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By Mi Yang and Linda Yu
As an old hotel in northeast Beijing becomes one of the latest projects to be swept up in the city's conversion craze – intent on turning lower-performing retail, hotel, and serviced apartment properties into new office space – landlords and investors continue to scour the market for the next convertible building to get in on the action.
Since the retail-to-office conversion project at Pacific Century Place completed a year ago in the high-profile Sanlitun area, a handful or two of other office conversions have sprung up in the market as landlords and investors have been inspired to follow suit and pursue potentially higher gains. In the last year or so, these office conversions have generally seen achievable rents increase by as much as 30-50% from their former incarnations as retail, hotel, or serviced apartment properties.
But while the numbers are compelling, landlords and investors need to ask a critical question before jumping at the next conversion opportunity: is every building in Beijing suitable for
At first glance, office conversions in Beijing seem a no-brainer. Grade A office vacancy hovers around 5% and is among the lowest in the world, while rents are the second-highest in Asia. Adding to this are development restrictions preventing new commercial buildings from being constructed within the city centre. In a market where pent-up office demand remains and upgrade potential is huge, interest in office conversion is high.
But when we take a step back to look at the bigger picture, we see that all of the office conversions in recent years total less than 2% of the entire office market. In other words, office conversions continue to be special cases. Most office conversions to date have also been small in scale, limiting their influence on the wider market. As such, conversions have not introduced significant inventory to the market compared to new construction. Still, landlords and investors need to act smartly to reduce the risk of converting an unsustainable property.
First, a building must be deemed suitable for office conversion. Retail spaces, for example, tend to suffer from odd-shaped floor plates that cannot be easily divided into uniform office units, or lack enough lifts to support the daily crowds of office workers that come with office buildings. Old hotel and serviced apartment buildings, meanwhile, may be limited by outdated structural features like low ceilings. Properties which are too far off the mark for office space may not be worth the effort.
While a prime location has helped Pacific Century Place's converted project command relatively high rents, modern office features such as high ceilings, raised floors, and bright corridors have set it apart from other newly completed office conversions in less desirable locations on the edges of office clusters. Hindered by obstacles like low efficiency ratios, these projects will find it difficult to achieve comparable results. Their relevancy in the market will also be challenged in the future as obsolescence quickly sets in.
Beijing is facing a major influx of new office supply and much of what is coming through the pipeline is of higher quality. As tenants flee low-end buildings for better and more competitively priced office space, poorly converted office buildings will be among the first to be abandoned in the market.
So, while there are some office conversions that make strong financial sense, we need to remember that not every building is suitable for such an undertaking. Only buildings with characteristics that are compatible with office conversion will prove a worthy investment in the long run. The good news is that as more landlords and investors get their hands on the right projects, we can expect to see a greater number of high-quality office conversions complete to form a small, but unique contribution to the market.
Mi Yang is the lead office analyst for JLL Research in Beijing, and Linda Yu is a manager on the team.
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