Study shows office vacancies could double by year's end, but project may push

PUBLISHED : Wednesday, 23 September, 1998, 12:00am
UPDATED : Wednesday, 23 September, 1998, 12:00am

The latest reclamation project in Central and Wan Chai, if pushed ahead as planned, will exacerbate the office oversupply problem in the central business district and drive up vacancies, Chesterton Petty says.

In the worst-case scenario, vacancy rates in Central could surge to 24.4 per cent by 2014 when the effect of the present reclamation plan was felt, the property consultant said.

It estimated the supply of grade-A office space in Central would reach about 2.4 million square feet this year.

Given a slow take-up, this huge supply would push vacancy rates up to 17 per cent by the end of this year, from below 8 per cent last year, it said.

Another 2.2 million sq ft was expected to be completed in the next two years. These new offices would increase the total stock of grade-A office in Central by almost 25 per cent, Chesterton Petty said.

Also, the Northeast Tower - phase two of the International Finance Centre - and the redevelopment of Swire House would add another 2.65 million sq ft in 2003.

Chesterton Petty said the Asian economic downturn would dampen office demand which would not be sufficient to absorb the new supply.

'Although there will be no major office projects in Central after 2003 until development of the reclamation sites starts, supply will still exceed demand by a wide margin over the next decade,' it said.

'On top of this excessive supply, the Central reclamation project will provide yet another 11 million sq ft, which will no doubt push vacancy rates up further.' The consultant said the economic downturn had devastated the Central office market. Prices and rents had plunged 30 to 40 per cent since last December.

Chesterton Petty based its projections for the office market on past experience of the relationship between take-up in Central and office rents, interest rates and office supply.

The results of its study indicate that office take-up will decrease by about 9,200 sq ft with each 1 per cent increase in office rental. Every one-percentage-point rise in interest rates will reduce take-up by 83,000 sq ft.

But abundant supply would boost a particular year's take-up as the limited availability of supply in Central was historically the biggest constraint on demand, it says.

Chesterton Petty assumed that the 11 million sq ft of office space on the proposed reclamation sites would be developed in eight annual phases, from 2007. Accordingly, about 1.37 million sq ft would be marketed each year until 2014.

It also assumed there would be no other major office development or redevelopment from 2007 to 2014, and by the end of 2014 the total grade-A office stock in Central would reach about 30 million sq ft.

According to Chesterton Petty, the grade-A office vacancy rate in Central would start to drop from next year, eventually falling to about 8 per cent in 2002, then double to about 16 per cent in 2003 before easing to about 7 per cent in 2006.

The company predicted interest rates would most likely decline gradually from this year's estimated 10 per cent to 8.5 per cent in 2002, and then fluctuate between 8 and 9 per cent afterwards.

In this scenario, when office leasing for the reclamation sites would begin in 2007, Central's office vacancy rate would jump to about 9.5 per cent and eventually rise to 17 per cent in 2014.

This would put immense downward pressure on office rents at that time, and the entire vacant office supply would take at least 10 years to be absorbed even without new office space coming on to the market after 2014, according to Chesterton Petty.

However, if the economic recovery came at a slower pace and interest rates stayed in double digits until 2002 and then fell to between 9.5 and 10.5 per cent, a slower take-up and a higher vacancy rate were expected, it said.

In a bleaker scenario, the yearly vacancy rate when the reclamation project was introduced from 2007 to 2014 would range from 14.4 per cent to 24.2 per cent, which was about five to seven percentage points higher than in the most likely scenario, it said.

Provided the economy picked up more quickly, and interest rates dropped to 7 per cent in 2002 and then stayed at 6.5 to 7.5 per cent, office demand would become stronger with higher take-up and less vacant space. In that case, the vacancy rate was expected to rise to 11.4 per cent in 2014.

Chesterton Petty said the reclamation project would lead to a serious oversupply of office space in Central.

Based on its projections on vacancy rates, between 10 per cent and 25 per cent of the prime office space in Central could be vacant, which meant that office rents would plunge.

Unless office demand were to surpass its anticipated level, the remedy for the unavoidable oversupply situation was to trim supply in the first place.

It suggested that the development of office projects on the reclamation area be undertaken over an extended period.

For instance, if the projects were developed over 10 years instead of eight years, the office supply per annum would be lowered to about 1.1 million sq ft. Accordingly, vacancy rates would be lower, it said.

Another solution would be to reduce the amount of office space to be provided within the reclamation project's commercial zoning, it said.

If the office project were scaled down by 20 per cent, the vacancy rate would most likely fall to about 11 per cent in 2014, Chesterton Petty said.

If the project were reduced to three-quarters of its planned size, the vacancy rate would probably be reduced to 9.5 per cent in 2014, much lower than what it could have been based on current plans, the consultant said.