Covid-19 and oversupply driving down prime office rent

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Demand for office space has been on a downward spiral for some years now.

The Covid-19 pandemic and the resulting economic fallout is aggravating a downward spiral on the Klang Valley commercial property market which started several years ago affecting malls and office space and the situation is unlikely to end well, industry sources said.

VPC Alliance managing director James Wong said although big companies “will definitely want a Kuala Lumpur City Centre address” for prestige and convenience, the virus has somewhat changed office dynamics.

The emerging hybrid model — a shrunken office with some employees in the office and others working from home — is said to be a future trend.

“It is a new trend for the coming years,” said Wong.

With digital communication and the coming 5G technology, Wong said demand will further fall, affecting rents, which have been on a downward spiral for some years now.

He is already seeing a 5% drop in rental reviews even among buildings with more than 80% occupancy.

The mix of the pandemic and oversupply is a potent cocktail. “With the rise in supply and unstable demand, vacancy rate is expected to increase in 2021,” Wong said.

Three office buildings were completed last year in the Klang Valley, the National Property Information Centre said in its Property Market Report 2020. The buildings are:

  • Menara Hap Seng 3 with a net lettable area (NLA) of about 240,000sq ft,
  • Sumurwang Tower @ i-City Shah Alam (NLA: 290,000sq ft) and
  • Tropicana Gardens Corporate Office (about 200,000sq ft),

Exchange 106 in Tun Razak Exchange, with an NLA of 2.65mil sq ft, was completed a few years ago. It is more than 70% vacant, an industry source said.

The Bukit Bintang City Centre mixed integrated development and Merdeka118 located across it are seeking tenants.

Exchange 106 and Merdeka118, with 106 and 118 storeys, respectively, are among the region’s landmark projects.

The Federal Territory of Kuala Lumpur and Selangor, which make up the Klang Valley, have about 140mil sq ft of office space, according to Napic’s Commercial Building Occupancy and Space Availability Report 2020.

Last year, KL’s occupancy was 77.6%, Selangor’s 69.2%, the report said. Together with Johor, they are the only states with occupancy below 80%.

Occupancy and rental have been trending downwards since 2016, the report said.

Supply/occupancy of purpose-built offices (govt/private) in Malaysia

2016 2017 2018 2019 2020
Total space (mil sq ft) 223.99 231.42 235.08 243.16 249.51
Occupied space (mil sq ft) 184.39 192.67 193.64 195.90 200.10
Occupancy (%) 82.3 83.3 82.4 80.6 80.2

Source: Napic

Supply/occupancy of purpose-built offices (govt/private) at Dec 2020

Existing stock (mil sq ft) Occupancy (%)
Federal Territory of Kuala Lumpur 99.84* 77.6
Selangor 44.97* 69.2
Johor 14.46 72.1

Note: * KL and Selangor have a combined 144.81 mil sq ft, or 64.65% of the total country’s office space
Source: Napic

A leasing manager of some 30 years for commercial properties said this is the first time she is seeing occupancy at the 70%-odd level.

She said it is premature to talk about trends, comings and goings for now although potential tenants are mulling going hybrid and considering rotating shifts.

The first three months of this year saw some activity compared to last year with requests for details flying around. Every one of these asked if the landlord was prepared to contribute to the capital expenditure, that is, to bear the cost of fit-outs.

CapEx or office administration cost is about RM250 per sq ft, so a 10,000 sq ft space will amount to RM2.5 million.

“It is a big chunk. The landlord can spread the cost out over the tenancy period,” the source said.

Some multinational companies are turning to instant offices, where a chief tenant rents bulk space and fixes up the place.

The net effect of rent-free periods and fit-outs is driving rent even lower.

For perspective, average prime office rent used to range between RM8.50 per sq ft and RM13 per sq ft and lower-grade secondary buildings between RM5 to RM7 per sq ft, according to Rahim & Co’s 2016/2017 Property Market Review.

Large mixed integrated developments with office components are seeking rent of about RM6 per sq ft, sources said.

“New owners will have a tough time. More facilities, cheaper rent,” a source said.

The pandemic seems to have thrown out previously-held logic among real estate consultants that the completion of spanking new prime offices will lead to a flight to quality. That has not happened.

“This pandemic has been here for slightly over a year. It is unlikely for companies to be making any major decisions regarding where they want to be or how much space they need.

“Office leases are generally for three years. I don’t think banks are saying, ‘OK. We want to have less space.’ It may be on their minds but they are not discussing the merits of less space at this juncture as they have other fires to fight.

“So the market today is as it is — keeping quiet.”

Mall landlords have a more immediate challenge and have it worse. This does not detract from the office space oversupply, he said

Late last week, the government ordered a number of malls in the city and in Selangor to close after they were flagged as Covid-19 hot spots. This will impact earnings and real estate investment trusts, Public Invest research said.

Global property consultancy Knight Frank in its Asia-pacific Real Estate Outlook 2021 report said the major headwind in the office sector in Jakarta, Manila, Shanghai, Beijing and Bangalore is new supply, which will soften the office rental market. Singapore will continue to solidify itself as a destination of choice among global companies, Knight Frank said.

Rising and falling rental prices are part and parcel of demand and supply. All cities face that.

But what is unique in the Klang Valley is that developers keep churning out office space like oodles of noodles, authorities keep approving development orders and banks keep dishing out financing, even as vacancy creeps up, despite real estate associations calling for a building halt years ago, although several property consultants said there was nothing to be concerned with even if office occupancy dropped to 75%.

Well, that day has come.