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Retail-to-office conversion attracts interest in the office market and draws the attention of investors; luxury apartments and high-end villas continue to record strong sales
BEIJING, October 17, 2016 – "Despite softening demand in the office market, many tenants are still willing to pay for a quality building, whether in a centralised location or an emerging area. Therefore, landlords who are responding to the realities of the market with greater flexibility are seeing the biggest gains," said Julien Zhang, Managing Director for JLL North China. Meanwhile, in the retail sector, two new malls opened with nearly all of their trading space open and ready for business in the quarter. Investors were inspired by the high occupancy rate achieved at Pacific Century Place – the newly completed retail-to-office conversion in Sanlitun – and scoured the market for other convertible properties in the quarter. In the logistics market, e-commerce and 3PLs continued to dominate demand. In the residential market, new tightening measures were introduced in a bid to cool the hot residential sales market.
High-quality projects continued to attract tenants, helping to drive net take-up to 107,300 sqm in the quarter. However, CBD absorption was negative for a third consecutive quarter; vacancies emerged at lower-end buildings where landlords were slower to respond to market conditions and reduce rents, or at buildings lacking the infrastructure required to meet tenant needs and expectations. Domestic finance firms continued to be active in looking for space, but overall demand remained soft. Some companies took advantage of relocation opportunities in the market as they became available.
The much-anticipated retail-to-office conversion at Pacific Century Place finally came online and achieved 90% commitment in the quarter. The successful outcome of the project, which speaks to tenants adopting co-working space with plenty of nearby amenities in the high-profile Sanlitun area, is an important reference point for others attempting office conversions or considering new developments in the market. One other completion also entered the market in the quarter: Lei Shing Hong Centre A (89,000 sqm) in Wangjing opened and quickly achieved 70% occupancy. The landlord offered below-average rents to secure large deals with stable tenants.
Overall rental growth was flat q-o-q, after landlords and tenants carried out varying actions in the market. "The perfect storm of many waves has come to shore, with some tenants wanting cheap space and looking at price above all else, while others seek better quality buildings and are prepared to spend on this," said Eric Hirsch, Head of Office Leasing at JLL in Beijing. "While rental growth continues to be restrained under market conditions and the large amount of incoming supply on the horizon, competitively priced, quality buildings are still expected to outperform."
Lifestyle brands are striking a chord with destination mall shoppers. As the customer base of destination malls like Taikoo Li matures, premium lifestyle brands are appealing to consumers who are willing and able to splurge on non-essentials. Also, malls continued to maximize on VR attractions in the quarter, while kids' brands were displacing second-floor fashion boutiques as mainstream tenants at suburban malls.
At 4.1%, suburban vacancy dropped to its lowest point since the market emerged in 2008, despite the opening of a new mega-mall in the south of Beijing in the quarter. The low-vacancy suburban environment is supported by growing demand, which has enabled most suburban projects to open fully or nearly fully occupied. For example, the massive 270,000 sqm-Paradise Walk entered the market in southern Beijing fully committed in the quarter, while 95% of store space was ready for business on opening day. This was especially impressive considering the large size of the project and the generally slower leasing market. Meanwhile, market vacancy was flat q-o-q in the urban market, where Beijing Harmony Plaza opened on the city fringe. Fully committed and with 90%-plus of its store space open and trading, the project achieved similar results to Paradise Walk in the quarter.
Landlords remained under pressure to raise rents, but the pace of growth was constrained by slow sales growth. However, rents have not yet turned and strong projects still managed to squeeze out slight rental increases. Overall rental growth was flat q-o-q. "As tenants make greater efforts to attract higher footfalls, landlords have been able to accept more flexible terms under the current environment," said Alice Law, Head of Retail Leasing at JLL in Beijing. "Landlords are aware that busy projects will have a better chance at recording higher sales, which will lead to further rental growth, a win-win situation for everyone."
The results achieved by the landlord of Pacific Century Place boosted enthusiasm for conversion opportunities in the quarter. Following the high commitment recorded at this project and due to the strong preference for office properties, assets with great conversion upside potential were very popular for investment in the quarter. Meanwhile, Parkson Taiyanggong in eastern Beijing sold for a total consideration of 2.32 billion RMB in the quarter. The domestic buyer is highly likely to consider converting this property to office to make the most of opportunities in the market.
Tightened controls on outbound investment continued to prompt domestic investors, particularly institutional investors, to consider more domestic opportunities. "The domestic market has been increasingly active since the start of the year, and this trend is likely to continue through to the end of the year," said Kevin Qin, Head of Capital Markets at JLL in Beijing. "This is further adding fuel to the seller's market in Beijing and encouraging buyers to consider alternative options as the availability of Grade A en bloc buildings remain scarce. As such, we expect activity to continue to pick up in well-located Grade B+ buildings, as several transactions were in progress in the quarter."
Due to the slight pick-up in leasing activity, rents edged up. Landlords took advantage of the relatively active quarter, using renewals or relocations to raise rents, while those in mature submarkets leveraged changes in tenancy to increase passing rents. This led chain-linked rental growth to rise by 0.7% q-o-q. Under the softer demand, moderate rental growth is still expected over the 12 months as the tight environment – with vacancy recorded at below 5% for a sixth consecutive quarter – suggests that the market remains undersupplied. High-quality warehouses will be the biggest rent-winners as 3PLs and e-commerce firms seek projects with better facilities.
Tongzhou Logistics Park in Beijing cooperates with Tianjin to better link the two cities. Tongzhou Logistics Park announced plans to jointly develop a logistics park with Tianjin's Baodi Economic Development Zone. Limited logistics land in Beijing is creating opportunities for the Tianjin government to benefit from cooperation with the government, especially as spill-over demand from Beijing enters Tianjin.
A new round of tightening measures was announced at the end of the quarter, in an effort to cool the hot residential sales market. The policy change effectively increases the minimum down payment for both first and second-home buyers, which is expected to restrain demand in the overall residential market. Considering the higher down payment requirement for non-mass market residential projects, especially for second-home buyers, the move should further restrain demand in the high-end market. However, as many buyers in the high-end market have high affordability, the impact of the new policy is expected to be somewhat limited. In the same policy announcement, the government also encouraged more mass market projects by increasing the land supply for such developments, which is likely to lead to the development of fewer high-end projects in the long term. Therefore, prices for the high-end market could still rise in the future. The tightening measures followed an announcement made earlier in the quarter restricting future development on commercial-titled residential projects, which is likely to shift some demand to the commodity housing market.
Both luxury apartments and high-end villas witnessed strong sales in 3Q16, recording 939 and 634 units respectively, up 39% q-o-q and 17% q-o-q, respectively. Following strong sales volumes in the first half of 2016, developers were encouraged to continue launching new projects on the market. A total of 1,766 luxury apartment units entered the market in 3Q16, up a remarkable 152% q-o-q. However, only 479 high-end villa units entered the market, down slightly q-o-q by 4%.
Meanwhile, on the back of strong transaction volumes, but fewer newly launched units, primary capital values for high-end villas increased a notable 5.2% q-o-q. However, the abundant supply of luxury apartments in the quarter restrained primary capital values growth for luxury apartments at 1.8% q-o-q. Meanwhile, the more active leasing market – due mostly to more short-term summer contracts and relocations triggered by stricter housing budgets from foreign companies – spurred rental rises for both luxury apartments and high-end villas, with respective q-o-q increases of 1.8% and 1.0%. Inventory shrinkage in the serviced apartment market gave some landlords an opportunity to raise rents, which increased by 1.0% q-o-q in 3Q16.
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JLL (NYSE: JLL) is a professional services and investment management firm offering specialized real estate services to clients seeking increased value by owning, occupying and investing in real estate. A Fortune 500 company with annual fee revenue of $5.2 billion and gross revenue of $6.0 billion, JLL has more than 280 corporate offices, operates in more than 80 countries and has a global workforce of more than 60,000. On behalf of its clients, the firm provides management and real estate outsourcing services for a property portfolio of 4.0 billion square feet, or 372 million square meters, and completed $138 billion in sales, acquisitions and finance transactions in 2015. Its investment management business, LaSalle Investment Management, has $59.1 billion of real estate assets under management. JLL is the brand name, and a registered trademark, of Jones Lang LaSalle Incorporated. For further information, www.jll.com.
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