Downsizing by MNCs due to uncertain market conditions was partly offset by demand from the latest generation of New Economy companies, according to Savills in its Market in Minutes - Hong Kong Office Leasing report for Q1 2022.
- The subdued business sentiment drove down the overall average Grade A office rents by 2.0% to reach HK$55 per sq ft net effective in Q1/2022
- Diminishing demand from the financial sector and PRC firms aside, there exists new office demand from companies trading cryptos and NFTs as more traditional firms are hit by regulation
- The substantial volume of existing vacancy (9.8%), combined with a very generous pipeline of new supply that will potentially reach 17.2 million sq ft should offer plenty of upgrade opportunities over the next few years, with green buildings likely to prevail
- More certainty may emerge in April/May about any possible pathway beyond COVID and this could result in more deals in the second and third quarters.
Overall Grade A rents down by 2% quarter-on-quarter
The first quarter was noticeably quiet in terms of transactions volumes with many tenants continuing to WFH amid a 'fifth wave' of the pandemic. Coupled with stock market turbulence and external uncertainties, such as the Russian invasion of Ukraine and the lockdown of major mainland Chinese cities, business sentiment was hit locally with Grade A office rents declining across the board. Overall average rents fell by 2.0% in Q1/2022 to reach HK$55 per sq ft net effective, 27.2% off their Q2/2019 peak.
Traditional office demand recedes
Many financial services firms are adopting flexible working practices as a more permanent way of working and are typically downsizing on lease expiry. If moving over to hotdesking, banks tend to lose 20% of their space with back-office functions most affected. The move to more agile business models seems most entrenched among MNCs while local businesses are tending to maintain a more traditional approach and we see this pattern emerging across the region.
Demand from Mainland firms is currently being hampered by border closure, debt concerns, 'common prosperity' and a more tightly regulated New Economy. The IPO market has been equally hard hit and saw only 11 companies listed on the HKEx main board in Q1/2022 raising HK$13.3 billion, the lowest since Q1/2013.
Demand from New Economy emerges
On the bright side, there exists new office demand from New Economy companies involved with blockchain, cryptos and NFTs. Many of these new start-ups, which have made substantial profits in recent years, are being run by young talents and entrepreneurs. This new generation favour modern and well-designed offices on the periphery of traditional business districts, such as The Chelsea, H Code, 33 Des Voeux Road West, The Wellington and Tower 535 with smaller floor plates and a much more contemporary feel, rather than more traditional Grade A offices. New tenants in fringe Central include Mantra Dao, Satori and 8 Block Capital.
Green certified space a highlight of the big future supply
The substantial volume of existing vacancy (9.8% or 6.2 million sq ft net in Q1/2022), combined with a very generous pipeline of new supply (11.0 million sq ft net from 2022 to 2025 with minimal pre-commitment) means there could be up to a total of 17.2 million sq ft net of available Grade A office space over the next four years, offering plenty of upgrade opportunities.
The trend will be exaggerated by a growing bias towards green certified buildings, and we believe that 20- or 30-year-old stock may face real challenges ahead. According to Savills' estimates, 47% of Grade A offices in Hong Kong (in terms of GFA) have already been awarded BEAM or LEED certification. We also notice a heightened ESG awareness among European firms followed by the US while PRC companies are often still more concerned about traditional building attributes.
Mr. Simon Smith, Regional Head of Research & Consultancy, Asia Pacific of Savills commented: "A total of 17.2 million sq ft net of available Grade A office space over the next four years may mean a long road to recovery for the office sector with tenant preferences shifting towards contemporary builds and green certified space."
Mr. Ricky Lau, Deputy Managing Director, Head of Office Leasing of Savills said: "Considering the impact of WFH and the reduction in office space take-up, Grade A office rents are likely to continue to drift down over the near term."
Mr. William Yiu, Deputy Senior Director, Kowloon Office Leasing of Savills said: "More certainty may emerge in April/May, for example when decision makers gradually return to office, both tenants and landlords will be prepared to tackle more serious renewal/relocation negotiations, with landlords likely to prove more flexible to retain key tenants. This could result in more deals in the second and third quarters."