Reworking Lease Expires

REWORKING LEASE EXPIRIES

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REWORKING LEASE EXPIRIES

THE ASIA PACIFIC OFFICE OCCUPIER MARKET REMAINS ROBUST. ANALYSING THE REGION’S TOP 25 MARKETS, ALMOST 230 MILLION SQUARE FEET (MSF) MORE OFFICE SPACE IS OCCUPIED AS AT Q2 2023 COMPARED TO Q4 2019. This stands in stark contrast to other regions. In addition, a further 250msf of space is forecast to be absorbed through the remainder of 2023 to end-2026 and with that, most markets are forecast to experience rental growth over the next few years (Figure 1). In short, for occupiers looking for the most favourable lease terms, the window of opportunity is now open.

Whilst looking at movements in rents is critical for occupiers, perhaps the most important aspect to track is the difference between the rent being paid, as per the lease terms, against the current market rental level. This will give occupiers a view on whether they have positive or negative rental exposure in the prevailing market conditions, which then prompts subsequent actions. Here it is important to understand two terms:

FIGURE 1: PROPORTION OF MARKETS EXPERIENCING RENTAL GROWTH, STABILITY AND DECLINE (Y-O-Y)

Where a tenant is paying below average market rents UNDER-RENTED

OVER-RENTED Where a tenant is paying above average market rents

Decline

Growth

Stable

Source: Cushman & Wakefield

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REWORKING LEASE EXPIRIES

FIGURE 2: MODELLING LEASE RENTS VERSUS MARKET RENTS OVER AVERAGE LEASE LENGTH

SYDNEY Lease term: 5 years (between market reviews)

Expiry: June 2023 Unit: AUD/sqm/yr

Rental escalation: 3.5% per annum

AN OCCUPIER COULD FIND THEMSELVES IN AN UNDER-RENTED SITUATION IF MARKET RENT GROWTH HAS BEEN STRONGER THAN ANY RENTAL ESCALATIONS INCLUDED IN A TENANT’S LEASE AGREEMENT. CONVERSELY, AN OCCUPIER COULD BE OVER-RENTED IF MARKET RENT GROWTH HAS BEEN WEAKER THAN ANY RENTAL ESCALATIONS. Two examples for Sydney and Ho Chi Minh City are provided in Figure 2, using standard market conventions for lease covenants. Here it is important to note that over the length of a lease term, these changes can not only vary year to year but that the differences between market rents and “lease rents” can be significant to the positive or negative by the end of the lease or at time of market review. The result being that a tenant may face a (significant) rental cost escalation or reduction upon their lease expiry.

Outcome: Over-rented

Lease rent 12% above market rent on expiry

Market Rent

Lease Rent

HO CHI MINH CITY Lease term: 4 years Rental escalation: None

Expiry: June 2023 Unit: VND/sqm/mo

Outcome: Under-rented Lease rent 5% below market rent on expiry

Market Rent

Lease Rent

Source: Cushman & Wakefield

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Taking the same approach but expanding it across the region’s top 25 markets and setting lease expiry at Q2 2023 reveals that most markets are over-rented (Figure 3). The situation is most severe in Hong Kong, which has experienced cumulative market rent decline of almost 25% over the past three years, the length of an average lease in the market. Such decline reflects local headwinds in 2019 and then the effects of the COVID-19 pandemic. Indeed, while the region continued to record positive net absorption through the pandemic years, the majority of cities saw market rents fall which explains why 88% (22 out of 25 markets) are currently over-rented. The three exceptions are Ho Chi Minh City, Hanoi and Seoul, though Singapore is arguably at equilibrium with just 0.4% over-renting. The example of Ho Chi Ming City has been worked above, with Hanoi following a similar trajectory. Seoul has been particularly resilient and has shown considerable market rent growth, even during the pandemic which as been sufficient to exceed the standard 3.5% annual rental escalation covenant. Rent growth in Singapore has occurred more recently due to tight vacancy and limited new supply coming to market.

FIGURE 3: LEVEL OF OVER- OR UNDER-RENTING ACROSS 25 ASIA PACIFIC MARKETS, Q2 2023 LEASE EXPIRY

Source: Cushman & Wakefield

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LOOKING FURTHER AHEAD, MOST OF THE 25 MARKETS ACROSS ASIA PACIFIC (88%) WILL REMAIN OVER-RENTED UNTIL THE END OF 2025, BUT THAT IN 2026 THE SITUATION WILL SHIFT SUCH THAT 50% OF MARKETS ARE UNDER-RENTED, AS RENTAL GROWTH RETURNS. THIS SHOULD BE A SIGNAL TO TENANTS TO EXAMINE THEIR LEASE RENTS IN RELATION TO THE CURRENT MARKET AS THEY COULD BE PAYING ABOVE MARKET RENT. Furthermore, occupiers should also consider the year-to-year trajectory of market and lease rents (Figure 4). For example, Melbourne is forecast to become under-rented in 2025, though arguably the greatest level of over-renting (i.e. biggest discount between market rents and leases) is occurring now through to 2024, suggesting action should be taken within the next 18 months. In contrast, both Singapore and Bangkok are expected to become under-rented in the next 6 months, suggesting more urgent action is required.

Looking at both rental forecast and the standard length of a lease in cities across Asia Pacific, Cushman & Wakefield sees the “windows of opportunity” where occupiers could experience the most favourable conditions in relation to their lease expiry (Table 1 overpage). Of course, market conditions can, and do change and so this should not be a set and forget exercise, especially if the window of opportunity is several years distant. Rather the analysis should be regularly updated to keep it contemporary. This is where in-depth market knowledge is integral, not only to assist on advising current and future market conditions but also to identify strategies that capitalise on those conditions. Advisers who work exclusively for the tenant can canvas a deep pool of landlords to access to the latest space availabilities. Furthermore, they can recommend best practice regarding issuing space requirements and subsequently evaluating all submissions received. Together, these factors help tenants navigate a market more effectively and efficiently.

FIGURE 4: LEVEL OF UNDER- / OVER-RENTING FOR SELECT MARKETS, 2022-2026

Lease expiry period

Melbourne

Bangkok

Singapore

Source: Cushman & Wakefield

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TABLE 1: IDENTIFYING THE WINDOW OF OPPORTUNITY FOR OCCUPIERS

Source: Cushman & Wakefield

Over-renting

Markets broadly in equilibrium

Under-renting

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OUR TEAM:

KEY TAKEAWAYS

1. Three-quarters (19 out of 25) markets are forecast to experience rental growth over the next 24 months. 2. 88% of markets in Asia Pacific are currently over-rented, but this will decline through to 2026 as ongoing rental growth takes effect. This suggests there is a “window of opportunity” for occupiers to rethink their lease expiries before markets start to shift. 3. For many markets in Southeast Asia, such as Singapore, Bangkok and Hanoi, arguably the best of conditions for occupiers have already past, though the gaps between lease rents and market rents will continue to grow, suggesting there is still some benefit in bringing forward negotiations. 4. In contrast, In India, significant annual rental escalations of 5% against forecast market rent rises of 1% to 2% mean that these markets are expected to remain over-rented). 5. For the remaining 52% (13 out of 25) markets, varying levels of under-renting are expected to endure through the forecast horizon. These markets should be investigated in detail to identify opportunities to rethink lease strategy and perhaps reset rents where local conditions allow.

ANSHUL JAIN Head of Tenant Representation, APAC anshul.jain@cushwake.com

ARPITA SRIVASTAVA APAC Tenant Representation arpita.srivastava@cushwake.com

NICK SEATON Head of Integrated Portfolio Management nick.seaton@cushwake.com

BERNARD LIM Transaction Management, Global Occupier Services bernard.lim@cushwake.com

TOM GIBSON Head of Project & Development Services, APAC tom.gibson@cushwake.com

DR DOMINIC BROWN Head of International Research, Global Think Tank dominic.brown@cushwake.com

ABOUT CUSHMAN & WAKEFIELD

Cushman & Wakefield (NYSE: CWK) is a leading global commercial real estate services firm for property owners and occupiers with approximately 52,000 employees in approximately 400 offices and 60 countries. In 2022, the firm reported revenue of $10.1 billion across its core services of property, facilities and project management, leasing, capital markets, and valuation and other services. It also receives numerous industry and business accolades for its award-winning culture and commitment to Diversity, Equity and Inclusion (DEI), Environmental, Social and Governance (ESG) and more. For additional information, visit www.cushmanwakefield.com.

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