Grade-A office rents in Hong Kong’s core areas under pressure amid corporate cost cutting

Rents in Hong Kong’s central business district - Central - plunged 8.5% in February from a month earlier, the most significant loss since the start of the financial crisis, surpassing the 8.1% drop registered in October last year, according to Knight Frank’s latest research report. The average rent of premium buildings in Central fell a staggering 9.7% in February, leading the market decline. This was in sharp contrast to the smaller dips of 3.5% and 2.3% in Kowloon East and North Point, respectively. With a rising number of landlords recognising tenants’ diminishing ability to pay, office rents continued their decline and fell 6.9% in February compared to the previous month.

Mr Mark Bernard, Executive Director of Commercial Sales & Leasing Department at Knight Frank, says, “That underscored the keen intention of landlords in core areas to prevent the exodus of tenants from their buildings. The deepening global recession forced many companies in Hong Kong to contemplate moving to less prestigious office spaces to cut costs.  In a bid to retain tenants who were becoming increasingly cost-sensitive and were about to move to non-core areas, landlords of offices in core areas cut rents aggressively over the past month.”

Despite the deep rent cuts offered recently by landlords, some tenants have still been bidding aggressively low with their rents, driven by the dire economic news around the world. Office rents in Central will continue to be under downward pressure, as the district still commands a huge rental premium over other areas. The average rents in Premium Central at HK$127.3 per sq ft per month is still 270% higher than the average in Quarry Bay, according to Knight Frank’s statistics.

“The office market is seeing an increase in the downsizing of corporates. However, its impact on vacancy levels has not been significant, as new supply is limited in core districts. Cases of financial companies breaking leases have started to emerge, but in percentage terms, they are insignificant at this stage compared with the numbers witnessed in the previous market downturn during 2002-2003”, Mr Bernard continues.

Table 1: Grade-A office rentals – February 2009

“With a large amount of office supply coming online in Kowloon East in the coming year, the district will continue to be a low-cost haven to companies hit hard by shrinking business volume. Last month, American International Assurance committed to six floors in Manhattan Place in Kowloon Bay and another international insurance giant is reportedly negotiating to take more than 100,000 sq ft of office space in the same district. This deal is likely to be closed soon,” Mr Bernard says.

Office leasing activity picked up after the Lunar New Year as expected. The market saw a number of major leasing deals involving large floor areas over the past month. A logistics firm committed to five and a half floors or 120,000 sq ft of space in Kowloon Commerce Centre in Kwai Chung; a sports apparel manufacturer took two whole floors with a total area of more than 40,000 sq ft in Landmark East in Kwun Tong; while The Executive Centre, a serviced office operator, decided to lease up to three and a half floors or about 46,000 sq ft of space in Exchange Square in Central. Other smaller deals involved mainly tenants moving to less expensive locations.

Office sales activity was feeble last month, with a distinct lack of major deals involving large values or floor areas. There were less than 70 office sales transactions in February, a drop of about 80% from the same month last year and the second lowest level in ten years. Grade-A office prices continued to soften, but the fall slowed to 3.4% in February from 4.2% in January and 26.1% in the fourth quarter of last year. The prices of some office buildings in core areas staged a small rebound in early March. Examples included Lippo Centre in Admiralty and Star House in Tsim Sha Tsui. With prices having plummeted 48.2% over the past 12 months, the bubble in the office sales market has been much deflated.
“So far, adjustments in office rents have lagged behind the corrections in office sales prices. The average rent of Grade-A offices has fallen 31.0% from the peak level recorded in mid-2008, compared with a drop of nearly 50% in office prices. While office prices may become increasingly resilient going forward with owners unwilling to sell at distressed prices, there may be a further correction in rents before the downturn runs its course,” Mr Bernard concludes.

Table 2: Grade-A office price comparison