Supply of large buildings including Jamsil 2nd Lotte World and KEPCO site headquarters building. 

Foreign capital investment decreases and Gasan Digital Complex office auctions pour in 
 

# Mr. Jeong (48), who runs a trading company in a 100㎡ (30 pyeong) office in Yeoksam-dong, Gangnam-gu, Seoul, is currently contemplating whether to move his office to the Gyeonggi-do area. This is because, in a situation where sales are already falling, the burden of operating costs has increased as monthly rent alone has to be paid regularly at a rate of 3 million won. Mr. Jeong said, “I am considering moving my office to Techno Valley in Gyeonggi-do, where monthly rent is cheap and transportation is good. “If it doesn’t inconvenience our employees, we plan to move the office immediately to cut costs,” he confessed. 

# As you pass by the Yeouido Bus Transfer Center, three high-rise buildings with dozens of stories come into view. The IFC Building was completed at the end of 2012 by global financial group AIG with an investment of 1.5 trillion won. Although it has been a year and a half since the building was completed, there are numerous empty offices that are only in good condition. The 'One IFC' building, which was completed first, was leased at 100%, but the situation for the remaining buildings is serious. 'Two IFC' still has about 30% vacant, and 'Three IFC' has no tenants. Even around 6 PM, it is difficult to find any floating population at the entrance to Three IFC. The 50-story 'FKI Tower', newly built on the site of the nearby Federation of Korean Industries, also left about 40% empty offices after its completion at the end of last year. An official from Brokerage A in Yeouido said, “When IFC and the Federation of Korean Industries Hall were built, we expected it to be packed with companies, but the reality was different. Due to the slump in the stock market, every building is putting up 'For Lease' signs to recruit tenants, so what can a new building do? “Unless the rent is drastically lowered, it seems difficult to fill the vacant spaces for the time being,” he confesses. 

How serious is the office recession? 

Yeouido's vacancy rate soars to 20% 

The office building market was hit hard by the real estate recession. Large corporations suffering from a liquidity crisis are putting their buildings up for sale, while large buildings are overflowing with empty offices and are struggling to attract tenants. In small and medium-sized buildings on back roads in the city, there are many cases where about half of the offices remain vacant. Even offices in the Gasan Digital Complex, a district that was impossible to enter just a few years ago, are being poured into the auction market these days. How did the office market, which was doing so well even during the recession, end up like this? 

According to Hanwha 63 City, a building asset management company, the average vacancy rate for office buildings in downtown Seoul was 8.3% as of the first quarter of this year. This figure is almost double compared to 2010 (4.4%). There is no place in Gangnam, Yeouido, or downtown that has a good atmosphere. 

According to data from real estate consulting company Remax Korea, the vacancy rate in the first quarter reached 15.8% in the Seoul metropolitan area as the supply of large office buildings such as Ferrum Tower and Center One poured in. The vacancy rate in the Gangnam area has also not fallen since entering the 10% range at 10.9% in the first quarter of 2011. The vacancy rate in the first quarter of this year soared to 13.4%. In Yeouido, with the recent construction of three IFC buildings and the Federation of Korean Industries, the vacancy rate is at a whopping 18.2%. Compared to the first quarter of last year (15.2%), it rose by 3% points. 

Shin Hee-seong, President of Remax Korea, said, “The Yeouido office faced the worst crisis as domestic securities firms underwent intensive workforce restructuring due to the stock market recession and foreign securities firms also withdrew one after another. To make matters worse, there are concerns that a 310,000 m2 office building will be built in the nearby Sangam DMC area this year alone.” If the construction of Park One across from MBC in Yeouido, following IFC and the Federation of Korean Industries Hall, is completed, we don't know how much more the office vacancy rate in Yeouido will skyrocket in the future. 

The situation is equally difficult in rural areas. The vacancy rate of office buildings in major metropolitan cities such as Daegu and Gwangju reaches 13%. Building owners are having trouble sleeping, fearing that the value of their buildings may drop to a low price. At the same time, office building yields also fell. According to the Ministry of Land, Infrastructure and Transport, the return on investment in office buildings in the first quarter of this year was only 1.45%. This is a drop of 0.08% points compared to the fourth quarter of last year. 

Office building vacancy rates have increased and yields have decreased, but ironically, rents are on the rise. In the first quarter of this year, the entire converted rent in Seoul was 106,688 won per 3.3㎡, up 2.5% from last year. Yeouido also rose by a whopping 6.3% to 96,640 won (data from office building trading company Genstar). There is a reason why rents are rising even though the vacancy rate is high. This is because building owners suffering from vacancy often waive some of the rent rather than lowering it. In fact, in the building rental market these days, there are countless cases of ‘rent-free (free rental for 2-3 months per year)’ conditions being put forward. 

Mr. K, manager of the Yeouido Imyeondo-ro Building Management Center, said, “The three floors have been empty since last year, but there is absolutely no demand to move in. The same is true even if you set a condition of waiving three months' rent a year. “I am worried that if this continues, the selling price of the building will drop,” he confessed. 

“The domestic office market was once a ‘complete rental market’ with a vacancy rate of less than 2%, but the atmosphere has recently changed. Since tenants are asking for jeonse instead of monthly rent, there are a lot of jeonse properties that were difficult to find. However, building owners are concerned that the value of their buildings will fall, so they seem to be making light of the fact that they are leasing.” 

The story of Jang Jin-taek, director of Remax Korea, clearly shows the reality of the office market. 

Reasons for the cold wind in the office market 

Demand has decreased, but supply of large buildings has increased rapidly 

There are many reasons why the cold wave hit the office market. 

First, supply increased rapidly. 

According to the Seoul Research Institute, the total area of office buildings in downtown Seoul has increased by 2.8% (1.12 million ㎡) every year for about 10 years since 2004, reaching 51.55 million ㎡ last year. The number of office buildings with a total area of 10,000 m2 has increased by 112 every year. Last year alone, supply was so overflowing that new office buildings with a total floor area of 1.09 million m2, including Grand Seoul (176,000 m2) and Yonhap Media Center (47,000 m2), were built. 

The atmosphere is no different this year. According to Mate Plus, an asset management company, the number of new office buildings to be completed in Seoul by the end of the year is expected to reach 1.02 million square meters. SK Networks' headquarters building has already been built in Daechi-dong, Seoul, and Hyanggun Jamsil Tower near Jamsil Station is scheduled to be completed in the first half of the year. At the end of the year, several mega-buildings are nearing completion, including the 25-story KT new headquarters in Gwanghwamun. 

The future is more problematic. Supply is expected to increase further as the second Lotte World high-rise building in Jamsil is built and the headquarters of large corporations are built on the Samsung-dong site of KEPCO, which is relocating to Naju Innovation City in Jeollanam-do. With the office vacancy rate already high, it is questionable whether demand will support supply. Ham Young-jin, head of Real Estate 114 Research Center, said, “As class A office buildings boasting state-of-the-art facilities are being built all over Seoul, poorly located and aged class B and C buildings will be ignored by tenants, leading to a vicious cycle in which the entire market will stagnate.” 

Second, large corporations located in office buildings in Seoul moved their offices to the metropolitan area in large numbers due to the burden of rent. In particular, Korea's leading IT companies located in Teheran-ro, Gangnam, are moving out to Pangyo and other places.

In 2012, Kakao moved its office from C&K Building in Yeoksam-dong, Seoul to H Square in Pangyo Techno Valley. Starting with this, a rush by IT companies to ‘get out of Gangnam’ continued. Game company NCSoft moved its office from the NCSoft R&D Center in Samseong-dong, Seoul to its new headquarters in Pangyo Techno Valley in August last year. Currently, more than half of the building in Samseong-dong, Seoul, where NCSoft was located, remains vacant. Nexon also moved its office from Taebo Station Sami Tower in Samseong-dong, Seoul to a new headquarters in Pangyo Techno Valley at the end of last year. SK Planet left Samhwa Tower in Jung-gu at the end of last year and opened a new headquarters in Pangyo. Not only IT companies but also financial companies are trying to reduce their office size or relocate to the outskirts of the metropolitan area due to the burden of rent. 

Seong-gyu Du, a researcher at the Construction Industry Research Institute, explains, “Foreign companies and financial companies are consolidating branches or reducing office space, and public institutions in Seoul are relocating to local innovation cities, which is also behind the office market slump.” Yeo-shin Yoon, managing director of CBRE Korea, said, “There are many cases where financial companies that are sensitive to the domestic economy try to lower not only the rent but also the deposit when renewing office contracts. “Office buildings have taken a direct hit as the financial sector, which is considered the largest consumer of offices, is reducing its size,” he confesses. 

Third, even foreign capital, which had been sending love calls to domestic office buildings, is leaving Korea. According to Cushman & Wakefield, a global real estate consulting firm, foreign capital purchasing domestic office buildings amounted to KRW 1.2381 trillion in 2011, but has decreased to KRW 928 billion in 2012 and KRW 800 billion last year. This is because the supply of domestic office buildings increased and the vacancy rate increased after the 2008 global financial crisis, leading to a sharp drop in returns. An official from a foreign building trading company says, “As the perception spreads that it is difficult to make as much money as before by investing in buildings, foreign capital is hesitant to invest in Korean offices.” 

Fourth, the real economic downturn also had an impact. Office auctions are pouring in at Gasan Digital Complex in Geumcheon-gu, Seoul, where small and medium-sized businesses were mainly concentrated. According to GG Auction, an auction information company, the number of bids for the Gasan Digital Complex Knowledge Industry Center (apartment-type factory) auction in the first half of this year was 42, the highest in the past 10 years. The industry is concerned that the number of auctions will exceed 100 within the year. Due to the economic downturn, small and medium-sized businesses are suffering from financial difficulties and are either unable to pay office rent or the offices themselves are being auctioned off. 

Even construction companies suffering from a liquidity crisis are busy selling office buildings. Daewoo Engineering & Construction sold its office building in Dogok-dong, Gangnam-gu, Seoul and its office building in Sinmun-ro, Jongno-gu, in the first half of last year. The sale price alone amounted to 200 billion won. POSCO E&C also sold a building in Yangjae-dong, Seocho-gu for 261.5 billion won. A construction industry official said, “The number of construction companies trying to secure liquidity by selling office buildings, which are valuable assets, is increasing. “The investment value of office buildings is not what it used to be, which is also why construction companies are active in selling,” he said. 

The outlook is also dark. This is because it is difficult for demand for building rentals to increase due to the economic downturn. Some large corporations are selling the buildings they used as headquarters and relocating to new buildings in core areas of Seoul, but the problem is that many of the existing buildings remain vacant. There is also great concern that the building market will have a hard time recovering unless the economy recovers or there is a craze for starting businesses like the venture craze of the early 2000s. 

Kim Min-soo, CEO of R Asset Asset Management, said, “The supply of office buildings in Yeouido and downtown areas has increased rapidly, and the imbalance between supply and demand has reached a serious level. “The real economy is at its worst and most companies are trying hard to reduce rental costs, so it will be difficult for the vacancy rate to decrease for the time being,” he said. 

However, some say that the investment value of buildings is still higher than that of other real estate products. 

“Office building returns have fallen, but from an investor perspective, there is still no long-term safe product like a building. In fact, even if the vacancy rate increases, building sales prices do not fall much. “As institutional investors in the financial market are looking for valuable office buildings that generate stable profits, demand for office purchases will remain steady for the time being.” 

This is the story of Heo Yun-kyung, a research fellow at the Construction Industry Research Institute. 

Is there a solution to revitalizing the office market? 

Remodel existing buildings and attract foreign capital 

Is there a solution to reduce the office building vacancy rate? The advice is that the government and local governments should step in and control the supply and demand of office buildings. If large office buildings are built one after another without demand being supported as it is now, there is a high risk that the vacancy rate will rise further. 

CEO Shin Hee-seong said, “It is not easy to balance supply and demand as it takes at least 5 years to construct a building, including various permits and site development,” adding, “If the number of empty offices increases, it will inevitably have a negative impact on the surrounding real estate market, so the government, “Local governments must step forward to control long-term supply and demand,” he emphasizes. Kim Il-soo, CEO of Star Asia Partners, said, “It is urgent to control the amount of new permits for large buildings, such as implementing some kind of quota system. “One way is to establish standards for the supply of large buildings through capital market investments such as funds,” he advised. 

Rather than just building new buildings, increasing the value of existing office buildings is also considered a solution. 

Research Center Director Ham Young-jin said, “To reduce vacancies in old office buildings, the government must come up with incentives to promote remodeling. “If we provide tax relief for improving building energy efficiency and reducing heating and cooling costs, we will be able to lower the vacancy rate in old buildings,” he said. Choi Hyun-il, a professor of real estate at Open Cyber University, said, “When supplying office buildings, we should not simply limit ourselves to business functions, but should add various concepts according to regional characteristics to attract new rental demand.” 

Another way is to attract large amounts of foreign capital. The State Oil Fund of Azerbaijan (SOFAZ) recently purchased Building A of the Pine Avenue office building in Eulji-ro 2-ga, Jung-gu, Seoul for $447 million (about 477.5 billion won). This is the highest price among building sales in the Seoul office market this year. The Pine Avenue Building, completed in 2011, has 6 floors underground and 25 floors above ground. 

An official from Cushman & Wakefield, which handled the purchase of the building, said, “It is significant as this is the first case of a Middle Eastern oil fund investing in the Korean office market. He said, “Korea’s economic fundamentals are still strong and the office market is highly attractive.” This means that although the office market has slumped, foreign capital's interest in large buildings continues. 

Ahn Min-seok, a researcher at FR Investment, said, “The Ministry of Land, Infrastructure and Transport publishes vacancy rate statistics, but the number of samples is not large, so reliability is low. Vacancy rate statistics for private companies also vary. He emphasized, “It is urgent to establish an office supply and demand forecasting system based on concrete statistical data like for apartments.” CEO Kim Min-soo said, “We must create favorable conditions for doing business, such as reducing corporate taxes and loosening regulations for small and medium-sized businesses, and the building rental market will naturally revive.” 

[Reporter Kim Kyung-min kmkim@mk.co.kr / Photo: Reporter Yoon Gwan-sik] 

[This article is from Maekyung Economy No. 1756 (dated 05.07~05.13)] 


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