A real or phony recovery

By Riyadi Suparno

In this time of continuing political and economic uncertainty, the office market, according to property consultants, appears to be rising from the dive it took in 1998 and 1999.

While it cannot yet be said to be buoyant, there are signs, from occupancy levels and leasing activity, that it has come off the bottom.

The following reports, including those on Page 9, are aimed at zooming in on the latest state of this sector.

JAKARTA (JP): Property consultant Jay Smith of PricewaterhouseCoopers reported that in the year 2000, and for the first time since 1997, the total space leased exceeded the amount vacated.

This bodes well for future take-up rates for office space, he said.

The head of research at property consultant company PT Procon Indah/Jones Lang LaSalle, Mina Ondang, concurred and predicted that demand for office space would continue to be positive this year.

She predicted that demand for office space would come mostly from small and medium-sized companies.

The business sectors that are likely to contribute to this demand are consumer goods related businesses, export oriented companies, and the trading, manufacturing and financial services.

Telecommunications and information service providers are also expected to generate demand, especially for office space in Jakarta's Central Business District (CBD).

On the other hand, Mina said, continuing mergers of banks will adversely affect demand for office space.

Occupancy

Occupancy levels are a function of take-up of space fueled by new demand or expansion of existing tenants, offset against the volume of space vacated.

The kinds of heady take-up rates seen at the height of the property market in 1997 (about 300,000 square meters in CBD) are the result of office space demand created principally from substantial levels of foreign investment, facilitating new business start-ups and expansion.

Falling foreign investments, the large idle capacity of Indonesia's industries, and continuing downsizing and business closures may affect new office space take-ups.

Total net take-up of CBD office space for year 2000 totaled 70,000 square meters, compared to a negative take-up of 63,000 square meters. The vacancy rate at the end of 2000 stood at 24.3 percent, compared to 25.5 percent at the end of 1999.

Outside CBD, net take-up in year 2000 totaled 82,400 square meters, decreasing vacancy levels to 19 percent. Higher net take- ups outside CBD in year 2000 was partly due to relocations of companies from CBD to outside CBD and the more competitive rents outside CBD.

The Jakarta office market occupancy level was 78.8 percent at the end of December 2000, with a total of 1.08 million square meters remaining unoccupied.

Rents

The fundamentals of the office market have changed dramatically over the last three years. Up to 1997, rents for office spaces in prime buildings were principally denominated in U.S. dollars and landlords tended to have the upper hand in negotiations, with many tenants chasing new space as it came on stream.

This activity encouraged the speculative building of offices - before new tenants had been secured on prelease agreements - and thus increased construction debts.

The debt-crunch of the late 1997 burst the development bubble as demand for office space slipped away. The extent of over- supply became painfully obvious while rental rates dropped significantly. Some even started to quote their rental rates in rupiah, or set a fixed exchange rate for their U.S. dollar rental rates.

In CBD, over 20 percent of offices still command U.S. dollar rents at prevailing market rates.

According to Procon Indah, in terms of rupiah, gross rental rates in CBD increased by 3.6 percent in the forth quarter of last year to Rp 94,2000 per square meter per month.

In terms of U.S. dollars, rental rates for CBD offices reflected a decrease of 5.2 percent in the fourth quarter of last year to USS$9.8 per square meter per month.

Outside CBD, the average gross rental increased slightly by less than 1 percent to Rp 62,200 per square meter per month, which includes a service charge of Rp 27,200 per square meter per month. Most office buildings outside CBD offer rupiah-based rentals.

Despite the anticipated higher demand for office spaces and declining vacancy rates in 2001, rentals are likely to increase only slowly this year, Mina Ondang said.

The current high vacancy levels of over 24 percent or over 700,000 square meters of CBD office space will ensure that the market remains very competitive and will prevent rental growth accelerating in the short-term.

Buildings with high occupancy levels and currently competitive rental rates are likely to be able to increase rentals at a faster rate than buildings with low occupancy levels.

Katherine Harberd of PricewaterhouseCoopers who shared the view said: "Pressure to increase rents remains minimal while vacancy remains at more than 20 percent. It is nevertheless positive that occupancy levels are improving".

Further weakening of the rupiah since the forth quarter of last year has negatively impacted the office market by reducing the value of rupiah-denominated rents.

"Thus U.S. dollar rents are even less affordable for tenants and depreciation negates any uplift expected by landlords from increasing fixed exchange rates," she said.

It is expected that a two-tier market will be retained with some landlords continuing to hold out for U.S. dollar rents, Harberb said.

"Recent experience has shown that rupiah-denominated space is leasing faster than U.S. dollar denominated ones. This may have the effect of pushing new tenants to the U.S. dollar rental buildings in future, where they can obtain the flexible floor areas they require, and pressure on rent increases may result."

Supply

PricewaterhouseCoopers noted that current rental returns and occupancies do not yet seem to warrant new construction.

By the end of 2000, total office stock remained at approximately 4.8 million square meters, both for lease and strata title (sale), with around 2.9 million square meters located in CBD. Strata-title offices represent only 8 percent of total stocks.

Of office building projects which were put on hold during the crisis, Da Vinci Tower (formerly Berlian Udatimex Tower) has resumed construction but changed use to Da Vinci furniture showroom with ancillary offices.

Wisma Asiatic is another office project currently under construction and scheduled for completion in mid-2002.

Outside CBD, according to Procon Indah, several projects have resumed construction, bringing the potential future supply to 66,000 square meters. With three additional projects likely to resume construction in 2001, total future supply outside CBD could potentially reach 89,000 square meters by year 2003.

Uncertainties

But some factors may prevent the office subsector from enjoying a smooth recovery. Those factors include funding problems, indebtedness of property companies, new impediments created by the government, and worst of all, the continuing negative political and social issues plaguing the country.

Jay Smith said: "Current unresolved political and social issues discourage foreign investment and this limits demand for office space. There is not enough growth from existing tenants at present to accelerate the office market recovery."

He also added that "economists believe a gross domestic product growth of 4 percent or 5 percent for Indonesia is not enough to push along economic recovery. Until the economic recovery begins to hasten, demand for office space will increase only gradually."

Also, there would be no new supply of office space until funding and debt restructuring issues are settled.

Funding for the whole property sector remains scarce and the restructuring of the huge debts owed by property companies is still put on the balance by the Indonesian Bank Restructuring Agency (IBRA).

Indebted property companies cannot move on because their assets, especially land certificates, have been taken over by IBRA. Unless IBRA completes the restructuring of their debts, totaling Rp 47 trillion, they will continue to be in limbo.

And this will affect the property market as a whole as these indebted companies control most of the property assets in the country, including the unattended 20,000 hectares of land across major cities in the country.

Enggartiasto Lukita, legislator and chairman of the supervisory board of the Indonesian Real Estate Association (REI), deplores the government's incomprehensive policy in the property sector.

"The slow debt restructuring of property companies creates uncertainties for all players in this sector. And we have to bear the costs for these uncertainties," Enggartiasto said.

Worse still, the government, driven by its zealots to increase revenues from domestic sources, especially from taxes, deals a blow to the just "waking-up" property market by demanding more taxes through two government regulations.

The government regulations are PP No. 140/2000 on income tax for construction and property consultant services and PP No. 145/2000 on a luxury tax on luxury houses, apartments, condominiums and town houses.

PP No. 140/2000, replacing PP No. 73/1997, sets a tax of 2 percent for construction contractors and 4 percent each for construction planning, supervision, and consultant services for a project worth more than Rp 1 billion. This new regulation does not increase the tax rate but changes the base of the tax calculation, that could be burdensome for contractors and consultants.

PP No. 145/2000 imposes a 20 percent luxury tax for sales of houses 400 square meters and up, as well as apartments, condominiums and townhouses of 150 square meters and up. According to a previous regulation, based on Law No. 8/1983, only luxury houses were subject to a luxury tax, and the rate was only 10 percent.

While this latter policy of slapping more taxes on property companies will affect the residential and apartment submarkets, this antimarket policy sends bad signals to the property market as a whole.

Mina Ondang said this policy will especially discourage investors from entering up-market property business and thus may slow down property asset disposal pursued by IBRA.

But Panangian Simanungkalit, a property consultant to IBRA, said IBRA had taken the so-called proceed-sharing policy to break the impasse in its property asset disposal.

With such a policy, indebted property companies can sell their properties, including office buildings, under IBRA control. The companies can keep 13 percent of the proceeds from asset sales, while the other 87 percent goes to an escrow account under IBRA supervision.

"With this policy, indebted property companies can move on with their businesses, while at the same time they are working out their debts with IBRA," Panangian said.

He noted that with this policy, investors should not hesitate to purchase any property assets under IBRA control, despite uncompleted debt restructuring of property companies.

To give a more solid legal foundation to property transactions, Panangian noted that IBRA was drafting a comprehensive debt settlement policy. This policy, expected to be completed by April, will become an umbrella for IBRA and property companies to break the property debt hung.

When this policy is in place, it is expected that the property sector as a whole, including the office subsector, will start to really recover, with the entrance of both local and foreign investors.