The rate of decline in overall rents slowed to 3.4% in the third quarter, compared with 3.8% in the previous quarter.
Hong Kong Island rents fell by 5.8% in Q3/2020 and rents in Central, Wanchai/Causeway Bay and Island East were down by 5.0%, 6.6% and 4.2% respectively on the back of much weaker take up. Kowloon rents fell more mildly by 1.3%, with rents in Tsim Sha Tsui and Kowloon East falling by 2.3% and 0.3% respectively. Rents in Kowloon West remained unchanged. All districts on Hong Kong Island recorded larger decreases than during the previous quarter while all districts in Kowloon did the exact opposite. Tenants are clearly prioritising cost over location and taking advantage of the availability of office space on the other side of the harbour.
Compared to their counterparts on the island, landlords of Grade A offices in Kowloon (especially Kowloon East and Kowloon West) are less willing to cut rents because they are more confident of being able to retain tenants given that rents in Kowloon East and Kowloon West (HK$20s-30s psf) are already the lowest across all Grade A office sub-markets. Moreover, there is less room for rental adjustment in Kowloon as rents rose by only 15% during the last upcycle (Q2/2014 to Q2/2019) while Island rents rose by a full 46.9% over the same period. As long as Central maintains its significant premium over other districts, and given the current business environment, corporates will continue to look for cost saving relocation options elsewhere on the island or in Kowloon.
PRC firms remain committed to Hong Kong, with leasing demand from diverse sectors including distribution companies and suppliers, Fintech, retailers and social media. Similar to PRC financial institutions and banks, these firms prefer core locations such as Central, Tsim Sha Tsui and Wanchai/Causeway Bay but require less space (3,000 to10,000 sq ft). Policies to foster development of the Greater Bay Area (GBA) should benefit the Hong Kong office market in the longer run and Wealth Management Connect, announced in late-June, may help to facilitate capital flows in the GBA, driving the growth of wealth management firms.
The overall vacancy rate rose sharply to 6.82% in September 2020 (4.03 million sq ft net) from 6.02% in June 2020 (3.55 million sq ft net). Vacancy rates in Central (6.8%) and Wanchai/Causeway Bay (7.2%) were up over the quarter from 5.6% and 6.3% at the end of second quarter. Island East remained the sub-market with the lowest vacancy rate, even though the rate rose to 2.4% from 1.9% in June 2020. Except Kowloon East, vacancy rates in Kowloon rose as well, with rates in Tsim Sha Tsui and Kowloon West reaching 6.0% and 4.6% respectively, up from 4.2% and 3.8% at the end of June. The surging vacancy rates in Central and Tsim Sha Tsui were mainly attributable to the relocation of anchor tenants.
While vacancy rates are trending up strongly, it is worth noting that they remain below the peaks of previous economic recessions such as SARS (13.46% in November 2003) and the Global Financial Crisis (9.23% in July 2009). The main reason is limited Grade A office supply this year (a very modest 430,000 sq ft net), much lower than supply levels in either 2003 (2.85 million sq ft net) or 2008 (3.57 million sq ft net).
Despite the active financial markets Central’s vacancy rate rose to 6.8% in September, more than doubling from 3.1% in September 2019 while Grade A office rents in the district fell by 15.3% over the first three quarters. We expect overall and Central Grade A office rents to fall by 15% to 20% and 20% to 25% respectively over the year as a whole.
Major forecasters expect the economy to recover in 2021 and the International Monetary Fund is currently forecasting real GDP growth of +3.9% next year. Such forecasts are largely dependent on the successful containment of COVID-19, the future direction of US-China relations and the maintenance of social order. It is estimated that the market will see 1.14 million sq ft of new Grade A office supply in 2021, from the completion of three Grade A office projects in non-core districts. Given these relatively upbeat assumptions, we expect Grade A office rents to fall more modestly by 2.5% to 5.0% next year.
Mr. Simon Smith, Senior Director, Research & Consultancy commented: “Rental markets are being buffeted by corporate uncertainties and a tendency to cut costs and downsize where possible. More profound changes to work patterns are possible in the longer term but are by no means a given.”
Mr. Ricky Lau, Deputy Managing Director, Head of Office Leasing said: “Cost saving relocations have affected take up in core Hong Kong island markets more than Kowloon and we expect to see continued consolidation into next year.”
Mr. William Yiu, Deputy Senior Director, Kowloon Office Leasing said “Although availability in some parts of Kowloon is challenging, tenants are increasingly looking across the harbour for cost effective space close to key transport infrastructure.”