Knight Frank Global Cities 2016 Report

(15 October 2015 – Hong Kong) – Knight Frank today launches its Global Cities 2016 Report to explore future trends and market performance in the real estate markets of the world’s 20 leading business cities. 

Photo (from left to right): Thomas Lam, Senior Director, Head of Valuation & Consultancy,  David Ji, Director and Head of Research & Consultancy, Greater China and Nelson Lam, Director of Commercial Agency, Hong Kong

Highlights:

• According to Knight Frank Research, Hong Kong ranked third in Asia Pacific in the 2015-2018 (year-end) forecasted prime office rental growth.
• In 2015, Hong Kong has the lowest prime office yields in the world.
• In Q2 2015, Hong Kong retains the title of the most expensive place in the world to rent office space in a tower building.
• Chinese companies are the main driver of the Hong Kong office market. In 2015, around 40-50% of new lettings in Central involve Chinese firms.
• The renovation of the aging office stock in Central is expected to affect Central’s Grade-A office supply in the long-term.
• In Central, the vacancy rate was down to 1.4% in September, close to the historic low of 2008.
• Increasing the office supply pipeline seems to be the way to relieving Central’s tight availability. However CBD2 or any further developments cannot replace Central in the short term, instead they will serve as complements.
• Hong Kong is likely to face a shortage of office space of around 2 million sq ft by 2020, equivalent to an office tower of a comparable size to Two IFC.

Performance of the office market around the globe:

The UN is forecasting population in the world’s cities to increase by 380 million people in the next five years. The increased urbanisation, combined with greater business demand, will cause office rents to rise in the key global cities. Knight Frank has been tracking prime office rents in 20 of these global cities. It forecasts that Madrid will top rental growth at 22.2% by 2018, followed closely by Mumbai (21.3%) and San Francisco (20.2%) ^{table 1}.

David Ji, Director and Head of Research of Greater China at Knight Frank, says “Despite the slowdown of China and its impact on the region’s economies, the Asia Pacific region will still see relatively strong economic growth over the coming years. Propelled by the huge forces of urbanisation, Global Cities in Asian countries like China and India will see much growth in the next three years.”

In 2015-2018 (year-end), eight out of the 20 global cities including Hong Kong are expected to see double digit growth in office rents. Hong Kong is expected to take the 8^th position with 12% forecast rental growth. By the end of 2015, Hong Kong’s prime yields will still have the lowest (2.9%) among the 20 global cities. Indian cities of Bengaluru, Mumbai and Delhi will achieve the highest yields at 10.5%, 10% and 9.5% respectively^{table 2}.

According to Knight Frank’s Skyscraper Index,In Q2 2015, Hong Kong, at US$255.50 per sq ft per year, retains the title of the most expensive place in the world to rent office space in a tower building. Meanwhile, London (10.7%) and San Francisco (8.2%) are seeing the fastest rental growth for high-rise offices in the six months to June 2015 ^{Table 3}, reflecting a buoyant occupier market in gateway cities.

Hong Kong office market performance and the latest trend:

Office vacancy rate:

Despite the uncertainties in the stock markets and the devaluation of the RMB, Thomas Lam, Senior Director, Head of Valuation & Consultancy, Knight Frank expects Hong Kong to continue to enjoy moderate rental growth with sustained demand from Mainland Chinese companies. In 2015, around 40-50% of new lettings in Central involve Chinese firms. Meanwhile, Central’s office buildings are aging, with more than 50% of the district’s Grade-A offices being over 25 years old. For some of them we see the need for renovation. Together with the shortage of new Grade-A offices in Central, such renovation will lead to a long-term impact to the district’s Grade-A office supply. Overall vacancy rates in Hong Kong decrease to 1.7% in September, and Central’s vacancy rate was as low as 1.4%, close to the historic low of 2008.

Office prime yields:

According to Knight Frank research, Hong Kong will still have the lowest prime yields (2.9%) among 20 global cities in the world by the end of 2015 as office property prices surged in previous years.

Office rental growth:

Looking ahead, Thomas Lam expects rents in Central will increase no more than 5% in 2016 and rents will slightly drop 0-5% in Kowloon East with abundant new supply in the pipeline. Despite the concentration of quality stock and attractive rents in Kowloon East, we believe CBD2 cannot replace Central in the short term because only some firms or operations prefer relocating to Kowloon East. In the long term, the emerging CBDs will serve as complements, rather than direct competitors, to Central.

Future office supply:

As some significant projects like CBD2, redevelopment of Wan Chai government offices have already been put in place to provide new office space, Knight Frank research shows that, Hong Kong is likely to face a shortage of office space of around 2 million sq ft  (equivalent to an office tower of a comparable size to Two IFC) by 2020. Thomas Lam remains positive about the long-term outlook for premium and Grade-A office buildings in the city, due to sustained long-term demand boosted by the Mutual Fund Recognition Scheme.

Five future trends in capital markets

Below are the five trends which should influence investors’ asset selection in 2016.

Global Cities 2016 Report page 34-35

1. Specialist Property

Key reasons for the growth in demand for specialist property relate to:

• The changing market requirements.
• The drive for diversification, particularly following the Global Financial Crisis (GFC).
• Yields across the traditional sectors have been squeezed, so investors have sought alternative ways of protecting and enhancing their wealth.

2. Property Income – Long or short?

• Commercial real estate is an income-driven asset class whose long term performance has been driven mainly by a high and stable level of income.
• However, market realities mean that more investors are being forced up the risk curve.
• In Asia Pacific, investors tend to focus more on capital values and rental growth prospects given  the relatively short lease of two to five years.
• In Hong Kong, for the past 10 years to 2014, the average annual income return on commercial real estate was 4.4%, against a total return of 14.4%.

3. Deregulation

• Government regulation exerts a major influence on global capital flows and can help to make or break real estate investment markets.
• Recently, the free trade agreement between China and Australia is expected to boost cross-border property investment between two countries.

4. Mixed-use

• Mixed-use projects offer portfolio characteristics that allow investors to spread risk, as well as gain exposure to a fast growing trend. For example, Battersea Power Station in London.

5. US and Chinese Outbound Capital

• US interest in China peaked in 2013. However, following the stock market turbulence of summer 2015, US interest in the Chinese market may cool down in the near-term.
• A slowing Chinese economy, together with easing policies on overseas investments has prompted many Chinese investors to seek opportunities abroad.Chinese outbound investment continues to grow, with a total of US $24 billion in overseas commercial property in the two and a half years to June.
• The Chinese outward investment trend is expected to continue in the coming years, as there are increasing needs by investors to diversify their portfolio into the relatively stable overseas market.