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Decentralisation still a key long-term strategy

The gap between CBD and decentralised rents are expected to expand again, thus offering more impetus to decentralise.

THE Urban Redevelopment Authority recently called for public feedback in late August on the master plan proposal for Jurong Lake District (JLD) as it looks to take one step closer to transforming the area into the country's second Central Business District (CBD).

Alongside earlier announcements in the year on the rejuvenation plans of Paya Lebar Central and the proposed remaking of Woodlands into the "Star Destination of the North", it is clear that decentralisation - the policy to relocate commercial offices to regional/sub-regional centres outside the CBD - continues to be a key long-term strategy of the government despite moves by some firms to locate in the CBD.

MORE RECENTRALISATION

The past couple of years have seen a renewed focus by occupiers on CBD offices, judging by where the majority of leasing activity has taken place. Based on CBRE Research, from 2015 to H1 2017, the CBD has consistently recorded a larger share of leasing transactions with the decentralised areas accounting for less than 20 per cent of leasing deals greater than 10,000 sq ft. Given the spotlight and attention given on decentralisation, why has there been a general trend of occupiers choosing to re-centralise?

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Rather than any real challenges facing decentralisation, this phenomenon can be largely explained by three key reasons: the narrowing rental premium between CBD and decentralised rents, supply-side factors and the competition for talent.

NARROWING RENTAL PREMIUM

Office rents have been trending downwards since Q2 2015. While Grade A core CBD rents declined a total of 21.5 per cent from its previous peak in Q1 2015 to Q2 2017, Grade B decentralised rents fell 14.7 per cent in the same time period. This led the rental premium between the Grade A core CBD (Q2 2017: S$8.95 per square foot per month (psf pm)) and the decentralised market (Q2 2017: S$5.80 psf pm) to shrink to a 10-year low of 54 per cent (Chart 1). This opened up a window of opportunity which existing and new occupiers capitalised, as evidenced by a number of large corporates relocating to better quality buildings within the CBD at very reasonable terms.

SUPPLY-LED DEMAND

At the same time, the recentralisation of occupiers has to a great extent also been supply-led. New and existing occupiers in Singapore tend to be attracted to newer office projects. Looking at the pipeline supply, an estimated 6.14 million sq ft of new office space will be completed from 2015 to 2017, of which 83.2 per cent is within the CBD area. New office developments in the decentralised areas on the other hand is minimal. At the same time, with little available space in decentralised prime office projects (where vacancy was 3.6 per cent as at Q2 2017), it is unsurprising that most of the concluded deals have focused on the newer projects.

COMPETITION FOR TALENT

Another factor that is oft-cited by occupiers for re-centralising is related to a human resource issue. In the battle to attract and retain talent, firms acknowledge that location is still a key drawing factor. This stems from the real and perceived benefits in having an office address in a high-quality CBD building that makes it highly desirable to prospective employees.

As a result, even technology firms, which have generally been fairly neutral when it comes to location, seemed to have tweaked their preferences in favour of the CBD. Some of the largest leasing deals by this sector over the past 12-18 months have been concentrated in the CBD including LinkedIn, Grab and Uber; this is further exemplified by the largest leasing deal in 2017 thus far - a US social media MNC (multi-national company) taking up 300,000 sq ft at Marina One. Such tech and media companies continue to seek talent from the millennials, and a prestigious work address seems to be a large draw for this profile of talent.

STILL A VALUE PROPOSITION

As we arrive at a key juncture in the office market which has likely reached its trough, what does the future hold for upcoming decentralised projects?

One of the biggest questions surrounding decentralisation revolves around the type of tenants that are willing to locate outside the city centre. Using the precincts of Marina Bay and the western suburbs (Buona Vista/Jurong East) as a sample example (Chart 2), it is observed that the banking and finance, legal and increasingly technology sectors continue to actively seek space within the CBD.

On the other hand, the decentralised market tenant profile is markedly more diversified. Its sources of demand generally stem from industries that do not necessarily require the profile that goes along with having a CBD address. These include consumer products, transport & storage, engineering, and construction-related firms. Government agencies have also been a key demand sector as the government took the lead to relocate to some of the decentralised areas to catalyse their development. Some of these examples include Agri-Food & Veterinary Authority of Singapore (AVA) and the Building and Construction Authority (BCA) at Jem and Central Provident Fund (CPF) at Novena Square.

One concern around diversifying tenant profile is the risks associated with weaning off support from traditional mainstay occupiers such as financial institutions, insurance and legal firms. This risk, however, might be abated given the government's push to diversify and seek new growth industries, potentially lifting demand for decentralised office schemes. Varying the demand pool also mitigates the economic fluctuations that can adversely affect office takeup of key sectors.

Also, there is a general consensus that the office rental market is recovering after two years of rental decline. Grade A core CBD rents are forecast to increase at a faster pace than decentralised rents, and that the rental premium between both rents is expected to expand once again, providing greater incentive for cost-conscious occupiers to decentralise.

Over the near term, Paya Lebar Central (PLC) appears to be the next most immediate decentralised project in the horizon. Just as Buona Vista was transformed into a bustling business hub in the western outskirts of the CBD, PLC is envisioned to be the eastern equivalent. However, PLC contrasts with other commercial hubs due to its close proximity to both the traditional CBD and Changi Airport.

The catalyst in PLC's rejuvenation is Paya Lebar Quarter (PLQ), which will be located right in the heart of this precinct. This project will be the largest decentralised mixed-use development and looks primed to play a crucial role in shaping the overall skyline and serve as the key landmark of this precinct.

With Singapore looking to maintain its status as a financial and technology hub, high quality space in the CBD will continue to stay relevant and highly sought after. However, the current spate of recentralisation by occupiers does not equate to the undermining of the decentralisation story.

Decentralisation at its core is essentially a value play that caters to a different segment of the demand pool. Key office attributes will still be essential to make it viable to potential tenants - high connectivity, accessibility to a wide range of amenities and Grade A office specifications, all at a fraction of what it would cost in the CBD.

At the end of the day however, healthy economic fundamentals still play a crucial role as the biggest demand stimulant. After all, it is not uncommon for a metropolis to have more than one core business district. Rapid urban sprawl resulting in a need for long-term sustainable urban development, the stress on CBD infrastructure and occupancy cost-savings are the key drivers for decentralisation in Asia.

A strong Singapore growth story will be good news for the entire office market - both within and outside the CBD.

  • Desmond Sim is head of research for Singapore and South-east Asia, and Dylan Chua is assistant manager at CBRE Research