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Rebalancing within Hong Kong SAR’s office sector


The Hong Kong SAR has a long-standing reputation of vying to be one of the most, if not the most, expensive office leasing markets in the world. This unenviable title, depending on which side of the real estate fence you sit, has historically been underpinned by both broad demand and constrained supply. However, the disruptive nature of COVID-19 has stymied demand and forced organisations to review their operating models, for what is generally their second largest overhead. In turn this has driven a correction in the market and potentially creating a long-term shift in the office leasing sector.

Waning demand has resulted in a significant market rebalancing. Six consecutive quarters of negative net take-up have resulted in average vacancy rates rising from 3.8% in early 2019, to 9.8% in March 2021 as market rents contracted by an average of 23% over the period. As we consider the effect of these changes, the question stakeholders should be asking is: are we looking at a fundamental change, or just another short-term cyclical correction?

Supply vs. demand

Space rationalisation by occupiers, limited new entrants to the market, and the adoption of work-from-home (WFH) policies stemming from COVID-19 have resulted in increased optionality for occupiers. Rising vacancy rates have been further compounded by record high levels of ‘shadow stock’ (occupiers’ desire for an early termination of all, or part of their real estate liability), which currently amounts to approximately 1.8 million sq. ft. of space. Arguably COVID-19 has exacerbated pre-existing trends of space rationalisation and optimisation.

Encouragingly, we have witnessed a marginal uptick in leasing activity and enquiries this quarter; likely buoyed by renewed optimism of the vaccine rollout and potential border reopening. Regardless of this positivity, there is a need to look at the considerable new supply coming onstream between 2022 and 2026, and consider if growth in demand will maintain pace with new major developments located across the Central Business District (CBD), Quarry Bay, Kowloon East and West Kowloon (immediately adjacent to ICC). Putting this into context, the 10-year average for new space is circa 1.6 million sq. ft. per annum, while next year alone will see more than 4 million sq. ft. being launched, including exciting new developments such as Two Taikoo Place by Swire Properties in Quarry Bay, and Airside by Nan Fung Group in Kai Tak.

Turning to prime districts, while there has been virtually no new supply in the CBD since 2003, this is set to change with the introduction of Henderson Land’s Murray Road Carpark Site, CK Asset’s Hutchison House redevelopment, the expected Queensway redevelopment and Site 3 – which is worth noting as a prime harbourfront location in front of Jardine house, with the current tender process encouragingly adopting a two envelope approach, with design aspects having equal merit to the land premium paid. This is overlaid by significant new supply in West Kowloon, with both the High-Speed Rail site being developed by Sun Hung Kai Properties and anticipated commercial sites within the West Kowloon Cultural District adding a further 3 million sq. ft. of competitive space to the market.

These new developments will redefine the historical boundaries of the CBD both eastwards and northwards, driven largely by the advent of new high-quality accommodation, coupled with improved infrastructure nodes. Four separate MTR lines will connect at Admiralty by 2022 (with further lines anticipated), enhancing connectivity to the eastern fringe of the CBD, as well as the High-Speed Rail Terminus in West Kowloon which has significantly enhanced connectivity to the Greater Bay Area. This is further integrated with improved east-west road connectivity, being both the Central-Wan Chai bypass on the Island which opened in 2019, and Route 6 connecting Kowloon East and West, set to complete in 2025.

Nearing a cyclical market trough

Market dynamics have shifted significantly, unsurprisingly being most pronounced in the CBD, where roughly 40% of Grade A space is leased to financial institutions, resulting in a 19% rental contraction in 2020 alone. While decentralisation has historically been a driving force for office moves, it is plausible that upcoming supply within the CBD, coupled with a narrowing delta between commercial districts and ever-rising capital costs, will manifest in stronger demand and rent growth for CBD locations when market conditions improve. We have already seen isolated examples of ‘recentralisation’ as firms look to upgrade and capitalise on current market conditions.

Given signs of stabilisation, we currently anticipate that the cyclical market trough will occur in mid-2021, yet the year is set to remain negative overall. Despite traditionally volatile rental trends, renewed optimism is unlikely to materialise in significant new demand over the near term given continued space rationalisation and continued adoption of WFH policies (to some degree) for the foreseeable future.

Consequently, shifting market conditions and new ways of working coupled with significant new supply, are manifesting in a healthy ‘rebalancing’ of negotiating power in favour of occupiers who have long struggled to achieve significant flexibility within their lease terms. The increased supply of quality assets is a value add for tenants in a post COVID-19 world who are increasingly concerned with advanced ventilation systems, Green Credentials, enhanced building automation and security, and overall staff wellness. Ultimately uncertainty creates opportunities, and from an occupier perspective, optionality is rarely this attractive.

To discover more about the latest office leasing trends in Hong Kong, contact David today to See What Could Be how he can help accelerate the success of your people and business.

This article was published in South China Morning Post on 27 April 2021.