Central office rent to rebound soon?
Central Grade A
office rents have been in a secular rising trend since records began (except from
1998 to 2003), as shown by the dotted red channel in Chart 1. Since peaking in Dec 2011, Central rents have been in a correction
cycle, falling 26% to around HK$81psf by February 2014 (orange dotted channel
in Chart 1). From a technical perspective, the correction cycle could continue
to early 2015 unless rents rise above this orange corridor.
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Chart 1: The trend of grade A office
rent in Central
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Would fundamental analysis lead to similar
conclusions on the future direction of office rents? The rest of this article will
discuss various fundamental factors
driving office rents.
Rents move
in line with unemployment rate
Offices are the places where employed workers do
their jobs. If follows therefore that when unemployment rate increases, office vacancy
will also rise, and vice versa. Except during times of very abundant new supply
(e.g. in the 90s, when vacancy rate outpaced unemployment rate – see red shaded
area in Chart 2), movements in vacancy rates and unemployment rate were highly
correlated, this was especially the case after 2003, when supply was
particularly low (blue shaded area in Chart 2).
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Chart 2:
Unemployment rate and grade A office vacancy rate are closely related
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As a result, when one can accurately forecast
future economic and employment conditions, one could also make reasonable
predictions on future office rent. One leading indicator which helps in gauging
future unemployment rate is the Purchasing Managers Index (PMI).
The PMI reading typically precedes unemployment
rate by six months (Chart 3), which allows us to estimate the direction and
magnitude of change in unemployment rate. From latest PMI reading, unemployment
rate could rise from current 3.4% levels to 3.5% in the next 3-4 months before
settling back at 3.4% level at the end of this year (Chart 4).
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Chart 3: PMI
helps to forecast the future unemployment rate
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The Global Financial
Crisis in recent years have weakened business activities for the financial
industry in Central, in contrast to the fringe office districts, which are
inhabited more by retail and tourism industries, as well as the booming construction
industry. As a result of this shift in dynamics, the premium of central office
rents has been declining, after having reached a “double top” formation in 2008
and 2012, reaching 1.6 in 2014 (Chart 4; blue line)
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Chart 4: Central Grade
A office rent premium has shown close correlation with unemployment rate since
the handover
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Strong
capital markets to benefit Central rent premium
However, with the
current rebound in capital market activities from the lows in 2012, and a
weakening momentum in mainland tourist arrivals, the time may have returned for
an increase in Central office rent premium. When the stock market turnover is high,
demand for financial services should also be good, and therefore benefit demand
for Central office space. Applying this logic to the stock-turnover-to-GDP ratio,
it is unsurprising that the ratio (blue line in Chart 5) closely relates to
Central office rent premium (red line in Chart 5).
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From technical perspective, it is also worth noting
that the stock turnover to GDP ratio line have decisively bounced off the long
term resistance (now support) line (the upper blue dotted line), and is
apparently forming a upward moving second technical support line (the lower
blue dotted line). Further, the Central premium line has also risen back to its
long term trend boundary, suggesting increases in the coming months. Whether absolute
office rent in Central goes up or down in the near future, it will most likely outperform
office rents in Causeway Bay (red arrow in Chart 5)
Other than stock
turnover, equity fund raised is also useful in judging the future trend of Central
office. The annual change in fund raised generally leads variations in Central rent
premium - as a result, the 20%-plus growth in equity fund raised in 2013 points
to high single-digit growth in Central rent premium in 2014 (Chart 6).
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Chart 6: Growth
in equity funds raised is followed by increased office demand in Central
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Growth fuelled by
the tight supply
According to the latest
Hong Kong Property Review 2014
published by Rating and Valuation Department, new completion of Grade A offices
in Central and Western District is almost zero. In contrast, Kowloon City,
Tsuen Wan and Sha Tin districts will face big supply coming to the market (Table),
further supporting our thesis of Central rental outperformance.
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Table: Grade A
office supply ranking
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From the supply point of view, Central Grade A
offices enjoys distinct advantages in next two years, corroborating the
preceding analysis. So the conclusion that follows might be: tenants should
renew leases as soon as possible, landlords should delay renewals as much as
possible, while investors should put Central offices on their radar screen.
Special thanks to Mr Chiu Kwok Yan in assisting the collection of data
and graphs
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