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News Release

Hong Kong and Macau

En-bloc Transaction Stalemate Ends in Shanghai; Office Rentals Maintain Sharp Decline

According to Jones Lang LaSalle First Quarter Property Review

In the Grade-A office market, average rentals continued to fall due to stagnant demand from MNCs.  “Tenants’ lack of access to capex and increased supply in the marketplace are the main drivers of the decline” noted Anthony Couse, managing director for Jones Lang LaSalle Shanghai.  In the retail market, ground floor rental levels appear to have reached a peak, declining slightly by 1.5%. Mass market residential transaction volumes continue to increase this quarter while limited price corrections in the luxury market resulted in few transactions. Investor sentiment in the market began to show signs of improvement as POSCO sold the Grade-A office tower POS Plaza to Lujiazui Group for RMB 1.76 billion, representing the first major en-bloc transaction for the year. In the industrial market, a growing domestic market and faltering export industry continue to shift the focus of investors and occupiers.

Rental levels decline another 14.9% in Shanghai. In 1Q09, average rentals for Shanghai CBD Grade-A office space declined by 14.9% q-o-q to RMB 7.0 per sqm per day. Both Pudong and Puxi witnessed a dramatic drop in 1Q09, decreasing 17.6% and 13.7% q-o-q, respectively. The main reason for the significant decrease in rentals is the intense competition between landlords in an environment of limited corporate demand. Premium Grade-A buildings were no exception from the rental decreases with average premium rentals dropping 18.0% q-o-q in Pudong and 16.4% q-o-q in Puxi. As companies tighten budgets and focus more on cost savings, landlords of premium Grade-A buildings are lowering effective rentals in order to stay competitive and retain tenants in light of the supply-heavy market.  The overall market vacancy rate remained stable due to most tenants renewing current space requirements rather than expanding or downsizing. One new building, BEA Finance Tower, entered the market adding 56,000 sqm in Lujiazui.

Leasing demand in the Shanghai office market remains weak.  Most MNCs continued to hold off on expansion plans. The pre-leasing progress for buildings to reach completion this year along West Nanjing Road and in Little Lujiazui also remained slow.  Tenants are no longer compelled to pre-commit to space in new buildings as supply heavily outweighs demand. Also, occupancy rates of many buildings completed during the supply boom in 2008 have barely increased from their pre-commitment levels. With the market continuing to shift toward the tenants favour, occupiers are now capable of renegotiating lease agreements to accommodate lower rentals locked in for longer periods.
Tenants were not willing to commit to long leases in the past when rents were high.  Although overall demand in the market is weak, some demand continues to emerge from domestic companies. For example, Ningbo Bank leased 3,000 sqm in Aurora Plaza and a domestic consulting firm relocated from a Grade B building to Chamtime International Financial Centre.  Prior to the supply boom in 2008, some companies were forced to spread operations throughout various buildings because a large space in one building was simply not available. Increased supply not only in the CBD Grade-A market but also the Decentralised Grade-A and Business Park markets now make office consolidation easier to accomplish. By merging operations under one roof, companies are able to improve productivity as well as negotiate lower rental terms. 
Prime ground floor retail rentals peak. After several years of steady rental increases, average rents for ground floor retail space in prime shopping centres have reached a peak. Prime retail rents this quarter declined 1.5% compared to 4Q08.  Although retailers still see the Shanghai market as a source of growth, many are reviewing expansion plans and paying more attention to the profitability of individual stores. These concerns are putting pressure on landlords to lower rents as retail sales growth slows. However, the dramatic rental drops witnessed in some of Shanghai’s other commercial real estate sectors are not expected in the prime retail sector as vacancy rates will remain very low. 

Landlords with vacant space opt for large tenants.  Some shopping centre landlords with vacant space on upper floors are now choosing to sign leases with large space occupiers who typically pay discounted rents. In the past, landlords in prime areas were unlikely to accept such leases due to lower achievable rents on a per sqm basis.  Considering the rising importance of cash-flow and future competition from new supply, large occupiers are now being welcomed by landlords. For instance, Infiniti was able to increase occupancy levels with the addition of California Fitness on the sixth and seventh floors and Muji on the third floor. Shimao International Plaza similarly added Sports City to the seventh floor.  These types of retailers traditionally drive increased foot traffic in the mall and attract complementary shops, which is the benefit landlords receive in exchange for lower rents.

Mass-market residential is turning the corner.  The bottom of the market may be near at hand.  Following a steady pick-up in transaction volume since September 2008, buying sentiment has continued to improve and overall sales volume is accelerating.  In the first quarter, Shanghai mass market residential sales were up 5% y-o-y and 23% compared to 4Q08. Significantly, March, a traditionally strong season for home sales, saw volume recover to levels not seen since October 2007, the month the Chinese stock market peaked.  The recent pickup in sales transactions can be attributed to the government measures to lower interest rates, down payment requirements and transaction costs and increase access to public housing funds, as well as increased disposable incomes over the last year and improved market sentiment.  While pent-up demand is playing a role, the aforementioned factors have combined to dramatically improve affordability and broaden the base of people who can participate in the market. Due to this recent pick up, many developers are now revising 2009 sale projections upwards from the predictions made during the end of 2008.
Further moderate price and rental drops in the luxury sector. As the mass residential market continues to see a pick up in transaction volume, the luxury residential market is still relatively sluggish as most developers are only willing to accept moderate price decreases. In addition, developers with future projects in the pipeline are deciding to postpone completion dates in order to wait until buying momentum picks up again. Concerning the leasing market, many landlords are lowering rentals due to weakening demand from expatriates. The number of new expatriates entering Shanghai is on the decline and those that are being deployed have less generous housing packages than in the past.

POS Plaza sold for RMB 1.76 billion. After a very quiet second half in 2008, investment activity has shown the first sign of a potential pickup.  As the exclusive advisor, Jones Lang LaSalle assisted  Lujiazui Group with the purchase of POS Plaza from POSCO for RMB 1.76 billion. POS Plaza, located in Zhuyuan, consists of a 34-storey office tower and four stories of retail space.  The transaction was the first major en-bloc Grade-A sale where a buyer and seller were able to agree on price since the significant shift in office market conditions witnessed in 3Q08. The transaction also demonstrates the rising role of domestic buyers in the real estate investment market. Transactions involving domestic players are expected to increase as domestic insurance companies enter the market and cash rich investors, including state-owned enterprises take a long term view and look to acquire assets. For the rest of the year, further transactions are expected to occur as a benchmark has now been established in the market.  

Investors focus on acquisitions rather than development.  Supply outweighing current demand in most property sectors in Shanghai is driving investors away from developing greenfield projects in the city.  The retail sector is the one exception with a low vacancy rate; however few prime downtown land plots are currently available in the market. In most cases, risks surrounding new developments are simply too high to justify an investment.  The shift in investors’ focus from new developments to acquisitions was evidenced in 2008 by a 60% fall in total Shanghai land sales compared to 2007. One reason behind the dramatic drop in sales was a cooling measure put in place by the government during 2007 that prohibited foreign currency deposits for land purchases; the government has since then loosened regulations in order to help encourage foreign investors back into land sales.  Investors however see this as a good time to enter or expand within the Shanghai property market by acquiring existing assets at a discount rather than new developments.
Industrial Logistics
Export demand falling, domestic demand on the rise. Shipping containers and freight traffic volume in Shanghai were both down in February by 18.6% and 12.2% y-o-y, respectively. The dramatic decrease in export demand has greatly affected the bonded warehousing market, while high vacancies continue to plague the market. Companies with excess inventory that was initially meant to be exported are now turning to temporary and cheap solutions for storage with little concern over the quality of the warehouse. More companies are also deciding to deliver goods through shipping vessels rather than air freight, utilising the vessels as temporary floating warehouses in an attempt to save money on storage costs. On the other hand, the growing retail market in the Yangtze River Delta is continuing to support demand for non-bonded space utilised for domestic distribution.

Business Parks

Landlords remain positive.  Despite the threat of large amounts of new supply arriving in the market, business park landlords remain optimistic. As the majority of projects are developed by state-owned or government linked developers, less emphasis is put on achievable rental levels while increasing tax revenue and attracting higher value economic activity are the primary focus. These low rents combined with government incentives make business parks a cost-effective solution for many companies. Target business park tenants are large space occupiers requiring more customised space than a typical CBD Grade-A office tenant. R&D centres, BPO centres and regional MNC headquarters are examples of such occupiers. Compared to years past, demand for business park space is steadily increasing as MNCs look to consolidate space while expanding the range of operations within Shanghai.

Expansion in mid-term still a possibility. Manufacturers still show interest in expanding operations related to domestic markets in greater Shanghai but are now showing more caution overall compared to prior years.  Three sectors in particular that remain healthy include the FMCG, machinery and fine chemical sectors. Landlords are beginning to be more flexible by lowering rentals in order to keep current tenants financially stable. Facilities possessed by state-owned enterprises have so far been the first to cut rental levels and privately owned facilities are also expected to follow this trend. In addition, increased attention in manufacturing asset management strategy, including sale-and-leaseback transactions, is anticipated to spark investment opportunities. Overall, both investors and tenants foresee growth potential in the long-run but are currently not jumping into large commitments.