Apr 26, 2020

In 2019, we released the Nairobi Metropolitan Area (NMA) Commercial Office Report 2019, which highlighted the state of the commercial office market in terms of supply, demand, performance, and investment opportunities within the sector. According to the report, the sector recorded a 0.2%-points and 0.7%-points y/y increase in average rental yields and occupancy rates, to 8.1% and 83.3%, respectively, on account of an improved macroeconomic environment and the continued positioning of the Nairobi Metropolitan Area (NMA) as a regional hub, thus attracting investors who require office spaces.

This week, we update our report based on research conducted in 9 nodes in the Nairobi Metropolitan Area Commercial Office Market by looking at the following:

1. Overview of the Commercial Office Sector,
2. Commercial Office Supply in the Nairobi Metropolitan Area,
3. Commercial Office Performance, by Location and by Grades, and,
4. Office Market Outlook and the Investment Opportunity in the Sector.

Section I: Overview of the Commercial Office Sector

The Nairobi Metropolitan Area (NMA) commercial office market continues to be facilitated by the country’s economic climate with office tenants both large and small continuing to drive current demand levels. Demand for office spaces has been primarily driven by the growth of Small and Medium-Sized Enterprises (SMEs) and the entry of multinational corporations.

Some of the factors that have continued to drive the commercial office sector include:

1. Kenya’s Growing Presence as a Regional Hub - Kenya’s ranking in the World Bank Ease of doing Business Report, has improved over time, improving by 19 positions to #61 in 2019, from #80 in 2018, and to #56 in 2020. The continued rise in ranking is attributed to the continued strengthening of access to credit, protection of minority investors and ease of paying taxes by merging all permits into a single unified business permit, and,
2. Increased Entry of Multinational Corporations - Office space demand has persistently increased over time due to the entry of multinational corporations, therefore leading to increased development of commercial office spaces. Some of the multinational corporations that opened regional offices in 2019 include Cigna, a global health service company, MAC Mobile, an FMCG technology solutions company, Mauritius Commercial Bank (MCB) Group and Abbott, a US-based healthcare company, respectively,

Nevertheless, the sector continues to face challenges, mainly:

1. The COVID-19 Pandemic - The current COVID-19 pandemic has slow down foreign investments as firms globally have put on hold expansion plans in anticipation of market developments. Also, the ongoing human movement restrictions due to the coronavirus have affected office demand reducing occupancies as several firms have resorted to working remotely,
2. Insufficient Access to Finance - There was insufficient access to financing with private sector credit growth coming in at 7.1% in December 2019 compared to a 5-year (2013-2018) average of 14.0%. This affected the growth of SMEs in the country as some reduced the scale of operations and others cut down on expansion plans and thus reduced demand for office space,
3. Oversupply in the Sector - Office space oversupply stood at 6.3 mn SQFT in 2019, a 21.6% increase from 5.2 mn in 2018, creating a bargaining chip for tenants by forcing developers to reduce or maintain prices and rents to remain competitive and attract occupants to their office spaces,
4. Delay in the Processing of Construction Permits - Delays in the processing of construction permits by some county governments such as Nairobi and Kiambu, affected developers by prolonging project implementation timelines and increasing construction and fit-out costs for firms, and
5. Insufficient Infrastructure - The rate of real estate development and increased commercial activity has by far exceeded the rate of infrastructural improvement causing strains on the trunk infrastructure driving up real estate development costs as developers resort to financing any infrastructural inadequacies.

Section II: Commercial Office Supply in the Nairobi Metropolitan Area

In 2019, total office stock in Nairobi increased by 2.2% to 36.3 mn SQFT, from 35.5 mn SQFT in 2018. However, the 1.5 mn SQFT of office stock delivered into the market in 2019, was 65.1% lower than in 2018, attributed to the delays in the issuance of approvals by the Nairobi County Government which resulted in a slowdown in construction activities.

Some of the notable office completions during the review period included:

Major Commercial Office Completions in 2019
	Office Development	Location	Size (SQFT)
1	The Address	Westlands	243,000
2	Garden City Business Park (Phase I)	Thika Road	134,160
3	1 Park Avenue	Parklands	133,000
4	The Arch Place	Kilimani	120,000
5	Kenya Institute of Supplies Management(KISM)	Kilimani (Ngong Road)	105,000
6	Laxcon	Westlands	100,000
7	Capital Square	Parklands	90,000
8	19 Kabasarian Avenue	Kilimani(Lavington)	76,600
Total			1,001,760

Source: Cytonn Research 2019, Knight Frank 2019

Office space supply has grown at 7-year CAGR of 24.7% to 36.3 mn SQFT in 2019, from 7.7 mn SQFT in 2012, driven by the positioning of Nairobi as a regional hub, thus increased entrance of multinationals as well as the growth of Small and Medium Enterprises (SMEs).

In 2019, the market had a supply of 6.7 mn SQFT against a demand of 0.3 mn SQFT, resulting in an oversupply of 6.3 mn SQFT. Demand was lowest in 2019 due to a tough economic environment and insufficient access to financing that affected the growth of SMEs in the country. Over the next few years, we expect a reduced rate of supply to a 2-year CAGR of 6.9% attributed to a market correction as the forces of demand and supply come into play.

The table below summarizes the commercial office space supply over time:

Commercial Office Space Supply Analysis (2011-2019)
Year	2011	2012	2013	2014	2015	2016	2017	2018	2019	2020F	2021F	2022F
Stock ( Mn SQFT)	6.7	7.7	9.7	15.4	22.9	28.9	31.8	35.5	36.3	36.9	37.5	38.0
Completions ( Mn SQFT)		1.2	2.1	5.9	7.8	6.5	3.5	4.3	1.5	1.4	1.3	1.3
Vacancy Rate (%)	9.0%	9.0%	10.0%	10.0%	11.0%	12.0%	16.8%	16.7%	19.5%	19.9%	20.2%	20.6%
Vacant Stock ( Mn SQFT)	0.6	0.7	1.0	1.5	2.5	3.5	5.3	5.9	7.1	7.2	7.3	7.4
Occupied Stock (Mn SQFT)	6.1	7.1	8.8	13.9	20.3	25.4	26.5	29.6	29.2	29.7	30.2	30.6
Net Absorption		1.0	1.7	5.1	6.5	5.1	1.0	3.1	(0.4)	0.5	0.5	0.4
Demand (mn SQFT)		1.1	1.9	5.3	6.8	5.6	1.6	3.7	0.3	1.3	1.2	1.2
Available Supply, AS(T)		1.7	2.6	6.5	8.8	8.4	6.3	9.0	6.7	7.7	7.8	7.8
Under(Over)supply		(0.5)	(0.8)	(1.2)	(2.1)	(2.9)	(4.7)	(5.2)	(6.3)	(6.5)	(6.6)	(6.7)
Office space supply has grown at 7-year CAGR of 24.7% to 36.3 mn SQFT in 2019 from 7.7 mn SQFT in 2012 Office completions declined by 65.1% to 1.5 mn SQFT in 2019 from 4.3 mn SQFT in 2018

Source: Cytonn Research 2019, Building Plan Approvals Data from the Nairobi City County

 Section III: Commercial Office Performance, by Location and by Grades

The commercial office sector performance softened in 2019 recording a 0.7%-points decline in average rental yields to 7.7% in 2019 from 8.3% in 2018. Occupancy rates declined by 3.3%-points to 80.5% in 2019, from 83.8%, in 2018. Asking rents declined by 4.3% to an average of Kshs 97 per SQFT from Kshs 101 per SQFT in 2018. The subdued performance was largely driven by:

1. An introduction of 1.5 mn SQFT office space to the market resulting to an oversupply of 6.3 mn SQFT which has created a bargaining chip for potential tenants, forcing developers and landlords to reduce or maintain prices and rents to remain competitive and attract occupants to their office spaces, and,
2. A decline in uptake of office space attributed to a challenging financial environment, leading to downsizing or business closures, especially for small and medium-sized enterprises (SMEs).

The table below summarizes the performance of the commercial office theme over time:

(All Values in Kshs Unless Stated Otherwise)

Commercial Office Market Performance Summary (2013 – 2019)
Year	2013	2015	2016	2017	2018*	2019	y/y ∆ 2018	y/y ∆ 2019
Occupancy (%)	90.0%	89.0%	88.0%	82.6%	83.8%	80.5%	1.2% points	(3.3%) points
Asking Rents (Kshs/SQFT)	95.0	97.0	103.0	101.0	101.4	97.2	0.4%	(4.3%)
Average Prices (Kshs/SQFT)	12,433	12,776	13,003	12,649	12,407	12,552	(1.9%)	1.2%
Average Rental Yields (%)	8.3%	8.1%	8.4%	7.9%	8.3%	7.7%	0.4% points	(0.7%) points
*Average rental yields for 2018 restated to include additional 2018 office completions Average rental yields and occupancy rates reduced by 0.7%-points and 3.3%-points, respectively to 7.7% and 80.5% in 2019 from 8.3% and 83.8%, respectively in 2018 Asking rents declined by 4.3% to an average of Kshs 97 per SQFT from Kshs 101 per SQFT in 2018, attributed to an oversupply of 6.3 mn SQFT office space as at 2019, which has created a bargaining chip for firms forcing developers to reduce or maintain prices and rents to remain competitive and attract occupants to their office spaces

Source: Cytonn Research 2019

1. Commercial Office Performance by Nodes

For submarket analysis, we classified the main office nodes in the Nairobi Metropolitan Area into 9 nodes: i) Nairobi CBD, ii) Westlands, covering environs including Riverside, iii) Parklands, iv) Mombasa Road, v) Thika Road, vi) Upperhill, vii) Karen, viii) Gigiri, and ix) Kilimani, which includes offices in Kilimani, Kileleshwa and Lavington.

Gigiri, Karen and Westlands were the best performers in 2019 recording rental yields of 9.2%, 8.3%, and 8.3%, respectively, attributed to increased demand by businesses and multinational companies due to their proximity to the Central Business District (CBD) and other business nodes, relatively good infrastructure network, their superior locations and availability of quality Grade A offices, enabling them to charge a premium on rentals.

Thika Road and Mombasa Road were the worst performers recording rental yields of 6.3% and 5.5%, respectively, attributed to; (i) poor location as a result of traffic congestions, (ii) the Mombasa Road’s zoning for industrial use, and (iii) lower quality office space. This made the locations generally unattractive to firms.

The Nairobi Metropolitan Area sub-market office performance is as summarized in the table below:

(All Values in Kshs Unless Stated Otherwise)

Commercial Office Market Performance by Node 2018 - 2019
Nodes	Price Kshs/ SQFT  2019	Rent Kshs/ SQFT  2019	Occupancy 2019(%)	Rental Yield (%) 2019	Price Kshs/ SQFT 2018	Rent Kshs/SQFT 2018	Occupancy 2018(%)	Rental Yield (%) 2018	∆ Rent Y/Y	∆ Occupancy Y/Y (% points)	∆ Rental Yields  Y/Y (% points)
Gigiri	13,833	117	80.4%	9.2%	13,833	123	85.0%	10.0%	(5.1%)	(4.6%)	(0.8%)
Karen	13,665	111	85.3%	8.3%	13,666	118	88.6%	9.2%	(6.5%)	(3.2%)	(0.9%)
Westlands	12,370	104	80.3%	8.3%	12,050	110	82.1%	9.0%	(5.2%)	(1.8%)	(0.7%)
Parklands	12,369	97	83.1%	8.2%	12,494	102	86.0%	8.4%	(4.8%)	(2.9%)	(0.2%)
UpperHill	12,397	98	80.0%	7.5%	12,560	100	84.0%	8.2%	(1.3%)	(4.0%)	(0.7%)
Kilimani	12,680	91	80.9%	7.1%	13,173	99	88.3%	8.0%	(8.5%)	(7.4%)	(0.9%)
Nairobi CBD	12,425	89	85.6%	7.1%	10,875	82	88.3%	7.6%	(7.5%)	(2.7%)	(0.5%)
Thika Road	12,600	84	80.4%	6.3%	12,517	86	81.5%	6.7%	(2.4%)	(1.0%)	(0.4%)
Msa Road	11,400	73	66.5%	5.5%	11,400	79	65.6%	5.8%	(8.2%)	0.9%	(0.3%)
Grand Total	12,638	97	80.3%	7.5%	12,507	101	83.8%	8.3%	(4.3%)	(3.2%)	(0.7%)
Gigiri, Karen and Westlands were the best performers in 2019 recording rental yields of 9.2%, 8.3%, and 8.3%, respectively Thika Road and Mombasa Road were the worst performers recording rental yields of 6.3% and 5.5%, respectively, attributed to poor location as a result of traffic congestions and lower quality office space.

Source: Cytonn Research 2019

2. Commercial Office Performance by Class/Grade:

Commercial office buildings are classified into three main categories based on the size and quality of office spaces. These are:

• Grade A: Office buildings with a total area ranging from 100,001 - 300,000 square feet that are pacesetters in establishing rents and that generally have ample natural good lighting, good views, prestigious finishing, and on-site undercover parking, and a minimum parking ratio of 3:1000 SQFT,
• Grade B: Office buildings with a total area ranging from 50,000 to 100,000 SQFT. They have good (but lower than Grade A) technical services and ample parking space, and,
• Grade C: These are buildings of any size, usually older, and in need of renovation, they lack lobbies and may not have on-site parking space. They charge below average rental rates.

The performance of the commercial sector softened with declines recorded across all the grades. This is largely attributed to oversupply which stood at 6.3 mn SQFT as at 2019. Commercial offices recorded an average rental yield of 7.7% at an average occupancy of 80.5%, monthly rental charges of Kshs 97 per SQFT, and price per SQFT of Kshs. 12,552.

Grade B office spaces recorded the highest rental yields at 7.9% as tenants prefer them due to their lower asking prices and similar amenities to grade A offices.

Despite declines recorded across all grades, grade A offices recorded the least declines in occupancy and rental yields at 0.4%-points and 0.6%-points, respectively, attributable to its preference by large firms. Their performance was slightly cushioned by the entry of various multinationals in the country in 2019 who prefer grade A offices due to their quality finishes, ample parking space, and high-end technical services.

The performance according to grades/class is as summarized in the table below:

(All Values in Kshs Unless Stated Otherwise)

Commercial Office Market Performance by Grade (2018 – 2019)
Office Grade	Price 2019 Kshs/ SQFT	Rent  2019 (Kshs/SQFT)	Occupancy 2019 (%)	Yield 2019(%)	Price 2018 Kshs/ SQFT	Rent  2018 (Kshs/SQFT)	Occupancy 2018(%)	Yield 2018 (%)	∆ Rent Y/Y	∆ Occupancy Y/Y  (% points)	∆ Rental Yields  Y/Y (% points)
Grade A	12,860	105	73.8%	7.4%	13,070	111	74.1%	7.9%	(6.3%)	(0.4%)	(0.6%)
Grade B	12,706	99	82.7%	7.9%	12,388	102	86.1%	8.5%	(3.3%)	(3.4%)	(0.7%)
Grade C	10,920	82	80.4%	7.2%	10,920	85	87.0%	7.9%	(3.5%)	(6.6%)	(0.7%)
Average	12,552	97	80.5%	7.7%	12,407	101	83.8%	8.3%	(4.3%)	(3.2%)	(0.7%)
Grade B office spaces had the highest rental yields at 7.9% compared to grade A and grade C offices rental yields of 7.4% and 7.2%, respectively

Source: Cytonn Research 2019

3. Commercial Office Performance by Class and Node:

For Grade A offices in 2019, Gigiri and Karen offered the highest returns with average rental yields of 10.1% and 8.8%, respectively, as they enjoy a superior location characterized by a serene environment and low-rise developments.

For Grade B, Westlands and Karen offer the highest rental yield of 8.7% and 8.2%, respectively, due to the locations remaining as major priority areas for businesses, and hence offer an investment opportunity in the market.

For Grade C, Parklands and Westlands offer the highest average rental yields at 9.0% and 7.9%, respectively, attributed to preference by Small and Medium Enterprises (SMEs) as a result of more affordable rates compared to Grade A and B rates.

The performance according to class and node is as summarized in the table below with the best performing areas of each grade highlighted in yellow:

Commercial Office Performance in 2019 by Nodes and Grades
Typology	Grade A		Grade B		Grade C
Location	Rental Yield (%)	Occupancy (%)	Rental Yield (%)	Occupancy (%)	Rental Yield (%)	Occupancy (%)
Gigiri	10.1%	81.3%	7.9%	79.0%
Karen	8.8%	87.0%	8.2%	84.9%
Parklands	7.3%	75.0%	8.1%	82.0%	9.0%	91.4%
Westlands	7.2%	72.6%	8.7%	81.2%	7.9%	86.4%
UpperHill	6.9%	69.1%	7.9%	85.1%	6.6%	82.5%
Kilimani	7.2%	70.0%	7.2%	81.7%	6.2%	92.0%
Msa Road	6.0%	79.0%	6.3%	71.3%	4.8%	58.6%
Thika Road	4.9%	60.0%	6.5%	84.6%	6.6%	80.0%
Nairobi CBD			7.2%	86.7%	6.8%	79.5%
·     Gigiri and Karen offered the highest returns with average rental yields of 10.1% and 8.8%, respectively ·     For Grade B, Westlands and Karen offer the highest rental yield of 8.7% and 8.2%, respectively

Source: Cytonn Research 2019

4. Serviced Offices Performance

Serviced (or shared) office spaces refer to fully furnished and equipped office spaces that are managed by a facility management company. Serviced offices have continued to gain popularity and account for approximately 0.9% of the total stock in the NMA commercial office market. Some of the new serviced office supplies in 2019 include (i) Nairobi Garage opening at Watermark Business Park in Karen, (ii) Kofisi, a subsidiary of Sunbird Group, which opened at 45 Africa Reit in Karen, and (iii) Workable Nairobi at Sanlam Towers in Westlands.

In 2019, serviced offices recorded yields of 12.3%, 4.3%-points higher than the un-serviced offices' yield of 8.0%. This is attributed to the attractiveness of the office setup to small businesses, start-ups and freelancers due to; (i) flexibility of the leases as they could range for short periods, (ii) no set-up costs required, and, (iii) opportunities for collaboration with other individuals/businesses in a competitive working environment.

The performance of serviced and unserviced offices is as summarized in the table below:

(All Values in Kshs Unless Stated Otherwise)

Serviced and Un-serviced Office Performance Comparison 2019
Location	Revenue Per SQFT		Occupancy (%)		Yield
	Serviced Offices	Un-serviced Offices	Serviced Offices	Un-serviced Offices	Serviced Offices	Un-serviced Offices
Westlands	248	104	81.2%	80.3%	15.9%	8.3%
Upperhill	199	98	79.7%	80.0%	12.2%	7.5%
Karen	186	111	70.0%	85.3%	8.7%	8.3%
Average	211	104	77.0%	81.9%	12.3%	8.0%
Serviced offices recorded yields of 12.3%, 4.3%-points higher than the un-serviced offices' yield of 8.0% Westlands and Upperhill were the best performing nodes recording rental yields of 15.9% and 12.2%

Source: Cytonn Research 2019

Section IV: Office Market Outlook and the Investment Opportunity in the Sector

In conclusion: having looked at supply, demand, and investor returns, we have a general NEGATIVE outlook for the commercial office sector theme in Nairobi Metropolitan Area (NMA) given the increased office space supply and expected stagnation in performance in 2020 depending on how fast the Coronavirus is contained. However, we expect a slowdown in construction activities allowing the existing demand to absorb the current supply in the long-run. The investment opportunity is in zones with low supply and high returns such as Gigiri and differentiated concepts such as MUDs and serviced offices recording rental yields of up to 7.9% and 12.3%, respectively.

The table below summarizes metrics that have a possible impact on the commercial office sector, that is the office space supply, performance, office space demand, and concluding with the market opportunity/outlook in the sector:

Commercial Office Outlook 2020
Measure	2018 Sentiment	2019 Sentiment and 2020 Outlook	2019 Review	2020 Outlook
Supply	·       We had an oversupply of 5.2 mn SQFT of office space in 2018, and it was expected to grow by 7.6% to 5.6 mn SQFT in 2019, compared to 10.8% in 2018 due to decreasing supply with completions expected to decrease by 21.4% from 4.3 mn SQFT to 3.4 mn SQFT in 2019	·       We had an oversupply of 6.3 mn SQFT of office space in 2019, and it is expected to grow by 1.9% to 6.5 mn SQFT in 2020 due to reduced activity as a result of the COVID-19 pandemic and delay of approvals by the Nairobi County Government	Negative	Negative
Demand	·       There was increased demand for office space in the Nairobi Metropolitan Area (NMA) evidenced by the 0.7% y/y increase in occupancy mainly attributable to political stability that has led to increased economic activities, positioning of the NMA as a regional hub and thus increased entrance of multinationals and improving macroeconomic environment, with the GDP growing at 6.0% in Q3’2018, higher than the 4.7% recorded in Q3’2017, and expected to close at 5.8% for the year 2018	·       There was reduced demand for office space in the Nairobi Metropolitan Area (NMA) evidenced by the 3.3% y/y decline in occupancy mainly attributable to an oversupply and minimal growth in private sector credit. However, there exists demand in differentiated concepts such as serviced offices from start-ups and multinational firms due to their ability to offer flexible lease agreements and office space	Neutral	Neutral
Office Market Performance	·       The performance of the office market improved with yields increasing by 0.2%-points to 8.1% in 2018 from 7.9% in 2017, and occupancy rates increased by 0.7%-points from 82.6% in 2017 to 83.3% in 2018	·       Performance softened in 2019 recording 0.7%-points and 3.3%-points y/y decline in average rental yields and occupancy rates, to 7.7% and 80.5% in 2019, from 8.3% and 83.8%, in 2018, respectively. We expect rental prices to drop slightly over the short term due to downward pressure arising from the decline in effective demand from the existing oversupply in the market	Neutral	Negative
We have a negative outlook for the commercial office theme in the Nairobi Metropolitan Area (NMA) given the increased office space supply and expected stagnation in performance in 2020 depending on how fast the Coronavirus is contained. However, we expect a slowdown in construction activities allowing the existing demand to absorb the current supply Investments should be made in zones with low supply and high returns such as Gigiri and in differentiated concepts such as MUDs and serviced offices recording rental yields of up to 7.9% and 12.3%, respectively, to boost returns

For 2020, our outlook for the commercial office sector is NEGATIVE with two out of three metrics we looked at being negative and one metric being neutral. Due to an oversupply of office space and the uncertainty brought about by the novel Coronavirus, investments in the sector should, therefore, be aimed towards long-term gains when the market picks up. The investment opportunity is in mixed-use developments (MUDs) and serviced offices that attract yields of 7.9% and 12.3%, respectively. We continue to track the performance of the office sector, and as per our Cytonn Q1’2020 Markets Review, the sector recorded 0.3% and 1.5%-points increase in average rental yields and occupancy rates, to 7.8% and 81.7%, respectively, an indicator of slow recovery. For more information click here. For the full Commercial Office Report 2020, click here.