Prime office tenants flee new buildings as landlords hold onto rising renewal rates

This bolstered net office take-up to 879,000 sqft, the highest since 2011.

Savills Singapore said prime office tenants, specifically those occupying Grade AAA spaces, are fleeing out of new buildings into even newer buildings as their landlords continue to ride on the rise of renewal rates.

This, in turn, buoyed Singapore’s net office take-up to its highest level since 2011 after hitting 879,000 sqft in the first half of the year alone. Vacancy rates in the CBD Grade A office market to dropped by 1ppt to 7.8% in Q2 across areas like Marina Bay, Raffles Place, Shenton Way, Tanjong Pagar, City Hall, and Beach Road/ Middle Road with the exception of Orchard Road precinct.

CBRE previously indicated that Singapore had the fourth strongest Grade A rental growth across Asia in Q2 at over 4.1%. Interest rate hikes also prompted Singapore as well as Hong Kong to increase short-term interest rates, driving the costs for investors upwards. Like Savills, CBRE had also previously indicated that tenants could be turned off by rapidly growing rents in Singapore.

According to Savills, these walkouts would only exert pressure on currently undeterred landlords in late-2019 when the new buildings completing in 2020 begin an aggressive campaign to sign on tenants. The firm forecasts nearly 800,000 sqft of Grade A CBD office space to be completed in 2018, coming mainly from Frasers Tower at Cecil Street.

The supply of Grade A office space this year is a drastic climbdown from the 2.25 million sqft recorded for 2017. “Therefore, although demand this year may be lower than last year, the deceleration rate in new supply plus the unexpected saviour in the secondary market that came in the form of co-working space operators gave landlords the confidence to raise asking rents,” Savills Research senior director Alan Cheong said.

During the 2016 to early-2018 period, tenants were committing to new buildings that were completed either in 2017 or 2018. “Their move was driven by the early bird sign on rents in these new builds as well as the incentive to move because their existing space and fit out had already become well depreciated. Then, the move was what we call a flight to new builds,” Cheong added.

“Tenants who are already occupying Grade AAA space feel that their landlords are not budging from significantly higher renewal rental rates,” the analyst said. “Some are voting with their feet by agreeing to move to new office completions in 2020. Although the forward rental rates for these future buildings are not low, nevertheless, it is still at a steep discount to the renewal rents in tenants’ existing Grade AAA buildings.”

However, even if rents were lowered, it could be from a much higher base than today’s rates. “This is the expected outcome because the relative lull in new supply between now and 2020 plays into the hands of landlords of both existing buildings and those in the pipeline,” Cheong added.

As landlords of existing Grade AAA space consistently push the envelope for higher renewal rents, the push factor on their tenants' increases and this gives landlords of buildings completing in 2020 and beyond greater confidence to stick to their asking rents. According to Cheong, these asking rents of buildings in the pipeline were punched into their Excel spreadsheets a few years ago and are by no means low.

“However, if landlords of existing stock use this supply lull to reset renewal rents to a level that is very much higher than the desktop-processed rents for new builds completing in 2020 and beyond, it will end up as a win-win situation for both,” he added.

However, landlords should take note of the roadmap that led market rents to where they are today. “That is, in the secondary market, demand was high — for co-working space and then for the newly completed buildings in the 2016-Q1/2018 period — from tenants who had already fully depreciated their office fit-outs and fixtures and thus were unfettered to move, and from those in the growing Telecommunication-Multimedia Technology (TMT) sectors,” Cheong said.

For the next two years, demand from co-working space operators is expected to be more subdued, and only demand from tenants who are thinking of moving to new buildings will remain. One scenario that could provide an upside surprise would be if a multinational(s), most likely from the TMT sector, decides to take up a large space in an office building.

“However, these events are binary in nature and hard to pin down with a high degree of accuracy, Cheong noted. Given the current dynamics, Savills forecasts Singapore’s CBD Grade A office rents are expected to rise by 10% in 2018.