The grade A office market remained active in Q2 2008, thanks to the generally positive market sentiment and a solid demand for office space. Central's average monthly net effective rents rose again to a new high of HK$122 per sq ft, while the vacancy rate dropped to a new low of 1.1%. This is having an impact on the relocation decision of companies there which are in need of expansion, according to international property adviser DTZ.

    "Despite high rents, the sound fundamentals of the local economy have continually spurred demand from the FIRE sector (finance, insurance, real estate and other professional services) for grade A office space in Central, the most prestigious office precinct in Hong Kong," said Mr Alva To, DTZ's Head of Consultancy, North Asia. However, Mr To observed that while Central's rental kept rising, the amount of take-up has dropped, signifying an ambivalent sentiment in the office market.

    In Q2 2008, grade A office take-up in overall Hong Kong Island totalled 251,081 sq ft, down 33.6% from the last quarter and 1.2% from a year ago. However, if including the take-up figure of One Island East (which amounted to 1,329,810 sq ft alone), the overall take-up of Hong Kong Island will rocket to 1,580,890 sq ft. "The overall figure is considerably higher if One Island East is included in the basket, but it should be noted that much of the pre-commitment of the property has taken place from the second half of 2007 to Q1 2008," commented Mr To. At the same time, Island East's take-up fell by 30.3% from the last quarter to 61,669 sq ft (excluding One Island East), but the figure is still the second largest among all districts on Hong Kong Island. It represents a year-on-year increase of 117.4%, and a thriving office market in the area over the year.

    The high rental and tight availability of office space in Central/Admiralty are driving more companies to relocate to the neighbouring district of Wanchai/Causeway Bay, which can be reflected by the increased take-up to 166,647 sq ft during Q2 2008, with a quarterly rise of 55.1% and a significant jump of 530.7% from a year ago. "This indicates a strong underlying demand for prime space in the nearby areas of the CBD, as many companies which need to move out of Central but do not prefer locations as far as Island East would choose Wanchai/Causeway Bay," added Mr To.

    Apart from Wanchai/Causeway Bay and Tsimshatsui, all the districts in Hong Kong saw lower take-ups in Q2 2008. Tsimshatsui's office take-up rose to 7,930 sq ft in this quarter, up 380.3% from the last quarter but still down 64.5% year-on-year. Tsimshatsui's relatively developed office market is underpinned by a stable local demand, as well as by companies which regard the district as an alternative choice to Wanchai/Causeway Bay in terms of decentralisation. Location-wise, these companies have a preference on Central and nearby districts, and prefer office premises of higher quality which can be found in Tsimshatsui. On the other hand, Kowloon East's take-up dropped 22.6% quarterly to 141,186 sq ft, but the figure is still the second largest after Wanchai/Causeway Bay. Market activities remained stable in Kowloon East especially among existing buildings, with tenants moving in from other districts as well.

    Meanwhile, the low availability of most districts has also left few options that could cater to occupiers' expansion needs, most remarkably noted in Central, where take-up dropped 91.7% from 166,860 sq ft in Q1 2008 to 13,851 sq ft this quarter. Take-up in Sheung Wan also decreased by 40.9% quarterly to 8,914 sq ft.

    Despite a volatile stock market and economic slowdown in North America, the stable business outlook of Hong Kong helped drive down the vacancy rates of all major districts from the last quarter. If excluding One Island East, Hong Kong Island's overall vacancy rate fell from 2.1% in Q1 2008 to 1.7% in Q2, which is 1.9 percentage points lower than the figure a year ago.

    Of all major districts, Central remained the best performer with a vacancy rate edging from 1.2% in Q1 to 1.1% in Q2 2008. This justifies the low take-up of Central recorded during Q2. Island East's vacancy rate also fell from 2% to 1.3% (excluding One Island East), which is the second lowest after Central. Mr To said, "Central's office market can count on the buoyant demand from the FIRE sector and companies which need to establish a presence at the prestigious CBD. Thin supply in the core CBD has prompted Central-specific corporations to pay high rents, or move to districts such as Island East where the ample supply of larger floor plates has attracted many tenants in need of expansion."

    Benefitting from the spill-over demand from Central, Wanchai/Causeway Bay recorded the biggest drop in vacancy rate among all districts on Hong Kong Island, down 1 percentage point to 2.3% as at Q2 2008. Mr To commented, "This signifies that companies are increasingly relocating to Wanchai/Causeway Bay and seeking the quality office premises there, at the same time when Central's rental continue to break new records." Sheung Wan's vacancy rate also edged lower from 3.8% last quarter to 3.6%. On the Kowloon side, while Tsimshatsui recorded a mild decrease in vacancy rate from 3.5% to 3.4% this quarter, Kowloon East registered a bigger drop in vacancy rate to 3.7% (excluding Kwun Tong 223) in Q2 2008, down 1.9 percentage points from the last quarter. "Demand for office space at Kowloon East was continually supported by companies in need of expansion or relocation, and this helped drive down the vacancy rate there," continued Mr To.

    Rental performance of all districts continued the momentum as at end of 2007 and was strong in the second quarter of 2008. Central's average net effective rents increased by more than 15% in the first six months of this year to an all-time high of HK$122 per sq ft, representing a quarterly increase of 5.2% and a remarkable 37.1% year-on-year which is the greatest among all districts. Mr Mark Price, DTZ's Head of Business Space, commented, "Due to thin supply of large floor plates and a robust demand for office space, the increase in Central's rents has matched our forecasted growth for the first half of 2008. Companies of the FIRE sector have been absorbing the record-high rents in Central in order to be present at this prestigious location." But Mr Price noted that the daily turnover of the stock market at Q2 was in general less than that of a year ago, and companies in Central are devoting an increasing budget for rental, this may add pressure to the rental growth.

    In fact, it is Wanchai/Causeway Bay which recorded a double-digit growth in rental this quarter which is normally more common to Central. As a prime destination of decentralisation, Wanchai/Causeway Bay's rental enjoyed a quarterly growth of 12.5% to HK$45 per sq ft, and an impressive year-on-year growth of 32.4% which is the second highest among all districts. "It indicates that the Wanchai/Causeway Bay market has been boosted by an increasing number of companies which seek office space in the area over the past year, thus supporting the rental growth there," said Mr Price. Average net effective rents in Island East also edged up to HK$30 (One Island East not taken into account) which represents an increase of 7.1% from the last quarter and 15.4% up from a year ago. "Because of the rising rental in Central, the rental gap between Central and Island East has further widened from HK$88 per sq ft in Q1 of 2008 to HK$92 in Q2 2008, sending tenants with non-essential reasons to remain in Central to relocate to other decentralised districts such as Island East, and this underpinned the rental growth of the district," said Mr Price. Benefitted from an increased take-up and a stable demand, Tsimshatsui's rental saw a quarterly growth of 6.7% to HK$32 per sq ft. Sheung Wan and Kowloon East's net effective rent per sq ft also rose 2% and 4% quarterly to HK$52 and HK$26 respectively.

    Mr Andy Yuen, DTZ's Director of Office Agency, pointed out that as the majority of new office supply between 2007 and 2009 lies in Kowloon East (over 6.2 million sq ft in Kwun Tong and Kowloon Bay combined), the district presents ample expansion options to companies of many trades, including those in the FIRE sector which may consider relocating their back office operations to such a comparatively low-cost district that commands approximately a fifth of Central's rents. With the ample supply and improving infrastructure in Kowloon East, it is expected that landlords of prime projects there are likely to keep rents competitive and offer more incentives to attract tenants.

    "With only the Nexxus Building providing a total GFA of 260,000 sq ft of office space to Central during the 2007-09 period, the tight supply there gives an edge to landlords during lease negotiations, but the trend of rental development may further depend on the performance of the local stock market, affordability of tenants as well as the local and global economic outlook for the second half of this year. Against this backdrop, we expect a stable outlook for the rental development of Central's office market, and at the same time we remain cautious against any consequence of the global and US economic downturn which may appear later this year," concluded Mr To.