Leasing will lead the charge for the office market’s recovery. Here’s why…

2022’s office market was fragile, given all the reasons we have repeatedly mentioned before – COVID-19, a sluggish global economy, the border between Hong Kong and mainland China closed, social distancing measures, continued trade tensions between the US and China, the Ukraine-Russo war and those interest rate hikes that made borrowing more expensive. Investors are further discouraged by banks offering high-interest fixed deposit plans.

According to Midland Research data, 817 office transactions were registered in 2022, about 38.8% down year-on-year, with the transaction value also declining about 57.6% YoY to only HK$21.69 billion. According to the RVD updated as of December, Grade A office prices were down by 4.1% and Grade B office by 4.0%. Rents in Grade A and B offices decreased by 6.8% and 4.1% year-on-year.

At the same time, the decline in international and mainland enterprises being able to set up – or remain – in Hong Kong put Grade A office demand growth under pressure, resulting in an overall increase in vacant floor space. As at the end of December, the vacancy rate of Grade A offices in Central was 8.3%, and East Kowloon registered 16.8%, dragging the overall vacancy rate of Grade A to 10.3%.

Grade A commercial building supply will peak in 2023, with nearly 4 million sq. ft in GFA completed in 2022. Some of these have pre-leasing contracts. Henderson's new super Grade A project in Central, The Henderson, has been leased by investment company Carlyle and auction house Christie's. These contracts show that top tenants are actively leasing top-quality offices, and high-calibre commercial buildings are still in demand. I predict that investors remain bullish on office buildings in valued locations such as Central and Admiralty. At the same time, the overall selling price is currently low, and once driven by a raft of positive news, office properties should outperform the market.

I extracted the top four Grade A office transactions with considerations of more than HK$80 million in December from Memfus Wong. There were from Wanchai, Sheung Wan and Admiralty. The most notable was the large-scale transaction of the 23rd floor of Capital Centre with three private car spaces in Wanchai, where ownership changed hands for HK$190 million for a unit price of HK$19,388 per sq. ft., which was about 14.8% lower than the last time this floor transaction, which was for HK$223.062 million.

Also noteworthy is the sale of units six and seven on the 43rd floor of Far East Finance Centre, in Admiralty, where ownership changed hands for HK$83 million. The unit price was HK$42,784 per sq. ft., about 13% higher than the market level in the district.

Turning to office leasing, according to Midland Agency, Sotheby's pre-leased six floors in Pacific Place, covering an area of nearly 30,000 sq. ft (GFA), for about HK$60 per sq. ft. a month. At the same time, Cheung Kong Centre and World-Wide House in Central recorded leasing transactions, where market rent is expected to be about HK$120 and HK$43.5 per sq. ft. per month, respectively, and the current new rent has fallen by 30% and 50% from its peak.

I also extracted December leasing transactions of more than HK$100,000 a month in core districts; four were in Central and Sheung Wan. Their unit rents ranged from HK$49 to HK$87 on saleable area. The most notable was the whole of the 5th Floor, World-Wide House, 19 Des Voeux Road Central, for HK$726,146 a month.

Amid 2022’s negativity, industrial, office and retail transaction volume amounted to 4,494 cases (including company transfers and transactions exceeding HK$100 million), slightly higher than 2020’s 3,799. In 2023, Hong Kong's return to normalcy is in sight, the Hong Kong – Mainland border is fully open, and we’re starting from a low base. Transaction volume in this sector will bottom out. Although the US Federal Reserve has said interest-rate hikes will continue in 2023, if US inflation falls, the Fed will slow the pace of the hikes.

As long as the US economy has a soft landing this year and international geopolitics do not deteriorate significantly, I expect industrial, office and retail transaction volume to reach 5,800 this year, an increase of about 30% YOY.

Also, although Grade A supply will peak this year, the long-term supply will gradually decline from 2024 to 2025, reducing future office future supply by more than 50%. Although the global economic cycle is still trending downward, and it is too soon to see the results of open borders, I don’t believe demand for investing and leasing will rebound immediately. Recovery will be gradual as the economy will need time to absorb the return of Hong Kong’s social life. Mainland and international enterprises returning to, or entering Hong Kong will provide the impetus for recovery.

When I checked Centaline Agency for the latest office rents, 13 of the 23 transactions had rent jump by 1.9% to 20.6%. And while it’s true these increases do not carry rents to 2019’s peak, they show that roughly half of the landlords from the latest transactions saw better prices, with confidence boosted by the open border.

Open borders will boost business travel and Hong Kong’s economy. Consequently, leasing demand, especially for the CBD, will likely increase, strengthening office rents. Still, according to Oxford Economics, interest rates will remain high for at least the year's first half. Colliers expects CBD office rents to benefit the most from the market recovery and to lead the overall recovery of Grade A office rents, which we forecast will increase by 3% YoY in 2023.

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