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MARKETIN
MINUTES
Savills Research
Office
Effective rent decline slows to a crawlOffice leasing activity has continued to rise in Q2.
Savills plcSavills is a leading global real estate service provider listed on the London Stock Exchange. The company established in 1855, has a rich heritage with unrivalled growth. It is a company that leads rather than follows, and now has over 600 offices and associates throughout the Americas, Europe, Asia Pacific, Africa and the Middle East. This report is for general informative purposes only. It may not be published, reproduced or quoted in part or in whole, nor may it be used as a basis for any contract, prospectus, agreement or other document without prior consent. Whilst every effort has been made to ensure its accuracy, Savills accepts no liability whatsoever for any direct or consequential loss arising from its use. The content is strictly copyright and reproduction of the whole or part of it in any form is prohibited without written permission from Savills Research.
“ With markets flushed with liquidity, it is only a matter of time before this feeds through to rising office space demand.” ALAN CHEONG, SAVILLS RESEARCH
• Office leasing activity has continued to increase from a year ago with more companies choosing to renew their leases in Q2/2021 as many lack budgets for fit outs should they move to new premises.
• Most existing tenants are re-evaluating their leases to right-size their office footprint. As firms renegotiate their rents and reduce their office space, the total value of rental contracts shrank in Q2/2021 from the same period last year, albeit leasing volumes were higher.
• While Chinese and tech firms continue to support overall occupier demand for good quality offices in highly sought-after locations, the new take-up mostly involved smaller offices compared with the larger scale office space required by former tenants. As such, overall vacancy stayed flat at 7.3% in Q2/2021.
• The new leases signed by the Chinese and tech firms who expanded their footprint in high-quality and well-located offices were likely to have signed at a slightly higher rent. Compared to Q1/2021, the average gross effective rent in our basket fell at its slowest since 2019, down by 0.4% quarter-on-quarter (QoQ) to S$9.37 psf.
• Our forecast for gross effective (stressed) Grade A CBD office rents in 2021 has been revised from -5% YoY to 0% to -3% year-on-year (YoY). For 2022, if no complications arising from new variants impact the economy, rents are expected to range from 0% to 2%.
Singapore – August 2021
Simon SmithRegional Head of Research & Consultancy Asia Pacific+852 2842 [email protected]
Alan CheongExecutive Director Singapore+65 6415 [email protected]
Marcus LooCEO, Singapore+65 6415 [email protected]
RESEARCH
SINGAPORE
Please contact us for further information
Savills team
Ashley SwanExecutive DirectorCommercial+65 6415 [email protected]
MCI (P) No. 022/10/2020Company Reg No. 198703410D
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MARKET COMMENTARYThe continuity of economic recovery in the domestic sector was broken by the imposition of tighter restrictions in May. Even though Singapore’s economy saw a robust growth of 14.3% YoY in Q2/2021, it was due to the low base last year when there was a non-essential business lockdown. Compared with the preceding quarter, the economy contracted 2.0% in Q2/2021, a reversal from the 3.1% expansion in Q1/2021. The manufacturing sector remained the bright spot, extending its growth from the previous quarter with a 18.5% YoY increase. However, on a QoQ basis, the sector ended its two consecutive quarters of growth with a contraction of 1.8%. Despite an overall contraction (-1.0% QoQ) for the services sector, the information & communications, finance & insurance and professional services sectors collectively expanded by 0.4% QoQ in Q2/2021, a turnaround from the 1.2% contraction recorded in Q1/2021.
In the face of additional pre-emptive measures since May, workplace capacity was reduced to 50% and eventually work-from-home (WFH) became the default. Despite the gradual reopening to Phase 3 (Heightened Alert) from June 14, WFH remains the default arrangement to keep transmission risks down. Notwithstanding that, many are still contemplating implementing flexible work arrangement in the long run. With that, office leasing activity picked up from a year ago alongside more rental renewals in Q2/2021. Notably, many firms renewed their office leases because they either do not have any fit-out budget or given a very austere one.
Rather than giving up their office space, most existing tenants are re-evaluating their leases to right-size their office footprint. As firms renegotiate their rents and reduce their office space, the total value of rental contracts shrunk in Q2/2021 from the same period last year, albeit leasing volumes were higher. In the Central Area, the number of
leasing transactions in the <100 sq m size category made up 41% of all leases in Q2/2021. In Q1/2021, the percentage was 35%. For larger unit sizes, >1,000 sq m made up 5% of total leasing volume, down from the 7% recorded in Q1/2021. Apart from the existing lease renewals, the leasing market is also supported by some new demand driven by Chinese and tech companies, who are still coming and taking up space here.
DEMAND AND VACANCYWhile some firms are consolidating their footprint alongside an increased uptake of remote working and flexible work arrangements, Chinese and tech firms continue to support overall occupier demand for well-maintained offices in highly sought-after locations. Nonetheless, the new take-up mostly involves smaller offices compared with the usual larger scale office space required by former tenants. As such, CBD Grade A offices tracked by Savills recorded a net demand of around 1,000 sq ft in Q2/2021. With supply remaining unchanged, overall vacancy levels stayed flat at 7.3% in the reviewed quarter.
Notably, the occupancy levels in Grade AAA buildings started to improve in Q2, while Grade A buildings continued to weaken. In terms of location, vacancy rates in micro-markets such as Marina Bay (down by 1.3 ppts QoQ to 8.2%) and Tanjong Pagar (down by 1.5 ppts QoQ to 6.6%) recorded the largest decrease from the last quarter. However, some prime office buildings are still facing pressure on their occupancy rates, pushing vacancy rates in other key business districts like Raffles Place micro-market up by 1.4 ppts QoQ to 8.4% in Q2/2021.
RENTSFollowing five consecutive quarters of falling rents in Savills basket of CBD Grade A office buildings, the rate of decline has slowed to a crawl, the slowest since 2019. This may be
GRAPH 1: Net Demand, Net Supply and Vacancy Rate of CBD Grade A Offices, 2016 to Q2/2021
-10%
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2016 2017 2018 2019 2020 1H/2021
SQ
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Net Demand (LHS) Net Supply (LHS) Vacancy Rate (RHS)
Source Savills Research & Consultancy
GRAPH 2: Rental Indices of CBD Grade A Offices, Q1/2016 to Q2/2021
150
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Source Savills Research & Consultancy
LOCATION MONTHLY RENT (S$ PER SQ FT) VACANCY RATE (%)
Marina Bay 12.25 8.2
Raffles Place 9.53 8.4
Shenton Way 8.61 10.2
Tanjong Pagar 8.43 6.6
City Hall 9.67 4.6
Orchard Road 8.91 2.4
Beach Road/Middle Road 7.43 4.6
TABLE 1: Micro-Market Grade A Office Rents and Vacancy Rates, Q2/2021
Source Savills Research & Consultancy
Office
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Underlying all this, the WFH theme is still pervasive.
The actions taken to combat the pandemic (WFH, restrictions to travel, social distancing) have reset the decades old parameters which have fashioned broad office market behaviour. Unfortunately, because the market is still nowhere close to attaining the next equilibrium, be it permanent or a transitory one, there is a lot of noise regarding its future trajectory. Thus, even for industry veterans, their views are almost as good as a naïve one because such an upheaval had never been experienced before.
However, we believe that some of the noise can be cleared off from the twin perspectives of money supply and credit growth. From a money supply angle, broad money supply (M3) had been trending up over the decades, but that accelerated in 2020, exceeded only by the years 1972 and 1986. (Graph 3) And despite the G20 economies contracting 3.3% in 2020, bank credit to domestic companies as a percentage of the global economy rose by an average of 14.4%. For the period January to April 2021, the average growth for the same measure was 17.7%. In other words, although economies did not fare well during this pandemic, more money was created as credit. (Graph 4)
All these increases could not be simply swept under a rug and it has to somehow manifest itself in some form or other in the economy. For example, credit can be channelled to:
- Financial (public and private equity, debt, alternative products etc);- Old economy firms;- New economy firms;- Consumers
Of the four general users of credit, the first three would most likely use a greater quantum of office space. We are already seeing the liquidity effects manifest themselves in the form of asset price inflation as seen in the exorable rise of global financial indices and real estate prices. However, the real economy is still not reflecting this. The spill over from the financial economy to the real one may take time though and we believe that it may be 2022 when we will see the effects. According to research by the OECD, in 2020, GDP growth amongst the G20 countries was a negative 3.3% but is forecast to rise 5.0% in 2021. Global growth is now projected to increase 5.8% this year, a sharp revision from the 4.2% given in December 2020. (Graph 5) The upward revisions were a reaction to the rapid roll out of vaccination programs in the developed economies and the massive spend by the Biden administration in the US.
a signal that office rents may be bottoming out. Compared with Q1/2021, the average gross effective rent in our basket slipped by 0.4% QoQ to S$9.37 psf. For good-quality buildings in prime locations, especially those rate AAA in our generic Grade A basket, rents have stabilised. While some firms gave up their space as part of a right-sizing strategy, some Chinese and tech firms have seized the opportunity to expand their footprint in better-quality and well-located offices. These new leases are likely to have transacted at a slightly higher rent as firms took up less space than the vacating tenants, hence easing the pressure on overall office rents.
As a result, key business districts such as Marina Bay, Raffles Place, Shenton Way and Tanjong Pagar micro-markets saw a more moderate pace of rental decline in Q2/2021. Rents in the Beach Road/Middle Road micro-market remained flat after five straight quarters of decline. (Table 1)
OUTLOOKAs a reaction to COVID-19, on balance, more office tenants are in the process of right-sizing than upsizing. Also, many have or are planning to shrink their space requirements significantly and intuitively, this leads many to conclude that rents should continue falling even after the pandemic is close to over.
While we certainly believe that downside pressure exists for Grade A CBD office rents, opinions amongst office leasing experts on the outlook for rents for the remainder of this year and next is still fragmented. However, what is notable has been a change to their prior beliefs in the past three months, shifting from being moderately bearish (a -5% YoY change for 2021) to close to neutral with some even opining that rents could rise. The latest outlook came in the weeks of June and July 2021 after in situ experience when landlords appear to be more confident in maintaining rents than at the start of the year. Furthermore, the plans of tenants to right-size are expected to be more distributed over the course of the next 12 months instead of clustering around the next two quarters. The spacing out effect coupled with buildings such as AXA Tower and Fuji Xerox Tower being taken offline for redevelopment has given landlords the confidence to dig in.
However, the expectations for office demand among professionals for the next one year is still varied and dependent on the sub-sector they are focused on. Activity in the co-working space has been high and so are those servicing tenants looking to expand from serviced-offices/co-working spaces, to their private premises. Then there is another group seeking to right-size and considering even industrial (B1) buildings (if they meet the screening criteria) or lower grade offices.
GRAPH 3: Broad Money Supply (M3) of Major Economies, January 2010 to May 2021
40
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United States United Kingdom TurkeySouth Africa Russia OECD - TotalMexico Korea JapanIndonesia IndiaCanada Brazil Australia
TO
TA
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015
=10
0,J
AN
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12 –
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Y 2
021
Source OECD, Savills Research & Consultancy
GRAPH 4: Domestic Credit To Private Sector By Banks As A Percentage Of GDP (Global), 2010 to 2020
80
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%
Source World Bank, Savills Research & Consultancy
GRAPH 5: G20 GDP Growth Forecast, Q4/2019 to Q4/2022
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Forecast
Source OECD
People’s Republic of China
Office
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Ultimately, the multiplier effects begin trickling down to office demand happen but the pass through is not expected to be equivalent to prior norms. The WFH culture is likely to water down the correlation between economic growth and office demand and this will be further compounded in complexity by the rise of new economy companies which add less to GDP under the income method but whose high rate of cash burn contributes to consumption, investment and thus office demand. In other words, in a COVID environment, we need a new model specification for office demand. Even then, the newly defined or redrawn parameters are likely to evolve as companies seek to understand how they will work with businesses both upstream, downstream and
landlords may wish to strip this off in their rental submissions to the authorities, each case may have to be taken on its merit and any disallowance of this may inadvertently leak through to boost the rental indices. The second is something that will be felt from 2022 onwards. The accelerating coverage of carbon accounting for more activities is likely to result in higher operating expenses for landlords. Ultimately, they will pass these costs to tenants in the form of higher base rents.
Our forecast for gross effective (stressed) Grade A CBD office rents in 2021 has been revised from -5% YoY to 0% to -3% YoY. For 2022, if no complications arising from new variants of the virus impacting the economy, rents are expected to range from 0% to 2%.
longitudinally in the new environment.The demand for Grade A CBD office space
should therefore return, but one must give it time. Companies need to retreat and rethink their new office space strategies and only when a new equilibrium is attained then they can use that as the baseline from which to expand. All this is expected from 2022. Until then, as landlords are still confident about their finances and with negative new supply (as AXA Tower and later Fuji Xerox buildings get redeveloped), rents should start to bottom in 2H/2021.
There are tailwinds which could make rents turn up faster and sharper than expected. One is the inclusion of fit out costs into the base rent. This is increasingly being practiced and although
Office
