The growing boundaries of China’s tech demand

Grade A office demand was slightly subdued in China at the beginning of this year, partially due to the deleveraging policy and current economic uncertainties. However, we continue to see steady growth from the technology sector, which will represent an increasingly important demand driver in the future as newly released supportive policies continue to stimulate the growth of this sector. Additionally, companies in traditional industries are also expanding their tech-related functions.

Policy stimulus to drive technology sector growth               

The announcement in 2019’s “Two Session” further supports technology companies’ development by issuing the rules of the new science and technology innovation board (STIB). This board is specifically set up for high-tech and strategically emerging sectors of vigorous growth potential, such as new generation IT, advanced equipment, new material and energy, and biomedicine. The pilot registration-based STIB features faster IPO process with higher market efficiency and transparency than the traditional approval-based system of A-share market. Shanghai Stock Exchange has already accepted 77 companies’ documents as at mid-April. Increasingly financing channels will further spur growth in the tech and related sectors, which will translate to increasing office demand.

Office space demand by tech firms recognized nationwide

While Tier I cities continue to receive strong demand from technology companies for headquarters and front-office uses, Tier II cities are also receiving more inquiries from technology companies, especially from unicorn companies. In addition to a few established tech hubs such as Hangzhou, tech giants are seeking back-office opportunities in Wuhan, Chengdu, etc. to leverage lower personnel cost and more affordable office rents compared to Tier I cities. Examples include Meituan’s set-up of a new 6,800 sqm call center in Chengdu, and Lenovo’s expansion in Wuhan with a big-data center of 6,120 sqm.

Figure 1 : Share of Grade A office demand in China’s key cities in 2018

Source: JLL Research
Note: Tier I cities include Beijing, Shanghai, Guangzhou, and Shenzhen
Key Tier II cities include: Hangzhou, Wuhan, Chengdu, etc.

Growing technology demand from traditional industries

Apart from the increase in office demand from the growth of tech companies, we have also discovered a spike in demand from traditional companies due who wish to expand their internal tech functions. Traditional companies are embracing tech, such as AI capabilities, to enhance their business performance; retailers are setting up online shops to promote sales; professional services companies are heavily investing in technology to deliver better results to clients; and financial companies are also actively investing in AI to improve profits. For example, in Shanghai, Sinochem, a state-owned enterprise, expanded a whole floor to setup its new online sales platform department. In Beijing, China Construction Bank leased 5,500 sqm for its new technology subsidiary.

In China, the growth of technology sector is policy-driven, nationwide, and even beyond the sector itself. Such growth will continue to stimulate office demand in key China cities.

Finance sector opening-up to bring new opportunities to Shanghai

Following the national government’s pledge to speed up financial reform and the announcement of 12 specific opening-up measures in the 2018 Boao Forum for Asia, Shanghai has launched its action plan of a 100 measures to further open-up the economy and boost the city’s position as an international finance centre.

35 out of the 100 measures announced are related to the financial sector and are aimed at firstly easing market access in the banking industry for foreign capital; secondly relaxing the restrictions on the proportion of shares and business scope in the securities industry for foreign investors; and thirdly encouraging the opening-up of the insurance industry.

When we studied the average office take-up of ten global finance companies across key cities we saw that Shanghai has the potential to grow office demand from foreign finance companies. In-terms of scale, Shanghai still has a long way to go compared to the world’s finance hubs such as New York and London. However, in China, Shanghai is the runner up after Hong Kong in terms of foreign finance company presence (Chart 1).

Chart 1: Average Office Take-up of Top Foreign Finance Companies (2Q 2018)
Source: JLL Research, 2Q18

Last year, Shanghai’s Grade A office market net absorption reached over 1.3 million sqm GFA, and finance companies were the biggest contributors accounting for 38% (Chart 2). Our view is that the new initiatives will lead to further increased office demand from the finance sector, even in the short-term.

Chart 2: Shanghai Grade A Office Net Absorption by Industry (2017)
Source: JLL Research

We have already witnessed an increased demand in leasing enquiries from two areas both newly registered foreign finance companies that are looking to set up their first offices in Shanghai; and existing foreign finance companies that have obtained licenses in new business areas and are looking for expansion.

The question is which locations are likely to benefit from an increase in demand from foreign finance companies? Based on transactions that have happened in Shanghai in the first half of 2018 (with both domestic and foreign companies), Lujiazui is still the top destination, for finance companies, especially from banking sector. But Lujiazui is not the only destination. For example, in Pudong, finance companies are also flowing into Zhuyuan and Yanggao Road areas. In Puxi, besides core CBD Nanjing W. Road submarket, the emerging CBD North Bund submarket is also capturing significant demand from finance companies.

Chart 3: Top 6 Destinations for Finance Companies (based on 1H 2018 lease transactions)
Source: JLL Research

As the financial markets continue to open up we expect an increasing demand for office space. Lujiazui will continue to strengthen its status as the financial centre of Shanghai, however rising rents and supply-shortage post 2019 will encourage spill-over demand to particularly the nearby high-profile business areas.

Achieving critical mass in Shanghai

New developments are springing up in Shanghai outside the traditional CBDs, as the core areas run out of room. From locations close to existing CBDs such as the Railway Station (north of Nanjing West Road submarket) to desolate areas away from any mature CBDs such as Qiantan, when and which of these new comers will become the next new CBD?

Map: Key emerging CBDs in Shanghai

Recently, many investors and developers have come to us to discuss one critical input – the scale (of commercial development) needed in order for the potential “future CBDs” to achieve critical mass. As development scale increases with demand levels, we chose three recently established mature markets for our scale assessment, namely Railway Station, Pudong Century Park, and North Bund clusters.

We found that, when their scale – including Grade A office projects and prime retail space – approaches 300,000 to 400,000 sqm, the areas began to achieve the critical mass needed to become a destination.

Figure: Commercial Scale When First Perceived as a Mature Submarket

Source: JLL

Take the Railway Station for example. This area’s office tenant profile previously consisted heavily of smaller-scale domestic companies. WPP Campus’ completion in 2015 pushed the submarket’s commercial scale close to 300,000 sqm, and after it successfully secured the famous company as an anchor tenant, demand started to grow organically.

The next nearby completion of KEC III- Enterprise Centre picked up this momentum and achieved a high pre-leasing rate of 80 per cent upon completion including a larger number of well-known multinational tenants such as Cardinal Health. By then, this submarket had secured its spot on the shortlist of mature business districts in Shanghai.

While the general range is 300,000 to 400,000 sqm, submarkets that are extensions of current mature CBDs will require slightly smaller scale, as they can naturally benefit from the spill-over demand from the central locations. For submarkets that are more isolated from the city centre, they will require more than larger scale, but also “a reason for high profile tenants to move there”, stemming from integrated efforts with project quality, joined forces from experienced developers, more government support, and so on.

Besides the scale requirement, what’s almost equally critical is the quality of the commercial projects. Sometimes, one trophy project can put a submarket on the map, and scale that follows can bring the submarket to maturity. While scale and quality are two relative objective inputs for a “future CBD”, they are not the only parts in this equation. Master planning of the whole area, how experienced the developers are, lifestyle elements, as well as what we like to call an “X factor” including historical attractions or river views, etc., are all factors that need to be evaluated holistically for more precise identification of future CBDs.

Hangzhou – pioneer of China’s new economy

Hangzhou, the birth place of the e-commerce titan Alibaba, has been fostering entrepreneurship and encouraging private sector growth. These initiatives have paid off handsomely, particularly in the office market as growth of its tertiary sector or services sector outshines Tier 1 cities such as Beijing and Shanghai.

The capital city of China’s eastern province of Zhejiang has been in the global spotlight since August, when it was chosen, in preference to Beijing and Shanghai, to host the G20 summit. Hosting the G20 has brought a variety of collateral benefits to the city, including increased media exposure, heightened popularity with tourists, as well as a wave of infrastructure improvements that connect the city’s neighborhoods and business districts.

All these advantages have helped to further build the city’s reputation as an innovation capital and a pioneer of China’s new economy.

In 2015, Hangzhou achieved real GDP growth of 10.2% while growth in the rest of China slipped to 6.9%.  Within GDP, tertiary sector growth is the most meaningful indicator of office market demand, and a key contributor to GDP. JLL compared tertiary sector growth across China’s thirteen Tier 1 and 1.5 cities and found that Hangzhou’s tertiary GDP growth rate exceeded that of all the others, and notably was an average of 5 percentage points higher than Tier 1 cities like Beijing and Shanghai.

Figure 1: Tertiary GDP of Tier 1 and Tier 1.5 cities

Source: Local Bureau of Statistics

Hangzhou’s robust and growing service sector has helped it achieve the highest Grade A office rents among China’s Tier 1.5 cities, reaching RMB 139 (US$20.50) per sqm per month. A few top quality projects in the city’s traditional CBD can achieve rents as high as RMB 8-10 sqm per day, comparable to some Grade A projects in the Shanghai CBD.

Figure 2: Tier 1 and Tier 1.5 city rental performance

Source: JLL Research

Policies to support the service sector – particularly tech and financial services – will continue to stimulate Hangzhou’s economy and drive demand for its office space.

• Technology: Hangzhou’s tech scene is symbolized by Alibaba. This local startup has grown to occupy around 500,000 sqm of office space in the city today. Beyond Alibaba, local government initiatives have made Hangzhou a top destination for talent seeking carreer opportunities in China’s tech industry. Examples include subsidies for startups and a development on the city’s outskirts called ‘Dream Town’ that houses over 700 startups. Successful startups are likely to upgrade their office space, fueling demand for the city’s Grade A offices.
• Financial services: Hangzhou aims to leverage its strength in e-commerce and renowned support for private sector firms to grow its role as a financial hub for the Yangtze River Delta. The city’s government currently is focusing its efforts on the hedge fund and third-party payment sectors, and is setting up “fund towns” while giving support to companies planning IPOs.

Going forward, these policies will continue to stimulate real estate demand and will further strengthen Hangzhou’s reputation as one of China’s most progressive and innovative cities.