After malls, office developments run out of steam

First it was malls with doubts raised as to whether the market was big enough to accommodate new entrants with several mega developments coming into the market. Now office developers find themselves in the same boat.

For the last decade, real estate has been the investment vehicle of choice for many, outperforming traditional avenues like the stock market. In all this time, however, the elephant in the room has always been the question of whether the growth of real estate was in realistic.

Developers have always insisted that the demand was there, a justification for prices that were deemed out of reach for many. The last one year has, however, been a mixed one for the sector. Prices flatlined at the top end of the residential market — in some instances, they dropped.

According to the Knight Frank’s Prime Global Cities Index, luxury homes prices in Nairobi dropped by 2.7 between march 2016 and March 2017.

Around the same time, alarm was raised on the fast growing number of retail developments (malls), with analysts pointing to an oversupply in Nairobi and arguing that developers need to now look beyond the major towns.

And now, to complete the cycle, it is the turn of office developments with fears that the space on the market is more than the demand.

Several reports including the latest JLL City Momentum Index have painted a rosy picture of Nairobi as a premier business destination.

The city’s hype was hinged on the move by a number of multinationals in the financial and professional services that chose Nairobi as their base for regional operations during the last five years. These Included Johnson & Johnson, Wrigley’s, Tullow Oil, Volkswagen and recently, French auto manufacturer Peugeot.

The demand for office space skyrocketed with premium Grade A offices being snapped up even before they could break ground. For any developer with some land and cash to spare, office development was the place to be. They were egged on by a relaxation of zoning regulations in hitherto residential areas of Karen, Kileleshwa, Gigiri and Kilimani that saw more land being made available for commercial office construction.

But the chicken have come home to roost. A report released by real estate development and advisory firm Cytonn, says the country is now experiencing a glut in the office development sector.

Oversupply

According to the report, commercial office space was oversupplied by 3.2 million square foot. The oversupply is expected to grow by 21 per cent to 3.9 million square foot in 2018. Obviously, this decline affected the bottom lines of many a developers’ account sheets.

In 2016, asking sales prices declined by 6 per cent to average at Sh12,031 from Sh12,776 in 2015.The rents and yields too stagnated remaining at average of Sh97 per square foot. Occupancy rates also went down from 91 per cent in 2011 to 88 per cent last year.

The report gave a slowdown in the growth of financial services and SME sectors as key reasons for the downturn of commercial office uptake.

This increasing vacancy rates has been more pronounced in the last two years with the report citing the departure of multinational firms such as HSBC and Atlas Development due to a harsh investment climate.

The trend seems set to continue with local corporate such as banks downsizing to cut on operating costs.

The upcoming elections were also cited as a factor in the softening of sales and rentals in the commercial office segment. This is certainly no music in the ears of developers.

Softening performance

“This decline has resulted in softening of the performance of the office market with occupancy and prices declining by 1 per cent and 6 percentage points respectively, while rents and yields remained unchanged from 2015 levels,” says the report.

A case in point is that of UAP Towers in Upper Hill, Nairobi that was built at a cost of Sh5 billion. After close to a year since opening, it has only managed a 35 per cent occupancy rate.

Currently, UAP Towers is the highest building in the city and developers will be keenly watching to see how long it will take to offload the remaining 65 per cent unoccupied space.

According to JLL’s Associate Director and Head of Corporate Solutions for East Africa Lucy Githinji, timing is everything when it comes to any development. She says most of the new office buildings on the market were constructed and released to the market during the same period, thus competing for that elusive occupier.

Complicating matters further, says Githinji, is the fact that most of the commercial office space currently on offer was built for speculative purposes.

“If you look at the market, UAP and Britam were constructed at the same time. If UAP has problems filling up, then you can be sure that the other new entrants will face the same scenario. Even in the best of time, we must remember that uptake of office space is always lower than the stock delivered,” says Githinji.

Still, there is a silver lining in the seemingly dark cloud of commercial office space.

The Cytonn report urges developers to concentrate on the construction of Grade A office space especially in areas with a low supply such as Gigiri.

Available Grade A offices have continued to record high occupancy rates of more than 90 percent.