While the industry feels pressure from greater supply and weaker demand, tactics such as a diversification into shorter-term stays and a concentration on mid-level tenants should help the most competitive properties shine. Zha Minjie gets the inside story.

Shanghai’s serviced apartment market saw lower occupancy rates in the second quarter this year, mainly because of the large new supply introduced over the past year.

Across the city, the overall residential rents and occupancy rates fell by 3.9 percent and 4.1 percent, respectively, quarter on quarter, according to research by international real estate services provider Savills. The strata-title apartment and villa markets recorded modest changes.

“A large, new supply coupled with flat demand from multinational corporations, the largest serviced apartment tenant segment, has put pressure on serviced apartments,” said James Macdonald, associate director with Savills Research China.

The price per square meter for the serviced residences stayed at 298.2 yuan (US$48.89) in Q2, a 4.4 percent drop compared with the same period last year. The occupancy rate was 86.5 percent, a 3.6 percent decrease from last year.

Projects have seen increasing competition in recent quarters as new supply enters the market, especially in the Pudong New Area, where a pilot free trade zone has been approved that will be a new center for international corporations.

The serviced apartment market is expected to see a significant amount of new supply as well as renovated projects reopening.

Five new and renovated serviced apartments, totaling 989 units, are expected to be handed over in 2013. If all projects open according to schedule, this supply will further increase the downward pressure on serviced apartment rents.

“Demand will take some time to absorb the new supply, resulting in elevated vacancy rates and depressed rents for certain segments of the market,” said the research.

Given the current pace of demand, it is expected that the new supply will be absorbed slowly. With high availability, the trend is expected to remain present for the remainder of the year.

With expatriates having returned home for the summer and lease contracts expired during June and July, vacancy rates are expected to rise in Q3, said Savills.

A number of serviced apartments, particularly in the high-end segment, are finding it increasingly difficult to maintain rents and occupancy rates at the current market levels, after having recorded close to three years of sustained growth since the World Expo 2010 Shanghai.

This is mainly driven by the large amount of supply recorded over the past 12 months, with the addition of new luxury projects such as IFC Residence and Mandarin Oriental, which added over 500 units to the market, and the reopening of renovated projects such as Fraser Residence Silver Court and Kerry Residences, with roughly 800 units in total.

It is also in part due to slowing economic growth and therefore flat demand from multinational corporations as they had to manage costs by cutting housing budgets.

The quarterly survey on hiring expectations for the next three months by human resourcing company Hudson indicates that 13.2 percent of respondents plan to reduce headcounts, while only 51.5 percent plan to recruit new staff, the lowest level since the first quarter of 2010.

Plans for international assignments are likely to follow a similar trend as companies continue to focus on sourcing local talent.

Jimmy Yu, general manager with Lanson Place Jinqiao Serviced Residences, said he still remembers when many multinational corporations withdrew all their overseas staff during the financial crisis in 2008.

But Yu is confident such harsh measures are unlikely to come this time.

“Many of our clients come to the city for projects ranging from six to nine months, which are the last to be affected,” said Yu.

The manager said that they’re “lucky so far to have a relatively high occupancy rate of 90 percent.”

The softening of demand from MNCs has resulted in fewer expatriates, especially those with housing budgets over 50,000 yuan per month. However, units priced in the mid-range of 25,000 yuan to 40,000 yuan per month are performing better with a larger pool of expatriates to pull from.

Additionally, the whole serviced apartment industry is noticing increased competition from the strata-title apartment market, especially for the longer-term stays of 12 to 36 months and particularly if local moves are involved.

For example, in the second year of residence, the individual is more familiar with the city and the options available to them, and more comfortable staying in non-serviced apartments leased by individual landlords, said Savills.

To diversify their business, serviced apartment operators have tried to tap into another segment of the market, namely the shorter-term stay. The shortest term that non-hotel licensed serviced apartments can provide is one month, according to the research.

Modena Putuo, operated by leading Frasers Hospitality, said half of its customers are short-term at its apartments in northwest Putuo District.

Research found that there are many ramifications of this strategy, like the shorter-term stays tending to have 15 percent higher nightly rates, but occupancy rates can be more volatile and seasonal, resulting in longer combined downtimes of units on an annual basis. Moreover, the shorter leases of some serviced apartments are encroaching upon the hotel industry, the main differentiator being the level of services provided by the hotels versus the level of privacy, less expensive nightly rates and larger units offered by serviced apartments.

Hotel operators have for a long time seen the opportunities in offering long-term packages in some of China’s second- and third-tier cities where there are few, if any, serviced residences. Even Shanghai has a number of hotels in more remote locations, which have no serviced apartment offerings, with a number of longer-stay clients, such as the Sheraton in Waigaoqiao.

This blurring of lines between hotels, serviced apartments and strata-title apartments will offer opportunities to the best properties, helping them to draw from a larger tenant pool, but will also result in increased competition, making it tougher for the weaker performers.

“Tenants, on the other hand, are the big winners with more options and flexibility,” said Macdonald.

Despite the drop in strata-title apartment rents by 0.5 percent during the second quarter, occupancy rates actually increased to nearly 88 percent, stemming from expatriates’ desire to secure larger units for the same cost. In order to save costs, many MNCs have begun seconding employees with smaller families.

Smaller units, one to two bedrooms, are found to be increasingly popular, as apartments in some projects with lower monthly rents of between 20,000 yuan and 25,000 yuan have seen rents rise 10 percent to 15 percent since the beginning of 2013.

Luxury residential projects in emerging areas, such as the North Bund area and Pudong’s Huamu area, are also becoming competitive compared with downtown projects.