Manulife US REIT - Annual Report 2020

• Widespread uncertainty over both economic and health conditions impaired office fundamentals in 2020. • Tenants delayed making long-term leasing decisions given heightened risks, unknown timelines for office re-openings and expanded remote work programs. • Leasing fell by 47.3% over the year, while 68.7% of Q4 activity being largely short- term renewals brought down average terms to just 6.7 years. • Give-backs of space amounted to 84 m.s.f. in 2020, pushing vacancy to 17.1%. • Sublease space is now well past its dot-com peak and has expanded by 50.7% since the onset of COVID-19. higher exposure to remote work-friendly industries such as tech, greater demographic shifts and more restrictive virus containment measures. Activity will moderately pick up in mid- 2021 as vaccination becomes more widespread. The U.S. office market recorded the first instance of more than 40 m.s.f. of occupancy losses in a given quarter in Q4, with a further 40.6 m.s.f. of negative net absorption bringing 2020 total occupancy declines to an unprecedented 84 m.s.f. This compares to 55 m.s.f. of occupancy losses experienced during the entirety of the financial crisis. Underlining the structural challenges for denser gateway geographies, 52.1% of negative net absorption occurred in CBDs despite them comprising 38.5% of national inventory. Within CBDs, however, losses have been more acute in commodity product, with Class B properties reporting occupancy decreasing 1.5x faster than in Trophy and Class A buildings. This trend is likely to continue given an even more accelerated flight to quality by tenants with the confluence of more generous concession packages and lease terms along with demands for best-in-class ventilation and building systems for employee health and wellbeing. As with leasing, occupancy losses have beenmost pronounced in gateway geographies. More than one-third of 2020’s give-backs took place in New York and the Bay Area alone, approaching 30 m.s.f. in the process, at a rate 2.2x faster than the national office market as a whole. Similarly, negative net absorption was also higher in more expensive and tech and energy-oriented markets such as Seattle (-3.1%), Boston (-3.0%), Denver (-2.9%), New Jersey (-2.5%) and Los Angeles (-2.3%). On the contrary, secondary and tertiary markets were more resilient, benefiting from more diversified tenant bases and expectations for inbound migration: metro areas with less than 60 m.s.f. of total inventory recorded net absorption of -1.3% of inventory, 60 basis points lower than the national average. This mix of give-backs (both planned pre-pandemic and in response to changing needs in the past nine months) and new supply hitting the market pushed vacancy up 110 basis points to 17.1%, rising twice as fast in CBDs than in the suburbs. Unlike net absorption, however, vacancy rose faster for Class A product on account of completions, which will reverse faster as tenants continue to relocate to higher quality buildings. Leasing is Subdued Relative to Historical Averages Short-Term Extensions are Pulling Down Term Lengths 80 70 60 50 40 30 20 10 0 10 9 8 7 6 5 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020 Leasing activity (m.s.f.) Average lease term (years) Gross leasing in Q4 was once again heavily subdued compared to historic norms, reaching just 25.2 m.s.f., bringing 2020 volumes to 125.6 m.s.f. Compared to 2019, this represents a 47.3% drop-off in transaction activity as long-term planning remains difficult apart from select highly capitalized users. Pulling down activity in Q4 was a lack of large-scale renewals that helped to buoy Q3 figures along with greater hesitation from the tech sector, which has been a core driver of net expansion over the past decade. In turn, finance represented 20.1% of all leasing in 2020, while tech fell to 17.7%; in previous years, the two were roughly tied. Residual leasing came mostly from government and energy renewals. Tenants continue to opt for shorter leases to delay decision- making as an interim step: 68.7% of quarterly transactions were renewals, of which 43%were five years or less in duration. As a result, the average deal term dropped even further in Q4 to 6.7 years for leases larger than 20,000 s.f., well below the pre-COVID-19 average of 8.5 years. Lease lengths will increase as the market begins to recover later in 2021 and into 2022. Mirroring broader macroeconomic and demographic trends, gateway markets saw a 51.5% reduction in year-over- year leasing compared to 42.9% elsewhere on account of 40 MANULIFE US REIT INDEPENDENT MARKET REPORT By JLL as of 31 December 2020 U.S. Office Overview