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The travails of the tenant
The lurch downward in Hong Kong’s commercial rents should be a boon for office tenants, who saw landlords jack up prices to record levels over the past few years. But how does this translate in real terms? Alex Frew McMillan reports
‘‘The falling rents might make it seem like a renter’s market. But it is not as simple as locking in a cheap rent – corporate clients can’t cancel their leases on the spot and move instantly into cheap space’’
Rents in Central have fallen 31 percent from their peak, according to figures from Colliers International, and are down 27 percent on average across Hong Kong. With a glut of new space coming on the market in Kwun Tong, that area is seeing the sharpest discounts, down more than a third, or 35 percent, from the top of the market.
Rising vacancy rates and a drop in demand are making life a little easier for companies that make a home in Hong Kong. That’s a welcome reprieve, and an adjustment to the recent balance of power.
“For the last few years, the landlords have had the upper hand,” says Giles Hunter, the chairman of the Hong Kong Chapter of CoreNet, an association that represents corporate tenants. “Now it is the tenants, within reason.”
But the decline in commercial rents is not the instant success story you might expect for tenants. To start with, Hong Kong rents are still exceptionally high. In Central, they were at HK$85 per square foot per month in January. The overall average for Hong Kong is HK$51 per square foot per month.
In fact, Hong Kong took over the top spot as the most expensive place in the world to lease office space, according to a global office real-estate review from Colliers. At US$178 (HK$1,379) per square foot per year, the Hong Kong rate at the end of 2008 had surpassed Moscow’s central wards (in second place at US$139 per square foot per year), with Tokyo, London’s West End and Dubai rounding out the top five. Most other cities are seeing even bigger declines.
The falling rents might make it seem like a renter’s market. But it is not as simple as locking in a cheap rent – corporate clients can’t cancel their leases on the spot and move instantly into cheap space now. Even if they can negotiate a new lease, it may not make sense to do so.
“For most occupiers in this town, property is a necessary evil,” Hunter says. “You can’t just turn around and drop your corporate real-estate costs because you might be locked into them for three or four years.”
Hunter heads the local arm of CoreNet, which represents 7,000 members around the world, from some of the largest multinationals on the planet. That includes 800 members in Asia from companies such as Boeing, the Bank of America and Hewlett Packard, all major tenants, as well as service providers such as real-estate brokerages and even ‘the enemy’, commercial landlords.
Hunter is also the director of corporate property in Asia for the insurance giant Prudential. He knows from experience that for corporate tenants, real estate is one of the biggest expenses. Rents typically rank as the second biggest cost after wages, or perhaps third after wages and technology-spending for tech-heavy firms.
That’s certainly true in Hong Kong, where there is still relatively little space available. Vacancy rates in Central have increased from around 1 percent to around 5 percent, and may peak at 8 percent. But that is still comparatively low. In the 2003 downturn, prompted by the tech bust and SARS, there was an 18 percent vacancy in Central.
“Those were desperate days,” says George McKay, the head of Occupier Services in Asia for Colliers International. “We see vacancies maxing at about 8 percent now, which is a big number considering where we were getting down to, but we don’t see it getting to nearly the same level of vacancy.”
There is a very small amount of new office space expected to come on the market in downtown Hong Kong over the next few years. Whereas an average of 2.3 million square feet of office space came on the market per year between 1986 and 2008, Colliers forecasts that 40 percent less new space, an average of 1.4 million square feet, will be created in each of the next three years.
“Despite all the gloom and doom, if you go looking for 100,000 square feet of Grade A space in Hong Kong there is not that much around,” says Hunter.
Corporate tenants are also locked in for longer terms than residential renters. In Hong Kong, they typically sign at least a three-year lease, often with an option to renew. Hong Kong tends to have much shorter commercial terms than other cities – 10-year leases aren’t uncommon in places like London. But it still means it can take years to benefit from cheaper rents.
“Most of the large tenants in Central have leases not due to expire until at least 12 months from now,” says McKay. Even if its lease does expire, the company normally has either a rent review – when the tenant has a contract to stay in the building but must negotiate a new rent with the landlord – or an ‘option to renew’ on the same space. It generally pays to stay put.
Landlords started locking in tenants to longer leases in 2006, once the market recovered from its lows in the 2003 downturn. Experts say a corporate tenant should start planning at least 18 months before its lease expires to see if it can lock in a better deal or if it needs to expand or contract its offices.
Location, location, location is still the mantra for corporate tenants. Law firms and accounting companies want to be in the Prince’s Building in Central. Financial companies want to be in Exchange Square and the International Finance Centre.
“It would be great from a corporate real-estate point of view if we could all move out to the New Territories,” Hunter says. “It’s just never going to happen.”
Even if there was sufficient high-quality office space in those areas, which there isn’t, companies cannot afford to be too far from their clients or their competitors, or risk losing out on business. Moving to a further-flung spot, even just half an hour away, would increase travel times and mean clients or their contacts would be spending too much time commuting and not enough time working.
“The right deal might be staying next to your clients in the same neighbourhood, with the lowest continuing cost,” Hunter says. “That might be better than moving to the New Territories, where you might get land at half the cost but lose half your staff and spend half your day travelling to see clients.”
Outfitting an office is also expensive. It may cost a bank as much as US$6 million to get 100,000 square feet of high-end office space into the kind of shape it needs, with expensive electronics and backup systems to install as well as the conventional fittings. Although the monthly rent may only be HK$20 per square foot per month, the real cost may approach HK$100, including the fit out.
So headline rents are not the only consideration. Office tenants want to write those fit-out costs off over as long a period as possible. If they sign a three-year lease with an option to renew for three years, they can write down the cost over six years. At the end of the first three years, the tenant may see cheaper real estate available elsewhere in Hong Kong. But that means they have to take an immediate hit to write off 50 percent of the cost of the previous property renovation, something their landlord will likely know when the two sides negotiate.
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