Building diemma

The Shanghai office market has borne up remarkably well since the onset of the Asian crisis and is in better shape than was anticipated 12 months ago. This is largely due to lower-than-expected supply in the Grade 'A' sector, combined with strong take-up from Chinese companies and owner occupation of several whole buildings in the Pudong area of the city.

During 1998 rents fell while vacancy rates as a percentage of total stock have stabilised, and in some cases fallen. In Shanghai it is Chinese companies that are taking up much of the surplus new space, especially in Pudong. Analysis of take-up of space in new and old buildings reveals that 365,000 sq metres of Grade-A space was absorbed during 1998, giving a yearend vacancy rate of 35 percent, equivalent to 577,000 sq metres of vacant space.

It is surprising that vacancy rates have fallen in Shanghai but this is due to the huge increase in stock in the last few years and the falling amount of vacant space as a proportion of total stock. In addition, 44 percent of supply scheduled for 1998 has been pushed back to 1999, including the 88-storey Jinmao Building. In real terms Shanghai will have around one million sq metres of vacant Grade A and International Grade-A office space by the end of 1999, nearly double the figure recorded at the end of last year.

Take-up from foreign companies has been strong in quality buildings and 1998 saw Shanghai Kerry Centre achieve occupancy of 60 percent within six months of completion. Meanwhile Shun Talc's Central Plaza achieved 80 percent occupancy since completion in January 1998. In Lujiazui the Senmao International Building has occupancy and committals for about 60 percent of the space since completion in second quarter of 1998.

Demand for quality office space from local companies is increasingly significant. Since reducing rents in early October 1998 to Yn1.6 per sq metre per day (equivalent to US$5.78 per sq metre per month) the Jinsui Building in 'Little' Lujiazui has leased 5,000 sq metres to local companies including locally listed Jinka and Shanghai 3F. As a result, the developer claims the building is now more than 80 percent occupied since completion at the end of 1997. This building is now the biggest bargain in Shanghai and is owned by the Agricultural Bank of China, which occupies 60 percent itself and is currently asking rents one-15th of the rents offered in the Shanghai Centre just four years ago. The Shanghai Centre is 85-90 percent occupied and rents are now US$24 per sq metre per month.

Developers and landlords continue to offer attractive lease packages as they compete to win tenants and generate cashflow, rather than having to pay for the management of vacant buildings. Tenants with space requirements of more than one floor can usually secure rent-free periods of three-to-six months.

Achievable rents are generally 10 to 20 percent lower than the asking rents given above for lease terms of two to three years, and 20 to 30 percent lower for large space takers. In addition to the basic rent charges, tenants must pay property management and parking fees as well as the cost of buying or leasing telephone lines.

More supply comes on stream
The 46-storey Citic Square located in the centre of the commercial node on Nanjing West Road will offer 73,000 sq metres of International Grade A office space out of a total gross floor area of 107,000 sq metres. Citic Square is conveniently located, with many bus routes serving the area. Access will improve further with completion of Metro Line 2 in October 1999 which will have two stations within easy walking distance. The building has office units ranging from sq metres over floors. The office lay-out is a partial square shape and is column-free, giving 75 percent efficiency. Some 400 car parking spaces are provided in two basement floors.

Supply will increase significantly in 1999 with 801,000 sq metres of new Grade-A and International Grade-A space forecast. Given the large amount of space coming on stream, falling rents and the high proportion of space being built for eventual owner occupation, we expect take-up to increase to 425,000 sq metres in 1999 giving a year-end vacancy rate of 39 per cent. The increasingly subdued economic outlook may make our take-up forecasts looks optimistic by the end of the year, but it is likely that there will also be the usual delays to completion.

Boosting take-up will be the several office buildings that are wholly or substantially for owner occupation. These include World Finance Building to be occupied by The Construction Bank of China, the Bank of China's plan to occupy 60 per cent of Shanghai Pudong International Finance Building, and the 60 per cent of Jinsui reserved for owner occupation by the Agricultural Bank of China. Developers of several other build-ings will retain a substantial proportion of office space for self-use, although details have yet to be confirmed.

Falling rents
Rents are already falling within the range we forecast for this year of US$10 to US$20 per sq metre per month for Grade-A and International Grade-A space.

Developers have come up with a variety of strategies for dealing with the current oversupply. The choice faced by developers is whether to proceed with projects and hope for the best or delay construction and wait for signs of better times before starting. The real dilemma comes with half-completed projects. Pressing ahead and completing construction in the present market can seem like throwing good money after bad. There is no simple answer and as a result Shanghai has a number of 'tombstone' projects that have seen little or no activity for a year or more. The municipal government has eased regulations that put a limit on the time between purchasing land-use rights and breaking ground and is allowing sites to be grassed over, but that is not an option where 40 storeys of concrete has already been poured.

The market will undoubtedly be difficult, but there is sufficient evidence that those developments at the top end of the market will achieve reasonable occupancy. Any wounds that are going to be inflicted should be visible by September, but for some developers the bleeding looks set to go on for a couple more years while tenants have a ball.

FPDSavills is a leading firm of international property consultants with offices in Shang-hai, Beijing and Guangzhou. For further details on these markets, please contact Sam Crispin in Shanghai by e-mail: scrispin@fpdsavills-sh.com or fax: (86) 21 6474 8909.