Apr 25, 2021

In 2020, we released the Nairobi Metropolitan Area Commercial Office Report 2020, which highlighted the state of the commercial office market in terms of supply, demand, performance, and investment opportunities within the sector and the overall performance of the sector in 2019. According to the report, the commercial office sector performance softened in 2019 recording a decline of 0.6% in average rental yields to 7.7% in 2019 from 8.3% in 2018. Occupancy rates declined by 3.3% 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 main reasons that led to the declines in performance in 2019 were; i)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, ii) 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).

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 in 2020 faced numerous challenges attributable to the covid-19 pandemic which brought about reduced demand for office space as well as the high supply which led to declines in both rental rates and occupancies. The sector saw an increase in the oversupply from 6.3 mn SQFT in 2019 to 7.3mn SQFT in 2020;

However, some of the factors that have continued to drive the commercial office sector include:

• Reinvention of Commercial Spaces: Since the emergence of the pandemic in early 2020 which was followed by lockdown measures, companies restructured and adopted remote working which led to a decrease in occupancy levels in the commercial office sector. There was also a need to redesign offices to open spaces so as to adhere to social distancing regulations as well as maximize the space thus bringing about the need for more office spaces. In addition, the popularity of co-working office spaces is picking up as they are offering companies spaces on flexible terms, and,
• Rise of Serviced Offices: Serviced offices are becoming a trend in the modern market as they provide flexibility with no significant upfront Capex and for the office owners they yield higher returns of up to 11.2% against the market average of 7.0%,

The sector continues to face challenges among them,

• The Covid-19 Pandemic: The pandemic has adversely affected the growth of office sector as it led to reduced occupancies and uptake of spaces. In 2020, occupancies dropped by 2.6% points to 77.7% from 80.3%, and the average rental rates declined to by 3.0% from Kshs 96 per SQFT in 2019 to Kshs 93 per SQFT, leading to a 0.5% decline in the total yield to an average of 7.0% from 7.5%.
• Oversupply of the office Space: Office space oversupply stood at 7.3 mn SQFT in 2020 with a total of 0.8mn SQFT of new office space coming to the market adding to the initial office stock of 36.3 mn SQFT.
• Reduced Occupancy Rates: The business restructuring which incorporated remote working has led to reduced occupancy levels as companies sought to reduce the sizes of their offices to minimize spending on rental charges, and,
• Limited Accessibility of Funds: Lack of proper funding for developers resulted in the use of expensive debts in the funding structure of most real estate developments with no exception of the commercial office sector. However, accessing loans for development has been a challenge as creditors are exercising a more conservative underwriting approach as a strategy to cushion themselves against the pandemic which is marked by high loan default rates.

Section II: Commercial Office Supply in the Nairobi Metropolitan Area

The supply of new commercial space continued to rise in 2020 despite the pandemic with the completion of 7 buildings offering up to 0.8 mn SQFT of extra space in to the commercial market. This office supply is expected to increase going forward with few developments in the pipeline bringing the expected incoming supply in 2021 to 0.9 mn SQFT. Some of these developments in pipeline expected to be completed in 2021 include the Global Trade Centre in Westlands, Riverside Square in Riverside and China Road and Bridge Corporation in Lang’ata.

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

Major Commercial Office Completion in 2020
#	Office Development	Location	Size (SQFT)
1	Millennium Business Park	Lang’ata	23,000
2	Templeton House	Westlands	33,132
3	Majani House	CBD	54,551
4	Capital Square	Westlands	101,000
5	Delta Chambers	Westlands	132,979
6	Central Bank Pension Building	CBD	180,000
7	Upperhill Chambers	Upperhill	270,000
Total			794,662

Source: Cytonn Research 2020/Knight Frank 2020 

The Office space supply grew by a 7-year CAGR of 21.3% to 36.4 mn SQFT in 2020 from 7.7 mn SQFT in 2012.  In 2020, the market had an available supply of 7.1 mn SQFT against a demand of (0.2) mn SQFT, resulting in an oversupply of 7.3 mn SQFT. The demand was low in 2020 due to a tough economic environment brought about by the pandemic forcing businesses to restructure thus reducing the demand for office spaces. Additionally, the adoption of remote working as a strategy for limiting the spread of the pandemic also reduced the demand for office spaces in 2020 and this is expected to continue in 2021.

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

Commercial Office Supply Analysis (2011-2020)
Year	2011	2012	2013	2014	2015	2016	2017	2018	2019	2020	2021F	2022 F	7 year CAGR
Stock ( Mn Sqft)	6.7	7.7	9.7	15.4	22.9	28.9	31.8	35.5	36.3	36.4	37.2	38.1	21.3%
Completions ( Mn Sqft)		1.2	2.1	5.9	7.8	6.5	3.5	4.3	1.5	0.8	0.9	0.5	(5.1%)
Vacancy Rate ( %)	9.0%	9.0%	10.0%	10.0%	11.0%	12.0%	16.8%	16.7%	19.5%	22.3%	23.9%	25.6%	12.0%
Vacant Stock ( Mn Sqft)	0.6	0.7	1.0	1.5	2.5	3.5	5.3	5.9	7.1	8.1	9.0	9.5	35.9%
Occupied Stock (Mn Sqft)	6.1	7.1	8.8	13.9	20.3	25.4	26.5	29.6	29.2	28.3	28.3	28.1	18.9%
Net Absorption		1.0	1.7	5.1	6.5	5.1	1.0	3.1	(0.4)	(1.0)	(0.2)	(0.3)
Demand		1.1	1.9	5.3	6.8	5.6	1.6	3.7	0.4	(0.2)	0.9	1.0
Available Supply, AS(T)		1.7	2.6	6.5	8.8	8.4	6.3	9.0	6.7	7.1	8.8	9.2	19.9%
Gap, GAP(T)		(0.5)	(0.8)	(1.2)	(2.1)	(2.9)	(4.7)	(5.2)	(6.3)	(7.3)	(7.9)	(8.2)	38.5%
Office space supply has grown at 7-year CAGR of 21.3% to 36.4 mn SQFT in 2020from 7.7 mn SQFT in 2012 Office completions declined by 53.3% to 0.8 mn SQFT in 2020 from 1.5 mn SQFT in 2019

Source: Cytonn Research 2020, 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 2020 recording a 0.5% points decline in average rental yields to 7.0% from 7.5% in 2019. Occupancy rates declined by 2.6% points to 77.7% in 2020, from 80.3%, in 2019. Asking rents and prices declined by 3.0% and 2.8% respectively to an average of Kshs 93 and Kshs 12,280 per SQFT in 2020 from per SQFT from Kshs 96 and Kshs 12,638 per SQFT, respectively in 2019. The subdued performance was largely driven by:

• Increased supply with the introduction of 0.8 mn SQFT office space to the market resulting to reduced occupancies and hence an oversupply of 7.3 mn SQFT which has forced developers and landlords to reduce or maintain prices and rents in order to remain competitive and attract occupants to their office spaces, and,
• The Covid -19 lockdown measures leading businesses to restructure their operations leading to lower demands for office space.

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
Year	2013	2015	2016	2017	2018*	2019	2020	y/y ∆ 2020
Occupancy (%)	90.0%	89.0%	88.0%	82.6%	83.8%	80.3%	77.7%	(2.6%) points
Asking Rents  (Kshs/SQFT)	95	97	97	101	101	96	93	(3.0%)
Average Prices  (Kshs/SQFT)	12,433	12,776	12,031	12,649	12,407	12,638	12,280	(2.8%)
Average Rental Yields (%)	8.3%	8.1%	8.5%	7.9%	8.3%	7.5%	7.0%	(0.5%) points

Source: Cytonn Research 2020

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.

In 2020, Gigiri, Karen and Westlands were the best performers recording an average rental yield of 8.5%, 7.8%, and 7.8%, respectively, due to their superior locations leading to the possibility of charging premium rents and the availability of quality Grade A offices.

Thika Road and Mombasa Road were the worst performing nodes recording rental yields of 5.8% and 4.8%, respectively, attributed to poor location as a result of traffic congestions, and lower quality office spaces, that are generally unattractive to many businesses.

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 Nodes - 2020
Nodes	Price Kshs/SQFT 2020	Rent Kshs/SQFT 2020	Occupancy 2020 (%)	Rental Yields (%) 2020	Price Kshs/ SQFT 2019	Rent Kshs/SQFT 2019	Occupancy 2019(%)	Rental Yield (%) 2019	∆ in Rent	∆ in Occupancy (% points)	∆ in Rental Yields (% points)
Gigiri	13,401	116	82.5%	8.5%	13,833	117	80.4%	9.2%	(0.9%)	2.1%	(0.7%)
Karen	13,567	106	83.6%	7.8%	13,665	111	85.3%	8.3%	(4.6%)	(1.7%)	(0.5%)
Parklands	10,958	93	79.9%	7.6%	12,369	97	83.1%	8.2%	(4.9%)	(3.2%)	(0.6%)
Westlands	11,975	104	74.4%	7.8%	12,370	104	80.3%	8.3%	(0.3%)	(5.9%)	(0.5%)
Upperhill	12,684	92	78.5%	6.9%	12,397	98	80.0%	7.5%	(6.3%)	(1.5%)	(0.6%)
Nairobi CBD	11,889	82	82.4%	6.8%	12,425	89	85.6%	7.1%	(8.3%)	(3.2%)	(0.3%)
Kilimani	12,233	93	79.1%	6.8%	12,680	91	80.9%	7.1%	1.6%	(1.8%)	(0.3%)
Thika Road	12,500	80	76.1%	5.8%	12,600	84	80.4%	6.3%	(5.0%)	(4.3%)	(0.5%)
Msa Road	11,313	73	63.0%	4.8%	11,400	73	66.5%	5.5%	(0.2%)	(3.5%)	(0.7%)
Average	12,280	93	77.7%	7.0%	12,638	96	80.3%	7.5%	(3.2%)	(2.6%)	(0.5%)

Source: Cytonn Research 2020

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 SQFT 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 across the three offices grades declined with the average yields on the Grade A, Grade B and Grade C decline to 6.8%, 7.5% and 6.8% from 7.4%, 7.9% and 7.2% respectively.

Grade B office spaces had the highest rental yields at 7.5% as tenants prefer them because of their cheaper rents as compared to grade A office while having decent technical services (not as good as those of grade A) and ample security

Grade A offices recorded an overall increase in occupancy rates by 2.5% points in 2020 to 76.3% from 73.8% in 2019. Grade A offices recorded the largest drop in the average rental rates by 3.8% points which led to the largest drop in rental yields by 0.6% points compared to grade B and C offices which both recorded declines of 0.4% points.

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 Grades - 2020
Office Grade	Price 2020 Kshs/SQFT	Rent 2020 Kshs/SQFT	Occupancy 2020 (%)	Rental Yield 2020	Price 2019  Kshs/ SQFT	Rent 2019  (Kshs/SQFT)	Occupancy  2019 (%)	Rental Yield  2019(%)	∆ Rent Y/Y	∆ Occupancy Y/Y (% points)	∆ Rental Yield Y/Y (%points)
Grade A	13,628	101	76.3%	6.8%	12,860	105	73.8%	7.4%	(3.8%)	2.5%	(0.6%)
Grade B	12,202	96	78.7%	7.5%	12,706	99	82.7%	7.9%	(3.1%)	(4.0%)	(0.4%)
Grade C	10,721	85	74.3%	6.8%	10,920	82	80.4%	7.2%	3.1%	(6.1%)	(0.4%)
Average	12,167	95	77.4%	7.2%	12,552	97	80.5%	7.7%	(1.5%)	(2.5%)	(0.5%)

Source: Cytonn Research 2020

3. Commercial Office Performance by Class and Node:
   

In 2020, Grade A offices in Gigiri and Karen offered the highest returns with average rental yields of 8.4% and 7.6%, respectively, as they enjoy a superior locations characterized by serene environment attracting high-end clients and premium rental rates. The Grade B offices in Gigiri and parklands had the highest rental yields of 8.6% and 8.5%, respectively. In the Grade C category, Gigiri, had the best returns with average rental yields being 8.5% while Westlands and Karen came in at the second place with both offering average rental yields of 7.8%.

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

Commercial Office Performance in 2020 by Nodes and Grades
Typology	Grade A		Grade B		Grade C
Location	Rental Yield (%)	Occupancy (%)	Rental Yield (%)	Occupancy (%)	Rental Yield (%)	Occupancy (%)
Gigiri	8.4%	80.5%	8.6%	85.6%	8.5%	82.5%
Karen	7.6%	85.0%	7.9%	83.1%	7.8%	83.6%
Kilimani	7.4%	79.0%	6.7%	78.9%	6.8%	79.1%
Msa Road	3.9%	60.0%	6.0%	70.0%	4.8%	63.0%
Parklands	7.3%	76.7%	8.5%	78.1%	7.6%	79.9%
Thika Road	6.7%	85.0%	5.5%	73.6%	5.8%	76.1%
UpperHill	6.4%	72.1%	6.9%	81.2%	6.9%	78.5%
Westlands	6.3%	76.3%	8.2%	75.7%	7.8%	74.4%
Nairobi CBD			6.8%	84.5%	6.8%	82.4%

Source: Cytonn Research 2020

4. Serviced Offices
   

 In 2020, serviced offices recorded yields of 11.2%, 4.2% points higher than the un-serviced offices' yield of 7.0%. This is attributed to the attractiveness of the office setup to small businesses, start-ups and freelancers due to; (i) flexibility of the leases, (ii) no set-up costs required, and, (iii) opportunities for collaboration with other individuals/businesses in a competitive working environment.

Westlands and Karen were the best performing nodes recording rental yields of 15.9% and 14.8%, compared to 7.6% and 7.8% for Unserviced offices respectively in the same areas.

(All values in Kshs Unless Stated Otherwise)

Serviced and Unserviced Office Performance Comparison-2020
Location	Revenue Per SQFT		Occupancy (%)		Yield
	Serviced Offices	Un-serviced Offices	Serviced Offices	Un-serviced Offices	Serviced Offices	Un-serviced Offices
Westlands	204	93	81.2%	79.9%	15.9%	7.6%
Karen	186	104	70.0%	74.4%	14.8%	7.8%
Parklands	174	106	68.6%	83.6%	13.2%	7.8%
Gigiri	181	116	80.0%	82.5%	12.4%	8.5%
Upperhill		92		78.5%		6.9%
Kilimani	190	82	65.0%	82.4%	10.8%	6.8%
Nairobi CBD	160	93	59.3%	79.1%	8.5%	6.8%
Msa Rd	105	73	50.0%	63.0%	7.0%	4.8%
Thika Rd	116	80	52.5%	76.1%	6.6%	5.8%
Average	161	93	65.8%	77.7%	11.2%	7.0%

Source: Cytonn Research 2020

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) due to the 7.3 mn SQFT. The continued impact of the performance of the pandemic also continues to affect the performance of the commercial office sector. We expect a slowdown in new construction activities allowing the market to absorb the current supply in the long-run. Pockets of value in the sector exist in zones with low supply and high returns such as Gigiri and in differentiated concepts such as the serviced offices.  

The table below summarizes our outlook on the sector based on the various key driving factors.  

Nairobi Commercial Office Outlook
Measure	2019 Sentiment	2020 Sentiment and 2021 Outlook	2020 Review	2021 Outlook
Supply	We had an oversupply of 6.3 mn SQFT of office space in  2019, which was 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	We had an oversupply of 7.3 mn SQFT of office space in  2020, and it is expected to grow by 1.1% to 8.0 mn SQFT in  2021, due to reduced occupancy rates brought about by reduced demand as people adopt the working from home alongside the incoming supply which is expected to affect the occupancy rates	Negative	Negative
Demand	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 existed 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	There was reduced demand for office space in the Nairobi Metropolitan Area (NMA) evidenced by the 1.3% y/y decline in the average occupancy rates mainly attributable to an oversupply. investment opportunity lies in differentiated concepts such as serviced offices offering yields of  up to 11.2% compared to 7.0% average rental yields of Unserviced materials	Neutral	Neutral
Office Market  Performance	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	The commercial office sector performance softened in 2020 recording a 0.5% points decline in average rental yields to 7.0% in 2020 from 7.5% in 2019. The average occupancies also declined in 2020 coming in at 77.7%, a 2.6%points decline from 80.3% in 2019. In 2020, we expect average 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, and the COVID-19 effects that has caused decline in occupancy rates and yields	Negative	Negative

For 2021, our outlook for the commercial office sector is NEGATIVE with the three metrics we looked at being negative. This is attributed to the reduced demand for commercial spaces brought about by the COVID-19 pandemic amid the tough economic environment as some firms downsize due to financial constrains while others embrace the working from home concept. The asking prices and rents also continue to decline as landlords endure giving discounts and concessions to attract and retain clients. The oversupply in the commercial office is expected to continue affecting the demand for office spaces. Investment opportunity exists in zones with low supply and high returns such as Gigiri and in differentiated concepts such as the serviced offices recording average rental yields of 11.2%, 4.2% higher than the market average of 7.0%. For the full Commercial Office Report 2020, click here.

Disclaimer: The views expressed in this publication are those of the writers where particulars are not warranted. This publication, which is in compliance with Section 2 of the Capital Markets Authority Act Cap 485A, is meant for general information only and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.