Grade A offices seen weak but downside limited

The macroeconomic headwinds blowing from the United States and Europe have raised concerns that Singapore’s office rental market could head for the kind of tough times it experienced during the last global financial crisis.

Back then, Grade A office rentals fell from a high of S$18.80 per sq ft (psf) per month in the second quarter of 2008 to S$8.00 psf in the first quarter of last year, translating to a jaw-dropping peak-to-trough decline of 57 per cent.

Singapore’s prime office rentals are notoriously volatile as the market is highly sensitive to the economy, given that it counts the financial sector as one of its biggest tenants, including some the world’s largest commercial, investment and private banks. This sector is now facing an overhang from the sovereign debt default risks in Europe and the threat of a double-dip recession in the US.

Our base-case scenario is that only Greece would default and the US would avoid another recession. That said, Singapore office rentals could still decline from current levels should external conditions continue to deteriorate. Still, we do not expect to see the same magnitude of decline as in the previous crisis, for three reasons: Better affordability, tighter supply and financially stronger landlords.

First, the current office rental rates are more affordable than before. Although the average Grade A rent has recovered by a robust 38 per cent from the S$8.00 psf bottom during the last crisis, the current rate of S$11.06 psf is still about 40 per cent below the S$18.80 psf peak in late 2007. In short, tenants are paying considerably less now for the same quality space than they did four years ago.

Second, we expect new office supply in the Central Business District to tighten from next year. From 2009 to the present, we have seen a large supply of new office space entering the market, with the addition of new prime office buildings in the CBD such as the Marina Bay Financial Centre, Ocean Financial Centre, OUE Bayfront and Asia Square. Fortunately, these offices were generally well absorbed by the market, as their launches coincided with the recovery from the global financial crisis.

The supply of new office space is poised for a decline as most of the large new office developments are near completion. We expect new supply to ramp up again only in 2016 and 2017, when the joint venture between Temasek Holdings and Malaysia’s Khazanah is scheduled to complete its Marina View and Ophir/Rochor office development. The project is being undertaken in conjunction with the recent railway track land swap between the Singaporean and Malaysian governments.

Tighter new supply conditions until 2016 should help support Singapore office rentals.

Finally, Singapore’s office landlords are generally in better financial shape. With their net gearing levels lower than in 2008, they should be able to withstand a new cyclical downturn. While office landlords may be willing to lower their asking rental prices given the potentially tougher economic times ahead, we do not expect many of them to be so desperate as to accept huge cuts in order to fill up their buildings.

Thus, while Singapore office rentals could decline in the current market environment, today’s lower rental levels, tighter supply outlook and financially stronger landlords mean we are less likely to see a repeat of the crash experienced in the previous crisis.

By Tan Chin Keong – analyst at UBS Wealth Management Research.

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