July 4, 2016

Grade A Office – Rental correction amidst high vacancy rate

Chengdu’s tertiary industry expanded by 8.9% YOY in the first quarter of 2016, and the proportion of tertiary industry to GDP increased by 1.2 percentage points YOY to 53.9%, according to the Chengdu Statistics Bureau. Echoing with the economic fundamental, the city’s Grade A office market saw a pickup in leasing demand during H1 2016, reflected in a negligible increase in the overall vacancy rate despite two new completions with a combined office GFA of 175,000 sq m. However, the city’s average vacancy rate remained high, at 44%, leading to a further rental correction.

By area, demand in the emerging submarkets (Dayuan and Financial Town), located within the Hi-tech Zone, was stronger than that in the mature submarkets (CBD, East Avenue and South Renmin Road), as preferential policies launched in H1 2016 attracted tenants to certain buildings in the Hi-tech Zone. Accordingly, net absorption increased by 187% YOY to 81,222 sq m in the first half; notably, 87% of net absorption was at existing projects completed before 2016. By area, 60% of the net absorption was in emerging submarkets. New set-ups and companies relocating to higher-quality offices, particularly domestic enterprises, and IT and internet related companies, were the major sources of demand.

Though demand picked up in certain areas, the overall market still saw intense competition due to the current oversupply situation. In order to achieve higher occupancy rates, some landlords offered further incentives to tenants, including rental discounts, extended rent-free periods and increased commissions for agencies. As a result, the average rent of Chengdu’s Grade A office market continued to decrease in 1H16, down by 6.8% HOH or 11.6% YOY to RMB95 per square metre (psm) per month as of end H1 2016.

One en bloc sales transaction was completed in Chengdu’s Grade A office real estate investment market during H1 2016. Ping An Insurance acquired the Tower 3 of Chengdu Yintai Centre from Yintai Group. The building is located in the Financial Town submarket, with a total GFA of approximately 80,000 sq m. Since 2015, more landlords have started to consider a sales strategy, given the increasing operational pressure and tight cash flow as a result of high vacancy rates. However, the rapid expansion of the market in recent years has had a negative effect on the asset performance. As a result, institutional investors have become increasingly cautious towards investing in Chengdu’s office market, though Grade A office properties in prime locations with professional management and a stable income stream may still attract investors.

Chengdu’s economic growth is moderating, as seen in a reduced target for GDP growth to 7.0% in 2016, 0.9 percentage points lower than that in 2015. This slowdown is expected to be reflected in demand for the city’s office space. In the second half of 2016, two new projects with approximately 120,000 sq m of Grade A office space are scheduled to complete, in the East Avenue and Financial Town submarkets, respectively. This will bring 2016’s new supply to nearly 300,000 sq m, exacerbating the current oversupply situation. In the short term, this will lead to a further increase in the vacancy rate, which is expected to exceed 45% in H2 2016, and a continued correction in the average rent. For landlords, the market will continue to be highly competitive. For tenants, however, the current situation offers a strong negotiating position and the opportunity to upgrade to higher-quality buildings.

Retail – Demand slowed but fashion and F&B sector remained active

Chengdu’s retail sales of consumer goods grew by 9.8% YOY to RMB224.6 billion in the first five months of 2016, a slowdown of 0.5 percentage points compared with the same period of 2015, according to the Chengdu Statistics Bureau. Retail revenue increased by 9.6% YOY to RMB199 billion, 1.2 percentage point slower than the previous year. Accordingly, the average vacancy rate in Chengdu’s retail real estate market increased and the average rent for ground floor retail space edged down in the first half of 2016, as several landlords made adjustments to their brand mix and rental level in order to compete.

No new supply entered the Chengdu’s retail property market in H1 2016, and the total stock remained unchanged at approximately 4.2 million sq m. Non-prime areas continued to dominate the retail market, accounting for 85% of total stock. By contrast, the prime retail market totalled 600,000 sq m of total stock, spread across eight shopping centres.

Demand in Chengdu’s retail property market slowed, with net absorption turning negative (-8,237 sq m) as supermarket chain Park’n Shop closed all three of supermarkets in Chengdu (total of approximately 21,000 sq m) and Samsung closed its 1,500 sq m flagship store at Chengdu IFS  in the first half of 2016. As a result, the average vacancy rate increased 0.2 percentage points HOH to 8.3% in 1H 2016. Excluding these closures, net absorption totalled 14,263 sq m.

The fashion and F&B sector were active during the first half of 2016, with several new leasing and opening activities. In the prime area, new leases and openings included: new leases from Line Cafe & Store, F&B brand Playking Flammekueche and fashion brand Bouthentique at Sino-Ocean Taikoo Li, as well as new stores from Versace, Maison Margiela, Uniqlo, Issey Miyake and F&B brand Ichininmae wayo-sushi; new leases from fashion brand Ailin and a new store from F&B brand Chuanxinmianmo at Yanlord Landmark; German fashion brand Philipp Plein’s new lease and new stores by fashion brand Eve by Eve and wedding dress designer Vera Wang at Chengdu IFS; fashion brand Reshake’s new lease at Silver Square; and F&B brand Mr.Jiaozi’s new lease at Fortune Cente. In non-prime retail areas, new leases and openings included: Calvin Klein’s new lease at CapitaMall Jinniu; Goldtrans Jeans’ new lease at Galleria; F&B brands Poleon.Wang and Yan Fu Zi’s new leases at Intime City; fast fashion brand Top Feeling’s opening of a 600 sq m store at Diamond Plaza; and a new concept store from Dior’s cosmetics line and a new restaurant by The Open Life at The MixC.

The average prime ground floor rent decreased by 1.6% HOH to RMB502 psm per month, with the average prime ground floor rent in prime and nonprime areas decreasing by 3.1% and 0.9% respectively. This was attributed to rental discounts associated with adjustments to brand and tenant mixes at several projects with high vacancy rates.

Chengdu’s retail investment market remained quiet in H1 2016, with no en bloc transactions announced. A gap between the expected capital values of landlords and the required yields of investors persisted. In addition, the current competitive market, including challenges from e-commerce, has led some investors to become cautious towards investing in this sector, given the difficulties in operation and management.

Six new projects, including Yintai Centre in99 and Quangyang Wanda plaza, with a total supply of approximately 750,000 sq m are expected to enter Chengdu’s retail property market in the second half of 2016, based on the current construction process. All these projects will be located in nonprime areas. This will inevitably lead to a rise in the average vacancy rate in the short- to mid-term. Below-average rents at these properties will pull down the average rent, while on a project basis, landlords making adjustments to their trade and brand mixes may offer discounts to attract desirable brands and compete with both existing and new supply.

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