1) Rental pressure on weakening demand and high supply. Office demand softened due to economic uncertainty. Nevertheless, TMT companies continued to expand in Tier 1 and several Tier 2 cities, accounting for 28.6% of total demand in 2Q19. Co-working operators slowed down expansion, as enterprises cut unproven new business lines. On the other hand, new supply in 2Q19 stayed high at 2m sm in 17 Tier 1/2 cities, with half of this new supply coming from Shenzhen and Shanghai, according to CBRE. As a result, vacancy went up by 1.2ppts in Tier 1 cities and 0.6ppt in major Tier 2 cities. Average rents fell 0.6%/0.2% q-o-q in major Tier 1/2 cities in 2Q19.
2) Rental pressure remains in 2H19. According to CBRE, there are 6m sm of new supply scheduled for 2H19, vs. 4m sm in 1H19, which will continue to put pressure on overall rents. Nanjing will likely lead the rental growth, followed by Hangzhou and Ningbo. Shenzhen continues to see high supply in 2H19, yet, Nanshan government’s rental subsidy could cushion downside risks. Tianjin and Shenyang will likely see higher rental downsides.
3) Urbanisation, higher tertiary education penetration to drive industry upgrade and office demand in the long term. We expect continued industry upgrade in Tier 1 cities due to rapid urbanisation in the past decades which will drive office demand. Several Tier 2 cities will likely stand out, given the higher number of universities, favourable talent programme and higher growth in the tertiary industry. Nanjing, Hangzhou and Wuhan are expected to lead office demand amongst all Tier 2 cities.
4) Supply to moderate in top Tier 2 (or Tier 1.5) cities. Office gross floor area (GFA) of new start-ups has slowed down since 2014/2015 in Tier 1 cities and top Tier 2 cities. Given the normal development cycle of 3-4 years, we expect new supply to be well controlled in these cities in 2019/2020. Guangzhou, Nanjing, Tianjin and Shenyang have been cutting office space for new start-ups in the past 2-3 years.
5) Rising investor interest in China’s office assets. Inbound (en-bloc) investments jumped 68% y-o-y to Rmb85bn in 2018, making up 32% of total transactions (vs.21% in 2017). Inbound investments remained active in 1H19 with Rmb46bn worth of concluded investments, accounting for up to 46% of total investments. According to a CBRE survey, China was ranked the most preferred market for cross-border investments in Asia Pacific (APAC) and offices were the most preferred assets. These factors, coupled with the prospects of China real estate investment trust (C-REITs) and a period of lower interest rates globally, will continue to support valuation appreciation.
1) Faster-than-expected decline of the domestic economy and external shocks. Rental rates declined in 2008 and 2009 as the domestic economy was affected by the global financial tsunami. Capital value stagnated in 2008, but regained growth in 2009.
2) Faster-than-expected depreciation of the Chinese yuan. Foreign capital may seek to exit due to downward pressure on the Yuan’s exchange rates.
High-tech remains a key driver; co-working operators to slow down. Expansion of TMT and unicorns (privately held start-up companies that are valued at over US$1bn) continue to support office demand in Tier 1 cities and several top Tier 2 (Tier 1.5) cities such as Wuhan, Chengdu and Hangzhou. Companies from traditional industries are expanding their technology (tech) departments. Deployment of high-tech in several traditional industries such as financials, retail, transportation and education are rising. According to CBRE, TMT accounted for 28.6% of net absorption in 2Q19, followed by finance (22.7%) and professional services (12.4%). Co-working operators expanded significantly in 2018 and are now slowing down with enterprises shrinking unproven new business lines amidst economic uncertainty.
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