Hong Kong office market grappling with record high vacancy rates

The vacancy in Central hit a net area of 2.2m sq ft.

In a recent report, Savills noted that the Hong Kong office sector was navigating through unprecedented challenges, marked by record-high vacancy rates that surpass even those seen during historically turbulent periods like SARS and the 2009 Global Financial Crisis. 

Prime business districts were particularly affected, with vacancy in Central reaching a staggering net area of 2.2 million square feet. 

Here’s more from Savills:

The market is grappling with a storm of factors: reduced demand due to economic underperformance, changing tenant preferences, high interest rates, and widespread cost-cutting measures by businesses. This has resulted in a surplus of 10.6 million square feet of office space across various districts. 

Landlords, facing intense pressure in this competitive market, have resorted to significant rental price cuts, leading to a 40% decrease in rents from the 2019 peak. As the sector was adapting to these economic uncertainties, it faces a period of significant transformation and adjustment. 

The prevailing high-interest-rate environment has intensified debt challenges for numerous prime office property owners. Compounding this issue, the downturn in the Chinese real estate sector has fueled a surge in properties placed under receivership, further exacerbated by the decline in office leasing activities. 

An inexperienced receiver taking over the management of a Grade A office building may lead to a certain degree of operational inefficiencies, with rigid rental packages, cost-cutting measures and inadequate services likely to lead to some tenant dissatisfactions and thus increasing vacancies. 

This situation has sparked a short-term ripple effect in the market. Neighbouring office buildings have hence experienced a temporary uptick in demand, driving occupancy higher in adjacent offices.

Nevertheless, this phenomenon may be potentially counterproductive in the medium term. As affected landlords contemplate lowering rents to recapture lost tenants, there's a risk of triggering a broader cycle of declining rents across the market. 

The softening of rents in core areas has led to another market dynamic. The rental differentials between prime areas and non-prime business districts have narrowed significantly, which prompted some financial institutions, particularly insurance firms, to relocate their non-core business operations back to prime Central Business District (CBD) locations. Examples of this trend include: 1) ICBC (Asia) moving operations from Kwun Tong to Hung Hom, 2) US data provider Dun & Bradstreet relocating from Kwun Tong to Admiralty, 3) Vistra (Tricor) transferring offices from Kwun Tong to Causeway Bay. 

These relocations highlight the increasing attractiveness of prime locations due to more competitive rents. Nevertheless, it is important to note that despite these movements, the overall leasing rate was still only recovering at a very slow pace. 

Looking ahead, based on the net office take-up figures of 1.3 million square feet per annum (2011 to 2019 average take-up), the office vacancy rate is projected to reach 17% by 2027. While Hong Kong's current vacancy rate of 14.8% may seem high, it is relatively moderate when compared to other major global cities such as London (10%), Sydney (12%) and New York(28%). 

With new demand still hard to come by in the short-term, however, it is foreseen that rents will likely follow a downward trajectory in the remainder of the year. The imminent US rate cuts would inevitably induce a rebound in business sentiment, which may moderate such rental declines over the next few months.