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Investors in office space set to earn less from rent

The future is not all that rosy for investors in the office space real estate sub-sector in the short term. Any doubts on this has all been been laid to rest by a report carried out to establish the status of office space in Nairobi by Cytonn Investments Limited, a real estate developer and investments consultant firm.

The Nairobi 2017 Commercial Office Report: Constrained Performance as a Result of Oversupply examined how the sub-sector performed in terms of rents, prices, yields and occupancy rates.

“We have a negative outlook for the commercial office market. Investments in the sector should, therefore, be biased toward the longterm for gains when the market picks up in three to five years,” says authors and presenters of the report, Cyntonn managers Shiv Arora, Juster Kendi and Nancy Murule.

According to the report, there was an oversupply of 4.7 million square feet of office space during the period. Pockets of value in the sector are in zones with low supply and high returns such as Karen and in differentiated concepts such as serviced offices and green buildings.

Cyntonn chief executive officer, Edwin Dande, says given the decline in performance and the increase in supply, they have a negative outlook for investments in the commercial office market in Nairobi.

The firm is instead proposing green buildings investments in office space be undertaken in prime locations such as Kilimani, which charge higher than average rents and are expected to have higher occupancies in future.

Considered as developments that guarantee increased user productivity, enhanced efficiency and operational efficiency through lower maintenance costs, green buildings are an emerging trend in the sub-sector.

Cytonn also recommends long-term investments and in specific pockets of value. Dande will also like investors take up differentiated concepts such as serviced offices with yields of on average 13.8 per cent higher than conventional office space yields of 9.2 per cent.

The report says last year, Nairobi had a total supply of 31.8 million square feet (sqft) of office space, 3.5 million Sqft of office space were delivered with an average occupancy level of 83.2 per cent.

This resulted in a supply of 6.3mn sqft against a demand of 1.6mn sqft, thus an oversupply of 4.7mn sqft. The oversupply is 62.1 per cent higher than in 2016 and 46.9 per cent higher than Cytonn’s projection of 3.2mn sqft.

The report says assuming current occupancy levels persist, we expect a 12.8 per cent increase in oversupply to 5.3mn sqft in 2018.

On performance, average occupancy rates declined by 7.8 per cent points from 91 per cent in 2011 to 83.2 per cent in 2017, with rental yields declining by 0.1 per cent points from 9.3 per cent in 2016 to 9.2 per cent in 2017.

In submarket analysis, Parklands and Karen had the highest returns with average rental yields of 9.7 per cent and 9.5 per cent, respectively with Mombasa and Thika roads having the lowest returns with average rental yields of 8.5 per cent for each.

Grade A offices had the highest average rental yields of 9.8 per cent, with Grade C offices having the lowest average rental yields of 8.4 per cent.

Grade A buildings have ‘high quality standard finishes, state-of-the-art systems, exceptional accessibility and a definite market presence while C blocks compete for tenants requiring just functional space at rents below the average for the area.

Grade B offices are the most common in Nairobi, with a market share of 54 per cent and are also the most popular with average occupancy rates of 85.1 per cent on average.

Such buildings compete for a wide range of users with rents in the average range for the area, with fair to good finishes for the area. The report compared the Nairobi region to selected sub-Saharan cities of Accra (Ghana), Kampala (Uganda), Dar es Salaam (Tanzania) and Kigali (Rwanda).

It was noted that by generating an average dollarised rental yield of 8.5 per cent, Nairobi outperforms only Dar es Salaam’s 6.4 per cent. However, Kampala has the highest yields for commercial offices at 10.6 per cent.

According to the report, the key drivers to the office sector remains Nairobi’s status as a regional hub that continues to attract global bodies.

Devolved governments have increased demand for office spaces in counties to cater for county governments and businesses expanding to rural towns.

“There is also the growth of small- and medium-sized enterprises, which are contributing to average rental yields in the last five years,” says Arora, Cytonn’s Head of Private Equity.

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