AMONG the major sectors of the local property market, the office sector had been seen as a pariah. The post-Lehman crisis redrew the financial landscape where deleveraging was the buzzword. Financial institutions were in no mood to expand, cost cuttings were deep and on top of that, the crisis triggered a series of flare-ups in the eurozone. As the supply of Grade A office buildings in the CBD increased with the completion of the new buildings in the Marina Bay area, vacancy levels started to rise. Consequently, by the law of demand and supply, rents began to decline, and had been doing so continuously since the second quarter of 2011.
The appetite for micro-strata units from small-time investors driven out of the residential market has maintained, if not, increased the rate per square foot paid for commercial property. This, in addition to a low interest rate environment has squeezed yields as capital values remained high, leading transaction volumes to decline as institutional buyers found it difficult to justify a purchase based on initial rental returns.
When the projected supply of CBD Grade A office space looked alarming, the fortunes of the office market started to reverse in Q1 2013 with rents surprisingly taking a strong rebound and rising 1.2 per cent quarter-on-quarter (see chart 1).
Although one can explain away the rental increase using the traditional argument of falling vacancy rates, observers are struggling to comprehend how this can be, when some 1.5 million sq ft of Grade A space in the CBD remains vacant. This is more than a year's average demand of 1.07 million sq ft in the past 10 years. If one looks islandwide, the total supply of office space from now till 2017 is expected to average 1.8 million sq ft per annum. This is significantly above the 10-year average islandwide net demand of 1.2 million sq ft per annum (see chart 2).
Doesn't this point to a market glut and so why then are rents and capital values rising?
There are a few possible reasons why and they are:
- A sizeable amount of the new supply is in the non-CBD region.
- The continued low interest rate environment
- Tactical short-term behaviour of the landlords
Supply in the non-CBD region
Of the 5.5 million sq ft of new office supply (all grades) coming on stream from 2013 to 2016, 52 per cent is in the non-CBD regions. With the Urban Redevelopment Authority attempting to set up regional business hubs in places like Jurong Gateway and Paya Lebar Central, as well as the proliferation of business parks, it is now insufficient to merely look at broad statistics to determine rents or capital values.
Financial institutions are likely to continue housing their front to mid-offices in CBD Grade A offices, if rents remain at reasonable levels. Non-financial companies, for example, representative companies for foreign manufacturing firms, fast moving consumer goods companies and petroleum corporations, having normally been located in the fringes of the CBD or ageing CBD properties, may well be enticed to move to locations outside the CBD.
With more non-CBD location options, the market is becoming segmented with CBD Grade A offices catering to institutions who need to remain there and others moving out.
With only 2.6 million sq ft of office space (all grades) slated for completion in the CBD from now till 2016, it represents an annualised supply of about 661,700 sq ft, clearly below the annual average take-up. This is a very low number and explains why landlords are becoming bold to raise rents.
Low interest rate environment
Whilst office yields have been falling since Q2 2008, so too have interest rates. The spread between these two is still wide (see chart 3).
In fact, it is so glaring that for some financial institutions who are renting space, from an opportunity cost angle, wouldn't it be better for them to purchase their own building (subject to the approval from the Monetary Authority of Singapore), than to lend out their surplus cash at overnight rates which last stood at 0.03 per cent in March 2013.
The fact of the matter here is that in Singapore, the lack of an interest rate policy meant that interest rates here have been lower than they should have been if there had been a policy. What this means is that the office yields will be low as they track our already benign interest rates.
For investors who hail from countries which have an interest rate policy, trying to replicate their initial yield driven investment philosophy here would therefore be a challenge. Office yields here will remain lower than global yields because of this important feature that we do not have an interest rate policy. Investors will have to reap their all-in returns through rental inflation and/or a higher terminal value when they sell the asset.
Landlords' behaviour
For the period up to 2015, there are very few landlords holding the new supply of CBD Grade A office space, while older stock in Raffles Place, City Hall and Orchard Road are sporting low vacancy rates. As such landlords can easily manage this vacancy, whether it is a few floors or a few hundred thousand square feet, allowing them to hold up rents.
The low interest rate environment is also lending a helping hand to these landlords as their holding cost is minimal.
With a number of smaller, new-to-market tenants, seeking to "be seen" in the CBD, unit rent is unlikely to be the determining factor; as location and image prevail.
Outlook
We believe that with new supply of CBD Grade A office buildings being limited over the coming three to four years, office rents will rise rather than fall, aided by key landlords' control over current supply and stronger than normal holding power supported by the low interest rate environment. While this may appear counter-intuitive to some observers, given the excess supply, one must keep in mind that 52 per cent of this new supply is in areas outside the CBD.
For offices in the CBD, demand is still likely to derive from financial, financial related companies like private equity, and oil and commodity trading set-ups. These are recognisable entities and landlords for new buildings that have either just completed or will be completing soon should be able to capitalise on these known drivers.
Therefore, there is a very high chance that at least for the next two to three years, rents for CBD Grade A offices can rise significantly.
Christopher J Marriott is CEO, Savills South-east Asia. Alan Cheong is senior director of Research & Consultancy, Savills Singapore.
