Seoul’s Swelling Supply Pipeline

By Darren Krakowiak

Walking to lunch in downtown Seoul recently, I was shocked when I arrived at my favorite Korean restaurant and it was closed.

What didn't surprise me was the reason: It was boarded up, along with every other shop on the block … yet another city block being redeveloped as a major office district.

Don't get me wrong: I'm certainly not against major office developments. New construction provides more modern, global-standard office space. This is important as the quality of existing space in Seoul is below the standard of comparable Asian cities overall.

Historically, major buildings in Seoul were typically built for the purpose of owner-occupation rather than for lease, which resulted in limited consideration being given to the needs of tenants in the design stages.

Furthermore, the historical focus on the pace of development in Korea led to limited attention being given to issues of functionality and aesthetical considerations. The scant presence of foreign companies until the past decade also resulted in Western design principles having limited influence on the development of office buildings.

New construction addresses this issue by providing new higher-quality, more efficient office buildings while also encouraging other landlords to refurbish existing space to ensure they remain competitive in the market.

New office projects also help alleviate the shortage of quality space across the market and facilitate upgrades and expansions by occupiers, some of which have been constrained in their current premises with limited alternative options. This is all good news for both local and foreign tenants.

The problem in Seoul now seems to be the growing number of new office projects being built. Indeed, the market could be getting too much of a good thing.

This is a particularly unique problem in the current global economy ― one of many quirks of the local market; as other financial centers around the world are seeing the amount of forecast supply dwindle in response to the economic crisis, the pipeline in Seoul has expanded considerably over the past year.

Considering prime and grade-A projects in the three main business districts, including Yeouido and Gangnam, Jones Lang LaSalle, the world's leading real estate services and money management firm, is aware of 2.1 million square meters of new space due to enter the market between 2010 and 2012.

In January 2008, this total projection was much lower at 860,000 square meters. To put this in context, it is estimated that there is currently around 4.5 million square meters of existing prime and grade-A space within the three main business districts.

So, if all of the new supply currently slated to enter the market between 2010 and 2012 were to eventuate, it will result in a 47-percent increase in the total size of the prime and grade-A market and a significant rise in vacancy.

The fact that the supply pipeline has only just started growing significantly after three years of falling vacancy (reaching a record low of 0.3 percent in September 2008) illustrates the late response of the Seoul market in reacting to market conditions.

The time-consuming site consolidation process, combined with the relatively limited foresight of future market conditions, has resulted in the vacancy rate reaching critical lows before the majority of projects currently slated for development were ready to commence site works.

Now, as the pace of new office development gathers momentum, demand for office space is shrinking.

At present, there have not been any announcements of project deferrals, but it is possible that some of the proposed projects will not be completed as currently scheduled. Securing finance to commence or continue projects will be the biggest obstacle to developments being completed as per their current schedule.

Alternatively, some projects may be voluntarily shelved due to the increasingly competitive leasing environment these projects will face as a result of the large amount of supply entering the market around 2011-12.

Combined with the lower rental growth now projected to occur over the next three years, it will be a tougher environment than was previously expected.

Nevertheless, even if half of all the stock slated to enter the market between 2010 and 2012 does not come to fruition on time, vacancy is still likely to increase to levels not seen in Seoul for over 10 years.

This will seriously test the modus operandi of the market: rentals have historically not responded strongly to changes in vacancy. However, with recent evidence of the market becoming more responsive to record-low vacancy, the risk for landlords is that the market will be equally responsive to record-high vacancy.

Rentals have not fallen since Jones Lang LaSalle began tracking the Seoul market 10 years ago, but if the supply pipeline does not deflate sufficiently, history will be made from 2010, with rentals falling and the balance of power in lease negotiations tipping in favor of tenants … just in time for the expected economic recovery.

Darren Krakowiak is a director at Jones Lang LaSalle Korea. He can be reached at darren.krakowiak@ap.jll.com.