Rental declines are expected to be mild over the remainder of 2021 before the supply challenges of 2022 and 2023, according to Savills in its Hong Kong office leasing report for Q2 2021.
- Grade A rents fell by 2.6% in Q2/2021 compared with a 3.5% decline in Q1/2021.
- Leasing demand from PRC corporates proved to be resilient over the quarter and was largely financial services driven. The proportion of Central Grade A offices occupied by PRC firms increased from 20.5% in July 2017 to 23.5% in June 2021 despite the challenging market conditions.
- Overall vacancy rates rose to 9.3% (5.7 million sq ft) from 8.9% in Q1, at a milder growth rate than in the last quarter. The current vacancy rates are patchy as some buildings continue to report high occupancy levels and remain quite selective regarding tenants.
- Kowloon vacancy rate may rise in 2022 given that 2.4 million sq ft net out of 3.9 million sq ft net of new supply will come on stream in the area.
Hong Kong – 29 June 2021 Rental declines are expected to be mild over the remainder of 2021 before the supply challenges of 2022 and 2023, according to Savills in its Hong Kong office leasing report for Q2 2021.
Rental declines in Q2 eased over Q1
Grade A rents fell by 2.6% in Q2/2021 compared with a 3.5% decline in Q1/2021 as market sentiment improved slightly over the quarter with less downsizing and fewer surrender cases. In Q2/2021, rents in Central, Wanchai/Causeway Bay and Island East fell by 2.8%, 3.0% and 2.6% respectively while overall Hong Kong Island rents recorded their lowest rate of decline since Q1/2020, registering a fall of 2.8%. Kowloon rents dipped slightly and remain relatively affordable to tenants, falling by 2.4% over the quarter. Rents in Tsim Sha Tsui, Kowloon East and Kowloon West fell by 1.8%, 4.2% and 2.9% respectively.
Decentralization not a one-way road
Averaging HK$114 per sq ft per month net effective in Q2, Central rents are at a 91% premium to the general market and while relatively costly, have fallen from the 96% premium recorded in Q2/2019. Despite the narrowing gap, we are still finding cases of decentralization such as Julius Baer committing to lease four floors in Two Taikoo Place suggesting that relocating to triple Grade A office buildings in decentralized areas is still appealing to corporates. The decline in Central rents is providing an incentive for some firms to return to the CBD - Standard and Poor's has rented two floors in Three Exchange Square according to Hongkong Land.
PRC firms prefer CBD trophy buildings
Mainland demand remains very core focused and driven by financial and professional services firms. Preferences are emerging for large-scale mixed-use schemes such as IFC and Pacific Place, for example China International Capital Corporation (CICC) has been actively taking up vacant units in One IFC, becoming one of the major tenants in the triple Grade A office tower. Meanwhile, Huatai Financial Holdings and Forthright Financial Holdings, are also expanding their presence in Hong Kong's financial hub.
PRC firms started their active expansion in Hong Kong in the early-2010s with a particular focus on the Central Grade A office market. By July 2017, about 20.5% of Central Grade A office space was occupied by PRC firms. That has risen to 23.5% in June 2021. To illustrate the point, One IFC and Two IFC have both seen a rising PRC presence, from 15.7% to 24.0% over the four years. In fact, with the floor area of new PRC lettings rising by 4% YoY over the year, it shows that despite the trade disruption, the social unrest, COVID and economic recession in 2020, PRC firms remain committed to the Hong Kong market, even as corporates tended to halt expansion or downsize.
Co-working sector stabilizing
Operators of flexible workplace have adopted different strategies as the industry restructures. Some overextended brands have chosen to close their centres while some operators are taking advantage of cheaper space and are actively expanding. The Executive Centre is rumoured to have leased a floor in AIA Central growing their footprint in Hong Kong to 11 centres, while The Desk is reported to have seen a 65% growth in membership in 2020 and enjoys high occupancy levels in its seven centres in the city.
Vacancy in Wanchai/Causeway Bay at record-high since 2003
The overall vacancy rates are high at 9.3% (5.7 million sq ft). The rise in vacancy was mainly driven by increases in availability on Hong Kong Island, where the vacancy rate rose from 7.4% to 8.0%. Whereas Central's rate (7.5%) was similar to Q1 level (7.6%), Wanchai/Causeway Bay posted a post-March 2003 vacancy rate high of 10.8% while Island East achieved a lower vacancy rate compared to other districts on Hong Kong Island since the district's major office portfolio recorded a rate of availability at only 1.3% in June 2021.
Kowloon's vacancy rate increase was marginal (10.9% from 10.8% in Q1), and the vacancy rate in Kowloon East dropped from 13.8% to 13.1% after securing several major leases over the quarter such as Manulife who committed to lease multiple floors (144,700 sq ft) in International Trade Tower. However, Kowloon will be under impact in 2022 given that 2.4 million sq ft net out of 3.9 million sq ft net of new supply will come on stream in the area. Kowloon East will see new supply of 1.6 million sq ft net from three Grade A office buildings, which are likely to drive up vacancy to over 15% as there haven’t been any major pre-lease commitments yet. Kowloon West will undergo a dramatic change as 1.9 million sq ft net of Grade A space will be completed over the coming two years, accounting for about 75% of existing Grade A stock in the district.
Mr. Simon Smith, Regional Head of Research & Consultancy, Asia Pacific of Savills commented: “Rising vacancy continues to put pressure on rents while a record IPO pipeline, growth in wealth management services and active PRC tenants are providing some support.”
Mr. Ricky Lau, Deputy Managing Director, Head of Office Leasing said: “A reluctance among some core landlords to cut rents has not been shared by fringe and decentralised owners and tenants have continued to take advantage of the lower costs available in some markets to relocate. That said, some other tenants have noted the narrowed rental gap between Central and non-core areas and were able to remain in Central at discounted rents.“
Mr. William Yiu, Deputy Senior Director, Kowloon Office Leasing said “Overall vacancy is high but patchy as some buildings continue to report high occupancy levels and remain quite selective regarding tenants. Most office workers are back at their desks suggesting a limited long-term impact from WFH and local CEOs have shown a preference for more traditional office culture and pre-COVID ways of working.“