The National Bureau of Statistics (NBS) reported China¡¯s investment in real estate development surged 32.1% year-on-year in the first four months of 2008, to reach RMB 695.2 billion. Not a bad clip given the credit woes being reported across the Western world. Does this mean real estate in China and, more specifically Shanghai, will avoid much of the fall-out from the ongoing global credit crunch? This article will look at some of the issues currently facing the Shanghai office market in terms of how build rates, corporate expansion plans and different market sectors, maybe affected by wider macro influences.
A lack of supply has been the defining characteristic of much of the Shanghai office market over the last few years, with vacancy rates in Grade-A buildings hovering at around just 5% since 2004. However, this headline figure obscures four important sub-divisions within the market: Premium Grade-A against their older Grade-A peers, Business Centres and finally Grade-B offices. Vacancy rates across these four sectors are not constant and, more recently, look to have been on divergent paths.
In addition to the building categories, there are also important differentiations to be made in the type of tenant, and the prospect of their interrelationship with occupancy rates. These can broadly be divided into four major categories: large multinationals and their domestic equivalents, medium sized domestic companies, medium sized foreign equivalents and new foreign entrants. The credit crunch as it now stands, is likely to effect these groups in quite different ways.
With domestic consumption growing at a breathtaking pace, up 21.4% year-on-year in the first half of 2008 to RMB 5,103.3 billion, leading multinationals and their local competition are likely to remain committed to the China, regardless of fall-offs in their more developed markets (a severe downtown in core markets may even increase this commitment, in the search for growth). This bodes well for take-up of the Premium Grade-A properties, where demand should remain brisk. Conversely it is likely to effect smaller foreign operators either already in China or, planning to expand here. While, for medium sized domestic operators, there is likely to be an invisible dividing line between those who are over reliant on exports being hurt and those serving domestic consumption, remaining reasonably buoyant. Trends which will likely hold-back older Grade-A and Grade-B rents.
Dealing first with new office projects being developed: by the second quarter of the year, eleven buildings were added with a total of 554,000sqm. This represents approximately half of the estimated 1,068,000sqm expected to come on line this year which is almost equivalent to all new office projects added between 2004-2007. These additions have also been skewed towards Pudong, with development there representing 663,234sqm of the total. In addition to this spurt of construction, there has been a marked and rapid increase in the number of business centres (serviced offices). At last count there were some 45 centres now operating in the city, up from just a handful three years ago. Given the sheer volume of space being added, a softening of rents in some areas along with higher vacancy rates, seem almost inevitable.
Anecdotal evidence suggests this process is already starting. Asking rents across the top tier serviced offices have declined about 20% from their peak, as established international operators face the duel challenge of smaller, less expensive domestic competitors and, a slowing down in general demand. The picture is more varied across Premium Grade-A offices and, is more dependent on location. While in Pudong, buildings such as Azia, were once running a waiting list, they are now having to reduce rents to retain tenants, who can find more options opening up in some of the newer developments. In contrast Puxi has seen record rents achieved ¨C with RMB 18/sqm/day in Plaza 66 and RMB 20/sqm/day being quoted at The Center. With the exception of Park Place, this reflects the lack of Premium quality stock added over the last 12-months. So in general Puxi rents are expected to remain firmer than their Pudong counterparts over the next 18-months.
In this sense, higher quality buildings may escape the effects of the global credit crunch. Although they are unlikely to escape entirely the additions of space to be added in 2008 and 2009. These additions are expected to lead to a leveling out and perhaps even drop in rents in Pudong. However, large scale relocations in search of marginally lower rents are most unlikely: only if prime rents got really out of synch (perhaps 25% differential) might there be any big movement in the market between Puxi and Pudong.
However, this new round of building is likely to impact on older Grade-A and Grade-B offices, with the former more at risk to downward adjustment. As the older Grade-A buildings lose their prestige marque, they will face the challenge of re-positioning their value point. Being stuck between Grade-B and their newer cousins, the likelihood is, some of these buildings will be obliged to adjust down their asking rents. Again, Pudong is expected to show the most pronounced changes in this context.
While a marginal fall in Pudong rents is not a foregone conclusion it is a possibility. Should this happen, it will not be on account of the global credit crunch, rather due to the significant amount of stock being added into the market this year and next. Conversely the prospects for Puxi rents suggest continued growth over the next 18-months across both Grade-A and Grade-B properties. If there is one section which may be adversely effected by a combination of over-stocking and credit crunch woes, look to the serviced office market, with its reliance on smaller multi-national entrants. Still not a foregone conclusion: but the segment likely to face the greatest challenges over the next 18-months.
