Industry / Real Estate

Office Real Estate (China)

Group Research / January 13, 2021

Photo Credit - AFP

Overall Outlook

Occupancy recovery on delayed supply in 3Q20. Office demand has softened due to economic uncertainty. Nevertheless, subsectors of TMT, domestic financial companies and other professional firms are driving demand given their expansion plans. Leasing activity recovered in 2H20 and is expected to continue into 2021 as China’s business activities normalise. Meanwhile, new supply in 3Q20 fell to 0.13m sm in 17 Tier 1/2 cities, with half of this new supply coming from Tier-1 and major Tier-2 cities, according to CBRE. Vacancy went up by 0.5ppts in Tier-1 cities and down by 0.8ppt in major Tier-2 cities. Average rents fell 0.7%/0.4% q-o-q in major Tier 1/2 cities in 3Q20.

Stable rents in 2021. According to CBRE, although there was 8m sm of new supply scheduled for 2H20, vs. 1.9m sm in 1H20, this would likely be offset by continued improvements in leasing momentum amid steady recovery in China’s economy. We also expect further delays of new supply to smooth out the cycle.

Rising investor interest in China’s office assets. Foreign buyers continue to have a strong appetite for assets though their activity is still constrained by travel restrictions. Transaction volume for office assets exceeded Rmb11.6bn in 3Q20. As clear recovery signs emerge in the form of an improving economy and strong leasing demand momentum, China should remain as one of the most preferred markets for cross-border investments in Asia Pacific (APAC), and offices should be the preferred assets. Coupled with the “Three Red Lines” policy, highly leveraged developers are likely to monetise their commercial properties for the sake of improving their debt levels, which could create additional transaction opportunities.

Supply to moderate in top Tier-2 (or Tier-1.5) cities. Office gross floor area (GFA) of new starts has slowed down since 2014/2015 in Tier-1 cities and top Tier-2 cities. Given the normal development cycle of 3-4 years, we expect new supply to be well controlled in these cities in 2021. Guangzhou, Nanjing, Tianjin and Shenyang have been cutting new starts of office space GFA in the past 2-3 years.

Urbanisation, tertiary industry growth to drive industry upgrade and office demand in the long term. Rapid urbanisation in the past decade has led to industry upgrades in Tier-1 cities, which will drive office demand. Several Tier-2 cities will likely stand out as well, given the higher number of universities, favourable talent programme and higher growth in the tertiary industry. Nanjing, Hangzhou and Wuhan are expected to lead office demand among all Tier-2 cities.

Flexible working arrangement may not have a significant impact on China’s office demand. Despite a number of multinational companies around the world pushing through technology upgrades and a flexible working culture, our interviews with corporates in China shows (1) return to office is taking place faster than expected as the pandemic is well controlled, (2) flexible working arrangements may reduce the space of each working station but increase the space for meeting rooms and collaboration areas; and (3) softening of rentals in the city centre will allow companies to maintain their space there.

Co-working space significantly impacted. With SMEs more significantly impacted by the pandemic and falling demand for project-based working spaces out of main office stations, co-working space operations have been negatively affected. More companies will choose to provide flexible working spaces on their premises rather than rent co-working spaces.

Near-term outlook

Demand to gradually recover, driven by TMT and financial industries. TMT, Healthcare, Financials and other Professional Services continue to drive the majority of leasing demand. Office demand most affected by the virus were hospitality, F&B, transportation and retail. However, the coronavirus outbreak could stimulate sub-industries of TMT such as online gaming, education and enterprise online working services. Other than that, the removal of limits on the ratio of foreign capital permitted in the life insurance, futures, funds and securities industries could also spur leasing demand for office space. According to CBRE, TMT companies and financial institutions were especially active, accounting for around half of leased space in 3Q20.

New supply likely to see further delay to smooth out vacancy. According to CBRE, the vacancy rates of prime office space in major cities improved by 0.4ppt q-o-q to 25% in 2Q20, a historically high level. Vacancies in Guangzhou remained at a historical low of 7.8% in 3Q20; leasing demand from TMT companies was the key driver. Shenzhen and Nanjing showed improvement as new supply decreased. Vacancy rate averaged 17% in 3Q20 for Tier-1 cities and 28% for major Tier-2 cities. Wuhan, Tianjin and Changsha continued to see above-40% vacancy rates in 3Q20. Looking ahead, there was 6.1m sm new supply scheduled for 2H20, vs. 1.9m sm in 1H20. Some cities may see a vacancy spike but we believe new supply is likely to face further delays and smooth out the vacancy rate.

Rental decline narrowed with Qingdao started to see q-o-q increase. Rental rate in Tier-1 cities dipped 0.7% q-o-q in 3Q20, with Shanghai’s rental stabilising after a meaningful correction in 2Q20. Shenzhen’s rental growth inched down only by 0.4% q-o-q. Average rental rates in major Tier-2 cities edged down 0.4% q-o-q in 3Q20, compared with 2.8% decline in 2Q20, with Qingdao starting to see rental growth of 2.6% q-o-q.

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Our In-House Experts

Ken HE Liang
[email protected]
+86 21 6888 3375

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