Grade A office rents in Central down 1.5%

Rents to edge down 8% in the next 12 months behind the fragile economic recovery of the US and the debt crisis in the Eurozone.

Grade A office rents in Central have experienced its maiden decline in two years, according to Colliers International’s Hong Kong Office Market Report.

This largely falls back on deteriorating business sentiment amidst uncertain global economic environment which caused expansionary demand from the banking and finance industries to weaken. Coupled with growing rental resistance towards individual pricey developments, Grade A office rents in Central mildly decreased 1.5% quarter-on-quarter (QoQ) in 3Q 2011. 

“Clouded by the fragile economic recovery of the U.S. and the lingering sovereign debt crisis in the Eurozone, several multinational corporations temporary shelved their expansion plans, while a number of landlords became more flexible in rental negotiations,” said Simon Lo, Executive Director of Research & Advisory, Asia at Colliers International.

Meanwhile, rental growth in the other sub-districts tapered off with Wanchai/Causeway Bay at 2.2% QoQ, Island East at 3.7% QoQ, Tsim Sha Tsui at 4.8% QoQ and Kowloon East at 3.5% QoQ. As a whole, the overall Grade A office rent in 3Q 2011 remained unchanged, compared to the previous quarter.

“Compared Wanchai/Causeway Bay, Island East and Kowloon East, Central district would be the most vulnerable to easing with rental gap close to historical highs as of 3Q 2011,” commented Lo. 

However, the slowdown in office leasing activities has yet to be fully reflected across the board in 3Q 2011. In spite of drawback in demand by banking and finance corporations, tenants in private equity and the legal sector were comparatively active in office leasing enquiries and typically required 3,000 to 5,000 sq ft offices. This helped push net take-up levels in Central from negative 105,000 sq ft in 2Q 2011 to 125,000 sq ft in 3Q 2011.

Faced with sky-rocketing rents, some small or cost-sensitive tenants in Central have started looking for alternate office accommodation outside Central or at less pricey options in lower quality offices at the fringe of Central.

“We see a chain effect forming with relocating SME tenants from core Central pushing out those previously located in fringe Central, who is consequently forced to move to other sub-districts such as Wanchai/ Causeway Bay,” adds Lo. “Movements of such are elements which drive leasing demand in the marketplace. The overall net take up of Grade A office increased 48% QoQ to 374,000 sq ft in 3Q 2011.”

Meanwhile, the overall vacancy of Grade A office trended upwards by 14 basis points from 4.6% in 2Q 2011 to 4.7% in 3Q 2011. Upward pressure on office vacancy is expected to continue due to the anticipated completion of two office developments in the remainder of 2011, including LHT Tower in Central of over 100,000 sq ft (net floor area) and the development at 414 Kwun Tong Road in Kowloon East of 203,000 sq ft (net floor area), and pending vacancy as a result of increasing lease expiry or surrendered spaces in 4Q 2011. The average vacancy level of the overall Grade A office market is expected to reach its historical average of 5.0%, potentially during the first half of 2012.

On the sales front, investment demand for office property softened in 3Q 2011. The total consideration of investment sales transactions in the quarter was Hk$3 billion, below the historical average of HK$5.6 billion per quarter. With the limited enbloc office investment stock available for sale, strata-title office properties in decentralised locations in Kowloon East took the spotlight focus. Despite low activity in the market, office prices still held firm in 3Q 2011 as investors refused to budge from their asking prices or willing to sell their office premises at significantly discounted prices.

Looking forward, dark clouds are looming over the Central office market as the district has been experiencing falling rents since July 2011. In view of the weakening economic environment and deteriorating business sentiment, it will be increasingly difficult to find tenants, especially in the banking industry, or to secure large office spaces willing to pay expensive rents in Central. According to Colliers’ research, the overall Grade A office rents are projected to slow and undergo a downward correction by 8% over the next 12 months.