Hong Kong and Macau, 9 January 2009 -- In the Grade-A office market, oversupply combined with slowing demand continued to sway rental agreements in the tenant’s favour. “Landlords are now more willing to offer generous renewal packages in order to retain high-profile tenants,” noted Anthony Couse, managing director for Jones Lang LaSalle Shanghai at the firm’s Q408 property review. In the retail market, a high level of demand supports an increase in rents even with 86,000 sqm of additional retail space coming on stream in this quarter. Luxury residential finished the year on a quiet note with few transactions and diminishing demand from new expatriates. For property investment market, no new foreign acquisitions took place in the last quarter as many investors view 2009 as the time to buy. With domestic consumption projected to increase in the Yangtze River Delta, growing demand for domestic retail distribution is expected to drive the logistics real estate market in 2009. Overall, 2009 is anticipated to be a change in pace due to the effects of economic stimulus measures.
Rents drop 10% across the city. Significant rental declines were seen in most of Shanghai’s Grade-A office buildings in the 4th quarter. Pudong average rentals fell 15.5% compared to the previous quarter as buildings completed in the third quarter still struggle to find tenants while landlords of older buildings offer generous renewal packages to retain key tenants. The declines were not limited to just supply-heavy Pudong, as Puxi rents declined 8% in the 4th quarter. No significant changes in the overall vacancy were seen as city-wide and Pudong vacancies remained at 13% and 22%, respectively. One new building, Mirae Asset Tower, was completed this quarter adding 51,000 sqm to the market. Pre-commitment for this building saw little change, remaining at approximately 40%. Shanghai World Financial Centre also saw limited change in the amount of committed space, remaining at approximately 40%.
Premium Grade-A building Landlords adapt to the market. Rents began to decline in all office sectors in Shanghai in 3Q08, all except Puxi’s highest quality – Premium Grade-A – buildings, where rents increased by 2.2% in the third quarter. In the fourth quarter however, average rents for Puxi Premium Grade-A buildings joined the rest of the market and decreased by almost 12%. Rents for Premium Grade-A buildings in the Pudong submarket dropped 18% q-o-q as the majority of the new supply in Pudong has been of Premium Grade-A quality and positioning. Even though vacancy rates for Puxi Premium Grade-A buildings is very low (4.6%), Puxi landlords must compete with newly completed Premium Grade-A buildings in Pudong (market vacancy rate of 33%) in enticing or retaining high profile tenants with lower rents. Overall, Premium Grade-A buildings are still achieving higher rents than the overall Grade-A market average but the price spread compressed from RMB 2.5 more than average in 3Q08 to RMB 1.6 in 4Q08.
Rental declines expected to continue in ’09. After two consecutive quarters of rental decline, office rentals are expected to continue the trend in 2009, given high vacancy and additional new supply. Demand for additional space from MNCs will be limited until hiring freezes are lifted and growth resumes. New supply deliveries scheduled for 2009 will create additional downward pressure on rents in Pudong and Puxi, amplified by the upcoming wave of new supply over the next 12 months in decentralised locations. Tenant retention will also play a large role in the market and landlords will be under pressure to offer generous renewal packages in order to keep their best tenants. However, the lower rental environment is expected to create an emerging source of demand from a wider base of domestic companies as many can afford to relocate from their current space in Grade-B buildings to the Grade-A market.
Retailers still see China as a source of growth. Although retail sales across the world are on the decline, many international retailers still see the Chinese market as a source of potential growth. However, retailers are increasingly more cautious when drawing up expansion plans. Retailers are now only willing to expand within the city or throughout the country if the store is capable of being profitable in the near-term. New entrants into the market this quarter included Marks & Spencer, Dunkin Donuts and Net. Best Buy continued to expand the company’s presence in the city by opening several additional locations in the fourth quarter. Average rentals for prime ground floor space in Shanghai increased by 3.1% q-o-q as demand for quality space has not slowed down. Shanghai’s prime retail projects did not see any signs of retailers fleeing the market. The overall vacancy in the market remained low at 6.5%. Plaza 353 in Huangpu District and Plaza 96 in Pudong both opened to the public in the fourth quarter, collectively adding 86,000 sqm to the otherwise tight market.
Retail rents will be last to fall in 2009. Rents in all other sectors have already begun to fall, while retail rents continue to rise. Growth in total retail sales is expected to slow down in early 2009. The effect on prime rents will begin to show when leases start to expire and tenants who will find it more challenging to be profitable negotiate for lower rentals. Retailers will be expected to generate ways to differentiate themselves from the competition, and landlords will have to become more proactive about retaining their best tenants. A substantial amount of new supply in prime downtown areas will be completed in 2009 but is not expected to cause a dramatic decrease in rentals, as healthy take-up of the new space is expected. On West Nanjing Road, three new projects, Park Place, Tom Lee Building and Ivy Commercial Plaza, are expected to enter the in 2009 and add a total of 80,000 sqm to the famous shopping street.
Regulatory changes have strengthened mass market. Several amendments were made to provincial and national regulations to entice more buyers in the market. In addition to several reductions to interest rates, the government has put forward other incentives to spur the market. The new measures, set to revive the residential market, mainly include reduction in transaction and borrowing costs and decrease in down payment for first-time home buyers. These regulatory changes combined with lower prices did in fact have an effect on the market, as transaction volume increased in November and December. Prior to the regulatory changes being implemented, September 2008 will represent the low point in transaction volume on a seasonally-adjusted basis.
Luxury market remains subdued. Although regulatory changes attributed to an increase in mass market residential transaction volume in November and December, the luxury market remained subdued as many projects still refused to lower prices in the fourth quarter. Although anecdotal evidence suggested substantial declines in sales prices, capital values of luxury apartments in Shanghai only saw a moderate correction as the majority of sellers remained optimistic on the mid to long-term outlook. In the second-hand market, transactions also remained limited in 4Q08 being limited to distressed sales. Average capital value of luxury apartments fell by 3.7% q-o-q to RMB 33,805 per sqm in 4Q08. The leasing market was also impacted as a growing number of expats are localised, new arrivals are fewer in number, and new supply is released. Luxury apartment rents fell 3.4% from third quarter.
Cool outlook for 2009. It appears that the current price adjustment is still not sufficient to attract potential luxury buyers who continue to stay on the sidelines, awaiting further price declines. As such, we expect to see further drops in capital values of luxury apartments in Shanghai in 2009 until buyers’ confidence is restored. As overseas Chinese play a large role in the luxury sales market, confidence of luxury buyers is less closely tied to the domestic economy and stimulus policies than in the mass market. With lower leasing demand from expatriates, and the declining role of expatriate packages, vacancies will be on the rise in 2009 and rents will continue to decline.
Benefit from flexible positioning. The recent rise in vacancy levels is partially due to seasonality, but also indicative of increasing cost consciousness amongst multinational corporations in light of the global economic downturn. Luxury properties with large unit sizes focusing on the long-stay segment seem to be most exposed to softened demand from fewer expatriate relocations, repatriations and housing budget reductions. On the other hand, high-end properties with smaller unit sizes that are willing to take on medium-and short-term stay demand are better positioned to maintain, or even grow occupancy, as companies replace long-term relocations with medium-term assignments. In this environment, serviced apartments’ ability to redefine their customer base has served as a hedge against changing market conditions.
Foreign real estate acquisitions drop 26% from previous year in Shanghai. 2008 witnessed a slowdown in the amount of foreign real estate acquisitions in the Shanghai market with no new major transactions involving foreign investors occurring during the fourth quarter. Foreign acquisitions totalled RMB 16 billion throughout 2008, down 26% from 2007 and down 12% from 2006. Several factors played a role in the slowdown of foreign money; however the main driver was restrictions placed by the central government on so-called “hot-money”. Global factors such as the overall lack of liquidity in credit markets around the world also played a large role as many foreign investors were unable to raise enough capital or leverage for investments. On top of this many foreign investors are beginning to revisit investment opportunities in developed markets since declines in capital values in these markets have occurred more rapidly, presenting high return possibilities in a perceived lower risk environment.
Cautious investors turn focus toward Tier I core investments; Tier I activity to pick up in ’09. Investors in the past few years turned to Tier II and III cities in search of higher yields and to escape overvalued assets in China’s Tier I cities. Global economic conditions have however changed this strategy as capital values in Tier I cities begin to fall significantly, presenting new investment opportunities. Although foreign acquisitions in Shanghai slowed to a halt in the fourth quarter of 2008, a pick up in 2009 with foreign investment is expected to follow the easing of regulatory restrictions and as buyers and sellers adjust to more reasonable expectations for both parties. Capital raised in 2007 and 2008 hasn’t yet been spent, and investors wait in the sidelines for capital values to come down. In 2009, there is an expectation that it will be easier to raise RMB loans as credit restrictions are poised to loosen.
Rentals for bonded space experienced first decline. Slowing demand for Chinese exports caused rents for bonded logistics space to decline in Shanghai. Demand for non-bonded space remained stable in the fourth quarter as the need for domestic distribution channels resulted in rentals remaining at the previous quarter’s level. Logistics developers are adjusting their previous development plans to be more conservative as uncertainty plagues the current market. However, four new projects will be released in 2009: Prologis Park Hongqiao North, Prologis Park Songjiang, OceanBlue Lingang Logistics Center Phase III and Vailog Jiading Logistics Distribution Center. All together the projects will add 142,774 sqm of space to the market. In 4Q08, Sinotrans began operation in the initial stages of the Sinotrans Logisitics Centre developed by Goodman in Fengxian District. On December 23, GIC Real Estate acquired ProLogis’ operations in China and 20% interest in property funds in Japan for a total cash consideration of US$ 1.3 billion.
Quality business park supply will increase by end 2009 and remain an attractive cost-saving option. At the moment quality space in Shanghai’s popular business park zones is hard to find. However, by the end of 2009 large amounts of new supply will start to be completed, especially in Jinqiao and Zhangjiang. This new supply will put some downward pressure on rents but there is pent-up demand waiting for the space. Compared to core CBD buildings, business park rents are already significant lower and will be under less pressure to fall. Business park space continues to be an attractive cost-saving option for occupiers even compared to decentralised grade-A buildings.
Long-term outlook remains optimistic. In light of slowing economic growth, many manufacturers have temporarily delayed new set-up and expansion plans but remain optimistic with the medium-to-long term future. Many manufacturers view this as an opportunity to rationalise and consolidate operations from other geographies. During the fourth quarter, major investment promotion events were held at key development zones in Shanghai. At the events, companies in an array of industries announced over 100 investment and expansion projects. These corporations included ExxonMobil, Intel, Coca Cola, ABB, Microsoft, Neusoft and Sandvik. Rosenberger, a global high-tech manufacturer, recently confirmed plans to relocate from Jinqiao to a larger facility in Zhangjiang East. Investment activity involving manufacturing space is expected to pick up in 2009 with some manufacturers willing to engage in sale and leaseback options in order to free up capital for other functions.