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Back in business
Hong Kong still has the most expensive offices in Asia. But with the pundits predicting further falls in the year ahead, Alex Frew McMillan expects life to get a little easier for tenants
The world has a new heavyweight champion when it comes to office rents - Moscow. London’s West End used to hold the belt, always just ahead of Hong Kong in the standings. But thanks to the Russian capital’s 32.6 percent office space increase last year, it now sits atop the standings, at US$255.6 (HK$1,981.6) per square foot per year.
Britain’s free-falling property market has hit the West End, knocking its prices 32.5 percent over the course of 2008 to US$186.2 per square foot per year. So it is only just ahead of Hong Kong, according to new figures from DTZ Research, which saw its prices fall just 5.5 percent year on year, to US$185.2 at the time of the report, released in January.
“Rents [in Hong Kong] got too high, that is the reality,” says Mark Price, DTZ’s head of business space for North Asia. “But it is probably a healthy correction more than a crash.”
Commercial rents in Hong Kong peaked in the third quarter last year. Since that crest, rents have fallen 15 percent to 20 percent, and pundits predict they will fall a similar amount again this year, for a 30 percent overall drop.
Property consultants Colliers are predicting a 26 percent decline in Grade A office rents and a 35 percent drop in capital values for commercial property in 2009. Those drops are the worst of any real-estate sector, with luxury residential rents forecast to fall only 15 percent, capital values dropping 20 percent, and industrial and retail space also faring better.
“In the Asia Pacific region, hardly anybody is optimistic about the outlook for 2009,” Alva To, the head of consultancy for North Asia at DTZ, said in mid-January.
In Asia, only 3.0 percent of respondents to a DTZ survey say they have a positive outlook for real estate for the year ahead, while 69.7 percent say they are negative, and 27.3 percent expect no change in the market.
Although the real-estate downturn is much more serious in both Western Europe and the United States, people in these markets are much more optimistic. Overall, 20.0 percent of Western Europeans have a positive forecast for 2009, while only 40.0 percent are negative and another 40.0 percent expect no change. In North America, a mere 8.7 percent are optimistic about the year ahead, 39.1 percent expect further losses for real estate, but 52.2 percent expect no change.
Why are Asians so downbeat, when the United States and Europe face much more serious property problems thanks to irresponsible lending and over-use of borrowing?
“The reality is, things are much worse in the UK and the US than they are here,” Price explains. “But this survey is based on sentiment and emotion. Perhaps people are more realistic here. In the UK, anybody under 40 hasn’t seen it [go down]. They are probably not aware of how bad it can get.”
“Asia Pacific people have got a good memory,” To adds. “We have been through three cycles in Asia.”
Not only is Asia not overleveraged or over-lent, suggesting the recovery will be quicker, but property professionals and amateurs alike are much more aware of what happens when property markets fall, whereas the West has seen a long bull run from 1993 through 2007.
Although real-estate markets are depressed globally, the picture is a little more mixed when it comes to commercial space. Some cities are still seeing decent growth in office space rents.
Tokyo’s central five wards saw a rise of 19.8 percent over the course of last year, to US$165.4 per square foot, ranking them fourth in the world. China’s commercial property also gained last year, according to DTZ, but only very slightly, up 0.8 percent year on year. The gains nationwide came despite severe problems in Shanghai, where Pudong commercial property fell 13.1 percent.
The biggest office-rent gainers were in the Middle East, with two cities in the United Arab Emirates joined by Cairo in Egypt at the top of the percentage leaps. Dubai’s office space surged an incredible 51.0 percent in a year, to US$157.2 and fifth place. Similarly, Abu Dhabi’s office property ran up 63.4 percent, the biggest percentage increase among the major markets, and good enough for a tie with Paris for the ninth most expensive office buildings in the world at US$125.20 per square foot per year.
The biggest falls are in the United Kingdom, in the City of London and the West End, where prices are down 35.8 percent and 32.5 percent respectively, followed by Seoul in South Korea, down 30.1 percent.
Office rents are of course one of the first areas companies target as a way to cut costs. Headcount cuts also mean they need less space.
“The possible strategies that occupiers may consider include staff retrenchment, lease restructure, decentralisation...”, says Iain Chapman, the director of commercial space at Colliers. “On the other side, vendors are now open to negotiate with new tenants and adopt a realistic approach on rentals.”
In Hong Kong, vacancies are starting to creep up from record lows. They have now edged to 2 percent in Central. But that’s the actual vacancy rate - market watchers say many more tenants want to give up space, given the opportunity, although they may now be tied into long-term leases.
“People are in a wait-and-see holding pattern,” Price says. “Everybody has been expecting rents to fall, which they have, but they haven’t hit a bottom yet. So more tenants are waiting, and to make matters worse, capital expenditure is not easy to do during this credit crisis.”
Island East, the new Swire Properties project in Quarry Bay, is one of the few bright spots, with new tenants taking up space in the fourth quarter. But many developers that have new office buildings coming on the market now are struggling. There is huge new supply appearing in Kowloon East, where the vacancy rate is now an incredible 31.3 percent, compared with 2.6 percent overall on Hong Kong Island and 3.4 percent in Tsim Sha Tsui.
“Kowloon East prices have seen a small drop but it has suffered more than anywhere with new supply,” Price says. “Landlords are now desperate to offer deals and they are under enormous pressure.”
The last property slumps came in 2003, when a recession produced by the dot.com bust played into the sudden downward shock caused by SARS, and in 1997, when the Asian financial crisis swept the region. Now the United States real-estate crisis is the quake producing what is increasingly being called a financial tsunami.
For Hong Kong, this downturn is different from the 2003 and 1997 slumps. The underlying fundamentals of Hong Kong’s office market are still strong, with little new space due to come on the market in the most expensive areas, especially Central. In 1996 and 1997, a combined 968,000 square feet of new supply came on the market in Central. In 2002 and 2003, the figure reached 2,361,500 square feet. For 2007 and 2008, combined, it was just 260,000 square feet.
“There is still going to be relatively tight supply in Central, even though I don’t think we have seen the end of the credit crunch,” Price notes.
Vacancy rates were much higher in the previous slumps, too, at 8.7 percent in 1997 and 15.1 percent in 2003, compared to 2.1 percent in 2008. Rents per square foot per month stood at HK$63 in 1997, HK$25 in 2003 and HK$105 in 2008.
“In 2003 and 1997, vacancy was way above 6 percent, and that’s when things can go into freefall,” Price says. “Landlords are not under the same pressure as 1997 or 2003 because they are enjoying very high occupancy, so rents won’t drop to the levels of 2003 or 1997.”
So Hong Kong is unlikely to surrender its place near the top of the ‘most expensive’ charts. The one negative factor is that Hong Kong has a greater exposure to the FIRE sector - finance, insurance and real estate - than it did before. The FIRE sector accounted for 29.3 percent of Hong Kong’s economy in 2008, up from 24 percent in 1997 and 21 percent in 2003.
That’s the sector that has been hit hardest by the credit crunch and seen the most dramatic job losses. FIRE companies also take up some of the most expensive space in the most prestigious buildings. So the financial downturn will hit the landlords running those buildings: Hongkong Land, Swire Properties and Sun Hung Kai Properties.
DTZ forecasts that the current slump will last roughly five quarters, dating back to August 2008, which would mean the market should hit bottom near the end of this year.
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