Imbalanced property market may have negative repercussions – Part 2: Office segment

AN undersupply of affordable housing, particularly in major urban areas, coupled with an oversupply of office and retail spaces, may lead to deeper imbalances in the property market, says Bank Negara Malaysia in its 2015 annual report, which was released recently. Despite a 35% increase in housing stock since 2005, the gap between the housing stock and the number of households widened from 2.1 million units in 2005 to 2.5 million in 2015. Annual housing completion has declined considerably in the past five years as the number of households continued to grow. There was an estimated average shortage of 85,911 housing units per year between 2011 and 2015.

Bank Negara says the most acute shortage has been in affordable housing. Half of Malaysian households earned RM4,585 per month and below in 2014. According to the Median Multiple, a methodology recommended by the World Bank and the United Nations to evaluate urban housing markets, a house is considered affordable if a household can finance it with less than three times its annual household income. This suggests that houses priced up to RM165,060 would be affordable to a median Malaysian household. Only 21% of new residential launches in 2014 were priced below RM250,000, says Bank Negara.

While affordable housing initiatives have gathered momentum, they are still not enough to meet the demand. The rapid increase in house prices has been partly attributed to the imbalance between supply and demand, particularly in the affordable housing segment. Using the Median Multiple methodology, Bank Negara found that houses in Malaysia, on aggregate, were considered “seriously unaffordable” in 2014. In Kuala Lumpur and Penang, houses were “severely unaffordable”, while those in Johor and Selangor were “seriously unaffordable” and “moderately unaffordable” respectively.

Moving forward, an estimated 202,571 new houses will be needed every year from 2016 to 2020 to match the estimated growth in the number of households. This is 2.5 times the number of houses being built annually. Bank Negara says a comprehensive and carefully designed national planning policy is needed for the property market to support the government’s aim to deliver more housing. It notes that the government needs to commit to and support the private sector to ensure the low and middle-income groups have access to quality, affordable housing.

Meanwhile, Bank Negara says there is an oversupply of office and retail space. Office space in the Klang Valley recorded a vacancy rate of 20.4% in 2015, compared with the regional average of 6.6% and national level of 16.3%.

“In tandem with the high level of vacancy in the Klang Valley, monthly rent for prime office space in Kuala Lumpur is the lowest among regional cities at only US$2.60 psf,” says Bank Negara.

Yet, despite the low rents, Savills Research, in its May 2015 Property Market Overview, says several Grade A office buildings, completed between 2011 and 2014, have occupancy rates of only 50% to 75%. The situation could be aggravated by an incoming supply of large projects in the next few years. According to Jones Lang Wootton’s 4Q2015 Quarterly Property Market report, an average of 4.9 million sq ft of new office space will be added to the market each year for the next three years.

Similarly, signs of oversupply are emerging in the retail sector in major urban areas, particularly in Penang, Johor and the Klang Valley.

“Although vacancy rates in some of these areas have been improving in recent years, rates of 12.4% in the Klang Valley and 28.2% in Pulau Pinang remain relatively high compared with other regional economies,” says Bank Negara.

Read on to see what property experts have to say about these trends.

Office segment

1. Y Y Lau, country head and managing director of JLL Property Services (M) Sdn Bhd

We would like to point out that since 2007, the supply of office space in Kuala Lumpur (central business district [CBD] + Fringe) averaged slightly more than two million sq ft per annum with the exception of 2012, when KL received over five million sq ft.

After 2012, the annual supply fell below average. In 2016, supply is expected to remain limited. However, there will be a spike in supply in 2017 in the Prime Fringe area while in the KL CBD area, huge supply will come from 2019, after the completion of several mega projects.

Our in-house estimate is that the oil and gas sector takes up around 30% of Grade A office space in KL CBD while financial institutions take up around 40%. This is followed by business services with 17%. It is healthy to have different sectors, rather than one single sector, driving office demand. We think the next wave of demand could come from technology companies and business services. Several recent mergers are also driving relocation demand.

Landlords of existing commercial properties can choose to cash out by selling their properties. We note that more than 40% of office buildings in the CBD are over 15 years old; this could be an opportunity for new landlords to refurbish.

Proper planning by the authorities should be in place. Approvals for proposed projects should be granted only after the plan has been carefully studied. The office market is currently a tenant’s market. We see that some developments still thrive in this environment because they are well located and have high specifications. In addition, dual compliant buildings (MSC and Green Building certified) are in limited supply. Developers should get professional advice before planning their projects and think of how they can differentiate their projects from just another office building. It is also noteworthy that InvestKL has been tasked with bringing in 100 multinational corporations (MNCs) to set up offices in Kuala Lumpur by 2020. The initiative should help absorb some of the office space.

So far, InvestKL has brought 51 MNCs into Kuala Lumpur. The recent weakness of the ringgit has provided opportunities for foreigners to set up business in Malaysia. We think increased foreign direct investment should be promoted to make Malaysia a preferred regional hub for office space. More foreign interest and expertise can be brought in with foreign participation and this will help to improve the oversupply situation.

2. Sarkunan Subramaniam, managing director of Knight Frank (M) Sdn Bhd

The low oil price environment has certainly affected the office segment in the past couple of years. MNCs are looking to reduce the number of staff they have. This has a direct impact on the amount of space they occupy. Occupational cost [which involves offices and warehousing] represents the second biggest cost next to labour — reducing staff strength would also have a direct impact on the space required.

When you rent space, it is pretty much a commitment to the size you are — the rent you pay for a certain number of years — so, obviously, what has happened is that a lot of companies, especially in the oil and gas sector, are pre-committed to the rates and sizes.

However, some have started to renegotiate their rents with their landlords for more palatable rates and are looking at how they can reduce their space. Some may have resorted to subletting their space while some managed to convince their landlords to reduce their space. So, this is what’s been happening in the office segment today. And judging by the oil price environment, the oversupply in the office segment will remain for some time.

The immediate pressure that is being felt in the office sector will have an impact on the bottom lines of building owners, real estate investment trusts and those who own these large investments and assets. Their projections of rental income may be slightly dampened.

The key solution is for landlords to realise this wave of competition, to maintain good tenants in an atmosphere that they can survive. The idea is to make it breathable and make them able to pay the rent and make the amount competitively lower. This is the strategy and the solution that owners of various buildings should realise. They should wait for the recovery to arrive. Then they can go back to their tenants and enjoy better profitability as the market improves again.

3. Brian Koh, executive director of DTZ Nawawi Tie Leung Property Consultants Sdn Bhd

Based on the Bank Negara report, with the low oil prices you can expect demand from oil and gas players to decline. Or growth will be weak for the next 1 to 1½ years. We have been cautioning about this for quite some time and we would affirm that we are likely to witness a weaker market for the next two to three years.

At the moment, there is still a lot of construction going on and there are still people who need office space — unless the banks start pulling back their support from all of these so-called more speculative projects. Notwithstanding that, they are aware that the market is not exactly strong. And a tightening of cash flow is expected due to the unfavourable conditions.

Perhaps the best [and most direct] way to control the supply of office building projects in the future is by freezing approvals. City Hall has frozen approvals of hotel projects — why not office projects?

This article first appeared in City & Country, a pullout of The Edge Malaysia Weekly, on April 4, 2016. Subscribe here for your personal copy.