Office buildings from smaller cities under pressure from supply glut, weak demand, report says

Premium office rents in China's first-tier cities have softened but remain high, while rents in second-tier cities are under pressure, according to a report by real estate consulting service company Cushman & Wakefield.

Rents for grade A office buildings in Beijing, a barometer of China's commercial property market, retreated by 1.5 percent quarter-on-quarter in the second quarter to 514 yuan ($83) per usable square meter, according to the report. Rents for such space in Beijing have been easing since last year.

Nationwide, Beijing's grade A offices are still the most expensive, followed by those in Shanghai, which in the second quarter stood at 405 yuan per usable sq m.

Zhang Ping, director of Cushman & Wakefield's Beijing research operations, said the decline in Beijing office rents reflects the broader economic slowdown and sluggish demand from multinationals, which are the major tenants of China's premium offices.

"Western multinationals are squeezing their rent budgets. Many still occupy the core business centers but are narrowing down their office space. Others are migrating to non-core business centers in first-tier cities," said Zhang.

Beijing has already bid farewell to the time when premium offices were in severe short supply and rents skyrocketed. Zhang said that in 2011, office rents in Beijing grew at an annual rate of 73 percent. The capital's average rent level ranked fifth globally that year, exceeding Manhattan.

But rent rises screeched to a near-halt in 2012, with annual growth of just 3.2 percent. The city's rent level dropped to the seventh worldwide.

The report said office supply in first-tier cities remains tight, as no sufficient premium office is expected to be available for companies in the next few years.

Average vacancy rates in first-tier cities, namely Beijing, Shanghai, Guangzhou and Shenzhen, stood at 5 to 7 percent, while the average vacancy in 20 Chinese major cities monitored by C&W stood at 11 percent.

C&W said total inventory for China's grade A office stood at nearly 34 million sq m at mid-2013. It estimated in the next three years, 58 million sq m of new offices will become available, of which about 19 million sq m will be in first-tier cities.

While markets in first-tier cities face short supplies, second-tier cities' office buildings are abundant, if not oversupplied, as developers have been flocking to these cities for potential growth.

"In these cities, insufficient demand exerts growing pressure on office sale and leasing activity. Pressure is especially high in Qingdao, Chongqing and Chengdu, where vacancies are well above 30 percent," Zhang said.

The pressure is also mounting on these cities' retail property sectors. The report observed that in cities like Chongqing, Shenyang, Qingdao and Xiamen, vacancy rates for shopping malls stood at about 15 to 20 percent, while the same rate in first-tier cities was 9.98 percent.

"Because of the failure of market positioning and product differentiation, some new projects in second-tier cities are facing leasing difficulties. During a recent trip to Chengdu, I found some of the projects have failed to attract enough tenants to open even one year after completion," Zhang said.

Andy Zhang, managing director of C&W China, said retail property is facing oversupply because many developers, constrained by central government's housing purchase limit policies in the past three years, had shifted their attention to third- and fourth-tier cities, where no restriction is imposed, or to commercial properties. Many have no experience in operating commercial property and had difficulty in attracting tenants.

The report also observed that compared with traditional department stores, shopping complexes that integrate shopping, restaurants and cinema venues have a brighter prospect.