Clipped office rents may herald structural change in demand

20150513-bt-clipped-office-rents-herald-change-in-demand-pic THE Business Times reported last week that several property consultants are lowering their forecasts for CBD Grade A office rental growth this year. This was triggered by weaker-than-expected leasing demand for office space in the central business district since late last year, resulting in weak rental growth in the first quarter of this year.

No significant improvement in demand is expected in the short term. Given slow economic growth, most financial institutions are taking a conservative stand on their office space commitments. In fact, several multinational banks could shed office space in Singapore - either by returning some space to landlords when their leases come up for renewal, or by disposing of excess space on an ongoing lease by finding sub-tenants or replacement tenants.

Since the end of last year, real estate investment trusts (Reits) with substantial Singapore CBD office stock have been sold down. CapitaLand Commercial Trust (CCT) and Suntec Reit have eased 7.4 per cent and 11.7 per cent respectively from the end of last year to last Friday. Although the Keppel Reit price has been weak for some time, it has still dipped 1.6 per cent year to date.

In contrast, Reits with strong exposure to retail property - such as CapitaLand Mall Trust, Frasers Centrepoint Trust and Mapletree Commercial Trust - posted price gains of 4.4 per cent, 8.7 per cent and 7.8 per cent respectively over the same period.

Office Reits have also underperformed because of concerns about a potential oversupply from the upcoming completion of Guoco Tower, Duo Tower, V on Shenton and Marina One.

Now, with fresh concerns about weak CBD office demand, could this spark a new wave of selling of Singapore office Reits?

To put things in perspective, even if office rents were to flatline this year and decline next year, Reits may still be able to lock in positive rent reversion on lease expiries/re- newals next year. CBRE's Grade A (CBD Core) average gross effective monthly rental value rose almost 15 per cent last year to S$11.20 per square foot (psf). In the first quarter of 2015, the rental level managed a 1.8 per cent quarter-on-quarter increase, and CBRE now expects the figure to remain flat for the rest of this year.

Supposing the rent were to ease 5 per cent next year to S$10.83 psf, it would still be higher than the S$9.55-9.75 psf in Q1-Q4 2013 (the previous rental, assuming a three-year lease).

Another point to note is that Singapore's prime office rents are already pretty low today. The Q1 2015 rental level is about 40 per cent lower than the all-time peak of S$18.80 psf in Q2 and Q3 2008, before Lehman's collapse. More importantly, Singapore office rents are competitive vis-a-vis other cities such as London, Hong Kong, Beijing, Shanghai and Tokyo. Singapore was ranked 14th in the CBRE's Global 50 Index of the most expensive cities in terms of occupancy cost for prime office space for the 12 months to Q3 2014. It was once in the top 10; the Republic was in ninth position in the Q3 2008 ranking. Global occupiers including financial institutions should find Singapore's office rents relatively competitive.

On the supply front, by some counts, the overall volume of new office supply completion in Singapore on a 3-4-year horizon is manageable.

The problem, however, is the bunching up of completions around the same period in late 2016/early 2017. Unless the spike in completions is accompanied by a matching jump in net take-up of offices, a rise in vacancy can be expected. A flight to quality by occupiers moving to newer projects, riding on soft market conditions to seal leases on favourable terms, could send landlords (including Reits) of existing office buildings scrambling to find replacement tenants.

The problem would be exacerbated if what some market watchers believe is true: that Singapore's CBD office market could be on the cusp of a structural change in demand.

Some occupiers are being drawn to suburban offices and business parks. Last week, BT reported that Daimler (which owns the Mercedes- Benz brand) is moving from Centennial Tower (a stylish office building owned by Pontiac Land Group) to Westgate Tower, next to Jurong East MRT Station. The rental saving has been estimated at around 30 per cent.

Internet search engine giant Google is widely expected to move from its funky offices at Asia Square Tower 1 in the financial district to Mapletree Business City II (MBC II), a business park development in Pasir Panjang. Cost may not be the only reason Google is planning the move to suburbia; the campus-like setting of the space Google is expected to lease at MBC II - it will enjoy an expansive floor plate spanning three blocks, and plenty of roof space - is said to be a major draw.

Microsoft too has been reported to be mulling over a move from One Marina Boulevard in the CBD to MBC II.

Previously, office landlords could rely on tech companies to make up for the slack in Grade A office demand from financial institutions in the CBD. This may no longer be the case.

These are factors that Singa-pore's planners will have to take into account when deciding how much land to sell for new office developments in future, and where. These factors will have a bearing on the playing field in which the likes of Suntec Reit, CCT and Keppel Reit operate.

Source: Business Times, 13 May 2015