Several unique factors, topped off by the enduring trend to working from home and an exodus of companies.
By Nick Corbishley, for WOLF STREET:
Office demand in Hong Kong, one of the world’s most expensive property markets, remains “extremely weak,” says Cushman & Wakefield. More and more companies are allowing a larger percentage of their workforce to work from home on a long-term basis, reducing their office space needs. By the end of last year, overall net absorption — the sum of square feet that became physically occupied, minus the sum of square feet that became physically vacant — of Grade-A office space had slumped to -2.3 million square foot, the steepest annual drop on record.
Many companies are downsizing as their need for space shrinks. Homegrown luxury goods company Lane Crawford relinquished 19,400 sq ft at One Island South in Wong Chuk Hang. FTLife Insurance released an entire floor (16,500 sq ft) of the FTLife Tower in Kowloon Bay. DHL reportedly leased 90,900 sq ft at International Trade Tower in Kwun Tong, downsizing and relocating from Kowloon Bay.
Coworkers’ centers like WeWork and Regus also scaled back their presence in the city for the first time since 2016, according to CBRE. While some closures were planned before the pandemic, new lettings by coworking centers shrank by 39% year-over-year in 2020. At the same time, travel restrictions led to a sharp fall in new leasing demand from mainland Chinese firms, which plunged by 74% year-over-year and 62% from 2018 and 2019, respectively.
In other words, a lot more office space is hitting the market than is leaving it. Total vacant office space rose to 8.12 msf in the fourth quarter, up 69% year over year. “A rising amount of surrender and sublet space” pushed the availability rate for all grade office buildings one percentage point higher to 12.6%, up from 8.8% in Q4 2019, says Cushman & Wakefield. “It’s the highest level since Q1 2005.”
In Q1 2005, Hong Kong’s commercial real estate sector was emerging from the debris of the first SARS pandemic (2002-04). After being identified by W.H.O. as one of the areas affected by the virus, investment sentiment and activity in the city froze. Office prices dropped around 15% in 2003. Grade A office rents in the city declined by 17.2%. Central Business District, home to some of the most expensive commercial real estate, dropped 22.5% year-on-year. Yet even at the height of the SARS crisis, Hong Kong’s GDP grew by 3.1% in 2003 and 8.7% in 2004. And that helped pave the way for a strong recovery of the commercial real estate sector.
Things are very different this time. The city has so far racked up five consecutive quarters of economic decline, from the third quarter of 2019 to the third quarter of 2020 (the figures for the fourth quarter haven’t yet been published). Hong Kong is now in the grip of its worst recession on record. The economy shrank by 9.1% in the first quarter, 9% in the second and 3.5% in the third. Unemployment has risen to 6.6%, the highest rate since the last quarter of 2004, when it peaked at 8.4%.
Hong Kong’s office market has been hammered from all directions. It has been battered by the pandemic-induced Work-From-Home revolution, which has prompted many companies to cut back on office space. It was pummeled by the pro-democracy student protests that continued to rock the city in the first half of 2020, until they met the immovable force of the Chinese Communist Party. Beijing’s subsequent imposition of the national security law sounded the death knell of Hong Kong’s “One Country, Two Systems” framework, which had granted the city a considerable degree of autonomy following its handover from the UK to China in 1997.
Against this backdrop, office rents in Hong Kong plunged at their fastest rate since the Global Financial Crisis. In the fourth quarter, average rentals experienced the steepest quarterly decline since Q2 2009, falling by 6.3%, according to Cushman & Wakefield. These crumbling prices come on top of the fall in prices that already occurred in 2019. That brought the full year decline to 19.3%. Of all the city’s districts, Greater Central, where many of the most expensive office properties are located, came out worst, with rentals falling 6.7% quarter-over-quarter and 22.4% year-over-year on average respectively.
The new security law brought a certain amount of order and stability to the city, which the local government hopes will spur mainland companies to set up shop in the city. But it also set in motion a gathering exodus of international companies. Now that Hong Kong has been subsumed into the mainland’s realm, the city appears to have lost some of its allure as an international business and financial hub.
The Vanguard Group, The Motley Fool, hedge fund Elliott Management… 52 banks and financial companies and 24 insurance firms are already packing their bags. Many global luxury brands are relocating to mainland China, to be closer to their major growth market. Versace, Salvatore Ferragamo, L’Oreal and LVMH-owned Bulgari, Fendi, Givenchy and Celine all reduced headcounts in their Hong Kong headquarters last year and moved resources to the mainland, reports South China Morning Post.
Cushman & Wakefield notes that while vaccines may offer a glimmer of hope in the long term, the near-term impact of vaccines on the local market will be minimal. Firms continue to face a bleak economic environment. Leasing demand is likely to remain subdued, particularly in the first half of the year, and surrendered space may continue to climb. As a result, “although new supply is set to remain limited, vacancy rates are forecast to climb further, continuing to put pressure on rentals… (which) are forecast to fall between 11% and 16% over 2021.” By Nick Corbishley, for WOLF STREET.
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