New supply in central Seoul means tenants’ market to continue

Abundant new supply in Seoul’s central business district has continued to perpetuate a tenants’ market in 2012.

Tenants have kept control of the office rental market as the CBD experienced a record high vacancy rate and landlords were pressured to reduce rents. Approximately 1.35 million square meters of new prime and grade A office space will be added to the market by 2016. Most of this new space will be located in the CBD and Yeouido, and should drive vacancies up in these areas.

Compared to the CBD market, vacancy in the Gangnam business district is expected to be more stable due to the lack of available prime space and continuing demand. Consequently, Seoul Grade A office market is expected to remain a tenants’ market in the coming years.

Economy

The Korean economy is expected to maintain a slow pace in 2012, after a strong performance in 2011. According to the Bank of Korea, South Korea’s gross domestic product expanded by 3.6 percent last year on the back of thriving exports, despite slack construction investment, private consumption and capital spending.

The economy will expand more slowly than anticipated this year. Real GDP growth is estimated at 3.4 percent in 2012 due to high fuel costs and a gradual slowdown in both exports and domestic market consumption. The consumer price index grew by 4.2 percent in 2011, exceeding the Bank of Korea’s target rate, but slipped to 3.4 percent this year.

Retail sales have posted a poor performance amid continuing high inflationary pressures. Korea’s private consumption is also easing. Private consumption recorded a 2.3 percent growth in 2011 compared to 4.4 percent in 2010. Although the Korean economy has seen employment steadily improving with unemployment rate reaching only 3.4 percent, young people are bearing the brunt of the downturn, with the unemployment rate of those aged between 15 and 29 above 8 percent. Despite lower growth forecasts in 2012, long-term economic prospects remain sanguine. On March 15, the Korea ― U.S. Free Trade Agreement finally took effect. According to government estimates, it will help the Korean economy to expand by 5.7 percent and create 350,000 jobs within a decade. In addition, Korea and three other emerging economies, namely Mexico, Indonesia and Turkey, will become the next target of international investors after the BRICs (Brazil, Russia, India and China).

In the third quarter of 2011, Seoul Grade A office vacancy rate peaked at its highest level in history due to the completion of four projects totaling an approximate gross floor area of 262,694 square meters in the CBD. Signature Tower, YG Tower, Mirae Asset Tower and 101 Pine Avenue were launched in the third quarter of 2011.

An increase in the vacancy level and abundant new supply led to tenants benefitting in the form of rent-free periods which continued to reduce effective rents. The new Grade A office market demand improved on the back of increasingly favorable leasing conditions. For example, major companies, in particular SK E&C and Daelim Industry, moved to new office spaces, upgrading from a lower grade to Grade A buildings.

As a result, the Seoul Grade A vacancy rate declined from 13.6 percent in the third quarter of 2011 to 9.2 percent in the first half of 2012. Rental values, however, remained stable with a slight increase by 1.1 percent from the second half of 2011 to 28,620 won per square meter per month in the first half of 2012. Due to the successful leasing of Grade A buildings in the CBD area, promotional incentives were tight. As a result, the gap between face and effective rents decreased in the first half of 2012. However, this narrowing spread is likely to be temporary as a significant volume of office projects is scheduled to be completed in the CBD through 2014.

Outlook

Approximately 1.35 million square meters of new prime and Grade A office spaces will be added to the market until 2016. These new prime and Grade A offices are expected to be completed, representing a 29 percent increase in total leasable stock as compared to the previous years.

Most of the new office space is located in the CBD and YBD, which should drive vacancies up in these areas. Although some of the projects have been delayed due to the global financial crisis, the completion of major projects will persist. Thus, given the expected significant availabilities, occupiers will actively review relocation possibilities to upgrade their office space in the coming years.

Central business district

Several real estate development projects such as the Doryum-dong Building (Doryum 24), N tower and Chungin district (1-3, 8 and 12-16) will be completed in 2015. Therefore, vacancy rates in the development project area, especially in the Chungin district, are expected to increase for several years. The vacancy rate in the CBD area is forecast to exceed 20 percent in 2014. Monthly rental growth is expected to continue to show a weak steady trend due to the influence of an increased vacancy rate. The rental rate in the CBD will maintain its stable level or increase slightly by 2 percent to 3 percent.

Gangnam business district

As conglomerates and the IT industry showed growing demand amid a tight supply of quality space, vacancy in the GBD is expected to continue to fall. Although several buildings like K office building will open in 2013, the new building will be located outside of the GBD’s main area. Thus, the impact will be marginal. In the GBD area, rent for large prime buildings is expected to continue to rise due to a sustained demand and limited new supply of quality space in a major location.

Yeouido business district

Large buildings such as Two IFC and Three IFC have been completed. In addition, the Federation of Korean Industries Hall, with 168,681 square meters of space will be delivered in the fourth quarter of 2013. Consequently, occupancy and effective rental rates are expected to fall in the second half of 2012, after a prolonged period of stability. Although the two IFC towers and the FKI buildings have set higher rents, the new prime office buildings will also begin to offer competitive incentives to secure tenants due to One IFC’s pre-leasing success and its aggressive marketing approach.

Conclusion

Looking ahead, we expect tenant-favorable conditions to prevail in Seoul’s office rental market until some of the excess supply is absorbed. New supply in the CBD and Yeouido will likely hold back any rent uptick, but the multitude of incentives should strengthen occupancy in these new developments. Thus, leasing transactions involving upgrading from lower grade to new prime office buildings is expected to increase and remain widespread in the Seoul office market.

Meanwhile, the lack of new construction and healthy demand will sustain low vacancies in Gangnam, which in turn will fuel moderate rent increases. Rent in the Seoul grade A office market will edge up due to newly-completed buildings and rising inflation rate. However, with new supply entering the CBD market, effective rents are expected to continue to show a weakening trend. Thus, Seoul Grade A office market is expected to be a tenant’s market in the coming years.

By Tony Yoon, Head of CIS, Cushman & Wakefield Korea

This article was contributed by the Cushman and Wakefield Korea, the local unit of the New York-based global commercial real estate consulting firm. ― Ed.