Office buildings in Admiralty and Central, Hong Kong. Photo: K. Y. Cheng
Hong Kong has a long-standing reputation as one of the most, if not the most, expensive office leasing markets in the world. This unenviable title, depending on which side of the real estate fence you sit, has historically been underpinned by both broad demand and constrained supply.
The disruptive nature of Covid-19, however, has stymied demand and forced organisations to review their operating models, for what is generally their second largest overhead. In turn this has driven a correction in the market and is potentially creating a long-term shift in occupier requirements.
Waning demand has resulted in a significant market rebalancing. Seven consecutive quarters of negative net take-up have resulted in average vacancy rates rising to 10.1 per cent in March this year from 3.8 per cent in early 2019. Market rents contracted by 22 per cent on average over the period.
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As we consider the effect of these changes, the question stakeholders should be asking is whether this is a fundamental change, or just another short-term cyclical correction?
Supply versus demand
Space rationalisation, limited new market entrants and the adoption of work-from-home policies have all resulted in increased optionality from a tenant’s perspective.
Rising vacancy rates are further compounded by record high levels of “shadow stock” (early termination of all, or part of an occupier’s real estate liability), which currently amounts to about 1.8 million sq ft. Arguably Covid-19 has exacerbated pre-existing trends of space rationalisation and optimisation.
Encouragingly however, we witnessed a material uptick in leasing activity and enquiries through the first quarter, likely buoyed by renewed optimism of the vaccine roll-out and potential border reopening.
© Provided by South China Morning Post Sun Hung Kai Properties has a new design for its new West Kowloon project. Photo: Handout
Regardless of this positivity, there is a need to look at the considerable new supply coming on stream between 2022 and 2026, and consider if growth in demand will maintain pace with major new developments located across the Central Business District (CBD), Quarry Bay, Kowloon East and West Kowloon (immediately near ICC).
Putting the supply equation into context, the 10-year average for new space is around 1.6 million sq ft in net floor area per annum. Next year alone, more than 4.6 million sq ft of Grade A office space will be launched, including Two Taikoo Place in Quarry Bay by Swire Properties and Airside in Kai Tak by Nan Fung Group.
While there has been virtually no new supply in the CBD since 2003, the scene in prime districts is set to change with the introduction of Henderson Land’s Murray Road development and CK Asset’s Hutchison House redevelopment.
There are also the potential redevelopment of Queensway and the prime harbourfront plot known as Site 3 in Central, with its two-envelope tendering approach ensuring the design aspects have equal merit to the land premium paid.
© Provided by South China Morning Post Artist impression of the New Central Harbourfront Site 3. According to the government master layout plan, the New Central Harbourfront Site 3 is designated for retail and office. SCMP Pictures (Undated handout)
This is overlaid by significant new supply in West Kowloon. Both the High-Speed Rail site (XRL Terminus) being developed by Sun Hung Kai Properties and commercial sites within the West Kowloon Cultural District are expected to add more than 3 million sq ft of net floor areas of competitive Grade A office space to the market.
These new developments is likely to redefine the historical boundaries of the CBD both eastward and northwards, driven largely by the advent of new high-quality assets, coupled with improved infrastructure nodes and connectivity.
Four separate MTR lines will intersect at Admiralty by 2022, enhancing connectivity to the eastern fringe of the CBD, as well as the High-Speed Rail Terminus in West Kowloon which has significantly enhanced accessibility to the Greater Bay Area.
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This is further integrated with improved east-west road connectivity, being both the Central-Wan Chai Bypass on the Island which opened in 2019, and Route 6 connecting East and West Kowloon to be completed in 2025.
Cyclical market trough in mid-2021
Market dynamics have shifted significantly, unsurprisingly being most pronounced in the CBD where roughly 40 per cent of Grade A space is leased to financial institutions and rents slumped 18 per cent in 2020.
While decentralisation has historically been a driving force for office moves, upcoming supply within the CBD and a narrowing delta between commercial districts and ever-rising capital costs is likely to be favourable to CBD occupancy.
We have already seen isolated examples of “recentralisation” as firms look to upgrade and capitalise on current market conditions.
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Given signs of stabilisation, we currently anticipate that the cyclical market trough will occur in mid-2021, yet the year is set to remain negative overall. Renewed optimism is unlikely to materialise in significant new demand over the near term given continued space rationalisation and adoption of work-from-home policies, to some extent.
Consequently, shifting market conditions and new ways of working, coupled with significant new supply, are manifesting in a healthy ‘rebalancing’ of negotiating power in favour of occupiers who have long struggled to achieve significant flexibility within their lease terms.
The proliferation of high-quality stock is a value add for tenants in a post Covid-19 world who are increasingly concerned with sustainability, air quality and ventilation, Green Credentials, enhanced automation and security, and overall staff wellness.
Ultimately, uncertainty creates opportunities. From an occupier’s perspective, optionality is rarely this attractive.
David Wood is the Senior Director and Head of Tenant Representation on Hong Kong Island of Colliers Hong Kong
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This article originally appeared on the South China Morning Post (www.scmp.com), the leading news media reporting on China and Asia.
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