In Hong Kong, the heightened US-China geopolitical tension coupled with the fluctuation of the COVID-19 pandemic locally has continued to weigh on the office rental performance. In 2020, we forecast overall Grade A office rents will fall 14% YOY, with a bigger correction of 18% YOY in the CBD (Central and Admiralty). As Hong Kong Grade A office rents decline, the rental gap between the CBD and other submarkets will shrink. We believe the narrowing rental gap between core areas and other submarkets, as well as the upcoming new office supply around Central, should provide more recentralisation options for companies to consider within the CBD area.
By saying “recentralisation opportunities”, we are not denying the circumstance that some cost-conscious occupiers are still looking for cost-control and business continuity planning in non-core areas during this rental correction phase. However, the Hong Kong Grade A office sector is a very dynamic market, and we have observed that the rental gap in Hong Kong between the CBD and outer districts has been narrowing since 2019, mainly due to slower leasing momentum in core areas. This situation creates new opportunities in the CBD for the financially well-established occupiers.
Historically, the CBD net effective rent has been as low as HK$19 per sq. ft. during the September 2003 SARS market downcycle, displaying a rental gap of only HK$9 compared to Island East at that time. When the office market recovered, the rental difference between the CBD and Island East gradually widened again, reaching HK$87 during February 2008.
Whilst the COVID-19 challenge is compounding a weak economy and leasing market, we forecast the CBD rents to fall by 18% in 2020, after a 6% drop in 2019. With the office market entering a consolidation phase, CBD rents are declining at a faster pace than non-core areas, narrowing the rental gap to HK$61 between CBD and Island East (as of June 2020), and we expect the rental gap to further narrow to HK$53 (US$6.8) by 2022.
New supply in the next few years will provide more options
In the previous decade, low levels of availability and limited new supply in the CBD area has restricted occupiers’ choice in the core locations. Over the last 5 years, there was only one new Grade A supply recorded in the core area, Shanghai Commercial Bank Tower, which was completed in 2016 to provide less than 100,000 sq. ft. Vacancy rate in the CBD was recorded at the sub -5% level for almost 6 years between May 2014 and Jan 2020. However, this situation is gradually changing, as we are expecting to see more availability come up around the core areas, while the vacancy rate for the CBD has been climbing over the last few months to reach 6.1% in Jun 2020.
Mainland Chinese firms growing in demand
The potential next wave of demand in Central comes from PRC firms with it being one of the most favourable submarkets for mainland Chinese companies. PRC firms had been one of the key drivers in Hong Kong office market before the impact of US-China trade war and the COVID-19 pandemic. In 2018, over 800,000 sq. ft. of Grade A office space was leased to mainland Chinese firms. Despite this new demand, the market had become relatively quiet with most occupiers becoming cautious. Recently, there are signs of a potential return in demand from PRC companies, with the market seeing more Chinese firms tapping into the IPO market to list in Hong Kong (instead of the US) due to current tightening of US regulations on listed Chinese companies. According to Nikkei Asian Review’s quoting on UBS, about 42 Chinese companies trading on U.S. stock exchanges qualify for listings in Hong Kong. If they issue 5% of their outstanding shares in Hong Kong, it would amount to total US$27 billion.
Apart from the potential return of secondary listing from Chinese companies, closer integration of the Greater Bay Area (GBA) should also help to strengthen Hong Kong’s competitiveness. The preferential policy related to the GBA development will likely help bring a positive spin to the overall office leasing demand going forward. For instance, on 29 June 2020, the People’s Bank of China, the Hong Kong Monetary Authority, and the Monetary Authority of Macao, jointly announced the launch of the cross-boundary Wealth Management Connect Pilot Scheme in the GBA.
This is another new financial initiative after the stock and bond connects were launched to increase access to capital flows from the GBA. Whilst most newly set-up companies usually involve several-thousand sq. ft. of office space before any organic expansion in the city, these elements may not necessarily result in immediate occupancy of large office spaces from the PRC firms. However, we believe mainland Chinese demand will continue to be one of the most important demand drivers over the long term against the bigger picture of the GBA initiatives.
Although we forecast the CBD rents to temporarily decline in the upcoming months as the current rental correction cycle remain. This will not change the status of Central and Admiralty as one of the most important and resilient office submarkets. The local workforce prefers a short commute time so submarkets with good accessibility will always be highly valued. Against this backdrop, we recommend office occupiers move quickly to take advantage of falling rents in the CBD while planning their real estate strategies and workplace transformation after COVID-19. We also recommend companies with a long-term vision in Hong Kong to actively seek for pre-leasing or flight-for-quality opportunities amid the higher availability and increasing new supply around the CBD area, while also taking advantage of the current tenant-favourable market to secure leases with more attractive terms.