Wednesday, November 3, 2010

Warisan Merdeka, KLFID, And The Demand For Office Space In Kuala Lumpur

Although announced as part of the government’s 2011 budget proposals, neither the RM5 billion Warisan Merdeka (to be developed by Permodalan Nasional Berhad) nor the RM26 billion Kuala Lumpur International Financial District (to be jointly developed by 1Malaysia Development Berhad and Abu Dhabi’s Mubadala Group) are strictly speaking government projects, although the latter skirts a very fine line on that issue.

There’s a lot of opposition to both projects, but funnily enough, it’s Warisan Merdeka that has attracted the most vitriol despite being less in scope and risk, and despite PNB not being directly owned by the government. I guess its the inclusion of a 100 story office tower that has raised people’s hackles, and the prospect of a 5-10 year development in one of the worst traffic areas of the city.

But the real issue here is the viability and feasibility of both projects – will there be enough demand to absorb the inclusion of so much additional office and commercial space?

So what I’m going to do in this post is to have a go at estimating office demand in the KL area up until 2020. I’m concentrating here on office space only, as there’s little information on how much commercial space is incorporated in these projects.

First the basic data I'm working with, sourced from NAPIC (in sq. meters):


Current office space in the KL area is about 6.7 million sqm, of which about 5.4 million is in use as of 2Q 2010. The occupancy ratio has been above 80% since about 2005, and there’s been an obvious impact from the recession of 2008-2009:


I’m doing two simple specifications here, one purely stochastic and the other related to income (as proxied by real GDP):



…where y is the amount of office space taken up (in sqm), @trend is a trend variable, and AR(1) is a 1 lag autoregressive function. The d variables are quarterly dummies to account for variation in GDP.

The results are as follows:



All the coefficients are significant, and diagnostics all check out. I used the forecasted series from my earlier estimation of GDP in this post as the explanatory variable for the second specification.

The forecasts generated are as follows:



The point forecast for 2020 ranges from 7.2 million sqm (spec 1) to 6.9 million sqm, with a 95% confidence range of about 0.3-0.4 million around the central forecast.

If we assume an 80% occupancy ratio is the sweet spot where developers can still build while still expecting a decent return, that means the KL area can comfortably handle a level of supply of between 8.6-9.1 million sqm by 2020, a general increase of about 25%-35% over ten years (2.3%-2.8% on average).

Put another way, the KL market can absorb between 150k-250k sqm a year, without impacting rental yields.

So what’s the impact of WM and KLIFD? Right now there’s 750k sq meters under construction, which is about three years supply if we’re generous, five years if we aren’t. WM on its own will add another 200k sq meters when the tower is completed in 2015, about another year’s supply. KLIFD will have a lower density than WM, but the site is five times bigger and development is spread over a longer period – call it another 400k sqm.

If we look at the worse case scenario here, current projects in the pipeline plus WM and KLIFD pretty much saturate the market until 2020, but that’s a low probability occurrence – bearing in mind we’re talking about 10 years down the road, and some pretty heroic assumptions on my part. Best case scenario is that the same projects only fulfil about half estimated demand.

The key here is that KLIFD and WM elicit a supply response – if they scare other developers away from adding on to supply until it’s clear the demand will be there, then both projects will probably generate the kind of returns that make them worthwhile. My feeling is that the addition of WM and KLIFD might put some downward pressure on rentals and occupancy ratios over the next decade, but the effect will be transitory. I expect the demand to be there, though probably not as much as PNB and 1MDB might like.


  1. Something odd's going on with the second regression. Higher income leads to lower office space demand?

  2. Weird, innit?

    More than likely it's caused by omitted variable bias - I didn't exactly specify a full featured model. Rental price would be an obvious candidate for inclusion, but it would also be endogenous to the model.

    All this would matter if we wanted to know the "why" instead of just the "what". For a simple forecasting exercise, its not really necessary.

  3. If I comment anything on what you write, I'd look mighty stupid.

    Again I say, man, you're one smart dude. :)

  4. Are we following the Dubai development model, Infra expenditure for short term GDP gains. I think we have enough tourist sights. If you go to Putrajaya, you can see a lot of the buildings are underutilised. Looking at the 2011 Budget, the only worthwhile project is the MRT. Which of course would need a government guarantee since it can only be viable on its own in probably in 2020.

    I think the 2011 Budget should have concentrated on reducing taxes for individuals and corporations and increasing subsidies/incentives for DDI. To offset this, they should reduce operating expenditure. With IT, they don't need so many government servants.