What's behind the surprise 3.5% drop in URA's office rental index in Q3

Oct 22, 2021

MOST property consultants were surprised by the 3.5 per cent quarter-on-quarter drop in the Urban Redevelopment Authority’s (URA) central region office rental index in Q3 2021, which came after the 1.3 per cent rise in Q2 2021.

Consultants attribute this to a “flight-to-quality” by tenants resulting in a two-tier market, pointing to URA’s data showing that Category 1 office buildings - covering the better-quality buildings in the city area - posting the second consecutive q-o-q increase in the per square foot monthly median rental. In contrast, the monthly median rental fell in Q3 for the remaining office space in Singapore - or Category 2.

A seasoned market observer - while acknowledging the ongoing flight-to-quality as some tenants choose to relocate from older office buildings into newer, better-located ones and take advantage of current soft market conditions - highlighted another reason for the continued decline in office rents for Category 2 buildings.

Some of these buildings' owners lack financial power to pay for tenants' fit-out expenses or grant them extended rent-free period of tenants; thus they are more likely to agree to a lower rental rate to support occupancy rates in their properties.

On the other hand, the choice buildings in Category 1 are typically held by more deep-pocketed owners with the wherewithal to offer attractive incentives to either retain tenants whose leases are coming up for renewal or secure new tenants.

The URA collects office rental data based on what is stated in rental contracts submitted to the Inland Revenue Authority of Singapore for stamp duty payment. The taxman may not be agreeable to have some of these incentives excluded from the rentals stated in the contract. “So the rental figure that flows through to the URA index may be inflated in such cases. This also helps landlords to protect the high headline rent figures in their buildings, which will come in handy for future lease negotiations,” said another industry observer who acts for major office landlords.

URA’s data released on Friday (Oct 22) shows that for Category 1 office buildings, the median monthly rent for office leases that started in Q3 2021 was up 0.8 per cent q-o-q to S$10.07 per square foot, from S$9.99 psf in Q2 2021.

In contrast, for Category 2 office space, URA’s median monthly rent for leases that began in Q3 2021 was down 1.3 per cent q-o-q to S$5.16 psf, from S$5.23 psf in Q2 2021.

URA’s data showed that islandwide net demand for office space, as measured by the change in occupied space, continued to shrink for the third consecutive quarter, albeit at a slower pace than in prior quarters, said Cushman & Wakefield’s head of research for Singapore, Wong Xian Yang. The negative net demand of about 54,000 sq ft for Q3 2021 is smaller than the -248,000 sq ft in Q2 2021 and -205,000 sq ft in Q1 2021.

“A similar trend was observed in the Downtown Core (which includes the financial district), which saw negative net demand of 118,000 sq ft in Q3 2021, compared with -377,000 sq ft in Q2 2021 and -312,000 sq ft in Q1 2021,” he added.

“The flattening out of negative net absorption could be indicative that the broad office market could be bottoming out. The growth in Grade A office rents, tight supply pipeline amid ongoing redevelopments and expected stronger future office demand due to economic recovery...would provide tailwinds for the office market,” Wong said.

Lam Chern Woon, head of research and consultancy at Edmund Tie & co, also expects a gradual recovery in the coming quarters, led by the prime CBD market. “However, the continued uncertainty on when the Covid situation can be better arrested will cast doubts on the long-term hybrid workplace strategies of occupiers and cap the strength of the office market recovery,” he noted.

In similar vein, CBRE’s head of research for South-east Asia, Tricia Song, said: “As the pandemic evolves into an endemic, this paves the way for firms to adopt the hybrid working model while reassessing their space requirements. This may eventually result in space returning to the market - a trend that will be particularly pronounced among consumer banks.”

On a brighter note, Song sees technology and non-banking financial services firms continuing to spur leasing activity. “The second bright spot is the prevailing tight vacancy, particularly within the CBD Grade A market.”

JLL’s head of research and consultancy for Singapore Tay Huey Ying sees a long runway for rent growth in the Singapore CBD Grade A office market, supported by favourable demand and supply dynamics.

Singapore’s attractive offerings as a global office hub should help in continuing to draw tech firms, wealth management outfits and family offices, among others, to set up offices in the city. Meanwhile, CBD office supply growth is set to slow and could even shrink in the medium to long term, given the lack of greenfield sites for new developments and the ongoing redevelopment of ageing office assets into mixed-use projects.

“Guoco Midtown and Central Boulevard Towers could possibly be the last of fresh office injections on greenfield land within the CBD in the coming decade if the government is focused on releasing land outside the CBD in their efforts to develop suburban hubs to bring jobs closer to homes,” said Tay.

URA’s data shows that islandwide vacancy rate of office space climbed to 12.9 per cent as at end-Q3 2021, from 12.6 per cent as at end-Q2 2021.

Its price index for office space in the central region slipped 2.4 per cent in the third quarter, against the increase of 0.9 per cent in the previous quarter.