Offices 2020 Shanghai: Double the Stock. Double the … 2020 Shanghai: Double the Stock. Double the...

Offices 2020 City ReportMarch, 2014

Offices 2020 Shanghai:Double the Stock. Double the Demand?

Double the Stock. Double the Demand?

Introduction

■ Will Shanghai’s office market be oversupplied by 2020? ■ Which industries will be the major drivers of office demand going forward?

■ What are the implications for specific submarkets?

The companion report Offices 2020 Shanghai: Building China’s Global City has painted a big picture outlook for Shanghai’s office market. In this white paper, we will dig deeper into occupier trends and seek to answer the following key questions:

We begin by examining the strong correlation between tertiary industry size and occupied office space, and project future demand in Shanghai through 2020. Next, we highlight the launch of Shanghai’s pilot Free Trade Zone (FTZ), a historic move towards reforms in the financial and service sectors. The ensuing policy framework will become a key catalyst for office demand in the medium and long term. Finally, we consider which are likely to be the most active industries and new sources of office demand and analyse the nature of tenants’ space requirements to determine which submarkets will benefit and which could face challenges in the future.

HONGKOUYANGPUZHABEI

JINGAN

PUTUO

CHANGNING

MINHANG

HUANGPU

XUHUI

PUDONG

Offices 2020 Shanghai 3

IntroductionStrong growth in the service sector leads to balanced supply and demand

A large pipeline of office projects in Shanghai’s established and emerging business districts has caused concern among many developers and investors about the potential for oversupply in the medium to long term (see Figure 1). By the end of the decade, Shanghai’s overall Grade A office market could see as much as 5.7 million sqm of additional office space, representing an 80% increase on current stock. At first glance, these figures are frightening in both absolute and relative terms. Will Shanghai’s office market be oversupplied by 2020? To answer this question, we take a closer look at the key drivers of office demand.

Figure 1: Shanghai Grade A office supply: 2013 vs 2020

02468

101214

2013 2020

Million sqm

CBD Decentralised

Source: Jones Lang LaSalle

Offices 2020 Shanghai4


The service sector broadly encompasses a significant majority of the demand for office space. By looking more closely at the historical tertiary industry component of GDP for Shanghai over the past 19 years (1995-2013), we find there is a strong correlation between the nominal value-added from the tertiary industry of the economy and the aggregate occupied Grade A office space. Using a linear regression model to explore the relationship between the two variables we achieve a very high R2 = 0.921 (see Figure 2).

Figure 2: Linear regression model: aggregate occupied stock versus tertiary GDP

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Source: CEIC, EIU, Oxford Econmics, Jones Lang LaSalle analysis

We believe this relationship between the size of the service sector and the demand for office space is likely to continue in the future. If that is the case, then in order for there to be sufficient demand to absorb the future supply of office space, there will need to be significant growth in the service sector. This will come from not only baseline growth in the overall economy, but also from the Shanghai government’s plans to develop a service-led economy, targeting to increase the service sector to 65% of GDP in 2017 from 62% in 2013. Inputting this service sector target into our regression model we find the total occupied stock can double to 12 million sqm by 2020, which implies a vacancy rate of approximately 10% based on the supply pipeline (see Figure 3).

Figure 3: Shanghai office supply, demand and vacancy rate

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It is not an overstatement to say that service sector expansion is at the heart of China’s most important economic priorities. In fact the success of efforts to rebalance the economy away from investment led growth toward consumption led growth will rest largely on growing the service sector. To understand why, consider that service sector businesses tend to be more labour intensive and less capital intensive than investment led economic activity characterized by such things as infrastructure development and construction. By focusing on service sector development, better paying white collar jobs will be created which should help to increase the size of China’s middle class. This in turn will mean more people have the capacity to consume. So rebalancing the economy from investment led growth to consumption led growth will result from there being more consumers rather than from a change in behaviour among existing consumers where they might spend more and save less.

Note: * The projection on future supply factors in delays and downgraded projects.

** Building downgrades occurred in 2002, 2003, 2006, 2008, 2009, 2010, 2012 and 2013



China (Shanghai) Pilot Free Trade Zone: A catalyst for service sector reform

China’s State Council approved the launch of the country’s first free trade zone (FTZ) in Shanghai in 2013. The new FTZ is more than just free trading; the official launch of the FTZ is a signal of the government’s continued commitment to push ahead with financial and service sector reform. All six areas in the reform guidelines released in September 2013 were service sector related. In addition, it is expected that the zone will allow for experimentation with pilot reforms in financial deregulation, RMB convertibility, and interest rate reform. This will benefit the whole city’s financial services industry and spur greater demand for downstream professional services. In addition, by utilizing a “negative list” approach rather than only allowing a specific set of industries to conduct business, the FTZ will also bring new sources of activity, especially from many foreign businesses which until now faced limitations on the scale of their investment in China. From this prospective, the announcement of the FTZ is analogous to that of China joining the WTO in 2001. In the process of meeting the requirements for WTO membership, great focus was brought to reducing the restrictions on foreign businesses in the manufacturing and trading sector. In a similar way, the Shanghai FTZ can be viewed as a mechanism for reform of China’s financial industry and deregulation in the broader service sector.

China (Shanghai) Pilot Free Trade ZoneFollowing Premier Li Keqiang’s visit to Shanghai in March, 2013, China’s State Council approved the country’s first free trade zone (FTZ) in July, followed by an official launch on 29th September, 2013. The development of the FTZ was also mentioned late in China’s Third Plenum of the 18th Communist Party Central Committee, viewed as one of the most important meetings to set China’s economic agenda for the next five to ten years.Shanghai’s FTZ, occupying 28.8 square kilometers, consists of four areas along the city’s east coast, namely Waigaoqiao Free Trade Zone, Waigaoqiao Bonded Logistics Park, Pudong International Free Trade Zone and Yangshan Free Trade Port Area. All four areas of the Shanghai FTZ are situated along the coastal edge of the city and are about 25-60 kilometres from the existing CBD.The main purpose of the zone is to expand China’s economic and financial reforms, especially the opening up of the service industry. Instead of building a new CBD to compete with the existing CBD, the free trade zone will instead serve as a “testing ground” for economic reforms. Successful policies are likely to be quickly replicated in other FTZs around China and eventually to the country as a whole.The first series of guidelines for the FTZ include 18 industries in six areas, which are all service sector related, including financial services, shipping services, professional services, commercial trade services, cultural services and social services. In addition, another key part of the FTZ’s initiatives is a “negative list”, which represents a new management approach to foreign investment. It means any business not on the list will allow participation by foreign investors. Compared with the current Catalogue for the Guidance of Industries for Foreign Investment, the new approach could be a big step forward in improving the regulatory environment for foreign investment. The list is expected to be simplified to allow for additional sectors in the next few years.

Hongqiao International Airport

Pudong International Airport

Fengxian

Pudong

Jingshan

Zhejiang Province

Jiangsu Province

Songjiang

Qingpu

Jiading

Minhang

Baoshan

Chongming

Waigaoqiao Bonded Logistics Park

Waigaoqiao Free Trade Zone

Pudong Airport Free Trade Zone

Shanghai

Decentralised

Yangshan Free Trade Port Area

12

3

4

CBD



When comparing these two influential events, it is worth looking back at the impact entering the WTO had on the Shanghai office market. The influx of foreign investment and the huge growth in manufacturing in the country as a whole led to a boom in office demand in China’s tier 1 cities. Due to its outward-facing international nature, Shanghai became a preferred location for many companies to set up their China headquarters. Over the past 12 years, these headquarters operations have expanded ten to twentyfold. (see Table 1). In addition, thousands of foreign companies from manufacturing and trading industries set up new offices in Shanghai during the period. China’s new reforms are expected to have a similar impact on Shanghai’s office market. By locating China’s first FTZ in Shanghai, we have a clear indication that the city will play a leading role in the service sector reform agenda and we expect that to translate into significant new office market demand.Table 1: Changes in size requirement for Shanghai Grade A space

between 2001 and 2013

Occupier Size Requirement in 2001 (sqm)

Size Requirement in 2013 (sqm)

% Growth between 2001 and 2013

Continental 2,000 20,000 1,000%

Schneider 1,500 20,000 1,300%

Ford 1,200 10,000 800%

Uniqlo 500 10,000 2,000%

Nike 2,000 55,000 2,700%



The two key sectors driving demand: Financial and Professional services

Financial services - Drivers The finance industry is already the most important source of demand in Shanghai’s Grade A office market, accounting for 27% of total occupied office space as of year-end-2012 (see Figure 4). On the back of policy support and market forces, we expect the finance sector to maintain rapid growth and account for an even larger share of office demand in the medium to long term.

The central government’s goal to build Shanghai into an international financial centre will be one key factor supporting growth of the city’s financial sector. In addition, Shanghai’s position as an established gateway between China and the rest of the world, and as the primary domestic financial centre, have positioned it as the logical location to test market reforms (see Figure 5). Beijing will continue to reign supreme for commercial lending owing to the large number of state owned enterprises (SOEs) headquartered there, but for other parts of the industry from securities trading to investment banking to fund management to insurance and private equity, Shanghai is the main domestic financial centre, even in the face of the aspirations of other municipalities around the country. Over the balance of this decade, the growing middle class will create enormous new demand for wealth

Figure 5: Key drivers for financial sector in Shanghai


Figure 4: Shanghai Grade A office tenant profile by industry


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Finance Service Non-Finance Professional Service Chemicals & Pharmaceuticals Manufacturing & Trading High-tech & IT Retail Real Estate & Construction Logistics & Shipping Mining & Energy Others

Growth in Finance Sector

To build Shanghai into International Financial

Centre

China’s Financial Reform

China (Shanghai) Pilot Free Trade Zone

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New Markets, such as Interest Rate and Currency Trading

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Rise of Middle Class



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Figure 6: Shanghai’s employment in financial sector

Figure 7: Shanghai’s GDP in Financial Sector

Source: Shanghai Statistics Yearbook 2012, Shanghai 12th Five Year Plan, CEIC, EIU, Jones Lang LaSalle analysis

Source: Shanghai Statistics Yearbook 2012, Shanghai 12th Five Year Plan, CEIC, EIU, Jones Lang LaSalle analysis

management and the investment industry. Their purchases of cars and homes, which are now the largest markets of their type in the world, will foster increasing demand for insurance products, and market based reforms will substantially increase employment in credit, interest rate, and currency trading. Therefore, the city is expected to benefit more than any other from China’s future financial deregulation. The size of Shanghai’s finance sector, in economic terms, is forecasted to double by 2020, representing a CAGR of 11%. Employment in the sector will see a similar growth rate, with an expected 9% CAGR through 2015 (see Figure 6 and 7).From a leasing prospective, it is worth mentioning that the relatively slow business licence approval process has been a big hurdle for foreign financial services institutions to expand into new markets, products and sectors and therefore has been a barrier for them to expand their office footprints. There is a long waiting list for foreign banks to set up subsidiaries and obtain various licenses. Not surprisingly, we have seen that an approved license usually coincides closely with new office space requirements. Currently the world’s largest foreign banks have their Asia regional headquarters and the majority of their staff in other international financial centres such as Hong Kong, Singapore and Tokyo. If these firms are permitted to expand more quickly and participate in additional market segments through deregulation, which the Central government has long said it supports, then we expect in the medium to long term Shanghai will see stronger office demand from foreign financial firms. For the time being, though, most of those investment bankers and traders remain in locations outside of China. This situation will change as deregulation and streamlining of the various approvals processes takes place.In contrast, rising office demand from domestic financial companies has been clearly visible in recent years. The domestic banks, insurance, investment, trust and private equity companies as well as securities firms have been eager to grow their businesses and still have plenty of opportunities to continue doing so. Typically office demand from domestic financial institutions manifests itself through a combination of three mechanisms: owner occupied space, upgrading from older buildings and through the setup of new operations.


Table 2: Recent notable transactions from domestic financial institutions

Occupier Transaction Date

Size (sqm) Demand Type

A domestic financial institution 2013 85,000 Owner

Occupation

Huaitai Securities 2012 15,000 Owner Occupation

Manulife-Sinochem 2013 11,000 UpgradeBOCOM Schroders 2013 5,200 UpgradeStandard Wealth 2013 4,500 New Set-upNanjing Xinyuan Fund Management 2013 2,500 New Set-up


Evidence of the depth of this demand can be seen in recent market activity (see Table 2). Owner occupiers in the financial sector contributed about 8% of Shanghai’s overall take-up between 2011 and 2013. With 250,000 sqm of space already pre-committed by owner occupiers including domestic retail banks, insurance and securities companies over the next four years, this trend will continue to be important to the market. Upcoming office properties with signage and retail space are highly sought after by such tenants who compete with one another for prime locations and properties. Financial deregulation will allow an increasing number of new financial products and markets as well as new players from private companies to enter the market which has been dominated by SOEs and government linked businesses up to this point. High quality office space will cater to these businesses which will look to improve their corporate image and compete for talent. Younger members of senior management teams, many of whom grew familiar with Grade A office environments while working overseas, will also have a greater preference for leasing high quality space compared to their predecessors.



Financial services - Implications for submarketsWith a strong guiding hand from the Municipal government, the Pudong CBD, including Lujiazui and Zhuyuan, has solidified its status as the financial centre of Shanghai. It is the most sought-after location for financial institutions, both international and domestic. However, from an office market perspective, the area is almost fully built out, with very few future commercial development sites available. After Shanghai Tower in Lujiazui and the two Century Avenue projects in Zhuyuan are completed in the next three years, new supply will be extremely limited. The predicted strong demand from the financial services sector means that the Pudong CBD Grade A office market will remain very tight in the medium to long term. Therefore, rather than oversupplied, as many had labelled Pudong during the global financial crisis, it is more relevant to consider where the next financial centre in Shanghai will be located as Lujiazui becomes completely filled up.It is our opinion that Qiantan, located along the Huangpu River to the Southwest of Lujiazui, has the greatest potential to become a new financial cluster, similar to London’s Canary Wharf. We see Qiantan as the most likely location to house both spill-over demand from Lujiazui and split-office demand from financial companies, for four main reasons:

• Qiantan covers 2.8 square kilometers and is one of very few areas in Shanghai that can provide large, contiguous greenfield land to develop close to the established CBD. Also, it is targeted by the city government as a “second Lujiazui” in Shanghai. Alongside Disneyland, Qiantan is among the city’s major developments planned for the next five years.

• Qiantan enjoys better transportation compared with most other emerging areas of the city – a 15-minute drive to People’s Square downtown and 20-minute drive to the existing Pudong CBD. It also has convenient accessibility via public transportation with three metro lines converging in the area.

• The land development in Qiantan is being mostly managed by Lujiazui Group, Shanghai’s largest State-owned commercial developer and the developer of the existing Lujiazui Finance and Trade Zone. Lujiazui Group has a proven track record and demonstrated ability to build a commercial precinct utilizing a long term perspective.

• Finally, although the existing commercial environment in Qiantan is weak, it will improve as the neighbouring areas are developed including Pujiang Yaohua Business Area and the Pudong World Expo Area – where almost 20 large SOEs have already committed to build headquarters buildings.


Professional services - Drivers Professional service companies contribute about 16% of the occupied space in the Shanghai office market (see Figure 4). Like the financial services sector, we expect the professional services sector to also comprise an increasing share of total office take-up in the medium and long term. This is mainly due to four factors, the first and perhaps most important of which is growth in the finance sector (see Figure 8). The expansion of financial sector businesses will create huge additional demand for legal, accounting and consulting services, as well as marketing and headhunting services to support them. Mature financial centres around the world clearly show the correlation between large Grade A office space needs for financial services and for professional service firms (see Figure 9). This means that Shanghai’s transformation into a global financial centre will be just as beneficial for professional services as it will be for financial services.The service sector stands to benefit not just from the growth in the financial sector, but also the expansion in business activities in a wide range of other sectors such as growth in manufacturing, healthcare, retail, IT, and a number of other industries in Shanghai and Greater China. After all, professional services count many businesses, not just financial institutions, as their clients. As the whole country continues to develop and Shanghai emerges as a business, shipping, and cultural centre for the country, professional services will continue to develop in tandem. As in the financial sector, the government is working to open up the professional services sector. For example, in the Shanghai FTZ, methods and mechanisms to enhance collaboration between Chinese law firms and foreign law firms will be explored. Finally, the past 10 years have shown relatively strong correlation between China’s IPO market and business demand in the professional service sector, with both showing strong activity from 2010 to 2011 and then cooling off in 2012 and 2013, mirroring the global trend. Looking forward, despite some Chinese companies’ interest in listing shares outside China, China’s A-share market is still the most attractive for Chinese businesses. According to currently available information, China has about 600 companies waiting to list their shares as the moratorium on IPOs finally comes to an end after one and half years. As activity revives, this will once again be an important driver of business for professional services firms.

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Figure 8: Key drivers for professional service sector in Shanghai

Figure 9: Global city comparison with financial and professional service sectors’ contribution to take-up





Professional services - Implications for submarketsDue to the nature of their business, professional services sector occupiers will continue to look for space primarily within the CBD area in order to be close to their clients. While some finance-oriented professional service firms will prefer the Pudong CBD, most are expected to focus on the Puxi CBD, especially the Puxi core area, which currently has the highest concentration of professional service

companies in Shanghai. Similar to the Pudong CBD, the future supply in this core area is limited. The main difference between the two areas is that Puxi has a rapidly growing decentralised market in the peripheral areas. This is expected to draw some existing tenants out of the CBD, particularly those with low margins that are not client-facing such as logistics and manufacturing firms. This will free up space in the Grade A market and provide more available expansion space within existing projects.


Additional active industries: Healthcare and Retail brands

Healthcare - DriversThanks to the rapid development of China’s healthcare sector, office demand in Shanghai from pharmaceutical, medical devices, healthcare and other life sciences companies has been a growing share of net take-up over the past three years. At present, the industry comprises about 8% of occupied space in the Shanghai office market (see Figure 4). Looking forward, there are many drivers to further growth both from market and policy forces (see Figure 10). The nation’s healthcare spending is expected to grow from $357 billion to $1 trillion by 2020, representing a 12% CAGR (see Figure 11). Backed by the strong outlook for the growth of the industry as a whole, we anticipate this sector is also likely to maintain its outstanding performance in terms of demand from an office occupier perspective, especially in Shanghai, where most multinational healthcare companies have located their headquarters. The huge market opportunity will attract more healthcare companies to increase investment in their existing projects and add more business lines such as drug discovery, medical device development, manufacturing and sales and marketing. In addition, increasing numbers of foreign companies are keen to establish a significant long-term presence in China, with a few already undergoing organizational changes to this end. This will drive more healthcare companies to relocate their regional quarters to Shanghai due to city’s

Healthcare Industry

Rise of Middle Class Further Healthcare Reform Aging Population

Urbanization

Change in Lifestyle

Expand Basic MedicalInsurance Programs

Industry Upgrade Emphasized in

12th Five Year Plan

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Source: McKinsey & Company, Jones Lang LaSalle

Figure 10: Key drivers for the healthcare industry

Figure 11: China’s total healthcare expenditure.

strong talent pool and the status as one of China’s most mature industry clusters, driving expansion demand for office space. For instance, some businesses have already relocated their global headquarters for select business units to China: GE’s X-ray business and Bayer’s general medicine business are two examples. In addition, Baxter has moved their Asia-Pacific regional headquarters to Shanghai. Many companies’ CRE division have changed their reporting lines such that their China operations report directly to the chief executive or to the global board.



Healthcare – Implications for submarketsUnlike professional and financial services, the predicted strong net take-up from the healthcare sector will not be realized for the most part in the CBD as many companies will consider decentralization for their office needs. Although high profit margins will continue to allow many pharmaceutical companies to afford the high rental rates in the CBD, some large foreign pharmaceutical occupiers have grown rapidly and their current size requirements are large enough (>15,000 sqm) to make build-to-suit space in a decentralised location a viable alternative. In addition, as more and more MNCs are taking a long term view of their business strategy in China, we can expect greater interest in stand-alone options with signage rights on their building in order to further upgrade their corporate image. These options are mainly located in Shanghai’s decentralised areas and in business parks, but are very rare in the CBD. This decentralization trend is visible in some recent transactions (see Table 3), and other top foreign pharmaceutical companies are now seriously looking at decentralised options.

Table 3: Recent notable leases from foreign healthcare company Occupier Date Location Size (sqm)

Roche 2013 Hongqiao Transportation Hub 18,000

MSD 2012 Caohejing 25,000Source: Jones Lang LaSalle


Retail brands - DriversThere is no doubt that the rise of middle class has become a main theme for China’s economy. Besides the aggressive expansion of physical stores, in the past several years we have also seen rapid growth in the office space requirements of retail brands. Retailers currently comprise around 8% of occupied space in Shanghai (see Figure 4). With growth of the service sector being a strong policy priority, we anticipate continued rapid expansion of the middle class in Shanghai and China. According to IHS Global Insight, the middle class* in China will grow from 15% of the total population to 37% or 501 million people by 2022, surpassing the entire EU and US middle classes, and about 5 to 10 times higher than that of either Japan or the UK. Our analysis indicates that Shanghai’s consumer class has doubled in size in the last 5 years and will increase by a further 50% in the next 5 years. The growth rate of this consumer class means that opportunities for retailers are huge in China (see Figure 12). Some foreign retailers are already generating over a third of their global sales from China (see Figure 13). Yum Brands, the parent of KFC and Pizza Hut, stands out at the top of the list with half of their global revenue coming from China. These examples and the strong overall market outlook have certainly encouraged other brands to aggressively pursue expansion. China is playing an ever greater role in the business strategy of global retailers. The subsequent increase in investment

and office demand comes from increases in headcount for corporate functions such as marketing, finance, tax, human resources, real estate, sourcing, franchise management, and merchandising. The growth in the corporate presence of retail brands is a trend that has been clearly evident in leasing transactions and inquires over the last several years. The counter argument that more and more Chinese consumers – particularly in the luxury sector – are traveling overseas to do their shopping still results in a need to market to and engage clients locally.

China EU USA Japan UK

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2017 Consumer Class2022 Consumer Class

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Note: ** (a) Includes Hong Kong (b) Includes Hong Kong, Macau, and Taiwan Source: Web source, Annual reports 2012

Note: * middle class defined as household income greater than $ 15,000 in constant 2005. Source: IHS Global Insight, EU=EU27

Figure 12: China’s middle class forecast with global comparison*

Figure 13: Percentage of global sales derived from China**



Retail brands – Implications for submarketsNike’s relocation from Plaza 66 in the Puxi core CBD to a tower designed to their specifications in a Tishman Speyer project in the decentralised market is a signal that retail occupiers will also start to consider moving out from the CBD, similar to healthcare sector companies. The tight CBD market means it is hard to find in-house expansion space, while sufficient new supply in decentralised areas will allow retailers to meet their expansion needs and even reserve space for future growth at a huge rental discount compared to the CBD. Continued rental growth and rising occupancy costs of the CBD will force more companies to consider decentralization. That said, as the current space requirements of all but the very largest retailer tenants in Shanghai won’t be as large as those in the healthcare sector, most retailers will have less incentive to decentralize in the short term.


Emerging sources of demand

Globalization of Chinese companies - Drivers More large domestic Chinese companies, both state-owned and private, are becoming true multinational companies. With the support of the central government, which is promoting local companies to “go global”, China’s outward foreign investment stock reached $509 billion in 2012 (see Figure 14) and became the world’s third-largest cross-border investor after the United States and Japan. Increasing numbers of cross-border M&A deals involving Chinese companies also indicate that domestic corporations are working quickly on the transformation from local into multinational. Figure 14: China’s outward FDI between 2000 and 2012

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Source: Zero2IPO Research, UNCTADstat

Figure 15: State-owned and private companies’ share of total overseas M&A deals

Private companies State-owned companies

2009-2011

12% 88% 24% 76%

2012-2013

Source: Thomson One, Dealogic and KPMG

In the past, stated-owned corporations, mainly in the energy and finance sectors held the dominant role in Chinese firms’ globalization. This contributed to the robust net take-up and rapidly rising rents in the Beijing office market between 2010 and 2012 as those SOEs took-up large amounts of space to establish their national headquarters, and preferred a location close to the central government. However, private companies are now playing a more and more significant role compared to their SOE counterparts in terms of investing abroad (see Figure 15). One of the most important reforms addressed in the Third Plenum is to grant markets a “decisive” role in resource allocation. This reform, if followed through, should enable private firms in various industries to gain better access to capital as well as release additional markets from the monopolistic competition that SOEs have long enjoyed. The Shanghai office market is likely to benefit more from the trend due to its hub city status and central location in the Yangtze River Delta Region, which has already produced a large portion of China’s successful private companies. About 50% of China’s Top 500 domestic companies are now headquartered in the region. Due to its supportive environment for private businesses, the YRD region will be well positioned to benefit from China’s growing number of private enterprises. In addition, Shanghai is likely to benefit from outward business expansion due to its international business environment and mature financial infrastructure including numerous financial exchanges and established financial institutions. Table 4: Large domestic private companies and their required space

for headquarters offices in Shanghai

Occupier Main Industry Size (sqm)Ping An Group Finance 65,000Tencent IT&High tech 45,000Suning Retailer 15,000




Globalization of Chinese companies - Implications for submarkets According to completed transactions and on-going leasing deals in Shanghai, most large domestic companies, especially in the finance and mining industries, prefer to own office assets rather than lease them. Upcoming buildings that can provide naming and signage rights are the most sought after options for those large corporations. However, as the CBD market will face a supply shortage of buildings to purchase, those owner-occupiers’ needs will most easily be met in decentralised areas. Many landlords of large new decentralised developments have planned multiple smaller scale office buildings with the intention to sell enbloc to domestic owner-occupiers. The areas that are closest to the existing CBD would be preferred for stated-owned financial and mining companies, while large private companies in manufacturing, IT, and auto sectors could accept the areas which are relatively further away from the CBD. That said, some divisions – especially customer facing functions – still need CBD space and are more likely to lease it.

New entrants - DriversBesides the large occupier groups mentioned above, it is also important to consider the emergence of new industries as a source of demand. Although currently these are in large part ignored by landlords as target occupiers, the following six industries are likely to become emerging sources of demand for Grade A office space in the future (see Figure 16). Hospital management and entertainment are driven by both policy and market forces. For example, hospitals and clinics are now an encouraged industry for foreign investment based on the most recent revision to the Catalogue for the Guidance of Industries for Foreign Investment and new reform guidelines in the Free Trade Zone. This will be a huge growth industry for China and will boost Shanghai office demand as many MNCs choose to manage operations from Shanghai. Others industries are primarily market driven and are growing quickly in their own right. E-commerce and new media in particular are noteworthy examples. Both sectors are expected to grow dramatically due to new technology, adoption of that technology by China’s massive population and changing consumer behaviour.

Figure 16: Emerging demand source for Shanghai Grade A office space

Hospital Management E-commerce

Education Entertainment

New MediaNew Energy

New entrants - Implications for submarketsOn the basis of past experience early signs from new deals already visible in Shanghai, the location preference for these industries vary dramatically (see Table 5). Tenants that are frequently client-facing, such as sales functions, will prefer to be located in the CBD. Such industries include hospital management, new energy, and new media. Tenants that are less client-facing or more sensitive to cost including e-commerce, education and entertainment will choose decentralised offices. Table 5: Key drivers and location preference for new entrants

Industry Key Drivers Preferred LocationHospital Management Policy + Market CBD

E-commence Market DecentralisedEducation Market DecentralisedEntertainment Policy + Market DecentralisedNew Energy Policy CBDNew Media Market CBD


Double the Stock. Double the Demand?Benefiting from a strong growth outlook for finance and professional services as well as for emerging sectors and Chinese domestic corporates, Shanghai’s Grade A office market will see sufficient demand to absorb the huge supply of space in the future. In fact, even as the office stock nearly doubles to 13 million sqm, our model suggests that the vacancy rate will not exceed 10% in 2020. With the finance sector leading the way, the CBD will still be the most important cluster for commercial activity in Shanghai in the medium to long term. Thanks to the well-established status of the financial cluster in the Pudong CBD, that area will continue to play an important role in meeting the expansion needs of finance companies or finance-related professional service firms. However, the supply constraints in the medium to long term will lead to an emerging financial cluster in the Qiantan area.In the Puxi CBD, where the demand base is now much more diversified, we expect to see a changing pattern of demand. Expansion requirements and rising rents will lead an increasing number of large-sized occupiers from the healthcare and retail industries to gradually move out of the area. The space left by their decentralisation will be back-filled by professional service firms over time, which will remain in the CBD regardless of the level of rents due to the nature of their business. The trend of Chinese companies’ internationalization

Conclusion

will lead to new leasing demand in the CBD, while some additional new demand will come from emerging industries that will also be interested in the limited available space in the downtown market.In addition to some large occupiers in the healthcare and retail sectors relocating to decentralised areas, many CBD occupiers from the manufacturing, trading and logistics sectors with relatively low rental affordability will continue to relocate to lower-cost locations. This will support absorption of emerging decentralised office supply. In addition, more office buildings for enbloc sale in the fringe areas are expected to become home to large domestic owner-occupiers. Lastly, some new industries which are less focused on client-facing activities will become new sources of demand in the decentralised market.As the traditional CBD gets built out, many office tenants will target the geographically closer parts of the decentralised market before branching out to more remote destinations as they are more conveniently located near traditional downtown areas. For example, some current decentralised submarkets that border on the CBD in Hongkou, Zhabei and Putuo Districts are developing higher quality office stock, and will gradually merge with the traditional business centres in Puxi to become part of an expanded CBD. Qiantan in Pudong, although not next to the Lujiazui area, it will emerge as an important new CBD for financial occupiers due to its unique advantages for development as Lujiazui gets built out and fully occupied.

Anthony Couse Managing DirectorEast China +86 21 6133 5555 [email protected]

Anny Zhang Head of Pudong, Markets, Shanghai +86 21 6133 5427 [email protected]

Daniel YaoSenior Manager Research, Shanghai +86 21 6133 5456 [email protected]

Michael KlibanerHead of Research Greater China +852 2846 5276 [email protected]

Joe ZhouHead of Research East China +86 21 6133 5451 [email protected]

James Allan Head of Tenant Representation, Shanghai+86 21 6133 5425 [email protected]

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COPYRIGHT © JONES LANG LASALLE 2014 All rights reserved. No part of this publication may be published without prior written permission from Jones Lang LaSalle. The information in this publication should be regarded solely as a general guide. Whilst care has been taken in its preparation no representation is made or responsibility accepted for the accuracy of the whole or any part. We stress that forecasting is a problematical exercise which at best should be regarded as an indicative assessment of possibilities rather than absolute certainties. The process of making forward projections involves assumptions regarding numerous variables which are acutely sensitive to changing conditions, variations in any one of which may significantly affect the outcome, and we draw your attention to this factor.

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