The storm before the calm

CHRIS ARCHIBOLD looks at the likelihood that MNCs may find S’pore less attractive as office rents continue to surge

The office market in Singapore has changed dramatically in the past two to three years. In mid-2004, Singapore office rents were in a trough caused by the Sars outbreak; less than three years later business sentiment is strong in Singapore and across Asia. This has driven demand for office space.

The market bottomed out in mid-2004 and saw strong rental growth in 2005 and record growth in 2006. In 2005, Grade A Raffles Place rents rose 23 per cent and last year the market saw a dramatic rental spike of 63 per cent.

Most major Grade A buildings currently have occupancy rates of over 95 per cent. This scarcity of space, coupled with high demand and a lack of future supply (supply projections are well below market norms), will cause a serious space crunch over the next few years. This is likely to continue to drive rents northwards.

This phenomenon has been brought about by three key factors - the lack of new office supply coming to the market, the rapid expansion of the financial sector and the recovery of the regional and domestic economies.

The lack of supply is a result of the conservative sentiment among developers in Singapore around the Sars period which has meant that the amount of space currently being developed speculatively is well below the average annual supply rates.

Singapore has traditionally seen a five- to six-year property market cycle (three years up and three down) but due to the lack of supply and high demand, this cycle is likely to see an abnormally extended rental growth period. Given the traditional six-year cycle, and the fact that the market bottomed out in mid-2004, the peak should be around mid-2007. However, under current circumstances, rents are projected to continue to grow for the next two to three years. Our property clock shows that the Singapore market has just completed the fastest rent rise phase of the cycle but still has a number of years of growth.

The two impending integrated resort developments are also likely to have a positive impact on Singapore real estate. Developments of this scale will increase employment opportunities both in terms of the development process and the jobs created within the resorts.

These developments are aimed at drawing both tourists viewing the various attractions and business people using the convention facilities, and will raise Singapore’s exposure to the international community. The impact is likely to be increased business activity, boosting Singapore’s attractiveness for foreign investors.

Given the impending supply crunch and rising rents over the next few years the question on everyone’s lips is: ‘At what point does Singapore become unattractive to further foreign investment and the job opportunities associated with it?’

To answer this we need to review two fundamental issues - price and supply.

Taking price first, average Grade A rents in Q4 ‘06 were around $9.60 per sq ft per month (see chart). This is still below the market peaks of $11.15 in 1990 and $10.40 in 1996.

Given that a number of the prime Grade A Raffles Place buildings transacted deals at around $12.50 psf per month in the first two months of 2007, this points to the previous benchmarks being breached this year. Our research shows further rental increases in 2008 and 2009 with more record rentals likely to be set.

If this proves to be the case, will it deter investment in Singapore by the major MNCs? To answer this you need to look at where the expansion is coming from and the motivation behind it. A good barometer is the take-up of space in the latest core CBD developments. The majority of space in the latest developments has been filled by the expanding banking and finance community. Much of this expansion is coming from the US and Europe so it could be argued that Singapore’s competitiveness is judged against occupancy cost in those cities.

If you look at pure rental costs in London and New York against their counterparts in Asia, Singapore still compares favourably, and it is cheaper than its major Asian financial centre competitors, ie, Hong Kong and Tokyo. Thus, inward investment is likely to eye Singapore as a favourable location at the present time. This is on top of the other locational factors, such as living environment, business transparency, communications and tax structure, in which Singapore also fares well.

That said, Singapore’s rental competitiveness may well change over the next couple of years as the market is likely to continue to see increases whereas some of Singapore’s regional competitors such as Hong Kong and Shanghai are likely to see downward pressure on rents due to upcoming supply.

The higher rentals are causing many occupiers - both SMEs and MNCs - to relocate from the CBD to more cost-effective premises. But as the growth is caused by positive business sentiment the higher costs are unlikely to stop tenants from expanding. Rather, they may review their occupancy standards and workplace strategies.

Future supply is a cause of real concern as there is little coming to the market over the next few years. If there is physically nowhere to expand, MNCs may be forced to look elsewhere. They are by their very nature able to move business units around the region.

Given the supply crunch and demand boom, the authorities have taken various actions to alleviate the situation and plan for future occupation. These initiatives include the announcement of new regional and sub-regional centres in areas such as Jurong, the release of new land sites and making space available in various government properties.

While these initiatives will prove useful there are issues in terms of their impact. The release of new land sites and the announcement of new regional and sub-regional centres will not provide space for a number of years due to the length of time needed to construct new premises.

Existing space freed up from government properties will provide immediate relief but this is limited in scale. Also, in most cases the space is not suitable for MNCs which are looking for new, regular-shaped efficient office space.

The supply crunch is going to be an issue for the Singapore office market for the next two to three years and this could be exacerbated if projects are delayed due to lack of building materials and competition for labour with so many projects under construction at one time.

With increasing demand and a scramble for space, we are likely to see MNCs continuing to pre-commit to future new developments earlier than has traditionally been the norm, restacking their current premises with higher density work spaces or relocating business units to other countries.

Another way of easing pressure on existing supply may be to loosen regulations on the occupation of high-tech buildings. This would bring more immediate opportunities to conventional office users and may encourage more developers to build new supply.

The speed to market of high-tech supply can be faster than that of pure office space because many of these buildings are built on green field sites in business parks (such as Changi Business Park) where there is easy site access (unlike the constrained sites in the CBD) and no demolition or site clearance is necessary. The buildings are also lower and therefore faster to build.

The writer is regional director, head of markets, at Jones Lang LaSalle

Source: The Business Times