CBD office market

Of the four major real estate sectors here, namely residential, retail, office and industrial, other than what is well acknowledged as the retail sector’s malaise, prime office real estate is also laboring under a cloud of issues. On the demand side, the sector is confronted with a sea change amongst office tenants. The other is the onset of a quantum leap in supply in the coming years. Although the office market is not in as complicated a quandary state as the retail sector is currently mired in, it is nevertheless heading into uncertain times because the increased supply expected in the next two to four years in the CBD alone is and coming at a time when the financial tenants are saddled with excess real estate. On top of that the determination to develop the regional centers raises the question of who will take up space in these decentralized places.

Not too long ago, if fact, just as recent as late-2014, market watchers maintained a positive outlook of the office sector for 2015. Chief amongst reasons was that the supply in 2015 and even for much of 2016 was limited. The major supply in 2015 was confined just to the South Beach development, which had by the end of 2014 a committed level of 80% of its 500,000 sq ft of net lettable area (NLA). For 1H2016, the major office completions in the CBD was just EON Shenton and SBF Centre with a combined NLA of 581,700 sq ft. Given that the 10 year average annual net new take-up of Grade A CBD office space was just over 1 million sq ft, the supply, or more precisely, the paucity of it, favored landlords.

However, in just three months, by the end of the first quarter of this year, the outlook turned to one of extreme caution. Reason? A couple, one being financial institutions which have a sizeable shadow space within their real estate footprint are now accelerating their pace to rent them out. The excesses arose either because of Mergers and Acquisitions or through the scaling back of certain risky business lines which because of the on going implementation of Basel 3, commanded a higher capital allocation to such activities. Two is that business park space has started to become more active in competing for tenants currently located in the CBD Grade A office space. The move by Google and Facebook are two prime examples where they have chosen to relocate to a more campus like environment at Mapletree Business City instead of staying within the CBD despite having premises that are of Grade A office specifications.

In 2014, the net increase in take-up for Grade A office space was 760,000 sq ft, below the 10 year average. With multinational banks still saddled with both internal problems and also increased cost of regulatory oversight, their appetite to expand here may be absent. With business park space potentially seeking to cream off some demand from companies in the Telecommunication and Technology space, the 1 million sq ft average annual historical demand figure could well be reset lower. The new norm may fall to more like 0.75 million sq ft per annum. This may then form the new baseline for annual net office take up for the foreseeable future. Of course the annual take up could rise towards the 1 million plus sq ft mark if there are new large completions particularly in the years 2016-2019, but this is only just a case of demand being somewhat influenced to chase supply for those years when there are large completions. Even so, the amount of new square footage coming on stream which has yet to be find pre-commitment is 7.5 million sq ft. This excludes the shadow space and secondary stock from existing buildings.

All this may seem like very depressing reading for landlords and investors who have already positioned themselves in the sector. But in truth, what are the likely prospects for the sector? Whilst by no means as rosy as the scenario painted last year, it is also by no means as negative as it appears, that is, so long as the future supply in both CBD and non-CBD areas are reined in.

On the supply of non-CBD office space, the determination of developing the regional centers by the adage that if you supply, they will come, (without having deeper thought of the nature of demand) is untested. If the world had not gone through the Global Financial Crisis (GFC), supply side measures may have a better chance of a successful take-up. This was because previously, banks used to be the leaders in taking up large swaths of office space. Each time a Grade A office tower is completed, one would expect to have at least a major financial institution taking well over a hundred thousand square footage of space. However, nine years on from the crisis, these institutions are still smarting from the after effects, Much of the investments made in the CBD office sector were done in a period prior to the GFC and no soon had these been completed, their main tenants find themselves fighting their own battles.

Just like the retail space, while office rents have been improving for the past 2 years, it masked important issues that tenants such as banks were and are still facing. A push towards the regional centers could well be coming at an inopportune time. A decade ago, when the global economy was still free to harness the power of leverage, new supporting industries and backroom functions of office space users in the CBD could have taken up space in the new regional centers. Today, the business environment has changed and a putsch to develop the regional centers using a supply creating its own demand strategy would add even more stress to the existing and incoming CBD office stock. This will not give enough time for the CBD office tenant landscape to heal (from the potential overhang in the face of lower annual take-up) and evolve (to attract new to market users). For the latter segment, there was hope last year that internet and other technology based companies would be the fillip to the stagnating banks in terms of spatial requirements. Unfortunately, given evidence from Facebook and Microsoft, this assumption has been seriously challenged by business parks.

Whilst business parks may attract the new age technology companies, regional centers may end up fighting for the same remaining tenant pool in CBD office market. Regional centers offices are unlikely to be magnets for technology companies. Even if the environment around them is consciously landscaped, it may not necessarily turn on these new age technology company. For instance, no matter how one deliberately sculptures greenery at grade in a regional center, if one look out of the window of a high floor unit were unravels the sight of distant flare stacks burning off waste gases or chimneys effusing faint colored aromatics, everything else may not matter. There is also the common belief that sprouting regional centers would reduce the number of trips for workers. We are not sure about this because in Singapore, the workforce and their skillsets are distributed in accordance to where major HDB estates are. By having a regional center say in the East does not mean that the majority of the office or retail workers will have lived in the East. Many would still be living in the rest of the island.

What are the several bright spots on the demand side? One is the insurance and re-insurance industry. Another is the solar energy industry. The latter looks promising as Singapore positions to be the regional Headquarters base for leading global companies in the industry. The risk to traditional office space is that they may not be the sole recipient of their office needs as Business Park space may cream off some demand. However, net on net, the value add that the solar energy industry brings to the economy would be positive for both office and business park space.

To conclude, the CBD office sector will need a period of convalescence to nurse itself back to strength. It is not ill now, but will be heading into a period of turbulence soon. The decisions to add millions of square footage of office space in the next 4 years were made either with a pre-GFC frame of mind or arose from government to government land swap agreements. Today, we could be beginning to see that the potential drivers for demand are changing and we know that the traditional office tenants are very unlikely to be able to absorb the supply coming on stream over the next 4 years. CBD office space needs time to recover from those legacy issues. For the new demand drivers, we are still awaiting for clearer signs as to what they are. Whilst we had listed down insurance and solar energy companies as growth sectors, they alone may not be able to raise the CBD demand levels back beyond the 1 million square foot mark any time soon.

For what is already in the pipeline, little can be done. However, supply from unlaunched sites, be it those in the CBD or in the regional centers are still within control. On the demand side, we realize that there are known unknowns, and therefore the future supply from unsold sites should preferably be moderated till more robust studies on the future of office demand are conducted and correctly concluded. If not, the sector will have a Sword of Damocles hanging over it many years to come.

This article appeared in The Edge Property Pullout of Issue 684 (July 6) of The Edge Singapore.

Alan Cheong is the head of research and consultancy at Savills Singapore. The views expressed here are his own.