The office segment of Sri Lanka’s property market is likely to see rising levels of activity over the next few years, as developers scramble to bridge a shortage of premium space.

There is an expanding gap between available space and demand in Colombo, according to a recent report by international property firm JLL, with a shortage of grade-A office stock in particular.

With minimal supply coming on-line over the first three quarters of the year, the occupancy rate has remained unchanged since the start of 2016, at around 95%. This is a far cry from the 60% seen in 2009, reflecting rising demand stemming from growth in the economy and the entry of more high-end firms. 

Grade A in demand, supply gap widening

While demand for grade-A office space is currently some 3.8m sq feet, existing supply is only 2.3m sq feet, the JLL report found.

Demand is being driven by traditional markets, including banking and financial services, as well as the manufacturing sector, though JLL also noted an increase in leasing of prime office space by state agencies. This trend should be sustained by solid growth for the remainder of this year and into 2017, with the IMF projecting Sri Lanka’s GDP will expand by 5% per annum through to 2018.

In the meantime, the shortage of high-end office space will force many firms to lease second-tier accommodation, with rentals set to rise as demand creates a flow-on effect throughout the segment. If demand growth continues, owners and developers of grade-B office space should see strong take-up of their offerings. This should also boost returns on investment.

As it will take some time for the prime office space market to find a balance, owners and developers will have an advantage, according to Gagan Singh, chairperson of JLL’s Sri Lanka operations. “This trend is expected to continue in the near to medium term, and should make way for noticeable rent and capital value appreciation in upcoming quarters,” she told local press in August.

Not only will rental returns continue to rise – with increases of between 10% and 15% biennially the present standard for grade-A office space – but higher demand for such accommodation will also drive up asset values. Capital value appreciation is forecast at 7-8%; combined with rising rental revenue, total returns could be in the 11-14% range for the year, according to JLL.

Construction sector boost

While in the medium term this shortage of premium office space is set to continue, Colombo’s pool of commercial accommodation is expected to expand dramatically through the $1.4bn Port City project, a 269-ha mixed-use development being undertaken by China Harbour Engineering Company (CHEC), which resumed this year.

Once new space at Port City begins to come on-line, the planned leasable area could increase office floor space by almost four times, Liang Thow Ming, chief sales and marketing officer of CHEC Port City Colombo, told local press in late September.

The push to deepen the pool of office space, along with growing demand in some other segments of the real estate sector and higher investment in broader infrastructure development, should feed into increased activity in Sri Lanka’s construction industry.

Given a shortage of land in some areas, this activity is set to drive growth in high-rise residential and tourism construction, as well as for offices, according to a September report from brokerage firm First Capital Equities. “The shortage in office space is also likely to add to... demand for more skyscrapers over the next five years,” the report said.

Offsetting oversupply elsewhere

The current demand for new office space, especially at the top end of the market, should be welcomed by developers and realtors, as another key segment of the property sector could be nearing saturation.

A recent survey by property research firm Real Estate Intelligence Unit found that 64% of Sri Lankan developers polled felt that the residential component of the market was close to being oversupplied, despite optimism stemming from operating in an improved economic climate.

The study also concluded that there could be excess capacity of 10,000 luxury residential units by 2020, an oversupply that could prompt some developers to focus on other segments, such as retail or commercial.

(Oxford Business)