Best Office Markets in Asia: Strong fundamentals entice investors

While the global credit crisis and sharp economic slowdown in the Western portion of the world have adversely impacted Asian countries, most Asian office markets are in better shape than those in the U.S. and Europe.
The aggressive expansion of financial and business services spurred demand in the core office submarkets in many of Asia’s major cities. That demand, coupled with tight office space supply, allowed most of the region to experience enormous growth in 2007. However, the expansion has slowed and demand has moderated slightly from last year’s frenetic pace.

But even with slower demand and increased supply, most office markets in Asia will still post vacancies in the single digits and rental rate growth, says Tomoyuki Yoshida, president of GE Real Estate. That means that most Asian markets provide significant opportunities for office investors. 

Here, the Global Real Estate Monitor takes a look at the best performing office markets in Asia, as well as those that present the best investment opportunities. 

Hong Kong

Hong Kong continues to be the gateway to China for most multinational corporations, and as China's economy continues to expand, the long-term prospects for Hong Kong look good.
"Companies are still coming into Hong Kong as a first step to set up in China," says Rod Routh, head of markets for Jones Lang LaSalle's Asia Pacific region. "We're starting to see demand easing in most Asian markets, but Hong Kong is bucking the trend. We've seen strong demand, and I don't think it will ease very much at all."

In 2007, Hong Kong’s overall office vacancy rate dipped to under 2 percent, with rents increasing 20 percent. Routh notes available space is located only in the suburbs, and demand has pushed rents to the highest level they've ever been.

So far this year, demand for Class A office space has remained resilient, says Andrew Ness, executive director of CB Richard Ellis Research in Asia. "Overall prime office rent still climbed considerably in Hong Kong towards middle of 2008," he notes, adding that prime office rents are expected to decelerate in 2009 and 2010. "Many large tenants have already executed expansion plans over the past 12 months, and the market is likely to witness a drop in leasing transactions in the second half as office leasing activity is expected to become dominated by relatively smaller transactions."

Vacancy is expected to increase slightly this year, according to Peter Hobbs, director of research for RREEF, the real estate investment arm of Deutsche Bank. He predicts the vacancy rate will top out by 2010 at above 5 percent as some new supply enters the market, primarily in peripheral areas.

This year, Hong Kong will add 250,000 square meters of office space including: ICC Phase 1 in West Kowloon, One Island East in Quarry Bay, and Landmark East in Kwun Tong. Another 570,000 square meters is due for delivery between 2009 and 2012.

During the first half of 2008, the Hong Kong property market saw cooler sentiment and less aggressive investment activity in the first half of 2008. However, local investors and institutional funds continued to allocate a portion of their capital to the market. For example, a local investor acquired Trade Square in Cheung Sha Wan for $194.6 million.

"Some people are optimistic about Hong Kong's future and some people are concerned… I believe that Hong Kong has a bright future because of the Chinese economy," Tomoyuki says. "Demand for office space will stay strong."

Kuala Lumpur, Malaysia

Kuala Lumpur, home of the world's tallest buildings – the Petronas Twin Towers – continues to experience plenty of demand for office space. Expansion by financial institutions, oil and gas companies, and local government agencies is driving demand, according to CBRE.

During the second quarter, several large-scale leases were signed, driving down the vacancy rate to 6.9 percent. The average prime office monthly rental rose 16 percent during the second quarter from the same period in 2007, according to CBRE.

Occupancy and rental growth is expected to remain stable despite the 15 new prime office buildings that are all expected to be completed by the end of 2010. By the end of this year, 917,000 square feet come online, although one building – Menara Commerce – is completely pre-leased to CIMB Bank Berhad.

"The outlook for Kuala Lumpur’s office market is cautiously upbeat," Ness says. "Kuala Lumpur benefits from strong, broad-based demand across a wide range of sectors (i.e. Islamic finance, oil and gas industry, and agribusiness and commodity), but this will be offset by an anticipated stream of supply through 2012 in both the CBD and decentralised areas. The result will be a relatively stable market with modest to moderate growth prospects further supported by a wide yield spread and the emergence of a REIT market."

Routh says Kuala Lumpur is especially attractive to investors, not only because of its strong occupancy and rental rate growth, but because of its relative value to other Asian markets. "Office assets in Kuala Lumpur are considered relatively cheap, at least in comparison to other cities," he explains.

Seoul, South Korea

Seoul's office market just might be the tightest office market in the world – something that bodes well for rental rate growth and office owners. Even though demand has moderated, a vacancy rate of less than one percent and little new supply means that rents in the South Korean city will continue to go up, Routh says. In fact, limited space availability in Central Seoul has pushed many large companies such as Hyundai, KIA, and LG Electronics to pursue expansions in non-core submarkets.

These unusually tight fundamentals will push rents in Central Seoul up by 10 percent in 2008 and 2009, according to RREEF's Hobbs. And, he expects Seoul’s office market will be holding at peak performance for at least another year or two. Vacancy rates aren't expected to increase until 2011 when nearly 600,000 square meters of new Class A office space is completed, boosting the existing Class A stock by 25 percent.

Although the new supply will depress rental growth to some degree, RREEF does not expect it to destabilize the market’s fundamentals since these new high-quality buildings will fill an underserved demand niche.

On the investment front, institutional investors are competing for quality buildings, trying to capitalize on the rental upside. The competition is keeping property values strong and making it difficult for investors to achieve favorable cap rates.

Tokyo, Japan

Several years of limited construction have contributed to tight office markets in Japan’s major cities, especially Tokyo. In 2007, the overall vacancy rate was a mere 3 percent in Central Tokyo, while rental growth peaked at nearly 21 percent in the city.

Although space continues to be tight in Central Tokyo, demand has softened slightly this year. Weaker demand, coupled with a moderate stream of new supply, is expected to pull the growth rate back into the 1 percent to 5 percent range for the remainder of the decade.

"The economy has been stable and growing as corporations came to Japan and expanded,"
Yoshida says. "But we don’t think growth will be as strong in the future."

Nonetheless, Yoshida says investors can enjoy investment arbitrage in Tokyo that is not available in Korea or Hong Kong. He points out that office property values peaked in mid-2007 and prices have declined by 10 percent over the past 12 months. Moreover, he notes that several Japanese property owners have gone under, creating the opportunity to invest in distressed assets.

"I think Japan will be the most interesting country for investment," Yoshida says.

Singapore

With projected GDP growth for 2008 of about 6 percent, Singapore's office market is not expected to see any major increases in vacancy, although the pace of rental growth will likely decelerate, according to Hobbs.

In 2007, Singapore office rents increased a whopping 75 percent, and although RREEF predicts that though slower global demand has cut into its rental momentum, rents are still expected to climb more than 10 percent this year – enough to rank Singapore first among Asia Pacific office markets in 2008.

Today, marketwide vacancy rates range from 4 percent to 7 percent, with fringe areas posting higher vacancies. Class A vacancy remained very tight at 0.6 percent and it is likely to remain that way since no new top-grade developments will be completed before the second half of 2009.
At that time, rental growth will likely evaporate by 2009 as roughly 10.1 million square feet of new space comes online by 2012.

Regardless, investment activity in Singapore's office sector is expected to remain healthy, with the most interest coming from core and core-plus investors who have a lower risk appetite and a desire for a growing economy.

In fact, investors seeking to place their money in office properties located in countries with a growing economy would be hard pressed to find better markets than those in Asia, Yoshida says.

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