Pace of absorption key to China's Grade A office leasing market assessment
Landlords need to consider more than stock and vacancy levels when assessing the grade A office leasing market
When talking about the future viability of China's grade A office leasing market, from a landlord's perspective, there is a temptation to pay exclusive attention to two key market measuring metrics - what is the present vacancy level in a given market and what percentage does total grade A stock now actively under construction constitute as a percentage of the existing amount of grade A office floor area available for leasing in a given city.
However, another crucial element that is often not adequately considered - possibly because it is difficult to calculate - is the pace of absorption. Apart from present vacancy level and percentage of increase in office stock as compared with existing base, the third key metric that must be assessed to determine the viability of a given grade A office leasing market is the pace of leasing absorption of new office properties.
Undertaking in-depth assessment of absorption time for newly released office properties across China's major office markets is one of the unique features of the China Business Office Building Index that was released by the China Real Estate Association with data and technical support from DTZ Research, and was a major factor contributing to the precision of the rankings of the viability of the individual office leasing markets.
Specifically, the most indicative metric in taking the "pulse" of a given office market is to track the number of months that new grade A office buildings require to achieve 80 per cent occupancy on average.
The reason why 80 per cent is such a critical point, in the leasing of any given office building, is because it is generally only after a building has attained this level of occupancy that a landlord's position becomes sufficiently strong to consider hardening the leasing terms for the remaining unlet space.
In a survey conducted by DTZ Research this year, which examined the rate of take-up of grade A office properties over a longer time horizon, it was observed that properties in first-tier cities could achieve over 93 per cent occupancy within two years of completion.
By contrast, in second-tier cities, average occupancy levels did not rise above 78 per cent within 24 months of being offered for leasing.
Furthermore, in second-tier cities, it is evident that over the past three years, absorption pace and occupancy levels have both been generally trending downwards. Between 2009 and 2011, newly completed buildings in second-tier cities could achieve over 50 per cent occupancy one year after completion. However, from 2012 onwards newly completed buildings could only reach 43 per cent, suggesting a growing mismatch between supply and demand
Indeed, in the peak office property completion years, from this year to 2018, the period between the first and third quarters of this year some cities experienced an even sharper slowdown in the speed of absorption.
While it took 16 months, on average, for a building to achieve 80 per cent in Chengdu in the first quarter, the pace of absorption slowed down to 23 months in the third quarter, with Qingdao similarly seeing absorption time rise from 16 to 21 months. This sharp recent escalation in absorption time is an indication of the fact that demand for office space in these two markets is still constrained by corporate relocation and expansion requirements, which can thin out when business confidence weakens.
Some cities saw the pace of absorption speeding up notably between March and September. In the first three quarters of this year, Beijing recorded one of the fastest rates of absorption of new grade A properties on offer and the sharpest reduction in the number of months required to achieve the key benchmark of 80 per cent occupancy.
Measured by the metric of development pipeline alone, Shenzhen, with pipeline as a percentage of existing stock indicating just under 200 per cent growth in grade A office supply between the fourth quarter of this year and 2019, one would have to surmise that this is a future office market that presents a considerable level of risk from the point of view of a prospective developer or landlord.
However, when considering the speed of absorption, in the third quarter of this year, Shenzhen required only about 12 months to reach 80 per cent occupancy. This impressive speed is supported by the fact that Shenzhen, along with Shanghai, is one of two cities in China that has been chosen to host a major new economic zone, catering to the modern service and finance industries, and many companies are queuing up to enjoy the benefits that they will provide.
Andrew Ness is head of research, North Asia, DTZ