Singapore Office Rents Could Peak This Year

Source : The Business Times, March 27, 2008

Tenant resistance will ease pace of rental growth, and office take-up may slow over 5 years, writes MORAY ARMSTRONG

IT WAS a year of new records for the Singapore office market in 2007. Rents were driven to new highs in terms of growth rates - prime rents surged a staggering 92 per cent year on year - and in terms of rent levels that far exceeded previous market cycle peaks. Vacancy rates dropped to unprecedented lows. Meanwhile, the sheer size of many leasing transactions was also on an unparalleled scale.

Shortage of space: Office leasing deals are still happening in spite of worries over the state of the US economy and the financial markets

All in all, a performance that made landlords, developers and property funds fairly content. In contrast, there was growing anxiety in the occupier community over fiercely rising office costs and a critical shortage of available space to accommodate business expansion. This was a consistent theme heard most vocally among various chambers of commerce.

The cries for help had, in fact, already been picked up early in the proceedings and government policy reaction was in full swing. Office development parcels and vacant state buildings were quickly offered to the private sector and 11 government land sale sites were awarded in 2007 (no office sites were awarded the previous year).

The concept of transitional office sites offered on short 15-year ground leases was tested successfully. The lower land premium levels (versus more traditional 99-year leases) reduce the developer’s cost and allow space to be leased out at lower rents. Furthermore, the government identified a number of departments located in the CBD that could potentially relocate to decentralised areas, thereby releasing available office space for the private sector to lease.

So where does the office market go from here? Will Singapore’s office market pitch from critical shortage of space to a glut? What should tenants budget for when leases are due for renewal (and just how do you explain to the head office a fourfold increase in your rent in Singapore when there is financial carnage at home base?) We have set out below a few observations and our thoughts on the market outlook.

Supply

From our tracking we can identify a total confirmed five-year (2008-2012) office supply of 10.18 million sq ft (of which almost two-thirds is attributable to government land sales), the bulk of which will be delivered only after 2010. This supply figure grew dramatically through 2007.

The volume of supply does not in our view appear excessive. An average 2.03 million sq ft per annum is lower than the average 2.21 million sq ft per annum delivered to the market through the 1990s. Bear in mind that the total office stock in Singapore today (70.33 million sq ft) is 186 per cent greater than the total office stock in 1990. Also note that there is a healthy level of occupier pre-commitment in many of the new developments.

Notwithstanding the above, a factor that should be taken into account is the prospect of secondary office stock (availability in existing office buildings) increasing, particularly after 2011 when some major occupiers will move to new CBD developments and some support functions are relocated out of town. Keep an eye out also for potential sub-lease space increasing if there is a greater economic downturn.

As matters currently stand, our sense is that secondary stock is not likely to impact significantly. Bear in mind that most corporates in Singapore right now are desperately short on space and are not holding much ‘fat’ in either their headcount or real estate.

Demand and take-up

Deals are still happening in spite of worries over the state of the US economy and the financial markets. It is noteworthy that the strong tenant interest in decentralisation (Tampines, Changi Business Park, Harbourfront and Mapletree Business City are favoured destinations) has carried forward from last year.

As these commitments are usually financially compelling, it is perhaps unsurprising. Pre-lease momentum for prime buildings may slow in the short term as financial institutions grapple with other issues. We are, however, still actively seeking immediate expansion space for many of our banking clients.

Over the past two years office take-up averaged 2.23 million sq ft. Going forward, we anticipate that take-up may fall back to 1.6 million sq ft on average over the next five years. It is notoriously difficult to accurately call the level of office demand, but in order to build some office occupancy modelling, we have adopted this take-up figure and our assumptions here suggest that overall islandwide occupancy could remain above 90 per cent over the next five years. Hardly over-supply conditions.

Rents

The tightness of availability and excess of unsatisfied occupier demand is likely to drive (selectively) further rental growth. Early last year, we suggested that the pace of rental growth would modify going into 2008. Our preliminary Q1 2008 figures seem to bear this out: Grade A rents advanced 8.7 per cent quarter on quarter to $18.65 per sq ft a month and average prime rents rose 6.7 per cent to $16 psf a month.

While market fundamentals remain highly favourable to landlords, we expect sentiment and a healthy dose of tenant resistance to higher rents will further ease the pace of growth and rents could well peak this year and then stabilise. Greater competition from 2010 onwards suggests that rents could ease downwards. Expect certain landlords with older buildings to moderate rent expectations through this period. Tenant retention will be higher on the agenda.

Policy and land sales

The planners appear to have made a telling contribution over the past couple of years and a welcome increase in supply is now visible. Hard-pressed occupiers already have relief in sight. It may be a timely moment to ease back on priming supply and monitor how the demand side holds up in the light of more cautious times ahead.

Moray Armstrong is executive director (office services), CB Richard Ellis