How closely does office demand in Tier 1.5 markets in the Yangtze River Delta (YRD) region mimic that of Shanghai’s? Based on our quarterly reviews and forecast discussions on the market, the answer appears to be – very close. What we saw in 2011YE in Shanghai – signs of weakening demand, exhibited through lower enquiry levels were also observed in Hangzhou in 4Q11 and in Nanjing shortly after the Chinese New Year holidays.
Specifically, I was expecting a delayed demand effect of at least 2 quarters between Shanghai and YRD Tier 1.5s. Domestic occupiers tend to play a more significant role in Tier 1.5s, typically occupying anywhere between 75 and 80% of Grade A office space. Conventional wisdom also suggests that these occupiers are well-funded, cash-rich, and more resilient against global economic shifts. They have also been the one source of demand that “picked-up the slack” when MNCs pull back during periods of economic uncertainties. As such, even though economic structure is quite similar amongst the YRD cities, overall demand pullback on an aggregate level should be less noticeable in the T1.5s. Therefore, the co-movements in the timing of occupier demand between the YRD T1.5s and Shanghai during the current economic cycle came as a bit of surprise, given the differences in economic structure, Grade A occupier profile, and market maturity. But market synchronisation actually means that I now have an additional data point (Shanghai, a much more transparent office market) to benchmark YRD Tier 1.5 demand performance, which should led to improvements in our forecast methodology.
Qualitative measures aside, we began exploring additional ways to quantify demand for space in the established business districts within the REIS China YRD cities. Namely, by 2012YE, we’re planning to place more focus on “CBD Demand Momentum” for the two key YRD Tier 1.5 cities, Nanjing and Hangzhou, in our reports. These metrics will look into the degree to which office net-take-up, after netting out the effect of new supply and abnormally tight market conditions, actually out- or under-performs the city’s historical benchmark. Combine that with our on-the-ground interviews with landlords and agents regarding enquiry levels and sentiments, office-demand co-movement with Shanghai, and a slew of other factors, our near-term demand outlook would be more robust.
However, despite convergence of demand cycles within the YRD economies, there remain considerable differences between the behaviors of local office markets**, resulting in differences in rental return correlations. Grade A landlords in the traditional business districts of Hangzhou and Shanghai, with sub-10% vacancy, will likely be able to withstand the temporary demand headwinds, given the much healthier supply fundamentals. Nanjing, on the other hand, with office vacancy above 20%, may be less lucky should demand continue to weaken.
*CBDs for the three cities are defined as follows: Shanghai: Pudong and Puxi CBD, Hangzhou: Huanglong and Wulin Submarkets, Nanjing: Gulou, Xinjiekou
**These differences include a variety of local factors, with land (office) supply and economic development policies being the main drivers that cause office cycle in one market to deviate from another.
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