Temper the optimism in Singapore office buildings

Aug 01, 2022

In the early days of the Covid-19 pandemic, workers in many cities across the world abandoned physical offices and worked from home. Questions arose about the fate of office buildings. Would these buildings become empty shells and see their values plummet?

But, aided by the rollout of vaccines, much of the world, including Singapore, has learned to live with Covid. In 2022, many workers are commuting to physical offices, and Singapore’s Central Business District (CBD) is getting back its buzz.

Fortunes are looking up for office landlords here. The Urban Redevelopment Authority’s office rental index in the central region showed an increase of 2.4 per cent quarter-on-quarter, picking up pace from the 1.6 per cent growth in the previous quarter.

According to Colliers, core CBD premium and Grade A office rents in Q2 2022 rose 6.1 per cent from a year ago to S$11.10 per square foot (psf) per month. Colliers noted there has been broad-based leasing demand coming from tech firms, asset managers, insurance providers, legal firms and energy businesses. CBRE Research expects Core CBD (Grade A) office rents to grow 8.3 per cent for 2022, versus 3.8 per cent for 2021.

BT reported in July that Amazon has signed a lease for about 369,000 square feet at IOI Central Boulevard Towers in the CBD, and that tenants such as ConocoPhillips, Boehringer Ingelheim, BASF, Vitol and Swiss Re are taking up space at Guoco Midtown in Beach Road.

The valuation of Suntec Reit’s Singapore office assets rose by 2 per cent between end-December 2021 and end-June 2022. Over the same period, the valuation of Keppel Reit’s office-focused Singapore portfolio rose by 1.4 per cent.

Deal activity

The office property investment market here has been buzzing with deals. Predominantly office buildings that have changed hands or are changing hands this year include CBD buildings such as Twenty Anson, Cross Street Exchange, and 55 Market Street, as well as Westgate Tower near Jurong East MRT station.

Recently, BT reported that Bright Ruby Resources group emerged as the buyer of 999-year leasehold CBD office asset Income At Raffles at 16 Collyer Quay. The price is understood to have crossed S$1 billion, or slightly over S$3,600 psf.

The buyers, who are splurging out mega sums for office buildings here, include groups owned by wealthy Asian families and institutional investors. Buyers are probably betting big on Singapore’s growing importance as a business hub and businesses needing physical offices despite the possibility of widespread adoption of remote working.

Recently, The Economist magazine said that Singapore could be the main beneficiary as the map of Asian financial hubs is being redrawn. With Asia contributing a third of global gross domestic product and its weight in the world economy rising, owners of premier office buildings here could benefit from Singapore’s growing stature as a financial hub.

Tempering optimism

Still, there are reasons to temper optimism in the office property market here.

Firstly, interest rates are rising. If borrowing cost is over 2 per cent per annum and initial net yield on the purchase of an office building is around 3 per cent, the spread between the net yield and the borrowing cost is fairly narrow. Should a major tenant vacate and a gap exist before the new tenant moves in, the spread can turn negative in the interim. Also, further increases in debt costs can erase any positive spread.

Sure, office rents may rise when leases come up for renewal, especially as supply of good grade office buildings appears tight. This in turn will lift the net yield. Still, it will take time for the effects of positive rental reversion to flow through.

Secondly, it may be risky to assume rising rent and occupancy in the office market here due to weakening economic and business conditions globally.

Many businesses may be re-rating Singapore upwards as a place to open or expand operations because of factors such as viewing positively Singapore’s handling of the Covid-situation and the tough Covid-related restrictions in China and Hong Kong.

But, economic growth projections in many countries are being lowered amid the United States’ Federal Reserve raising interest rates to fight rising inflation, and supply chain disruptions caused by war in Ukraine and Covid lockdowns in China. The risk of economic recession in the US and other economies is rising. With a weaker economic outlook, businesses may go slow on taking up more office space. If economies contract, businesses may actively cut costs, including trimming their real estate costs.

Thirdly, these are early days in drawing a definitive conclusion on the relevance of office buildings. Technological advances have enabled the widespread adoption of remote working. Many knowledge workers appear to value having flexible work arrangements.

Sure, some people complain of the fatigue of attending virtual meetings and find their home set-up unconducive for working. Also, in-person interactions may better build relationships, grow corporate culture and enhance collaboration, with ensuing productivity gains.

Going forward, the main working model for many businesses may combine a mix of working from home and a designated physical location. In a hybrid working model, the amount of office space required per headcount may reduce. Right sizing by office tenants could cut space requirements by 10 to 15 per cent.

Moreover, the physical location where team members gather for in-person meetings, brainstorming and bonding need not necessarily be the office building. Resorts, historic buildings and city hotels may compete with office buildings to be the go-to places for colleagues to gather.

Amid rising geopolitical tensions and political instability in many places, investors are drawn to buying physical assets in safe haven Singapore. With homes here, investors may have to pay high transaction taxes. With retail, logistics and data centre properties, highly specialised skill sets may be needed to generate good returns. Thus, plenty of money searching for big ticket properties here focuses on office buildings.

Still, a long-term investor needs to have both very strong financial and asset management skill sets to succeed. While the pandemic has not made office buildings redundant, landlords need to show businesses the value that a physical office brings.

Fending off competitors by signing a big cheque to snare a prime office building in Singapore from sellers, who often have good holding power, may be the easy part. The hard part could be to make the investment work by continuing to provide space which adds value to businesses, at a time when space needs are rapidly evolving.