Several years ago, a new, if slightly less ambitious, “Big short” trade emerged in US capital markets when several hedge funds – including Carl Icahn’s – took aim at US malls, shorting various CMBS tranches or stocks outright, in anticipation of the continued deterioration of US bricks and mortar retailers in general and the mall experience in particular. This trade paid off handsomely several years ago, at which point it stabilized near lifetime lows. Not longer thereafter, in the immediate aftermath of the post-covid Work From Home shift, a new big short trade emerged, one targeting office space which has been sitting vacant at far higher rater than during the pre-covid world.
And while that particular trade has yet to pay off in the US, there is one place where office bears may strike gold first.
As Caixin notes, for the last few decades, the clusters of office buildings that reach into the sky above major Chinese cities have served as a symbol of the country’s economic rise. But over the last year, however, those same structures have begun to look like more of a drag.
Contrary to the US where office lockdowns kicked in parallel with the covid lockdowns, the Chinese market for office space did well during much of the pandemic. After an initial slump in the first year Covid emerged, the market bounced back big in 2021, underpinned by strong demand from tech and finance companies. Analysts had predicted a strong 2022 as well. Instead, corporate demand for office space collapsed after the first quarter. Even China’s biggest cities, where demand is usually the strongest, were not spared.
“The market performed well in the first quarter, so we thought our forecast that the Beijing office market would be solid in 2022 would become a reality, but nobody expected a sudden downturn in the second quarter,” an insider at a property market research firm told Caixin.
The reason why 2022 was so dismal for commercial real estate in China is due to disruptions from repeated Covid-19 lockdowns coupled with a government crackdown on the tech industry, a major leaser of prime office space. With the end of “zero Covid,” there has been some hope that commercial real estate might lurch back into another rapid recovery, but industry insiders suggest that any rebound is still a way off, and will be complicated by a coming rush of new supply this year.
The slump in office occupancy comes at a bad time for an economy that depends so heavily on real estate, particularly when the residential market remains plagued by an unprecedented debt and liquidity crisis. Real estate contributes an estimated 25% of China’s GDP through direct and indirect channels, according to Wang Tao, chief China economist at UBS Investment Bank. Goldman recently calculated that China’s property market was the world’s single largest asset class.
While office space’s share of that contribution is difficult to pin down, investment in commercial property, which includes both office buildings and shopping centers, accounted for 12% of total real estate investment last year, according to the National Bureau of Statistics.
In 2022, China’s largest cities of Beijing, Shanghai, Guangzhou and Shenzhen all suffered losses in net leased office space — an industry metric of the amount of newly leased space minus the total included in canceled leases.
In Beijing last year, net leased premium office space plunged to 81,300 square meters (875,106 square feet) from about 1 million square meters in 2021, according to data from Savills PLC, a real estate consultancy. All of last year’s gains took place in the first quarter, when net leased office space came in at 95,000 square meters, according to Savills data. That means renters canceled a net 13,700 square meters in office leases in the following three quarters. As more leases got canceled, the vacancy rate for Grade A office space nationwide rose 1.5 percentage points in 2022 to 16%, according to Cushman & Wakefield, another real estate consultancy.
The trend could also be seen in Shanghai, Guangzhou and Shenzhen. In the southern Chinese metropolis of Guangzhou, net leased office space fell by 1,130 square meters in 2022, the first time in 10 years that the amount of office space in canceled leases exceeded the amount rented, according to Cushman & Wakefield data. The same goes for vacancy rates outside these four major cities. In several province capitals, the vacancy rate has exceeded 30%, according to a Cushman & Wakefield report from last month.
In Beijing, the slowdown in office leases was due to companies cutting costs as their business outlook deteriorated amid Covid lockdown disruptions, said Charles Yan, a managing director at Colliers, a property consultancy.
Meanwhile, suffering a similar fate to their US peers, Chinese tech firms, a major office tenant in big cities, have laid off staff and cut back on office space over the past year as a regulatory crackdown on the industry that began in 2021 has squeezed their profits.
“Almost all of the tech giants canceled office leases last year, and smaller tech firms followed suit,” the market research firm insider told Caixin.
Meituan, a giant in online food delivery and restaurant booking, canceled leases on 30,000 square meters of office space last year in Beijing’s Jiuxianqiao area, a business center. In September 2021, the company got hit with a 3.4 billion yuan ($501.2 million) penalty for violating anti-monopoly rules. In the first three quarters of 2022, Meituan reported a 5.6 billion yuan net loss attributable to shareholders, extending its 23.5 billion yuan net loss in 2021.
Last year, the office vacancy rates in Beijing’s Jiuxianqiao and Zhongguancun areas, two neighborhoods teeming with tech firms, rose 12.3% and 9%, respectively, according to Cushman & Wakefield data. These higher vacancies will ultimately push down rent prices. “When the vacancy rate goes up, the rent falls,” said Wei Dong, a policy analyst at Cushman & Wakefield.
This has already happened in Beijing. In the fourth quarter, the average monthly rent for premium office space in the capital fell 1.7% from the previous three-month period. Some small and midsize companies, especially trading firms, have also canceled office leases because their businesses either slowed or closed in the wake of the Covid-19 lockdowns, said Wu Wei, a commercial property agent. Among his corporate clients, 60% have recently moved to smaller offices, he told Caixin, adding that the value of the deals he helped close last year dropped 40%.
A co-founder of a Shanghai-based cosmetics-maker told Caixin that the company wants to cut back on office space, but is reluctant to cancel any of its leases because of the penalty it would have to pay. The company suspended its business during Shanghai’s lockdown last year, causing its revenue from the April-to-June period to plunge 90% year-on-year. Still, the company has not ruled out the possibility that it will cut back on office space or move to a cheaper location once its lease expires, the co-founder said.
Market insiders and analysts are cautious about predicting a near-term recovery in the commercial property market, even as economic activity resumes following the reversal of China’s strict “zero-Covid” policy. In late December, Cushman & Wakefield surveyed more than 60 office building owners and real estate agents and found that they don’t expect a recovery in rent prices or demand for office space anytime soon.
What’s next?
Some analysts have predicted that although demand will rebound in the second half, it will have fallen behind increases in the supply of office space, keeping the pressure on rent prices. In Beijing, about 740,000 square meters of new office space will hit the market this year, and 3.5 million square meters is set to come available over the next four years, according to Savills. All this new property available to rent looks likely to result in a glut as the average amount of net leased office space has been about 500,000 square meters a year over the last decade.
The situation is worse elsewhere in China. In Shenzhen, about 1.45 million square meters of new office space will become available this year, according to the Savills data.
This tsunami of new supply is partly due to the pandemic-related delays in the construction of office buildings due to be finished last year.
Second-tier cities are also facing over-supply of offices. In Wuhan, the capital of Central China Hubei province, the supply of new office space could reach about 1.4 million square meters this year, even though the vacancy rate of the city’s office buildings has been as high as 35%, according to estimates by China Real Estate Information Corp. (CRIC), a consultancy. Perhaps if Wuhan wasn’t also the source of the covid lab leak, it wouldn’t have to worry about a historic tsunami of office space supply.
And as China ponders how to avert a broader property market crisis, the US – whose office market was hit at least as hard long ago – has already figured out what to do next: it is rapidly converting offices into condos.
Tyler Durden
Sun, 02/19/2023 – 21:00
