Colombo commercial real estate market set to face supply glut

• Economic malaise created by COVID-19 to result in sluggish demand
• Pressure expected on occupancy rates and rental yields over the medium term
• JLL forecasts addition of 2.9mn sq. ft Grade A commercial office space over next 2-3 years
• Recently added Grade A office spaces facing lower than average absorption rates

By Nishel Fernando
Colombo’s commercial real estate market is expected to face an oversupply of office spaces weighing down on rental yields and occupancy rates across both Grade A and B segments in the medium term with several large-scale projects nearing completion within the central business district (CBD), according to a leading company engaged in commercial real estate space.

 
“Based on ongoing development activities, over the next few years, there is a sizeable stock of premium spaces to be introduced to the Central Business District (CBD) bounds, which will undoubtedly place further pressure on occupancy rates and rental yields over the medium term,” Equity Two PLC, a unit of Carson Cumberbatch PLC told its shareholders in its latest annual report. 

Jones Lang LaSalle (JLL) forecasts 2.9 million sq.ft. of new Grade A commercial office stock in Colombo over the next two to three years. 

Equity Two PLC cautioned that rental yields and occupancy rates across both Grade A and B segments would face pressure in the medium term, unless demand picks up beyond organic growth. 

Real estate developers and property managers are already faced with challenges in filling vacant spaces in the current market with the demand slowing down triggered by the adverse impacts of the COVID-19 pandemic while new office space stock being added to the existing stock.  

The company noted that the recently added Grade A office spaces in Colombo were facing lower than average absorption rates, reflecting the current market conditions. 

By the end of 2019 second quarter, vacancy rates in CBD’s office space remained drastically elevated and the overall vacancy rate of Colombo Grade A office stock rose to 20 percent from 11 percent at the end of 2018, According to JLL.  This was mainly due to the two new launches—One Galle Face office tower (Shangri-La) and Parkland Building, which added 550,000 sq. ft. and 60,000 sq. ft. of space to the overall stock respectively. 

However, JLL noted that some major negotiations at Shangri La (One Galle Face) office towers in 3Q and 4Q had eased the pressure on the overall vacancy rate by 4Q of 2019. At the end of 2019, the overall Grade A stock in Colombo reached an all-time high of 3.35 million sq.ft. of which 2.75 million sq. ft. stock being in the CBD alone while the vacancy rate of overall Colombo stood at 12.5 percent. 

The average rental value remained almost unchanged in 2019 compared to 2018, despite One Galle Face Office tower entering the market in 2019 with an all-time high rental starting from Rs.530 (US$ 3) per sq. ft. 

JLL was expecting rents in Colombo to stabilise by this year with the new supply entering the market.

With COVID-19 pandemic impacting the country’s businesses and the economy, some firms engaged in real estate sector offered several concessions to their tenants by renegotiating their immediate rent commitments and/or offering deferred payment plans.

Equity Two PLC expects the task of sourcing new tenants for vacant spaces to be a challenging one, as it would depend on the time it takes for the economic and business constituents to bounce back to pre-pandemic levels. 

It also cautioned that with the current uncertainty in the market overshadowed by the pandemic, the cash-tight developers would become more debt-ridden. 

“As we pass through the times saddled with doubts over when the prevailing pandemic end, the prospects of the local real estate market too remain uncertain with regard to the exact magnitude of the pandemic’s impact over the medium term, depending on the time it takes to recover. 

This may also result in delays and cost overruns of development projects due to the temporary halt of construction work, pushing some of the more cash-tight developers under a pile of debt,” the company noted.

In order to foster the growth in the sector, it stressed that the country should capitalise on its location strengths to become a strong service-oriented economy equipped to host international corporates and facilitate their expansion backed-up with a well-articulated strategy.

“This would require well-articulated strategy, careful planning and execution and the development of necessary infrastructure. Along with this, the improvement of ease of doing business through appropriate modifications to relevant economic policies, laws, and regulations are essential to position Sri Lanka as an attractive regional business hub,” it elaborated. 

The Colombo Port City remains such an opportunity for Sri Lanka to become a strong service-oriented economy by facilitating to host international corporates. 

“Based on the success of attracting sufficient foreign or local investors to occupy the added space, it would generate a significant amount of employment opportunities and positively contribute to spur the economic activity of the country over the long term,” it added.