The appeal of commercial property
During Q1 the recovery in global real estate markets has become more entrenched and far reaching. A broad range of investors are targeting real estate, attracted by improving market fundamentals, its perceived inflation hedge and favourable risk-adjusted returns. Investment volumes are now over 40% higher than a year ago, liquidity is improving and investors are selectively widening their search by geography and asset type. With a supply gap emerging for prime space in a number of core cities, the occupational market is turning more in favour of landlords. The signal to tenants, therefore, is that the time to make space decisions is now at hand, as leverage will gradually slip towards landlords over the remainder of 2011. Heightened demand over the past few months has generated renewed landlord confidence, and we are seeing rising volumes of speculative development in Europe, led by Moscow, Paris and London.
Mixed messages from the leasing markets
Corporate occupiers are showing much greater confidence, but this is still translating into a mixed picture of activity across the globe. In Asia Pacific, buoyant business sentiment and corporate hiring is underpinning a strong office leasing market. In North America and Europe, leasing volumes during Q1 have fallen by around 20-25% from the encouraging levels achieved in Q4 2010, and while this quarterly decline is largely a seasonal effect, it highlights that corporate occupiers remain cautious with their real estate decision making.
The Asia Pacific region continues to have some of the world’s strongest office leasing markets. Corporate space requirements are increasing in most markets, with regional net absorption growing by 30% year-on-year in Q1 2011. Hiring expectations are rising in China, India, Hong Kong and Singapore, which will support continued high net absorption levels throughout 2011. We are also seeing growing corporate occupier interest in the diversification benefits of emerging South East Asian markets such as Indonesia and the Philippines.
In Europe, office demand in general is still being driven by lease events and consolidation as corporate occupiers maintain their guarded approach. There has been a dearth of large-scale deals in Q1. Demand is growing fastest in the CEE region, particularly Moscow, Warsaw and Prague, while Stockholm is also witnessing strong leasing activity. Elsewhere, there are signs of increasing optimism in the Nordics, Germany and France, and although leasing volumes dropped in London in Q1, requirements have grown for the first time in 18 months.
The political turmoil in the Middle East and North Africa (MENA) has impacted on corporate occupier confidence in this region, and decision making has been postponed. However, the unrest is helping to strengthen Dubai as a regional hub, with discussions of corporate relocations from less stable parts of MENA.
The US office leasing market has reached near-universal stabilisation. Tour activity (a measure of corporate occupier interest) increased in two-thirds of US markets in Q1, and a significant amount of leasing activity has been for expansion space. In particular, the technology sector has been rapidly expanding its real estate footprint and, unlike the past ‘tech bubble’ in 2000, demand is being underpinned by more robust fundamentals. The financial services sector is expanding in New York, as well as in several regional banking centres around the country. Rounding out expansion activity across the US have been energy, biotech, education and various service-oriented firms.
Rental growth spreading
Rental growth for prime assets in the world’s top-tier office markets is at its highest level since Q1 2008, averaging nearly 8% year-on-year growth across 22 major markets. Strongest growth has been recorded in Hong Kong, Singapore, Shanghai, Beijing, Sao Paulo and Moscow. Solid rental growth is also a feature of core CBD office markets in North America and Western Europe, notably London, Washington DC and San Francisco. These markets will continue to top the rental growth league in 2011, although rates of uplift may decelerate slightly in some markets from the fast pace set in 2010. Robust rental growth is also spreading into office markets in Canada, France, the CEE region, Germany and the Nordics. Rents have started to turn around in India, Australia and some emerging South East Asia locations such as Jakarta and Manila.
However, for the majority of office markets across the globe, rental stabilisation or only marginal uplift are the predominant themes. In both continental Europe and the US, landlords have held rents relatively constant over the past few quarters, while gradually winding down concession packages offered to tenants. Our European Office Index increased by 1.5% during the quarter, and for the whole of 2011 we are projecting rental growth of nearly 5%. In the US, overall average asking rents increased by 0.7% during the quarter and we expect approximately 2% growth for full-year 2011. However, several US gateway markets will see much stronger growth, particularly for Class A space in core sub-markets.
A few office markets will continue to see downward rental pressure. Following the recent disasters in Japan, net effective rents in Tokyo declined by 1.5% in Q1 and further falls are projected for 2011. The debt problems in Europe’s periphery continue to be a drag on office rents, and declines have been recorded in Madrid (-0.9%) and Barcelona (-1.3%) and, together with Dublin and Lisbon, we expect rents in these markets to soften further before reaching the bottom in 2012. The Dubai market remains largely oversupplied, and despite potential for the regional turmoil to increase demand for office space in the Emirate, it is unlikely to offset the supply surplus. In Mexico City, rents are likely to decline moderately over the next three to four years, as new supply is delivered and developers offer increased incentives to prospective tenants.
Global vacancy rate trending down
Office vacancy rates are gradually trending downwards from their peak in early 2010. The global office vacancy rate now stands at 14.2% (across 94 cities), compared to 14.5% at its high point in Q3 2010. Subdued development activity in both North America and Europe will help to further erode rates in 2011. However, Asia Pacific is approaching the peak of its development cycle, and the regional vacancy rate is likely to increase modestly in 2011.
Peak in development cycle in Asia Pacific
The overall Asia Pacific vacancy rate continued to fall in Q1, to 10.9% from 11.8% a year ago. However, regional vacancy is still set to rise this year due to significant supply additions (40% more than 2010), though these are mostly concentrated in markets such as China (Guangzhou), South East Asia (Singapore, Bangkok, Kuala Lumpur) and India. Further construction delays have occurred in Indian Tier I cities due to weak demand and a tighter credit environment.
Increasing speculative construction in Europe
In Europe, office vacancy rates are up marginally at 10.3%, although shortages of prime space in CBD locations in London, Paris and Moscow are becoming more acute. In contrast, supply of second-hand space is high and available at a significant discount to prime. We expect some four million square metres of prime space to be delivered in 2011, the lowest volume for more than a decade, and the supply gap will widen as a result. This is encouraging speculative construction in many markets across the region, although most of this will not hit the market until 2012-2013.
Shrinking development pipeline in the US
In the US, occupancy gains and a lack of new supply have helped total vacancy levels to fall over the past few quarters from a cyclical peak of 18.7% at mid-year 2010 to 18.4% in Q1 2011. With employment in key office-using industries finally enjoying healthy growth and a very small – and shrinking – development pipeline over a three-year horizon, we expect vacancy levels to decline to the 17.5% mark by the end of 2011 and near to 15.5% by the end of 2012. If the economic recovery continues unabated and the return of speculative construction remains delayed, then even larger declines can be expected in 2013, and possibly 2014.
Latin American building boom
Across Latin America, a marked increase in demand for high-quality office space is now leading to significant increases in new development in a number of primary office markets. In a majority of cases, corporate occupier demand continues to be sufficient to cause market conditions to tighten, or to at least remain stable. In Sao Paulo, the Class A office vacancy rate is now under 7%, as tenants accelerate expansion plans. However, strong rental growth, approaching 30% for prime space in the city, is likely to slow in 2011 as new supply comes on line. Elsewhere, the Mexico City office market continues to see significant new supply with high-quality stock anticipated to increase by more than 40% over the next five years. Although the economic outlook is positive and tenant demand is healthy, the pace of additional supply is likely to outstrip the capacity of corporations to expand. Vacancy rates are therefore expected to rise from the present 12% to around 19%.
A perspective on Japan
Japan’s economy is projected to contract by 0.5% in Q1 and by 1.6% in Q2, before rebounding strongly in the latter half of 2011 and in 2012, as reconstruction efforts get underway. The disaster has inevitably impacted on short-term real estate dynamics. Net effective rents for Grade A offices in Tokyo, which had started to recover following the GFC, declined by 1.5% in Q1 and are now expected to fall by 5% in 2011 (we were previously predicting 10-15% growth). Nevertheless, occupier demand will recover, with a premium for modern earthquake-resistant buildings.
In the investment market, we do expect some impact on Q2 volumes, as investors are requesting updated engineering reports which will delay some acquisitions. Even so, for most established domestic and overseas investors, their attitude to Japanese real estate has not changed. They remain confident in Japan and see possible buying opportunities.