Office market remains tenant-favourable; emerging tenant types shore up leasing demand in retail market

Shanghai, January 9, 2020 – Cost-saving measures and lease renewals dictated the Grade A office market in 4Q19, but certain industries show promise moving forward. “As companies in TMT sectors increasingly look to upgrade their image, they are beginning to account for an ever-larger portion of Grade A leasing activity,” said Eddie Ng, Managing Director for JLL East China. In the retail sector, emerging tenant categories continued to expand despite a challenging market. Low vacancy rates in the logistics market continued in an environment lacking substantial new supply throughout the year. Finally, tight policy remained in place in the residential market, where new supply has driven modest increases in sales volume throughout 2019.

Grade A Office

The office leasing market was driven primarily by cost-saving measures in 2019. “Amidst economic uncertainties, corporates adopted more conservative leasing strategies. Affordability of decentralised areas appealed to the large-size tenants and we have observed renewals making up a large share of leasing activity,” said Anny Zhang, Head of Markets for JLL China.

TMT sectors have shown momentum in becoming increasingly important demand sources in the CBD, along with financial services and professional services, as they seek to upgrade brand image and talent retention. In 2019, TMT accounted for about 20% of Grade A office net absorption.

Over 1.5 million sqm of new supply is scheduled to enter the market in 2020, mostly in decentralised markets. One such emerging submarket, Qiantan, was successful in attracting tenants from the Pudong CBD in 2019. High-spec projects will help emerging areas become more appealing as business destinations. However, increasing supply will continue to put pressure on overall rents.

Business Parks

Overall rent remained stable in 2019 while supply remained at high levels. In 4Q19, one project with 38,420 sqm was completed in Shibei, while another two projects with a combined GFA of 281,000 sqm reached completion in Pujiang. New supply remained at high levels in 2019, totalling 682,000 sqm, while overall vacancy increased 2.3%, attributable to stable demand from pharmaceuticals in addition to TMT companies. Specific examples include Cloud Walk expanding 2,000 sqm (to a total of 8,000 sqm) in Zhangjiang Intelligence Island, and Green Valley leasing 4,000 sqm in Zhangjiang Innovation Park. Overall rent remained stable in 2019, declining 0.6% y-o-y to RMB 4.4 per sqm per day. Zhangjiang submarket saw a positive rental change, up 1.8% y-o-y.

Retail

Evolving consumer tastes are fuelling the growth of emerging tenant types despite a challenging retail market. According to Ellen Wei, Head of Retail for JLL China: “Millennial enthusiasm for street culture and young families’ preference for a more interactive shopping experience have motivated various burgeoning tenants to expand in malls, including activewear and streetwear brands, designer toy stores featuring claw machines and mystery boxes, pet stores and indoor zoos.”

Despite a supply jump in the fourth quarter, adding almost half a million sqm of retail space, 2019 total supply remains at slightly less than half of the previous year’s total, with several planned projects facing delays.

Looking forward to 2020, as the market will remain tenant-favourable, more landlords are expected to make concessions on rents to fill up vacant spaces, and more refurbished projects in the pipeline are likely to serve as growth engines of older assets, contributing to long-term asset appreciation.

Logistics

3PLs consolidating spaces as well as 2019's near-absence of new supply resulted in lower net absorption this year. Annual net absorption reached 105,833 sqm in 2019, below the average level of recent years. The strongest leasing activities occurred in the Fengxian and Lingang markets, home to pockets of the city's remaining vacant spaces.

China's growing cold chain economy continued to emerge as a demand driver, with a cold-chain operator and a fresh food e-commerce firm taking large spaces in the Northwest and Fengxian submarkets.

“The continued tight land market has narrowed Shanghai's supply pipeline, pushing development to nearby satellite markets,” said Richard Huang, Head of Logistics Service for JLL China Industrial.  The year 2019 saw only 47,000 sqm of new completions, the lowest level since 2002. New completions are expected to rebound in 2020 but remain below the recent average. Absorption should also rebound as 3PLs, manufacturers, upgraders and others seek space in upcoming projects in good locations. Rental growth is likely to moderate as more supply gives tenants more options.

Residential

Total sales volume in both the mass market and high-end market increased in 2019. Mass market sales volume for 2019 totalled 7.7 million sqm, up 17.7% y-o-y from a slow 2018. High-end sales were up for the full year 2019, with sales volume rising 30.3% y-o-y to 2,363 units, the highest level since 2017.

Sales progress diverged among new projects. Some newly-launched projects, including Oriental Bay Phase 2 in Xuhui, The Mansion in Pudong and Forte Elegant Garden Phase 3 in Huangpu, outperformed thanks to strong design, high quality and good value.

Shanghai's housing policy stance is likely to remain tight in 2020, although more monetary easing can be expected to stablise the economy amid strong headwinds. Demand will remain moderate, implying that sales performance between new projects will continue to diverge on the basis of design, quality and value in 2020.

Capital Markets

Shanghai’s total investment transaction volume hit RMB 106.5 billion in 2019, making it the fourth consecutive year to exceed RMB 100 billion. As in previous years, the office sector accounted for the largest share of en-bloc transactions, with 58.7% of Shanghai’s total sales. However, if we exclude lagged transactions from 2018 and two major government-backed transactions from calculations, the investment volume in Shanghai market in 2019 amounted to approximately RMB 65.1 billion, slowing significantly compared to previous years. This decline was the result of softening office market performance, as well as a shift in investment sentiment.

However, Shanghai’s investment market shows signs of resilience toward the last quarter, with announcements of several notable transactions. These include the acquisition of Pullman Skyway in Dapuqiao by Hong Kong Shanghai Alliance, as well as the purchase of Sanlin InCity for RMB 2.42 billion by a consortium comprising ARA Partners and two other companies. These transactions from cross-border players demonstrate that investors retain a positive attitude towards the long-term prospects of the Shanghai market.

“Looking forward to 2020, the market will remain active,” said Jim Yip, Head of Capital Markets, JLL China & East China: "We see cap rate decompression as investors continue to seek investment opportunities in the market. In an environment of low interest rates, core stabilised assets will receive more favour and attention from investors,"