Major Cities See Buoyant Office Demand but Retail Market Faces Headwinds

CBRE Releases China Real Estate Market Q3 2015 Review

Growing demand from financial SMEs and TMT companies was the main driver of office leasing activity in most cities in Q3 2015. During the quarter, Beijing, Shanghai and Guangzhou all registered new take up above 200,000 sq. m.  The rapid growth of e-commerce and slowdown of the mainland economy continued to weigh on the bricks-and-mortar retail sector this quarter, most notably department stores. On the back of buoyant logistics demand, net absorption in Wuhan and Chengdu hit 162,500 sq. m. and 112,000 sq. m., respectively. Nation-wide, average warehouse rent edged up by only 0.5% q-o-q. During Q3 2015 a new set of measures directed at loosening credit were rolled out at both the central and municipal level, in order to help reinvigorate the residential market.

Office Market - Tier I markets outperform

Approximately 1.7 million sq. m of new office space was delivered to the market during Q3, 2015. Shenzhen and Guangzhou both recorded new supply of more than 200,000 sq. m, the highest amount of any city included in our national coverage. The total area of new supply added to the market during the third quarter of this year amounted to 5.54 million sq. m., up by 22% over the same period last year.

On the demand side, total new take-up continued to increase, rising to 1.59 million sq. m., up by 9% q-o-q. Growing demand from financial SMEs and TMT companies was a key driver of leasing activity in most cities. The average vacancy rate fell to 16.5%, down 0.3 ppt. During the quarter, Beijing, Shanghai and Guangzhou all registered new take up above 200,000 sq. m. The burgeoning Shenzhen market has also been supported by demand from tenants looking to set up in its Free Trade Zone. In the Pudong area of Shanghai, the vacancy rate reached a historical low of 0.7%, largely due to strong demand from high value added manufacturing tenants. By contrast, many tier II cities continued to experience excess supply that saw their vacancy rates hover in the 30-40% range, even in the face of moderately increasing demand. The slowdown of economic growth in China saw an increasing number of manufacturing occupiers, including MNCs, adopt a cautious stance to their national leasing plans. Non-traditional financial SMEs, such as P2P companies, meanwhile, were quite active during the quarter and began to play a major role in the office market. We observed more instances of municipal governments offering their support to the local market in the form of subsidies aimed at benefitting new company set-up and office lease expansion. Relocation to newly completed buildings by several local governments during the quarter was also seen as a demonstration of regulators’ supportive stance towards the market.  

The polarization of market performance between tier-I and II cities is becoming more and more pronounced. The main cause of this phenomenon is a combination of excess supply and weak demand in many lower-tier cities. By contrast, tier-I cities experienced robust demand that saw rent rise by 0.8% q-o-q.  Led by q-o-q rent growth of 3.9% in the Pudong district, rent growth in Shanghai was the highest of any tier-I city on the mainland at 1.8%.Tier II cities, meanwhile, saw rent fall by 0.2% q-o-q. The situation in the office market in Shenyang was particularly dire, where rent continued to face downward pressure brought-on by the low-asking prices of excess supply in the local market. As a result, average rent in Shenyang fell by 2.0% q-o-q. Suzhou, Chongqing and Chengdu also experienced significant downward pressure on office rent. Chengdu saw its rent drop for the eleventh consecutive quarter.  In the face of fierce competition, landlords have become more aggressive in their efforts to attract tenants; landlords have begun to offer longer rent free period and other preferential commercial terms on lease. In addition, landlords have also been increasing commission for third party firms that bring in new tenants. This trend can be observed in cities, such as Chengdu, where the quarterly drop in effective rent has been relatively steep. The divergence of performance across markets is resulting in a divergence of investor outlook, as well activity, across markets. In tier II cities, for instance, we have begun to see private investors lease buildings in order to then sublease them to the market.

Looking ahead, we expect the market continue to face risk from an excess of supply. For example, the Shanghai and Shenzhen markets are expected to each receive one million sq. m. of new office space.  The slowdown of economic growth in China is causing many tenants to adopt a cautious stance; we expect demand from the manufacturing sector to continue to slacken. Meanwhile, we expect developers to face increasing risk from construction suspensions and delays due to the lack of short-term funding, among other market factors.

Prime Retail Market - Occupier demand remains weak

Supported by new completions in tier II cities including Dalian, Wuhan and Shenyang, total retail supply reached 1.7 million sq. m. during Q3 2015. Total net absorption for the quarter was 1.6 million sq. m.

In H1 2015, total online sales grew by 48.7% y-o-y. The rapid growth of e-commerce and slowdown of the mainland economy continued to weigh down on the brick-and-mortar retail sector, most notably department stores; in the first half of 2015, a number of department stores reported a drop in sales.

In the luxury segment, consumer confidence has been dented by the recent stock market turmoil. Luxury retailers faced strong headwinds, and continued to take a cautious stance towards expansion as a result. It took a longer period of time this quarter than the previous for landlords to adjust their rent expectations to match the rental budget of luxury retailers. Even in high-end, well-positioned projects run by established operators in tier-I cities, a few luxury retailers pulled back on their store expansion plans. Although we observed a few instances of store openings during the quarter, this is not a broader indication of improving sentiment in the sector; in general, leasing demand from luxury retailers remained muted throughout the quarter. The low level of existing demand for leasing in the market was driven mainly by experience-oriented retail and mid-range fashion retailers. 

Fast fashion brands remained active amid the broader state of sluggish demand characterizing the sector. New Look opened stores in Beijing, Guangzhou, Shenzhen, Chengdu and Chongqing; Topshop entered Galeries Lafayette in Beijing; Uniqlo partnered with Disney to open the world's first MAGIC FOR ALL concept store in Shanghai. As a result of changing consumption patterns and rapidly growing niche markets, international sports and specialist clothing brands continued to branch out in China. American sport brand Under Armour expanded in Shanghai and Beijing; British lingerie Agent Provocateur opened stores in Guangzhou and Chengdu.

As mentioned above, department stores faced increasing pressure during the quarter. Many department store operators had to close their stores or initiate asset enhancement initiatives as sales continued to deteriorate. Wanda Group closed almost half of its department stores over the past six months, and added more space for F&B tenants in its remaining ones. Central Department Store also closed its last branch in China. We observed many department store operators engaging in asset enhancement efforts, including store renovation and trade mix upgrades. By contrast, international department stores adopted a slightly more aggressive attitude, and sought to pursue untapped opportunities in the China market. For instance, during the quarter, Macy’s tapped into the mainland market by setting up an online store on Alibaba’s Tmall.com. When it came to expanding their brick-and-mortar footprint, however, international department stores continued to remain reluctant.

In light of the rapid growth of e-commerce and economic slowdown, the near-term outlook for the retail sector is rather poor. The growth of e-commerce is likely to further aggravate the effects from oversupply in tier II and III cities. Even so, rising income among an expanding consumer base in some tier-I and II cities is likely to encourage market growth in these areas. We expect experience-oriented retail to lead growth in leasing demand in the retail sector. For landlords, a key challenge going forward will be managing a balance between obtaining the optimal trade mix and maintaining a sufficient level of rental income. In markets where we expect competition among F&B tenants to intensify, we encourage landlords to bring in a more diversified set of tenants to their projects, including bringing in tenants from the entertainment sector, in order to attract more family-oriented consumers.

Industrial Logistics Market - Cross-border e-tailers on the rise

During Q3 2015, the market saw new projects delivered to local markets in Shenzhen, Chengdu and Wuhan, among other cities. The completion of W6 Warehouse developed by Nanyou Holdings Limited added a total of 100,000-sq. m. of new space to the Shenzhen market after nine consecutive quarters without any new deliveries of supply. Nonetheless, the addition of new supply during the quarter is unlikely to have a significant positive impact on the demand-supply imbalance currently facing the market. Supported by robust domestic consumption, industries such as retail, e-commerce, 3PL and automobiles & components, served as the key drivers of leasing demand. Lifeng Logistics leased 10,000 sq. m. at GLP Park Songjiang in Shanghai. One foreign automobile company secured 18,000 sq. m. at GLP Park Pinggu in Beijing. Online retailers Tmall and JD expanded their leasing area in Chengdu. On the back of buoyant demand, net absorption in Wuhan and Chengdu hit 162,500 sq. m. and 112,000 sq. m., respectively. Meanwhile, we observed the conversion of a few non-bonded warehouses into bonded warehouses, in an effort to meet soaring demand from cross-border e-commerce in Guangzhou and Shenzhen, where a series of preferential policies were rolled out in the FTZ of each respective city. Robust demand from cross-border e-commerce also drove up average warehouse rent in Guangzhou and Shenzhen by 1.2% and 3.0% q-o-q, respectively. Nation-wide, average warehouse rent edged up by only 0.5% q-o-q.

Investors continued to express strong interest in the logistics sector. For example, GLP established a USD 7 billion China-focused logistics infrastructure fund (CLF II) in cooperation with seven institutional investors, including some of the world’s largest national pension and sovereign wealth funds. The fund is scheduled to develop 13 million sq. m. of modern logistics facilities over the next four years. As the fund manager, GLP China holds a 56% stake in CLF II. Meanwhile, the Dutch pension manager APG and Shanghai-based logistics developer e-Shang jointly committed an additional USD 285 million to their JV in order to further expand its footprint in China.

In our recent publication “MarketScore—The key to investing in the China logistics market”, we identified 14 key factors driving the performance of the logistics property market across 17 major cities in China, and developed a ranking system for investment attractiveness. According to our ranking system, the top performing markets include tier I cities and Chengdu. Meanwhile, investors are advised to exercise caution when evaluating logistics investment opportunities in Qingdao, Hangzhou and Changsha.

Residential Market - Credit continues to ease

During Q3, a new set of measures directed at loosening credit were rolled out again, at both the central and municipal levels, in order to help reinvigorate the residential market. The measures included: cutting the mortgage-down payment ratio for first-time housing purchasers  to 25% (with the exception of cities that still maintain formal Home Purchase Restrictions policies); lowering the down-payment ratio for second–time housing purchasers by lowering the housing provident loan to 20%; easing restrictions on the use of housing provident loans across cities. However, the response from the market to the above policy stimulus measures and the interest and RRR cuts in August was limited. The total number of sales units in 17 major cities tracked by CBRE in Q3 remained essentially flat compared to the previous quarter, at a time when housing sales traditionally reach a seasonal speak in the “Golden September” period. Even though the housing price index released by NBS has risen over the last five consecutive months, momentum has begun to slow in tier I cities; m-o-m growth in tier I cities peaked in June at 3.5%, and has begun to gradually decelerate. The deceleration of price growth in tier I cities is mainly due to the more stringent policy and credit controls in place in these cities.

In light of the serious risks posed by the continued deceleration of economic growth, CBRE believes that the maintaining of steady economic growth continues to remain a high priority of mainland regulators. As such, we expect local governments to continue to roll-out new measures to encourage housing demand, in recognition of the importance of the role of the housing sector in the broader economy. Further measures aimed at helping low-tier cities destock their existing high levels of housing supply are likely to be rolled out in the ensuing quarters. In mega-cities, such as the tier I cities, however, we expect stringent controls on housing prices to remain in place over the short-to-medium term.

About CBRE Group, Inc.

CBRE Group, Inc. (NYSE:CBG), a Fortune 500 and S&P 500 company headquartered in Los Angeles, is the world’s largest commercial real estate services and investment firm (in terms of 2014 revenue). The Company has more than 70,000 employees (excluding affiliates), and serves real estate owners, investors and occupiers through more than 400 offices (excluding affiliates) worldwide. CBRE offers strategic advice and execution for property sales and leasing; corporate services; property, facilities and project management; mortgage banking; appraisal and valuation; development services; investment management; and research and consulting. Please visit our website at www.cbre.com.​