Quarterly leasing stable despite economic and geopolitical challenges

Leasing volumes in Asia Pacific during 2Q23 matched their levels from a year ago and were up 13% on 1Q23, as declines in India were offset by increases in Australia, Japan and China. Net absorption also pointed to robust demand with volumes up 28% over 1Q23 and 16% over 2Q22. Leasing demand was resilient given continued weakness in Mainland China and reports that decision making was delayed, particularly from occupiers headquartered in the US and Europe.

India continued to lead the region in take-up volumes with broad-based demand from flexible space operators, manufacturing and financial services firms picking up the slack from slowing tech demand, but take-up slipped by 21% from a very strong 2Q22. Chennai shone bright with manufacturing and tech driving a 90% surge in volumes over 1Q23 while Mumbai saw volumes increase 10% over the same period on the back of demand from professional services and financials.

In China by contrast, activity remains low by historical standards but picked up by 26% from 2Q22 when COVID-19 restrictions were in full force. Sentiment weakened substantially in 2Q23, with companies taking a much more cautious stance as they expressed concerns around the economy amidst expectations of a recovery shifting from 2H23 to 2024.

Elsewhere in the region, Tokyo beat its previous record for quarterly leasing volumes as the market continued to recover, with activity bolstered by pre-commitments in new supply. Seoul volumes ticked up q-o-q following the completion of new supply in Gangnam; however, volumes were down 39% over 2Q22 due to tight vacancy.

Pre-leasing also supported strong growth in Melbourne, while the small tenant cohort boosted leasing in Sydney with Australian volumes up 45% y-o-y.

Elevated supply volumes and rising vacancy a drag on rent growth

Over 1.6 million sqm of new supply was delivered in Asia Pacific during the quarter with a record 7.5 million sqm expected to complete during the full-year 2023, marking the peak of the current supply cycle. The regional vacancy rate ticked higher to 15.1% and is forecast to continue rising through the end of the year. Against this backdrop, Asia Pacific rents declined 0.2% q-o-q.

Positive net absorption and a declining vacancy rate gave landlords the confidence to raise face rents and lower incentives in Brisbane CBD. Meanwhile Sydney CBD landlords pushed up face rents despite negative net absorption and elevated vacancy as occupier demand for space in high-quality buildings remained strong. While Seoul CBD vacancy increased marginally, rates remain near frictional levels and as such, landlords continued to raise face rents and reduce incentives.

Shanghai rents trended down as tenants increasingly opt for renewals and cost saving strategies amidst a supply wave and heightened economic uncertainty. Enquiries were up in Hong Kong but have yet to translate into transactions; relocations to lower-cost submarkets remain a theme, putting downwards pressure on Central rents. Completions and future supply stimulated leasing demand in Tokyo, yet rents declined as landlords maintained an accommodative stance.

Continued buyer caution sees capital values trend down

Interest rates are at a cyclical peak and continue to drive a wedge in buyer-seller price expectations, restricting office transaction volumes. Moreover, North American and European buyers remain generally cautious about the office sector, given concerns about the impact of hybrid work on office leasing demand. As such, Asia Pacific capital values trended down, declining 0.9% q-o-q in 2Q23.

Rental growth drove an increase in Seoul CBD capital values as office transaction volumes surged to KRW 3.6 billion in 2Q23. Supported by strong rent growth, Brisbane CBD capital values rose despite softening prime yields; however, no transactions were recorded in the quarter. Bengaluru CBD also recorded capital value growth as investor interest remains high for core and build-to-core assets.

Melbourne CBD capital values declined sharply q-o-q as rents fell and yields widened; three sales totalling AUD 68.5 million were recorded, a q-o-q decline in transaction volumes. Beijing CBD capital values declined due to a combination of rental declines and weakening investor sentiment. Sydney CBD capital values declined as prime yields softened due to an elevated cost of debt environment as well as global economic headwinds.

Rents and capital values to decline further in 2023; growth positive in 2024

We maintain our view that leasing activity will be flat y-o-y; with risks to the downside due to weakness in the global economy and a slower than expected recovery in Mainland China. As a result, decision making from corporates, particularly those headquartered in Europe and the US, will likely remain delayed. However, the flight to quality we have observed should balance out some of these headwinds and provide support to Grade A office leasing demand. We expect supply pressures and rising vacancy rates to continue weighing on rent growth and we now expect Asia Pacific rents to trend down in 2023 (-1% y-o-y) and turn the corner in 2024.

Several large core transactions are in the pipeline, and we expect transaction volumes to pick up in the second half of the year. However, rents are expected to fall further before bottoming out and a combination of weak investor sentiment and elevated cost of debt supports our view that yields will continue to widen this year, putting further downward pressure on pricing. As such, we have revised down our forecast for Asia Pacific capital values (-2.5% y-o-y), and like rents, we forecast capital values to resume growing in 2024.