Dec. 17 (Bloomberg) -- When completed in 2015, the Shanghai Tower will be China’s tallest building. The 632-meter (2,074-feet) skyscraper will also deepen a glut of offices in the city, putting pressure on rents.
The project, in the Lujiazui financial district, will add 220,000 square meters (2.4 million square feet) of office space, or more than 10 percent of the new supply forecast for the city in 2015, according to RET Property Consultancy Ltd. About 2 million square meters of grade-A offices will be added between 2014 and 2015, more than double the supply in the previous two years, according to broker Savills Plc.
The Chinese government’s resolve to turn Shanghai into a global economic, financial and shipping hub by 2020 has led to an office building boom to accommodate companies such as Citigroup Inc. and Nike Inc. that set up a presence in the city. Rents in Shanghai outside of central locations may fall as much as 17 percent in the next three years as space is added and the world’s second-largest economy strives to maintain growth that has averaged 10.5 percent in the 10 years to the end of 2012, according to broker CBRE Group Inc.
“Such a big supply will pressure office rents in prime locations,” said Alex Chen, Shanghai-based senior associate director at RET Property. “The numbers are showing that vacancy rates and rents are definitely heading in a negative direction citywide.”
Office rents in Shanghai fell 0.3 percent to 8.41 yuan per square meter per day in the third quarter, the first quarterly drop since 2010, according to Savills.
Once finished, Shanghai Tower will rank as the world’s tallest building after the 828-meter Burj Khalifa in Dubai, data compiled by Chicago-based Council on Tall Buildings and Urban Habitat show. It will surpass China’s current record holder, the 492-meter Shanghai World Financial Center, which is diagonally across Dongtai Road and houses the local offices of Google Inc. and Ernst & Young LLP .
Lujiazui, on the east side of the Huangpu River in Pudong and across from the Bund historical waterfront area, has evolved from rice paddies three decades ago into Shanghai’s main financial district. The 421-meter Jin Mao Tower, now the city’s second tallest, sits across from Shanghai Tower and Shanghai World Financial Center.
Most offices being built over the next two years will be located outside prime areas where land is becoming scarce. About 70 percent of the new office space expected by 2015 will be in non-prime locations including those near Shanghai’s smaller airport in the city’s west and the area where the World Expo was held in 2010, Savills said.
The vacancy rate in Lujiazui is 3 percent and will double to about 6 percent by the end of 2014, according to CBRE. The grade-A office vacancy rate outside the central business district rose 0.3 percentage points to 24 percent in the third quarter from the previous three months, according to a report by Jones Lang LaSalle Inc. in October. For the entire city, the rate stood at 7.5 percent, the Chicago-based broker said.
“Lujiazui is currently the submarket with the lowest vacancy rates in the city and there are very few projects that will be completed” in the area over the next three years, said James Macdonald, Shanghai-based head of China research for Savills. “At the same time, demand for space in Lujiazui is still relatively strong.”
Office rents in the area were 10 yuan per square meter a day in the third quarter, rising 53 percent since the same period in 2009, according to Jones Lang LaSalle. The firm forecasts rents to increase 5 percent in the next two years because of the extra space Shanghai Tower will add to the market. Rents rose 14 percent in the two years that ended in the third quarter.
The government is pushing Shanghai, home to the larger of the nation’s two stock exchanges as well as interbank bond and foreign-exchange markets, to become a global hub for finance and shipping.
To reach that goal, the city inaugurated a free-trade zone in September as a testing ground for free-market policies that Premier Li Keqiang has signaled may later be implemented more broadly in the country. About 400,000 square meters of grade-B office space is in the 29-square-kilometer (11-square-mile) area, according to CBRE. Prime or grade A refers to the most stable high-income producing properties.
By the end of 2012, there were 1,227 financial institutions, including banks, securities firms and insurers in Shanghai, city Mayor Yang Xiong said in a speech on June 28.
Among developers that are joining the construction spree are Shui On Land Ltd., the Chinese company controlled by Hong Kong billionaire Vincent Lo, which is building Hongqiao Tiandi, an office and restaurant precinct, near the airport. Soho China Ltd., the biggest developer in Beijing’s central business district, is building a 86,000-square-meter mixed-used project called Sky SOHO in the same area, including office and retail space designed by Pritzker Prize-winning architect Zaha Hadid.
“The sheer volume of supply will place pressure on the city’s overall market,” said Macdonald at Savills. “Landlords have become increasingly aware of the impending glut of supply and have taken steps to ensure that they can maintain satisfactory occupancy levels” by cutting rents.
The overbuilding has drawn the attention of regulators. China Banking Regulatory Commission’s Shanghai branch asked banks to pay “high attention” to financing risks of the city’s commercial real estate, China Business News reported on Dec. 5, citing a notice issued by the regulator. The regulator said the city’s commercial real estate is “over supplied” and the market is “nearly saturated,” according to the report.
While new offices will mainly be located outside Lujiazui, it may still take time for the 125-story Shanghai Tower to be filled, said Sam Xie, a Shanghai-based property analyst at CBRE. The vacancy rate at Shanghai World Financial Center dropped below 25 percent only three years after the skyscraper opened in 2008, said Xie.
Shanghai Tower, being built at a cost of 10.3 billion yuan ($1.7 billion), will include offices, a luxury hotel and retail space. Developer Shanghai Tower Construction & Development Co. could have gone taller, President Gu Jianping told reporters in Shanghai in August, however the company didn’t aim for physical height when planning the building.
An increasing number of companies have chosen to move out of the traditional commercial areas to locations where rents are less costly and they get more space, according to Jones Lang LaSalle, which estimates companies can save about 50 percent with such moves.
Nike said last year it will lease about 600,000 square feet for its new headquarters in a Tishman Speyer project in the Yangpu district. The world’s largest sporting-goods maker may move from Plaza 66, a development on West Nanjing Road in the downtown area that stretches behind the Bund, as early as next year, said Anny Zhang, a Shanghai-based director at Jones Lang LaSalle who oversees office leasing.
“Landlords in downtown have already felt the pressure as they had to compete with those that offer cheaper rents in non-centralized areas,” Zhang said. “They may offer incentives by restructuring the leasing contracts with tenants or increase commission fees for brokers.”
It is uncertain how many companies will move out of prime locations because of moving costs, RET Property’s Chen said, adding that the market may not be “as bad as projected.”
Developers may change their construction plans or put off projects if they see a record supply hitting the market, according to CBRE’s Xie.
CapitaLand Ltd., Southeast Asia’s biggest developer, has fully leased one of its office towers on the outskirts of Shanghai for about two-thirds of the rent at its Raffles City building near People’s Square in downtown, said Jason Leow, the China chief executive officer at the Singapore-based developer.
“Lots of companies which don’t need to be in the city center are moving to the suburbs, so that provides an alternative to people who want more space but less prime buildings,” Leow told reporters in Shenzhen on Nov. 26.
Shanghai still has room to add offices because the amount of space pales in comparison to other cities, said Anthony Couse, Shanghai-based managing director for East China at Jones Lang LaSalle. Grade-A office space in Shanghai is 7.1 million square meters, compared with 11.1 million square meters in Hong Kong and 23.6 million square meters in New York, according to the broker.
“This is a tiny city, geographically massive, but compared to total supply of office space of other cities, there’s very small grade-A space,” said Couse.
Office rents will start rebounding after 2016 as demand picks up, while the vacancy rate is expected to drop back to below 10 percent by 2020, London-based broker Knight Frank LLP said in an October report.
Until then, the addition of offices, especially in areas outside central business districts, will put pressure on rents as demand declines, CBRE’s Xie said.
“We are not very optimistic about office rents in Shanghai in the 2014-2015 period because there’s no explosive demand behind,” he said. “The impact of offices in the decentralized areas will be very big on the market.”
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