Business parks located in the urban hinterlands used to be real bargains compared to the central business districts (CBDs) in China’s booming coastal cities. These locations were cheap to rent, and accommodating managers would offer all kinds of subsidies and allowances to the right tenant.
As prices for grade-A commercial properties in the CBDs continue to decline, though, companies that may have previously considered moving to business parks in outlying areas to save cash are rethinking their stance.
The problems stem from overcapacity. According to Savills Property Services, the total leasable stock in Beijing hit 7.8 billion square meters in the first quarter of this year. This was largely thanks to the addition of a number of office spaces in the CBD, which were originally slated to be up for lease in 2008. The vacancy rate, meanwhile, rose to 19.4% from 15.5% in the fourth quarter of last year. The rate has since surpassed 26%, a record high.
Matt Brailsford, deputy managing director for Savills in Beijing, estimates Beijing has a four-year oversupply of commercial real estate, and vacancy rates will stay in the double digits for the foreseeable future. “Shanghai is very much in the same boat,” he added.
Sliding prices
As the oversupply continues to build, landlords in Chinese cities are already subsidizing or lowering rent, a first-time trend for both cities. The average rent of grade-A office space in Beijing has decreased by 6.5% quarter-on-quarter to RMB177.5 (US$26) per square meter per month, according to the Savills report. In Shanghai, rents have fallen by as much as 14% from their peak in the third quarter of 2008. Vacancy rates hit 17% in the first quarter of 2009, up from 6.5% for the same period of last year.
Beijing real estate markets react slower than those in Hong Kong and Shanghai, which are more transparent, said Brailsford. Hong Kong commercial real estate prices decreased in the second quarter of last year and Shanghai the third. It wasn’t until the fourth quarter that Beijing began realizing new prices.
Market behavior is so unusual that standards are being rewritten, according to Mike Stacy, director of tenant representation, office services for CB Richard Ellis (CBRE). Landlords in Shanghai’s CBD are now offering “tenant improvement allowances,” a practice already common in the US, Singapore and Hong Kong, where the landlord will pay up to RMB2,500 per square meter for office furnishings and other necessities. Some landlords take the incentives approach a step further by offering lump-sum cash payments to attract new tenants.
Nevertheless, demand continues to weaken. Jileen Loo, director of business park services in China for CBRE, has seen companies in CBDs take advantage of once seldom-used contract clauses that allow them to return excess space to their landlords.
Others have gone so far as to downgrade in an effort to save cash. A company moving from grade-A to grade-B properties is rare, said Brailsford, especially since they can squeeze landlords for lower rents on grade A properties. But some firms are doing just that, in part to save money, but also to show fiscal responsibility to shareholders and overseas headquarters.
However, should CBD prices continue to decline, the business parks will face a quandary. Rents are already so low it’s difficult for them to drop any lower, said Loo.
Another advantage of business parks used to be their lease length, typically three to five years. When the market was hot, landlords in CBDs were hesitant to sign leases longer than three years, knowing that they could fill a vacated office quickly and update rental fees. Now this advantage is also at risk as CBD landlords have begun to allow longer leases.
Moving to a business park is a major decision. Most parks are, almost by definition, located far away from urban conveniences like public transit and social infrastructure preferred by employees – although they may have better distribution logistics. However, because business park property is frequently state-owned, many tenants enjoy rent subsidies. Municipal governments prefer the jobs, taxes and spin-off industries new tenants bring over rental profits.
The savings can be significant. Rental space in Shanghai’s CBD went for roughly RMB12 per square meter per day before the market began its decline, whereas in a business park it was on offer for just RMB3 per square meter.
Business parks also have a higher average “efficiency rate” – how much of the rented space can be used for productivity – than CBD offices. The average efficiency rate of a CBD office building is between 70-75%, said CBRE’s Loo. In a business park, the efficiency rate is usually between 80-90%.
The lower costs have already convinced large companies like Dow Chemical, which pulled up stakes in Shanghai’s CBD to move to a business park outside the city. Motorola also recently moved out of Shanghai’s CBD, adding to the oversupply of grade-A commercial space in the CBD district, said CBRE’s Stacy.
But CBD prices have dropped to about RMB6-7 per square meter per day, and CBRE’s Stacy expects them to lose another 15% over the next year, encouraging firms to stay put.
Expiration date
One advantage that business parks still retain over CBDs is leasing stability.
This is partly due to the business condition of their tenants, said Hugh Peng, vice president of Citi Property Investors. While multinationals in the CBDs are slashing head count, most of the companies in business parks are local or joint venture companies – the likes of software developers, insurance brokers, banking backup services and call centers – which so far have refrained from drastic layoffs. However, Peng noted that most business park tenants are still locked into old contracts.
Neither is the city center oversupply going to abate any time soon. “We are looking at double-digit vacancy rates as far as we can see,” said Stacy.
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