Financial firms here and abroad are moving into the International Financial Center (IFC) in Yeouido, Seoul, beginning next month. The center is being developed by AIG Global Real Estate in partnership with the Seoul Metropolitan Government with investment of $1.5 billion. / Yonhap

The Seoul office market is certainly drawing attention for the unprecedented – as well as the bold timing – of the building boom currently under way. The surge in construction deliveries since the fourth quarter of 2009 has caused availabilities to rise sharply at a time when most markets in Asia Pacific have begun to rebound.

In addition, weak economic conditions in the U.S. and Europe have heightened concerns about the global economy lapsing into a period of low growth or worse, a recession – and how they will impact South Korea and the entire Asia Pacific region. Yet, rapid office development in Seoul continues apace and is set to add more than 40 percent to Grade A stock over the next three years!

The Central Business District (CBD), which is the premier office market in Seoul, has largely been instrumental for the rise in vacancy rates. Robust business growth on the back of a resurgent economy, combined with historically low vacancies, has pushed office development to a blistering pace.

Hence, despite positive absorption, rampant construction in 2010 pushed up the vacancy rate to a record high of 18.4 percent. This unprecedented building spree has proven to be a boon for occupiers. After consistently rising since 2005, rent growth began to abate in 2010.

In addition, based on recent transactions completed in new buildings within the CBD, large concession packages including historically high free rent and generous work allowances have become a staple of the lease process.

In contrast, office markets in Gangnam and Yeouido have been relatively stable and quite tight even amid recent volatile global macro-economic conditions. Grade A vacancies in both markets remained at an ultra-low level of 2.0 percent through the first half of this year. Gangnam and Yeouido serve as niche markets particularly for information technology/pharmaceutical and financial firms, respectively, which have historically helped insulate them from market fluctuations.

Construction has been exceptionally robust in the CBD and Yeoido, where over 95.0 percent of the speculative projects totaling 1.8 million square meters are located. This wave of development represents a straight bet on South Korea’s economy. Demand for office space in the CBD and Yeoido has historically been highly responsive to improvements in the economy. However, leasing thus far has failed to keep up with the pace of economic growth. None of the new projects have been pre-leased through the second quarter.

Nonetheless, demand stands to pick up in the coming years along with a relatively sanguine near-term economic outlook for South Korea, as well as attempts among global policymakers to take measures to bolster a weakening global economic landscape. However, rapid absorption levels in the past decade will not likely be sustained.

While Seoul did not experience the boom and bust cycles as severely as other competing markets in the Asia Pacific region, market dynamics are set to change over the next three years.

We expect developers to be building faster than the demand for office space is increasing, which should keep vacancies elevated within the CBD and Yeoido over the next few years. At the expected range of absorption, in addition to an already above-average vacancy rate particularly for the CBD, we expect to clear the supply pipeline in three to five years and for Grade A vacancies for the entire Seoul office market to return to equilibrium (5-7 percent).

In the face of rising vacancies, rental rates are likely to slip further for both the CBD and Yeoido at least through next year. Meanwhile, low vacancies will sustain moderate rent increases in Gangnam that are at least in line with the growth rate of inflation.

For occupiers, such abundance of new supply on the horizon provides a wide range of options to upgrade, relocate, renew or expand at favorable lease terms particularly in the CBD and Yeoido.

However, this window will likely remain open right through to next year. We expect attractive rates among top-tier properties to continue to spur a “flight to quality” and help Grade A rates to stabilize in 2013. Therefore, vacancies are likely to surge at the bottom end of the market as tenants upgrade.