Hong Kong is likely to enter into technical recession for the first time since the global financial crisis in 2007-2008. The local economy is expected to record negative GDP growth for the second consecutive quarter in 3Q19 when the data is released in November. With the ongoing US-China trade war and escalating local political instability, demand for Grade A offices has slowed as demand from Mainland Chinese companies dwindles and fewer existing tenants look to expand. During these uncertain times, demand from flexible space operators eyeing expansion has been one of the few bright spots for the occupier market. However, with a recession imminent, it is unclear how this relatively new industry will evolve in Hong Kong.

The boom year for flexible space operators was in 2018 with new lettings spanning across 520,000 sq ft of Hong Kong Grade A office (approximately 0.5% of office stock), leading the sector to grow by more than 50% in the Grade A office market. Nevertheless, leasing demand by these operators has softened in recent months, as they turn towards more strategic expansion plans. Several operators are shifting strategies, requiring commitments from anchor tenants in parallel to agreeing to leasing new centres. The weakened local economic outlook is starting to have an impact as some operators are reportedly experiencing financial troubles. Despite this, there are still some large international operators who are waiting on the sideline to set up new centres if the right opportunity arises.

With JLL forecasting Grade A office rents to slide in the range of 20-25% over the next two years, and the occupier market shifting toward tenant favourable, what will this mean for the flexible space market? Based on previous downturns, requirements for offices predominantly came from businesses seeking to control real estate cost by either downsizing or relocating to more cost-effective locations. Flexibility of lease terms is advantageous for tenants in uncertain times, as they may not be confident in their office space requirements over the medium term.

This has long been one of the arguments for the flexible space industry:  that tenants will be drawn to these operators during tough economic times. This makes Hong Kong a great case study for the industry as economic headwinds are clear to see over the short term and tenants are already being tentative.

Over the longer term, JLL expects that up to 30% of corporate real estate office requirements will be comprised of flexible space by 2030. This will be employed in three forms: tenants incorporating flexible space in their offices (tenant flex), landlords running flexible space in their portfolio (landlord flex), or third party flexible space operators. Overall, there are clear advantages for tenants to incorporate flexible space into their real estate strategies. However, it will be interesting to see how it will evolve in Hong Kong and globally over the next few years.

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