However, in recent months, we have seen a plateauing in the frequency of rightsizing and even a overcorrection from some larger companies and firms. Cost savings remain important, but culture and retention are trumping that in an improved economic environment.

Cards stacked against tenants

Demand levels are increasing, space options are decreasing and rents are going up. However, that is just the cover story; the underlying message shows a Skyline with intense capital demand, which will translate into rent growth ahead coming more from investment demand than leasing demand due to aggressive competition and underwriting ultimately yielding even higher rents and lower concessions. Further, on the back-end of those sales, tenants can expect to see the tax component of operating expenses jump significantly due to record sales prices recorded.

The United Nations of Skyline

Canada, China, Chile, Korea, Qatar and Norway are just a few of the countries where capital placement in the Skyline has been prominent in recent years. Demand currently sitting on the sidelines is even higher than the levels we have seen invested into the Skyline over the past 24 months. As a result of this globalization, domestic institutions and REITs will be increasingly left to reevaluate investment strategies, consider joint ventures, move farther along the risk curve (and thus out of the Skyline) and expand their geographic focus from a handful of gateway cities to core product in the top 30 to 40 Skylines, shifting activity to many secondary Skylines ahead.

While construction activity across the Skyline has picked up in recent quarters (reaching 17 million square feet), the overwhelming amount of construction activity is concentrated in three markets: New York, Houston and San Francisco. The additional 40 Skylines JLL tracks have an average of just 198,550 square feet of space under construction. In fact, 10 Skylines have vacancy levels below 10.0 percent with seven of those Skylines showing no current development and two of those Skylines seeing just one crane �in the air.

This dynamic has caused a space crunch in Super-Trophy or AA buildings across most Skylines. In New York, of the most sought-after Trophy buildings, half had vacancies of less than 5.0

percent. In Chicago, only three buildings priced above $40.00 per square foot have occupancy levels below 90.0 percent. Trophy assets in Uptown Dallas all have occupancies above 85 percent and CBD’s Trophies are far outperforming the broader market with respect to occupancy and rents.

A similar tightening exists in Skyline value options. In Washington, DC, buildings priced ($45.00 NNN $+/-$70.00 FS) or below posted occupancy levels 16.0 percent higher than the overall Trophy market. In Miami, properties priced $40.00 per square foot or below demonstrated vacancy levels that were 29.1 percent lower than the overall Skyline.

Supply Space crunch is prevalent in luxury and value

Supply Space crunch is prevalent in luxury and value

Orange County (-460bp) Detroit and Fort Lauderdale (-420bp) Washington, DC (-340bp) Orlando (-330bp) Baltimore (-320bp)

13.4% 11.9% U.S. Skyline

historical equilibrium

direct vacancy

U.S. Skyline direct vacancy as of YE 2013

Secondary Skylines accounting for some of the sharpest drops in vacancy:

Supply Space crunch is prevalent in luxury and value

Only 4 Skylines still post direct vacancy rates above 20.0% Only 4 Skylines still post direct vacancy rates above 20.0% Cincinnati Cleveland Dallas Phoenix

11 Skylines now have single-digit direct vacancy rates 11 Skylines now have single-digit direct vacancy rates

Bellevue Charlotte Houston Philadelphia Pittsburgh Portland

Raleigh Richmond San Francisco St. Louis Washington, DC

Supply Space crunch is prevalent in luxury and value

50.0% percent of Skylines are seeing construction...

million square feet

for a total of

17

of office construction nationally is taking place in Skylines...

66.0% despite representing just

of office inventory nationwide

14.8%

Supply Space crunch is prevalent in luxury and value

Skylines with the highest rate of construction to existing inventory is a mix of primary and secondary geographies:

Newark (12.7%) Houston (9.8%) Richmond (8.4%) Austin (8.3%) Washington, DC (7.3%) Orange County (7.2%)

Demand

The Skyline once again led demand and occupancy gains versus the broader U.S. office market, besting countrywide levels by 45.0 percent and doubling the gains of the overall CBD. Overall, the Skyline registered just shy of 10 million square feet of occupancy gains in 2013, following nearly 22.4 million square feet of net absorption in the three years prior. However, the main difference between then and now is market participation with 70.0 percent of Skylines demonstrating consistent net absorption over the past �two years.

Ahead, both opportunities and challenges await landlords. Rightsizing has dominated the office sector over the past three years, yet recently, we have noticed a slowdown and potential plateauing

of the frequency of that trend. Approximately 15.5 percent of Skyline transactions involved rightsizing in 2013 with the vast majority stemming from law firms and banks and financial institutions. However, even within these sectors (and the accounting / consulting sector), evidence of an overcorrection by certain tenants has arisen. Further, looking at the growth industries across the Skyline (energy, tech, health care and media), few of those uses can operate in a remote environment like some of the traditional office sectors can.

Yet, one of the key challenges for landlords ahead is the lack of near-term large-block tenant demand with 2017 and 2018 tenants touring the market becoming the norm, not the extreme.

Activity and growth levels continue to expand and diversify

Demand Activity and growth levels continue to expand and diversify

Activity and growth levels continue to expand and diversify

Net absorption as percent of inventory (and percent of markets seeing occupancy growth)

61.9%61.9% 71.4%

2010

1.0% 1.3% 1.5% 1.6%

2011 2012 2013

Demand Activity and growth levels continue to expand and diversify

Energy, tech, media and healthcare dominate tenant growth

Accounting / consulting:

21% Growing 59% Stable 20% Shrinking

Architecture, construction & engineering:

25% Growing 70% Stable 5% Shrinking

Banking / finance:

22% Growing 64% Stable 14% Shrinking

Energy:

74% Growing 26% Stable 0% Shrinking

Healthcare:

32% Growing 68% Stable 0% Shrinking

Law:

22% Growing 51% Stable 27% Shrinking

Media:

41% Growing 53% Stable 6% Shrinking

Technology:

63% Growing 32% Stable 5% Shrinking

Demand Activity and growth levels continue to expand and diversify

Rightsizing what? In 2013 , the number of transactions where tenants grew doubled the amount where tenants gave back space

2013 Skyline transactions that exhibited

growth: 30.2%

2013 Skyline

transactions that exhibited

rightsizing: 15.5%

To shrink or to grow? Banks and law firms

< 20,000 s.f. saw their real estate footprint grow Banks and law firms > 20,000 s.f. saw their real estate footprint shrink

11

5

Banking / Finance

Law

Rightsizing has been dominated by 2 industries, which accounted for 83.3% of all rightsizing.

Demand Activity and growth levels continue to expand and diversify

More Skylines experiencing net new growth as opposed to net new contraction:

Skylines that saw highest concentration of expansions:

Atlanta Austin Bellevue Boston Chicago

Columbus Detroit Houston San Diego Tampa

Skylines that saw highest level of rightsizing:

Charlotte Cleveland Sacramento Washington, DC

Rents

While the Skyline segment of the market remains somewhat bifurcated from a rental standpoint, rents are beginning to grow across markets from industry-heavy primary Skylines to now even diversified secondary Skylines. Nearly two-thirds of Skylines are reporting consistent rental increases at a rate 1.4 times faster than the U.S. office market as a whole, referencing the tight fundamentals in core product. Despite the rent increases, stubbornly high tenant improvement allowances and only a slight reduction in rental abatement are indicative of a more challenging landscape for landlords and a welcome leftover of the lingering downturn to tenants across most cities.

From a geographical perspective, rental growth remains highest in tech- and energy-dominant Skylines; however, these markets, which have seen large upticks in new construction, may be the first geographies that switch from landlord-favorable positions to neutral positions in 2016 due to the new supply. Conversely, markets without significant speculative development (all markets besides Houston, San Francisco and New York) will see leverage for landlords extended over the next 24 to 30 months with a trickle down in tightening from the top-down and the bottom-up of �the Skyline.

Growth to spread across geographies and pricing segments

Rents Growth to spread across geographies and pricing segments

Rents for Skyline properties reach $40.73 p.s.f. , the first time they have broken $40.00 p.s.f. on record; with rental growth of 3.4 percent in 2013

2 0 0 6

$30.81

2 0 0 5

$29.16

$36.69

2 0 0 7

$37.86

2 0 0 8

$34.58

2 0 0 9

$34.51

2 0 1 0

$36.25

2 0 1 1

$39.39

2 0 1 2

$40.73

2 0 1 3

Rents Growth to spread across geographies and pricing segments

Increased demand and shrinking space options mean leverage in the Skyline is shifting away from tenants to landlords

2014: 18.6%

2015: 11.6%

2016: 2.3%

Tenant-favorable Skylines

Rents Growth to spread across geographies and pricing segments

Industry-driven Skylines are posting fastest rental growth over time:

San Francisco: 80.7% Bellevue: 18.2% Houston: 17.7% New York: 16.9% Orange County: 16.4%

Largest rent growth past 36 months :

Houston: 69.8% San Francisco: 69.1% Austin: 53.9% Denver: 52.4% Salt Lake City: 49.7%

Largest rent growth since 2005 :

San Francisco: 9.6% Bellevue: 9.2% Fort Worth: 7.9% Portland: 6.3% Austin, Denver: 5.1%

Largest rent growth past 12 months :

Investment

2013 saw a resurgence of investment sale activity with primary and secondary Skylines seeing year-over-year growth of 43.4 and 20.0 percent, respectively, on a square footage basis. While the broadening of transaction activity across secondary markets spurred a modest softening of cap rates, primary markets saw average cap rates compress below pre-recession levels, now pegged at 4.8 percent.

A resurgence of activity in New York, exhibited by nearly 5.1 million square feet of transactions and pricing exceeding $1,000 per square foot in three transactions, was a key primary market growth factor. However, Los Angeles surpassed New York sales volumes due to Brookfield Office Properties’ 4.9 million-square-foot acquisition of the MPG Office Trust portfolio - the largest trade of 2013

nationally. Foreign capital demonstrated significant growth with investments in New York, Washington, DC and Boston, accounting for 50.2 percent of buyers in primary Skyline transactions in 2013. Foreign investment is notably flowing from China and Norway, both of which saw U.S. investments surpass $1.0 billion.

While primary markets showed notable growth this year, secondary market pricing gains per square foot exceeded primary markets—�a trend evidenced in Raleigh, Miami and Philadelphia. Transaction activity in these markets continues to be driven by REITs and domestic institutional buyers, spurring growth across 14 secondary markets and expanding bidder profiles to institutional investors.

Foreign capital shifts domestics along the risk curve

Investment Foreign capital shifts domestics along the risk curve

New York ($0.0b 2012) New York ($0.0b 2012)

$2.1b 2013

Chicago ($0.0b 2012)

$0.5b 2013

Washington, DC ($0.3b 2012)

$0.8b 2013

Seattle ($0.0b 2012)

$0.4b 2013

Boston ($0.0b 2012)

$0.7b 2013

San Francisco ($1.6b 2012)

$0.0b 2013

Origins of large foreign investors in Skyline assets:

China: $1.4b

Norway: $1.2b

Australia: $0.8b

South Korea: $0.5b

Canada: $0.4b

Foreign investment activity continues to fly into the Skyline from all parts of the globe: $1.9b (2012) versus $5.2b (2013), accounting for 50.2% of buying activity in 2013 in primary markets

Investment Foreign capital shifts domestics along the risk curve

Liquidity growing in secondary markets with institutions edging out REITs as primary buyers

Percent of 2013 sales transactions acquired by REITs in secondary markets:

38.6%

Percent of 2013 sales transactions acquired by institutional buyers in secondary markets:

39.4%

Investment activity across the Skyline jumps to highest levels since 2007

Square feet transacted in the Skyline in 2013:

63.9 m.s.f.

Percent of Skyline markets that have seen sales volumes (s.f. basis) grow since 2011:

68.3% Percent increase in Skyline sales volume (s.f. basis) from 2012 to 2013:

30.8%

Investment Foreign capital shifts domestics along the risk curve

Appetite for risk varies greatly across buyer types

Over the past 24 months, occupancy of Skyline properties acquired by… (and percent of those assets classified as Trophy)

Foreign: 88.9% (64.7%)

REITs: 87.2% (50.0%)

Domestic institution / advisor: 86.7% (50.9 %)

Developer / property company: 79.6% (20.0%)

Equity fund: 68.2% (16.7%)

Cap rates continue to compress to record lows for core assets:

San Francisco: 3.2% (average low 4s)

Boston: 3.7% (average high 4s)

New York: 3.8% (average low 4s)

Minneapolis: 4.0% (average low 6s)

Seattle: 4.2% (average high 4s)

Washington, DC: 4.2% (average low 5s)

Atlanta: 4.2% (average low 6s)

Austin: 5.2% (average low 6s)

Houston: 5.3% (average high 5s)

Denver: 5.5% (average low 6s)

Interested? Intrigued? Dive deeper into current commercial real estate trends and statistics with our complete 2014 U.S. Skyline Review.

This comprehensive report is a beautiful printed document—part reference guide and part coffee-table book for the real estate aficionado. It includes detailed breakdowns of vacancy rates, absorption, average rents and more at Trophy and Class A buildings in the top 43 office market centers.