Can The Credit Crunch Dent Prime Office Market?

Source : The Business Times, September 27, 2007

MEGAN WALTERS and ALVIN TEO examine the impact of sub-prime woes on the real estate needs of financial institutions here

Volatile environment: With 70% of the top 25 buildings achieving full occupancy consistently, many businesses have resorted to reconfiguring their existing premises to contain more headcount due to shortage of spaces for their expansions

Singapore's fast growing financial sector has been a major user of prime office space and helped fuel the strong growth in rental and capital values of late. But the recent credit crisis in global markets stemming from defaulting US sub-prime loans has put a dampener on the financial sector.

At the start of the sub-prime fallout in July, Asian banks were thought to be relatively insulated from the problems. But by the end of August, banks, including DBS and the Bank of China, appeared to have greater exposure to US mortgage debt than previously thought.

DBS admitted to $2.4 billion exposure to collateralised debt obligations (CDOs), double what the market had expected. The Bank of China saw its share price fall 8.1 per cent when it became apparent that it held $9.5 billion or 3.8 per cent total securities investments in CDOs.

What will be the effect on the Singapore office market from this shake-up in the banking system? Cushman and Wakefield examine the issue by looking at the performance of the top 25 office buildings here.

Financial services are a key part of the Singapore economy, making up 20 per cent of GDP. More importantly, financial services' annual GDP growth was 17 per cent for Q2 07, more than double the manufacturing GDP growth rate of 8.3 per cent on the same basis.

Manufacturing is the largest single component of GDP accounting for 45 per cent GDP, but the growth rates in financial services means banking and related services is catching up fast.

The Singapore Department of Statistics found that for Q2 07, the financial services industry did extremely well with turnover growing at an astounding 39.7 per cent on an annualised basis.

A slowdown in the American economy is now expected - with higher borrowing costs, and falling house prices affecting US consumers. With the health of the financial sector dependent on the health of the main economy, the question is: to what extent is the slower growth of the US going to affect the financial sector in Singapore?

This will be two ways: first, the health of the general economy in Asia and, more specifically Singapore, and the second, where the interrelated nature of the financial markets means a downturn in the US financial sector will squeeze the financial sector here.

Of the two issues, the first - the general economic outlook for the region - is still very positive, whilst the second - the financial markets themselves - are still uncertain.

Following a review with 480 companies in seven Asian cities, including Singapore, IMA Asia, a consultancy firm, has revised its economic forecast for Asia (excluding Japan) upwards from 7.4 to 7.9 per cent for 2007 and 7.1 to 7.6 per cent for 2008, despite a substantial cut in the US GDP forecast.

The effect of the risk in the financial markets is much harder to judge - with no one really certain where the risk currently lies. This will be an issue for banks, uncertain whether to expand their regional operations to meet the projected regional growth, against the backdrop of uncertainty in the financial markets. What will be the effect of difficulties in the financial markets on Singapore prime office markets? As at end-August 2007, Singapore prime office rents are $12.21 psf/month with the Top 25 buildings at $12.28 psf/month.

It is expected that any immediate effect on the local prime office market will come from banks as tenants. Most banks are not the owners or landlords of the top 25 office buildings. The majority of the buildings are owned by local property developers or, most recently, funds.

C&W research has found that banks and financial institutions occupy nearly 40 per cent of floor space or nearly 4.8m sq ft in the top 25 prime office buildings, a long way ahead of the next largest category of occupants - professional services firms such as auditors and lawyers.

Given the current volatility of the market triggered by the sub-prime lending in US and the most recent fear of a liquidity crunch, would this affect this group of occupiers in their aggressive expansion plans as we have witnessed in the past 18 months?

A squeeze on bank profits from the credit crunch may result in a reduction in headcount, as already seen in Lehman and HSBC in the US, which will lead to some secondary supply back on to the market. It is possible that this may affect the developers in the real estate markets, but to date we have no evidence of any problems for developers occurring as a result of the current credit crunch.

We have consistently witnessed space being taken up due to expansions and new set-ups. Although at a slightly slower pace as compared to the first half of the year, it is largely due to a lack of supply of good class office buildings.

Vacancy rates are consistently hovering at only one per cent for this group of buildings. Many large financial institutions are also aggressively pre-committing spaces even before the building is constructed and this was best demonstrated in Marina Bay Financial Centre where the entire Tower 1 of about 600,000 sf was pre-leased three years ahead of the building completion! They include tenants like Standard Chartered Bank and French investment bank Natixis.

With 70 per cent of the Top 25 buildings achieving full occupancy consistently, many businesses have also resorted to reconfiguring their existing premises to contain more headcount due to shortage of spaces for their expansions.

The fundamentals of the Asia-Pacific economies remain strong with GDP rates remaining robust. Singapore's own GDP figures have just been revised upwards by MTI from 5-7 per cent to an upbeat 7-8 per cent range. It is possible that the credit crunch will have little effect as fundamentals remain strong, and Singapore remains a competitive place to do business. Any reduction in headcount by banks and freeing up of supply will more than be met by demand from other sectors.

However, sentiment plays a strong part in stock markets particularly in Asia. In the longer term, the current market wobble may lead to a correction in prices which will affect firms' expansion plans, and the banks' willingness to lend.

Megan Walters is with Cushman & Wakefield (Asia-Pacific); Alvin Teo is with Cushman & Wakefield (Singapore)