Published July 9, 2009

No easy game predicting office cycles


THERE is a tendency in the office market to look to the extremes as representative of the market norm. Nowhere is this more apparent than in Singapore, which seems to 'enjoy' particularly volatile market cycles.

Landlords naturally focus on purported record-busting rents in the upswings while tenants conveniently latch on to rumours of extraordinary discounted deals when the tide shifts. It therefore becomes challenging for all involved in the sector to formulate a measured and objective opinion.

The statistics often don't really help. As recently as November 2007, CBRE's semi-annual Global Market Rents Report recorded that Singapore was the fastest rising rental market year-on-year (+82.6 per cent). Last month, we reported that the Republic led the world with the largest year- on-year drop in office occupancy cost (-34.4 per cent). Neither ranking is particularly desirable.

The Singapore office market is undergoing a sharp correction brought on by the financial crisis and severe weakening of the local economy. With an economy expected to contract by 6-9 per cent this year, it's no surprise that demand for offices has wilted.

The most recent growth period of 2004-2007 (GDP 8.2 per cent average) saw office take-up at an average two million sq ft per annum. Impressive for sure, but still well below the mid-1990s' (GDP 9 per cent average) office take-up rates of just under 2.5 million sq ft per annum.

In contrast, during the 2001-2003 downturn (GDP 1.8 per cent average) we saw take-up of 0.18 million sq ft to minus 0.32 million sq ft per annum. This year looks pretty grim and negative take-up of 1.2-1.5 million sq ft is possible.

Core CBD vacancy has almost doubled since the start of the year to 8.5 per cent. The short-term outlook is worrying for landlords and we foresee that vacancy will grow through 2010 to exceed levels in past market downcycles.

Rents have already fallen 46 per cent from the market peak in mid- 2008 with average Grade A and prime rents now standing at $10.15 psf per month and $8.60 psf per month respectively as at Q2 2009. Further downward pressure on rents is a given, even as the pace of decrease shows clear signs of easing.

As if this was not challenging enough, we have a fairly sizeable pipeline of new supply over the next four years - 8.6 million sq ft in total or an average 2.15 million sq ft per annum. This is almost double the 10-year average of new supply and represents a 15 per cent increase in the existing private sector stock.

A feature of the new supply is that a high proportion (65 per cent) are Grade A offices. When the five new developments that fall into this basket are completed, the total size of the existing Grade A office stock will have grown by 81 per cent.

New supply will exceed demand through the next few years even before we take into account further availability arising from sub-leased space (currently about 400,000 sq ft).

So are we looking at an office market landscape that will take years and years to recover? We think this is far from a given. No one should underestimate the robustness of Singapore's office market, which has a habit of outperforming predictions (both in correction and recovery cycles). It is useful to look at previous stress points to illustrate the point.

In July 1992, The Business Times ran an article headlined Office properties face biggest glut ever. The report noted: 'A combination of a huge supply and falling demand has created the office market's biggest glut ever and led developers into a fierce price war to draw new tenants.'

Singapore's office market was enduring an uncomfortably high islandwide vacancy of 11.2 per cent. Of even greater concern was the prospect of a staggering 16 million sq ft of new office construction coming on stream over the following five to six years. This level of new office construction represented an increase of 53 per cent on the then total private office stock. Many market watchers were bearish. Some said there would not be a true recovery for four to five years. There was grave concern about prospects for the mega-office projects in the emerging Marina Centre area.

How did things pan out? The eight new office towers in the Marina Centre area achieved an average 60 per cent pre-let level upon completion. By 1996, vacancy had fallen to 8.5 per cent and prime rents had risen 32 per cent from the 1992 level.

At the depth of the Asian crisis in 1998, vacancy had risen to 14.6 per cent with around 5.1 million sq ft in the development pipeline (an increase of 10 per cent of the then total private office stock).

The conventional wisdom was again a prolonged period of over-supply and depressed rents. Yet, two years later vacancy had actually fallen to 11.3 per cent and prime rents had increased by 23 per cent from the 1998 level.

More recently in 2003 with the perfect storm (global finance and IT downturn, consolidation of local banks, local recession, declining foreign investment, Sars, etc) Singapore's office vacancy stood at 17.9 per cent (representing 12.6 million sq ft of vacant space) and prime rents were at a record low of $4 psf per month. Some market observers said it would take five to seven years before the excess space was absorbed, notwithstanding the limited supply of future confirmed new developments (estimated at only 2.8 million sq ft or a mere 5 per cent increase on total private office stock).

Not quite. Three years later in 2007, islandwide vacancy had shrunk by half from the 2003 level and Singapore was facing a critical shortage of office space. Prime rents had by then risen a staggering 275 per cent from the 2003 market low.

Today, one cannot see on the horizon 1) a new Asia-Pacific boom or 2) a dotcom boom or 3) a tremendous economic growth surge in Singapore. These were the three events that unfolded immediately following previous market crashes and which confounded the predictions of long-term office market malaise. The sheer scale of the economic and financial challenges today could point to a longer road to office market recovery.

Nonetheless, do not underestimate the swiftness with which supply could be absorbed when business growth returns. Landlords and developers look set to have to tough it out for at least the next couple of years.

But it could well be that the best leasing transactions from a tenant's standpoint will need to be concluded within the next six to 12 months before the market recovery is at hand.

The writer is executive director, office services, CB Richard Ellis