Window to upgrade in Shanghai’s office leasing market

Cost-driven upgrading: tenant-favourable market conditions provide opportunities for tenants to upgrade and control costs.

May 17, 2024

In recent quarters, we observed an increase in companies adopting cost-control strategies amid market uncertainties. These tenants postponed relocation plans and decided to renew, embracing cautious approaches in space requirements. On the other hand, Ageing CBD projects face competition from options in decentralised markets with lower rents, appealing incentives, and superior infrastructure and quality. The decentralisation trend allows tenants to potentially secure larger office spaces at reduced prices, aligning with their cost-saving goals.

Despite apparent cost-saving trends, some tenants are seizing opportunity to upgrades to Grade A properties since the beginning of 2024. The increase in inspection and upgrades indicates that many companies are actively exploring options in this tenant favorable market.

The intensified competition from decentralised submarkets and projects has placed downward pressure on rents, compelling Grade A landlords to become more flexible in negotiations. In response to the competitive landscape, landlords have adjusted their rental expectations and are willing to provide increased rent-free periods and fit-out incentives. In fact, some landlords are offering customised fit-out incentives to attract high-quality tenants with CAPEX concerns.

This tenant-favourable market condition created an opportunity for occupiers with expiring leases in Grade B offices, business parks, and flexible offices to upgrade and relocate to Grade A offices. This trend of upgrading primarily involves SMEs, as these tenants have a shorter real estate decision period. However, as the market rental value continues to decline, we expect to see larger occupiers seizing the current market opportunity.

Figure 1: Representative transactions of upgrading demand to Grade A offices in past 12 months

Source: JLL Research

In addition to improving building quality, some tenants move out of Grade B offices and into Grade A properties due to their company’s sustainability objectives and for higher quality property management. More companies are placing significant emphasis on ESG factors when selecting office spaces. The trend is especially evident in the preference for Grade A properties that have obtained LEED and WELL certifications. Companies, particularly foreign firms, are increasingly integrating their corporate ESG goals into their real estate decisions.

Sustainability plays an important role when companies consider relocation or expansion. For landlords of ageing Grade A properties, asset management and property management will also be increasingly important considering the large number of new supplies entering the market, leading to increased competition.

A diverse range of industries consistently play a significant role in driving office demand in Shanghai. The financial sector, professional services and TMT sectors have been the primary drivers of office demand in the city. Recently, we observed increased inspection and upgrade demand from professional services, especially companies with lower rent sensitivity, such as law firms.

There is an expectation of increased presence from sectors such as new energy and advanced manufacturing in the Shanghai office market. This projection is driven by supportive policies for “new productive forces”, which have championed the development of sectors including new energy and NEVs, autonomous driving technologies, and other high-tech fields. As a gateway city and a pivotal player in advancing these fields, Shanghai will likely witness an increase in deals from these sectors in the coming years.

Figure 2: Share of demand by industry by leasing area in past 12 months

Source: JLL Research