Office Markets Continue to Diverge; Retail Retal Growth Slow Further

Total new office supply reached 1.67 million sq. m. in Q2 2015. It is worth noting that Shanghai, Chongqing and Guangzhou recorded over 300,000 sq. m. in new completions, a record-high for quarterly new completions. In the retail sector, demand from retailers remained subdued. Overall nationwide G/F rents edged up by just 0.1% q-o-q, the lowest growth since Q2 2009. In the industrial sector, Tianjin saw the completion of 356,000 sq. m. of new supply, the highest ever in this market. Current loan rates are at historic lows and the continued monetary easing policy has helped lift sentiment in residential market. We expect the current momentum of housing sales growth to continue in H2 2015.

In Q2 2015, total new completions reached 1.67 million sq. m., down by 22.8% q-o-q. It is worth noting that Shanghai, Chongqing and Guangzhou recorded over 300,000 sq. m. in new completions, a record-high for quarterly new completions. In regards to regional figures, total new completions in West China reached 560,000 sq. m. Total stock in Chengdu reached over 6 million sq. m., comparable with the level of total stock in Guangzhou and of that in Shenzhen. By contrast, supply was muted in most of the Tier II markets in East and North China.

Overall demand improved during the quarter. Net absorption reached 1.48 million sq. m., up 43.4% q-o-q. Net absorption in Shanghai, Guangzhou and Chongqing reached record highs. In Shanghai, net absorption was over 350,000 sq. m. for the quarter, the highest of any market, which saw the vacancy rate in Shanghai tighten to 5.7%. Benefitting from leasing and owner-occupier demand from large financial institutions, net absorption in Guangzhou and Chongqing reached 200,000 sq. m. and 170,000 sq. m., respectively. Encouraged by additional easing measures on the requirements for business registration and by the set-up of a Free Trade Zone, net absorption in Shenzhen was 200,000 sq. m. for the quarter. In contrast, demand was muted across several Tier II markets. During H1 2015, net absorption reached a five-year low in Chengdu, where P2P companies have continued to surrender their lease. Demand was also weak throughout most of the Tier II markets in North and East China. Regarding industry-level demand, IT, trading and pharmaceutical firms were quite active during the quarter. With the exception of several foreign firms that engaged in expansion in Shanghai, foreign firms, especially those in Tier II markets, generally maintained a cautious disposition and held back on plans for expansion. Overall, a two-tiered market was observed during the quarter. Vacancy rates in Chengdu, Chongqing, Changsha, Wuxi and Shenyang were all close to 40%.

Rising demand boosted rental performance during the quarter. Led by q-o-q rental growth of 1.1% across Tier I markets, nation-wide rental increased by 0.6% q-o-q. Shenzhen reported rental growth of 2.0%, the highest among all cities. However, rental in Tier II markets remained broadly unchanged, with the exception of Nanjing, Ningbo and Hangzhou, all located in East China. Chengdu, Suzhou and Wuxi all saw rental declines of around 1.0% q-o-q.

Looking forward, a large amount of new supply is scheduled for delivery in Shanghai, Guangzhou, Shenzhen, Chengdu and Chongqing. With solid market fundamentals across Tier I markets, we remain upbeat on the outlook for demand. However, landlords in Tier II cities will likely struggle to keep pace with the growing stock. Against  the backdrop of an economic slowdown, cost-sensitive foreign firms and domestic SMEs will likely weigh on the leasing market.

Padded by new supply in Tier II cities in North and Central China, net absorption improved significantly. More brick-and-mortar retailers embraced e-commerce in a rapidly evolving retail landscape. Ever since pilot cross-border e-commerce zones were approved in China, we have begun to see more cross-border e-tailers branching out into shopping malls in core areas. For instance, some stores featuring imported goods opened in Chongqing, and several department stores in Guangzhou set aside special zones for imported goods from cross-border e-tailers. In addition, big-box retailers such as Walmart and Vanguard launched click-and-deliver programs and mobile payment in the face of rising competition from online supermarkets. 

In the era of e-commerce, retailers are also changing how they run their stores. Vivienne Westwood opened its first in-store coffee shop, at its Shanghai location in K11, and Gucci is planning to open a restaurant in Shanghai. Teenie Weenie opened a coffee shop at its store in Chengdu, following openings at its stores in Nanjing and Hangzhou. In addition to fashion retailers providing cafes for their customers, more high-tech products and internet companies have also tapped into the market.  A drone manufacturer DJI opened two experience stores in Shenzhen; messaging App Line opened a themed-cafe in Shanghai. In response to a more diversified consumption pattern, more retailers made experience-based elements a highlight of their stores. Retailers are looking to drive foot traffic and build customer loyalty with a refined product mix and enhanced in-store experience.

In the fast fashion segment, FFBs accelerated their expansion across China. H&M and Uniqlo opened nine and eight stores, respectively, in the 17 cities tracked by CBRE, most of which were opened in lower tier markets, such as Qingdao, Suzhou and Wuhan. Meanwhile, Forever21, New Look and Old Navy stepped up their activity in China. New Look opened two stores in Nanjing during the quarter. Forever21 opened two new stores in Shanghai, and one more store is scheduled to open in August. By contrast, demand from luxury brands remained lackluster. Following Chanel’s move to re-align prices in Q1 2015, several first tier luxury brands, including Gucci, offered greater discount rates on their products.

Effective as of June 1, China reduced the tariff on selected consumer goods by more than 50%. Several cosmetics brands, including L’Oreal and Estee Lauder, announced their plans to lower their prices accordingly. We believe that the further development of the China retail market and the roll-out of more supportive policies will likely trigger more consumption demand, and lend support to further retailer expansion in China. We expect the rise of a strong consumer base on the mainland to attract more international retailers to enter the China market. We also expect tenant mix to diversify as new types of tenants (e.g. bakery class, experience stores and imported goods supermarkets) expand in the market. Despite a large amount of new supply on the horizon, we believe that landlords will nonetheless manage to fill up their space by introducing such tenants to drive foot traffic.

This quarter saw the completion of new supply in Tianjin and Chengdu, among other cities. A total of 355,600 sq. m. of new supply came onto the Tianjin market, setting a new quarterly record. On the demand side, as China continues its transition toward a consumption-driven economy, industries that benefit directly from the strong growth of domestic consumption, such as retail, e-commerce, 3PLs and automobiles & components, are also dominating leasing activities in the industrial market. These consumer-driven industries demonstrated significant demand and high activity over the quarter:: Goodman signed contracts with Decathlon and SF Express for 157,000 sq. m. and 22,000 sq. m., respectively; H&M secured e-Shang Binhai Logistics Centre as its North China distribution center; Jumei leased 20,000 sq. m. in Prologis Tianjin Binhai Logistic Park. In regards to rental performance, average warehouse rent edged up by 0.9% q-o-q. In particular, major developers made annual rental adjustments over the quarter, driving Shanghai warehouse rent up 4.0% q-o-q. Meanwhile, some logistics facilities in Shenzhen were renovated into retail projects in order to obtain higher rental income, leading to the further tightening of supply. As a result, average warehouse rent in Shenzhen increased by 2.7% q-o-q.

The industrial market remains on the radar of many investors. GAW Capital Partners established a JV with logistics developer Vailog during the quarter, in an effort to developt a local platform for the development, acquisition and management of modern warehouses in China. Ivanhoe Cambridge and CBRE Global Investment Partners committed to investing in LOGOS China. Likewise, following the first round of investment in April 2014, RRJ invested another USD 250 million in Yupei. Meanwhile, China’s residential real estate giant, Vanke, announced its plans to set up a logistics subsidiary. Propelled by foreign capital, Chinese industrial developers are expanding their layouts across China, paving the way for IPOs. We expect this wave of expansion to further accelerate the development of the domestic industrial market.

As CBRE forecasted in our publication, while they continue to maintain a focus on eastern coastal cities, industrial developers are also expanding their footprint to cities along the Yangtze River, such as Wuhan and Chongqing, and even lower tier cities. According to the newly issued plan on the layout of national transportation nodes, circulation channels along the Eastern Coastal Economy Belt and Yangtze River Economy Belt are being drawn into the major national circulation system. We expect this preferential policy to further propel the development of the industrial market in these node cities. Meanwhile, we noticed that a strong appetite for a regional transportation hub brought about a shift in local governments’ attitudes to tier-1 industrial developers. Although some tier-2 cities in the Eastern Coastal Economy and Yangtze River Economy Belt are likely to face pressure from oversupply in the short term, we believe that support from central and local governments in combination with stable demand will accelerate the absorption of warehouses in these cities.

Residential Market - Sales market gains momentum

During H1 2015, the central bank cut the benchmark interest rate and reserve requirement ratio three times, each. The current loan interest rate is at a historic low. The continuation of monetary easing policy by regulators has added fuel to the mainland residential market. In addition, regulators from the national to the local level engaged in moves to help stabilize regional housing consumption, including enacting new policies on housing provident fund mortgages and relaxing provident fund withdrawing and loan threshold requirements. During Q2, national residential transaction volume continued to pick up, especially in major Tier I and Tier II cities; total sales units in 16 major cities tracked by CBRE surged 56% q-o-q, and 41% y-o-y. After several rounds of policy easing, the national residential market began to display the effects of destocking; national commodity housing stock in May decreased 1.21 million sq. m. m-o-m, showing its first decline in the last three years’ time. Meanwhile, inventory turnover period significantly declined in several major cities. In regards to housing prices, the housing price index released by NBS in May indicated the first pick up in the last twelve months, with the price index up 0.5% m-o-m in 70 cities; among mainland cities, tier1 cities recorded the highest single-month increase at growth of 3.0% m-o-m.

The recent enactment of monetary easing policies not only brings real benefits to home buyers and improves market sentiment, but also helps to ease growing pressure on developers’ cash flows. The new polies will continue to help developers destock inventories and increase the willingness of home buyers to engage in purchases. We expect the current momentum of housing sales growth to continue in H2 2015.