Global Financial Crisis and Post-Olympic Slowdown Take Shine Off Commercial Property’s Golden Year

Source: Jones Lang LaSalle

Beijing, January 13, 2009 – The widening and deepening impact of the global financial crisis on Beijing’s commercial property markets became more apparent in 4Q08. Julien Zhang, Managing Director and Head of Markets at Jones Lang LaSalle’s Beijing office, commented, “Corporate occupiers in the office sector, who had previously viewed the influx of new supply as an opportunity to expand and upgrade from older quality developments, have turned cautious since the plunge in global financial markets in September. Uncertainties in the global and local economies have led to a growing number of corporate occupiers, especially multinational corporations (MNCs), scale back or defer expansion plans.” The softening in demand and rising vacancy rates, which is now up to 22.5%, saw average office rentals in the overall market retreat by 5.1% from their record highs and down 1% for the year as a whole. These same macroeconomic factors also transpired into a similar pattern of weakening demand in the retail sector. Jason Chang, General Manager of Sandalwood’s North China operations, commented, “The anticipated drop off in demand following the Olympic Games has been exacerbated by the decision of retailers and new market entrants to delay the opening of new stores, which led to the more-than-expected decline in leasing activity. Although retail sales have continued to grow, uncertainties around a slowing economy has seen retailers become more cautious in the opening of new stores. Instead, those already with a presence in the city opted to focus on consolidating existing business operations.” The slowdown in leasing activity since the Olympics has seen average rentals decline by 3.4% from their record highs and reduced full-year growth to just 0.6% despite vacancy remaining at a relatively low 10.1%.

Looking ahead into 2009, Beijing’s commercial property markets will continue to face many of the challenges that confronted the market in the latter part of 2008. Both office and retail property markets are expected to see another record year of supply. In the office sector, the completion of 2.33 million sqm of new supply will expand the market by a further 27%, while the retail sector is expected to expand by another 51% on the back of an additional 1.67 million sqm of new supply. This influx of new supply will increase the downward pressure on rentals as supply further overwhelms demand.

While the movement toward a tenants’ market will stimulate some demand from occupiers expanding and upgrading at reduced cost, the greater challenge will be drawing expansion demand from a weakening economic environment. To this end, government policies such as the additional RMB 1.2 trillion of government spending announced in October, should help. But these policies will take time to work through the gears of the economy and their effectiveness cannot be readily assured. Julien Zhang commented, “In a year where market conditions are likely to change at a rapid pace, those who are able to react and adjust their real estate decisions in the most timely and appropriate manner will be the ones who will be able to capture the best possible outcomes in an otherwise challenging environment.”

Office

Landlords adapt to changing market conditions. Rising vacancy levels brought by the completion of an additional 413,380 sqm of new supply and another quarter of lacklustre demand saw landlords change their focus to tenant retention in 4Q08. Reductions in rentals were recorded across the whole quality spectrum, including some of the city’s highest-quality office buildings. Landlords of established buildings sought to offset the moves in upcoming and recently completed office projects, where incentives were being increased in an effort to drive up the occupancy. Among Beijing’s key office submarkets, the CBD recorded the sharpest drop in rentals, declining 6.2% q-o-q in 4Q08. Looking into 2009, the addition of yet more new supply is expected to see competition among landlords intensify, especially in the CBD where vacancy will be the highest. Indeed, the lower rentals on offer are likely to result in some re-centralization into the CBD and a slowdown in relocation toward business parks by some tenants. For 2009, average rentals are projected to fall by 15–20% in the overall market.

Growth in demand underscores Beijing’s importance as a regional business centre. Despite ending 2008 on a low note, there were still many positives in the office market to carry into 2009. The completion of 1.33 million sqm of new supply saw the office market expand by 18% and absorption reached 554,490 sqm despite the slackening in demand in the latter part of the year. As noted by Julien Zhang, Managing Director and Head of Markets at Jones Lang LaSalle’s Beijing office, “Unlike what we have seen in other regional office market, the impact of the global financial crisis has only weakened the demand for offices in Beijing. Though we have seen some tenants reduce their office requirements, occupancy at an aggregate level has continued to grow, underscoring the importance of Beijing as a leading business centre not only in China but within the region. While the global economic downturn will see MNCs remain cautious on expansion, the government’s massive stimulus packages and the opening up of more business markets to private enterprises will help drive demand from local companies in 2009.”

The continuing emergence of quality and green buildings. The growth of Grade A office space over the last two years in a market that was largely dominated by Grade B and C office buildings is ushering in the next stage of the Beijing office market’s development. The completion of 11 Grade A quality office buildings in 2008 (out of a total of 16 buildings) has provided quality-demanding tenants with a greater variety of suitable options to facilitate expansion requirements. This trend is set to continue with another 15 Grade A office buildings scheduled for completion in 2009. In addition to rising quality, the market is also beginning to see the move toward green buildings become a reality. The number of LEED-certified office buildings within the city is expected to soon increase to five. And the move toward green building construction and certification is likely to gather momentum as developers look at distinguishing their projects in an increasingly competitive market and corporate social responsibility (CSR) policies gather traction within companies.

Retail

2008 – a banner year for Beijing’s retail sector. The completion of a record amount of new supply, which saw the market grow 45% in size, and the hosting of the Summer Olympic Games helped spur demand for prime retail space to new record highs in 2008. The potential to leverage on marketing opportunities in the lead-up to the Olympics contributed to retailers leasing a record 925,000 sqm of additional retail floor space for the year. This is close to triple the amount posted in 2007 and more than double the previous record high posted in 1998. While demand has slowed significantly in the post-Olympic period, the strength of demand, especially in newly completed shopping centers, has kept vacancy relatively stable despite the weight of new supply and contributed to average rentals in the overall market peaking at a record high of RMB 7,238 per sqm per annum during the year.

Market looks toward new market entrants to underpin demand in 2009. Though the slowdown in the domestic economy has seen activity in the leasing market become quiet in recent months, growing retail sales, a greater variety of new high-quality shopping projects and attractive leasing terms are all expected to draw retailers back into the market in 2009. Retail sales, which grew by 21% y-o-y in the first 11 months of 2008 in Beijing, are expected to continue to grow in 2009 though economists are expecting growth to drop significantly in 2009 against the backdrop of a slowing economy. Policy changes aimed at boosting domestic consumption may alleviate some of the decline but are unlikely to be reflected in the market until the middle of 2009. In view of the expectation of weaker retail sales growth, established retailers are expected to continue to hold off on expansion plans. Instead, the leasing market will likely to be dominated by new market entrants who will be less concerned about the dilution effect on earnings associated with the opening of new stores. The weaker levels of demand for retail space, together with another year of record new supply, are expected to contribute to average retail rentals falling 15–20% in 2009, although established retail projects are expected to outperform the rest of the market.

Residential

Prices retreat from their record highs in the top-end of the residential property market. Beijing’s top-end residential property market closed the year on a low with prices retreating in 4Q08. High-end apartments fell by 6.3% q-o-q to an average price of RMB 19,711 per sqm, luxury apartments by 5.9% q-o-q to RMB 23,791 per sqm, and villas by 3.9% q-o-q to RMB 20,285 per sqm. A disappointing year of sales saw developers pull back prices in the primary market, putting further weight on prices in the secondary market already under pressure from poor market sentiments. Though transaction volumes in 2008 were down 25% y-o-y, the effect of lower residential prices and mortgage rates – the People’s Bank of China (PBC) benchmark mortgage rate lowered to 5.94% – did lead to relatively stronger transaction volumes over the last two months. Denis Ma, Head of Research at Jones Lang LaSalle’s Beijing office added “Despite the late pick-up in transaction volumes, prices at the top-end of the residential market are unlikely to be sustained entering into 2009. The expectation of buyers on developers to cut prices further and the potential for more incentives from the government, combined with a slumping leasing market, will keep a downward pressure on prices. The average price of high-end and luxury apartments are projected to fall 15–20% while those of villas by 10–15%.”

Announcement of policies to stimulate home buying. In an effort to boost flagging sales in the residential property market, a number of policy changes were made by the central government to boost home buying. The Ministry of Finance (MOF) announced an array of policy changes. These included lowering the minimum down payment requirement for first-time homebuyers from 30% to 20%, increasing the maximum discount on the benchmark mortgage rate allowed by commercial banks to 30%, reducing property deed tax for buyers of residential units less than 90 sqm in size from 1.5% to 1%, and the suspension of individual Land Appreciation Tax for homer sellers. Meanwhile, the PBC announced a reduction of the housing fund loan rate by 27 basis points to 4.05%. The central government has also allowed local governments more flexibility to introduce their own incentives and concessions to support local property markets. Although these changes are primarily aimed at increasing purchases of affordable housing in Beijing, potential purchasers of mid-range and even some high-end housing may also benefit.

Industrial

Warehouse rentals decline as demand wanes. The strong demand for warehousing properties in the lead-up to the Olympic Games has been replaced with the reality of weakened demand and high vacancy rates. The continuing slowdown in the global economy has seen demand for warehousing properties drop significantly in recent months. This drop in demand, along with the expiring leases of Olympics-related occupiers and a large supply pipeline, has contributed to a sharp rise in vacancy rates and rentals falling 8% q-o-q and 5% in 2008 as a whole. Looking ahead, the expectations of a continuing slowdown in demand and a glut of new supply are expected to drive rentals down 15–20% in 2009.

Investment

Investment market closes the year on a quiet note. In the largest investment transaction recorded in 4Q08, Finance Street Holdings purchased Meisheng Plaza, which is a mixed retail/office project located in Finance Street, for USD 235.2 million. The deal marks the end of a challenging year for investment in the commercial property market. While transaction volumes did not deteriorate significantly from the previous year, the expectation gap between buyers and sellers remained wide. However, with prices starting to decline toward end-2008, this gap is likely to narrow and lead to a more active investment market in 2009. In view of declining rentals and higher yields required by investors to compensate for the riskier investment environment, we project average prices to fall in the range of 15–20% across all property sectors in 2009.

Cautious investors turn focus toward Tier I core investments; Tier I activity to pick up in 2009. Investors in the past few years turned to Tier II and III cities in search of higher yields and to escape overvalued assets in China’s Tier I cities. Global economic conditions have however changed this strategy as capital values in Tier I cities begin to fall significantly, presenting new investment opportunities. Although foreign acquisitions in Beijing slowed to a halt in the fourth quarter of 2008, a pick up in 2009 with foreign investment is expected to follow the easing of regulatory restrictions and as buyers and sellers adjust to more reasonable expectations for both parties. Capital raised in 2007 and 2008 hasn’t yet been spent, and investors wait in the sidelines for capital values to come down. In 2009, there is an expectation that it will be easier to raise RMB loans as credit restrictions are poised to loosen.

Government looks to broaden the investment landscape of property markets. The introduction of REITs and easing the restrictions on insurance companies investing directly in the domestic real estate markets are just two proposals currently under review that may change the investment market landscape in 2009. REITs not only provide developers and landlord/operators an additional avenue to financing but also allow a greater number of individuals and companies to invest in the real estate markets. Meanwhile, the eagerness of insurance companies, who are already starting to loom as major players in the domestic property markets, to invest in the property markets could potentially lend further support to commercial property prices.

PUNE - OVERALL REAL ESTATE MARKET OUTLOOK

Source : Jones Lang LaSalle Meghraj


Residential Property Markets

After witnessing tremendous growth from 2003, Pune’s residential property markets have slowed down over the last 3 to 4 quarters. Sales for most projects have dropped significantly and are presently the lowest observed over last few years. Increase in property prices, coupled with upward movement in the interest rates for housing loans, are the key reasons for drop in demand.

Developers are still holding on their prices, but there are increasing instances cash discounts during negotiations or offers of incentives such as:

• Developer paying part or all of the EMI amounts during the construction period
• Developer paying part or full amount of stamp duty charges
• Developer offering free white goods/partly furnished homes
• Developer offering four/two wheelers with every flat booking

However, such offers and schemes are predominantly observed for projects at peripheral locations, and they are primarily by Tier II/III developers and fringe players on the market.

Developers are consciously making a shift towards budget/mid segment homes with product offering between Rs. 30-35 lakh for 2 BHK apartments.

Considering the trend over the last 6 months, there are limited possibilities of demand picking up over the next two to three quarters. Customer sentiments are at their lowest, and most buyers are anticipating further reduction in property prices before making their decision. There are chances of a meltdown in property prices by about 10-15% over the next few months. The suburban areas are most likely to be affected during this downturn. Also, considering the liquidity issues, there are high chances of projects getting delayed.


Commercial Property Markets

Pune has emerged as one of the prominent destinations for IT/ITeS spaces over the last few years. About 6 IT/ITeS SEZs are in various stages of construction. These SEZs are likely to add about 10 million square feet over the next two years. Most of the anticipated supply is in the PBD, while moderate and limited supply is anticipated in the SBD and CBD respectively.

In fact, the demand for commercial spaces is primarily driven by the IT/ITeS sector. Approximately 50% of the absorption for 2008 is in IT SEZs, about 45% in STPI units and the remaining 5% in non IT/ITeS office spaces. The absorption for 2008 till date is estimated at about 3.2 million square feet.

Apart from the competing supply from within the city, Pune is also competing with cities like Bangalore, Chennai and Hyderabad. During such times, apart from real estate costs, the city level infrastructure (hard and soft) also plays an important role in attracting clients for IT/ITeS and office spaces.

Over the last few years, strong demand from IT/ITeS players as well as corporates had driven the lease rents and occupancy levels northwards. However, in light of the global financial meltdown, the demand from corporate clients has slowed down. Most companies are treading a cautious path, with a focus on cost control, and are delaying decisions on expansion plans.

Sluggish demand over the last few quarters has reflected on the lease rents for IT SEZs as well as office spaces. The prevailing rents for IT SEZs are in the range of Rs. 30-34/sq.ft. (apart from EON and Blueridge, which are quoting in the range of Rs. 38-40/sq.ft). These rental figures have witnessed a dip of about 10-15% over the last quarter. Similarly, the average asking rents for office spaces in the SBD have witnessed a drop of about 5-10% and are presently in the range of Rs. 60-75/sq.ft. pm.

The pressure on lease rents is likely to continue in the short term due to competing supply and the global financial scenario. Developers have adopted a wait-and-watch approach and have delayed plans of launching new projects.


Retail Property Markets

Pune is yet to witness its first complete mall development – a development catering to retail, leisure/entertainment and eateries under a single roof. The existing retail developments are predominantly clusters consisting of one anchor tenant and vanilla retailers.

That said, Pune is likely to witness a retail revolution in the next two to three years, with a supply of about 7 million square feet to be delivered in various pockets of the city. Three 1-million square foot+ malls are under construction, apart from numerous malls ranging between 2-5 lakh square feet. Most of this supply (over 80%) is anticipated in eastern Pune (Yerawada, Nagar Raod, Vimannagar, Kalyaninagar, Koregaon Park and Hadapsar).

Considering the general slowing down of the economy, a definite impact has been observed in transactions for spaces in malls. This is also accentuated by the wait-and-watch approach adopted by retailers and delay in moving forward with their expansion plans. Transactions have been observed at high streets, as there is demand from retailer’s for ready properties.

Considering the competition, the pressure on lease rentals is high and there are strong chances of the rents moving downwards.

Tier II/III developers with plans for malls have adopted a wait-and-watch approach.


Land Markets

Land markets have been extremely sluggish over the last two to three quarters. Transactions have drastically reduced and developers – the prominent buyer segment have in most cases stopped buying land. Key reasons being:

 Drop in demand for ongoing projects
 Pressure on prices of ongoing projects
 Liquidity crunch

Developers are offering joint venture/joint development proposals instead of outright purchase to reduce the entry cost. Liquidity crunch has forced the developer to focus on completion of existing projects rather than venture out for buying land.

Land prices are still intact in most micro markets inspite of pressure on the sale prices for constructed assets. Some marginal movement downwards is anticipated in land prices in the next few quarters.

Pune Vis-à-vis Other Markets

Pune has the distinction of having more than one economic engines of growth. Apart from the burgeoning IT / ITeS Sector, the economy is also strongly driven by manufacturing sector (auto & auto ancillaries). Education and Administration are also the other prominent economic generators for the city.

Advantages of Pune

• Proximity and excellent connectivity with Mumbai
• Pleasant weather year round
• Availability of talent pool and resource pool
• Stable political and social environment

Limitations of Pune

• Infrastructure projects like airport, road, metro rail etc need to be given a priority. Most of these projects are delayed/slowed down
• Public transport system needs improvement

The property prices in the city are still realistic and reasonable in comparison to several similar cities in the north. The average property prices for residential apartments at suburban location are in the range of about Rs. 3000-3500/sq.ft.

The growth in Pune property markets has been on the back of strong end-user demand. Speculators operating in the market at any point in time were extremely low, and this has benefited the markets as property prices have not witnessed high correction despite sluggish demand over the last few quarters. Going forward, there would be pressure on prices, but the downward movement is anticipated to be between 10-15%.

It can be definitely said that strong demand still exists in the market, and that there are still buyers at the right price.


Guidance for the Future

In a falling market, it is important for developers to be realistic in the pricing structure. As discussed earlier, there is still demand for the right price and right product. Developers should also:

• Demonstrate cost control by either adopting new technologies or improving existing processes
• Focus on customer satisfaction and ensure timely delivery
• Focus on affordability of the target consumer and right pricing of products
• Offering better quality products and differentiate from competition
• Having another look at specifications and reducing unnecessary items