In Q4 2007, ongoing business expansion of foreign and local companies in Shanghai and to some extent new set up of offices by foreign enterprises rendered support to the leasing market. Against the shortage of new supply, Grade A office vacancy dropped further in Q4 2007. With the limited supply available in the market, some tenants\ chose to postpone their leasing until the upcoming new supply is completed. Rental value continued to rise with capital value firming up further at the same time amidst strong acquisition request and expectation of continuous RMB appreciation. The faster pace of capital growth than rental contributed to the mild contraction of gross yield for Grade A offices.

Looking forward, we expect to see further growth for both rental and capital values in the 2008 Grade A office market on the back of generally sanguine business outlook over the near-to-medium terms.

OVERALL MARKET REVIEW
The Shanghai Grade A office market continued to benefit from the robust economic performance during Q4 2007. The promising economic outlook over the short-to-medium terms drew more inflow of foreign direct investment (FDI) in which FDI in the tertiary industry continued to show robust growth during the quarter. The strong demand for office space as a result rendered support to office rental. However, as tightened credit and the government’s continued restrictions on foreign investment in real estate began to take their toll, the sale market turned quiet during the quarter.

MARKET UPDATE: SUPPLY, DEMAND & VACANCY
In Q4 2007, new Grade A office building supply reached 114,746 sq m, adding to an overall completion of 227,100 sq m in 2007. Among the new supply recorded in Q4 2007, all of them were located in Puxi area, namely Plaza 336 and LCH Centre in Huangpu, Metro Plaza in Loushanguan Road in Changning and Urban Development International, a new project developed by Urban Development in Hongqiao Road in Xuhui commercial complex area neighboring the Grand Gateway. These projects saw positive market response with reported occupancy rate achieving over 75% on the back of healthy market demand and limited new supply coming into the Puxi CBD area. Meanwhile, whilst Kerry's Jing'an Phase II reactivated its construction work in late December 2007, some of the scheduled new project completions were delayed to 2008. The vigorous growth of local economy and foreign investment continued to underpin Shanghai’s Grade A office demand. Multinational companies (MNCs) from banking, finance, insurance and legal sectors were amongst the most active tenants in the leasing market. In Q4 2007, net absorption amounted to 123,562 sq m, adding to a full year net absorption of 263,051 sq m. Meanwhile, the market also saw expansion or relocation demand from tenant eyeing for larger fl oor plate or better quality. The most notable recent transactions for this quarter are listed in Table 1.

The strong demand surpassed more abundant new supply pushed overall Grade A office  vacancy rate to a record low of 2.5% as at end of Q4 2007. Amongst all areas, Lujiazui recorded the lowest vacancy rate at around 1.1%, whilst all other submarkets saw decreasing vacancy rate compare with end 2006 with the exception of Huangpu area where most of new supply was completed during the year.

RENT ANALYSIS
Strong leasing demand for Shanghai Grade A office s underscored the owners’ negotiating power to stand firm for high rental. Meanwhile, the decreasing vacancy rate saw strong rental growth throughout all six sub-districts, in which Lujiazui and Jing’an recorded the highest yearon- year rental increment with over 15%, reaching around RMB297 and 337 per sq m per month respectively. As a result, overall rental went up by 3.5% QoQ to RMB277 per sq m per day, up 11.4% YoY in Q4 2007.

CAPITAL VALUE & YIELD
Notwithstanding a quieter sales market, capital growth remained robust in Q4 2007 after rising for 23 consecutive quarters. Acquisition demand for quality office  space was keen among both end-users and investors, leading to a further rise in overall capital value by 14.2% to reach RMB47,560 per sq m during the quarter. Meanwhile, the stronger growth of capital value than the rental value led to a further gross yield compression to around 7% as at end 2007.

MARKET OUTLOOK
Looking forward, the Shanghai Grade A office  market is likely to be continually underpinned by the increasing quest for new business set-up, expansion or relocation demand from multinational companies, banks, financial institutions and other professional firms. We expect the office  demand in Puxi area will stay strong this year in the midst of the positive pre-leasing momentum. Yet there are also more cases of cross-district relocation and expansion demand from tenants currently staying in Puxi looking for new office  space in Pudong area. On the supply side, Pudong is likely to become the focus of the market and along with more new supply coming into Grade A office  market in 2008. Among which the Shanghai World Finance Centre will contribute around 226,900 sq m. The supply in Jing’an is also notable, estimated at 163,400 sq m, while 75,000 sq m of high quality supply will also come on stream in Putuo, an emerging district for the office market. As a result of the ample supply, the vacancy rate in Pudong area is likely to go up in 2008, pushing up overall vacancy rate from the historical low record in 2007. Against the backdrop of this, we expect to see a moderate overall rental growth by around 2% in 2008. Yet the buoyant pre-leasing demand in some
popular Grade A office  buildings in Jing’an and Lujiazui could still support faster rise in rentals in these districts.
On the sales front, despite the strong investment demand from overseas, the lack of en-bloc sales of quality office buildings in the CBD area started to divert investors’ attention to emerging areas. Some investors will also look beyond Shanghai to other second tier cities such as Nanjing and Hangzhou. The level of transactions in the sales market is expected to standstill for some time owning to the aggressive prices asked by some landlords in anticipation of further asset price appreciation. Overall, capital value of Grade A office s will likely register a further increase of around 5% in 2008. The faster growth in capital value than rental may point to further yield compression this year.

Last update : Tuesday, 26 February 2008

Keywords : Real Estate, Grade A, Report, Colliers

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