The impact of Covid-19 quickly exacerbated the downward rental trend that started in late 2019. Rental levels have fallen for nine consecutive quarters – registering a -8.4% y-o-y drop as of end-1Q21. The successive rental declines have shifted leasing market conditions from a landlord-favourable environment to a tenant-favourable market, triggering more upgrading and relocation demand from tenants.

Moreover, the current situation has given rise to an uncommon trend in the Beijing office market, whereby rents for new leases are typically averaging lower than renewal rates. This is driving a new wave of market transformation that supports demand recovery, and presents distinct opportunities and challenges for landlords and tenants.

CBD sees largest rental gap between renewals and new leases; policy-led areas buck trend

Figure 1: Beijing Grade A Office Leasing Transactions by Submarket

Source: JLL Research, 1Q21

Following our analysis of more than 1,000 leasing transactions from 1Q20 to 1Q21, we found that the CBD was the submarket with the largest rental gap between new leases and renewals. On average, renewal rates in the CBD were about 16% higher than new leases. New supply pressure in the CBD Core Area brought additional pressure to landlords in the area and further intensified competition.

In stark contrast to the general trend, however, areas with strong support from government policies such as Zhongguancun and Finance Street are proving to be the exceptions: rents for new leases in these submarkets remain, on average, 4-6% costlier than renewals. Even amidst the market turbulence, landlord-favourable conditions in these submarkets persisted as robust policy support worked to continue benefiting areas where IT and finance companies cluster.

Budgeting for relocation – more of a balancing act than ever

Figure 2: Cost Analysis: Renewal vs New Lease

Source: JLL Research, 1Q21

As tenants with relocation demand must consider relocation costs, their decision automatically includes not just rent for new leases but also decoration costs, reinstatement fees, and other expenses. In a challenging market, these additional costs ultimately force some tenants to abandon their relocation requirements, even despite the lower-rent environment. With a gap of 15-20% between the average rate of renewals and new leases (as shown in the above chart), in most cases, only tenants with strong bargaining power will be able to control rental costs to meet their relocation needs.

A majority of tenants continue to spend conservatively, generally cutting out additional costs, while many landlords are leveraging renewal rates in a bid to maximise rent incomes from existing tenants. At the same time, landlords are aware that lower rents for new leases will increase their projects’ attractiveness, helping to maintain both occupancy and overall stability.

Narrowing window of opportunity for market participants to seize

With demand recovery off to a relatively strong start in 1Q21, positive signals in the market suggest that landlords are likely to regain notable bargaining power later this year, especially as rents are expected to start bottoming out by end-2021. Thus, the window of opportunity brought about by rising market pressure and the ensuing rental adjustment period will gradually close, leaving tenants with fewer competing options.

As such, tenants would be wise to find the means to act sooner rather than later. Meanwhile, forward-looking landlords would be well-placed to seize this moment to secure higher-quality tenants, further sacrificing on rent gains to share tenants’ relocation costs and bring them on side. All of this is expected to contribute to a more active leasing market in the months to come.

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