By most measures, Hong Kong’s residential property market is overpriced and the possibility of a large correction is much talked about. Indeed, prices are already coming down. Since reaching all time highs in 2013, transaction volumes have dropped to generational lows and prices have retreated by about 7% as the government’s cooling measures have started to weigh on the market. However, unlike others in the market, we think the risk of an outright collapse in residential property prices is unlikely.
Firstly, sharp corrections in Hong Kong’s residential market have historically been triggered by major external economic shocks: the US stock market crash of 1987; aggressive monetary policy tightening in China in 1994; Asia Financial Crisis in 1997; and Global Financial Crisis in 2008. With most economists forecasting moderate global growth over the next few years, barring a substantial policy misstep in China, an economic crisis is not our baseline scenario.
Secondly, holding costs for home owners remain low. As much talk as there has been on the tapering of QE and rising interest rates in the bond markets, the reality is that mortgage rates–which are closely tied to the US Federal Funds Rate–remain at extremely low levels. In fact the average mortgage rate in Hong Kong has actually fallen in the past
12-months as banks aggressively compete for business in an otherwise slow market. Furthermore, low interest rates limit investment alternatives with most Hong Kong investment properties generating positive carry. Not to mention there is plenty of debate as to how fast rates will rise and whether they will return to ‘normal’ levels at all.
Thirdly, supply remains low. While the government has been doing its best to ramp up supply, it is unlikely to get close to its annual target of 20,000 private residential units until 2016. The lack of supply in the primary sales market limits the amount of pressure placed on vendors in the secondary market, especially with some recent launches enjoying reasonable response rates. With government policy continuing to suppress demand, developers will need to continue to offer discounts to draw buyers into the primary sales market. However, the lack of motivation for sellers in the secondary market to lower prices significantly is likely to lead a gradual decline in prices over a prolonged period rather than a sharp correction. For bargain hunters, the wait may turn out being longer than they think.
Hong Kong: Office
- Leasing activity slows after a solid start to the year
- Rental decline in Kowloon East reverses gains recorded in 1Q14
- Government land sales market lends support to marginal capital value growth
Demand
Weak demand for Grade A office space contributed to net take-up slowing to 15,500 sq ft in 2Q14, down from 303,200 sq ft in 1Q14. Buoyed by smaller requirements (i.e. less than 5,000 sq ft) from the banking and finance sector and new PRC set-ups, net take-up in Central amounted to a market leading 79,600 sq ft. Beijing-based UCF
Corporate Financial Group leased a whole floor in Two Pacific Place in Admiralty to accommodate expansion plans.
Outside of Central, Wanchai/Causeway Bay and Hong Kong East were the only two office submarkets to record net withdrawals. With vacancy remaining tight in both submarkets – less than 2% in Hong Kong East – there was little room to cater for tenant expansion. Padded by sales transactions in strata-titled buildings, net take-up amounted to 24,700 sq ft in Kowloon East.
Supply
There was no new Grade A office supply completed in 2Q14. A commercial site in Tsimshatsui was released by the government for sale via public tender in June. Located at 15 Middle Road, the site covers an area of 28,309 sq ft and
has a maximum buildable GFA of about 339,700 sq ft. The purchaser is required to build a public car park with no less than 315 car parking spaces within the building.
Asset Performance
Kowloon East was the only major office submarket to post rental decline, reversing the gains recorded in 1Q14. The correction was driven by increased competition from refurbished industrial buildings and landlords shifting properties from the sales to leasing market. Capital values held firm across the market. Despite the pressure on rentals, capital values in Kowloon East continued to move higher on the back of owner-occupier purchases and strong government land sale results. In one of the largest transactions recorded this year, Citigroup purchased the East Tower of One Bay East in Kwun Tong for a record HKD 5.4 billion (about HKD 10,600 per sq ft), reportedly for its
headquarters. The amount is 20% more than that paid by Manulife for the West Tower in 2013. Meanwhile, First Group Holdings won the public tender for a commercial development site with a maximum buildable GFA of about 193,500 sq ft in Cheung Sha Wan for HKD 1 billion (Accommodation Value HKD 5,177 per sq ft).
12-Month Outlook
Demand for Grade A office space is expected to remain intact on the back of a moderately growing economy. Demand from PRC firms, along with the steady growth of the Finance Insurance Real Estate and Business Services sector should underpin rental growth in Central. However, rentals in Kowloon East are expected to face further downward pressure owing to increasing supply side competition. Rentals in the overall market are forecasted to grow modestly for the rest of the year. With rentals holding up and holding costs remaining low, vendors are unlikely to lower asking prices. With interest rates now expected to increase gradually rather than sharply, investors and especially end-users are likely to be on the lookout for opportunities, lending support to marginal capital value growth.
Hong Kong: Retail
- Retail sales retreat by 7% y-o-y in 2014
- Rental growth moderates across all prime retail assets classes
- Sales volumes up as investors target retail assets with value-add potential
Demand
The retail sector continued to show signs of a slowdown with total retail sales declining by 7% y-o-y in 2Q14. The decline was led by a 31.5% y-o-y drop in the sales of jewellery and watches, albeit off a high base of comparison caused by the spike in gold related sales a year earlier. The changing profile and spending patterns of Mainland Chinese tourists also contributed to the slower sales growth, with more same-day (lower spend) tourists visiting the city.
Despite declining retail sales, leasing demand in prime shopping locations remained largely intact. Mass market retailers, supported by sustained local consumption and the changing shopping patterns of Mainland tourists, remained optimistic towards expansion. Fast fashion retailer, Esprit, pre-leased three floors (17,944 sq ft) at Wings
Building in Central for around HKD 2 million per month while Korean cosmetics brand, Sulwhasoo, reportedly pre-leased a 9,400 sq ft space at Silvercord for around HKD 2.9 million per month.
Supply
No prime projects were completed in 2014.
Asset Performance
Sustained leasing demand and a tight vacancy environment in the city’s best shopping locations helped retail rents edge higher. However, with vacant shops starting to appear along some High Streets and sales slowing, retailers adopted a more measured approach in leasing negotiations. As a result, prime rentals remained broadly stable, edging up by less than 0.5% q-o-q in 2Q14. Activity in the investment market recorded a surprising pick-up with investors showing interest in larger sized premises with value-add potential in non-core locations. A portfolio of shops (15,088 sq ft) on the third floor of Diamond Square in Shun Tak Centre in Sheung Wan was sold to a Mainland investor for HKD 230 million. Link REIT sold four local shopping centres, including, the retail podium of Tung Hei Court (6,340 sq ft) in Shaukeiwan for HKD 72.9 million; Hing Tin Commercial Centre (28,313 sq ft) in Lam Tin for HKD 210 million; Kwai Hing Shopping Centre (24,664 sq ft) in Kwai Chung for HKD 438.839 million; and Wah Kwai hopping Centre (41,878 sq ft) in Aberdeen for HKD 518 million.
12-Month Outlook
With the decline in retail sales being mainly due to a higher base comparison brought about by higher gold prices at the start of 2013, retail sales are forecasted to return to growth in 2014. However, headwinds remain for the sector. The possibility of the government imposing a quota on visitors from Mainland China, for example, has the potential to affect the market negatively. On the positive side, international retailers, especially mass market retailers, remain keen on using Hong Kong as a springboard to enter the Mainland markets. Against this backdrop, we retain our forecast for rentals of prime retail assets to grow in the range of 0–5% in 2014. With holding costs remaining low and investors continuing to look for undervalued properties with value-add potential, we believe that capital values of prime retail assets should remain stable in 2014.
Hong Kong: Residential
- Sales market up slightly but still well below ‘normal’ levels
- Weak demand for leasing properties leads to further rental corrections
- Discounting at new launches continues to weigh on secondary home prices
Demand
In mid-May, the government relaxed conditions associated with the Double Stamp Duty (DSD) policy. Under the changes, second-home buyers can seek a refund of the DSD if their first home is sold within six months of the conveyance date rather than the sale and purchase agreement date of the new flat. For buyers upgrading through the
primary sales market, the grace period could potentially be extended from six months to a maximum of 36 months.
Demand for luxury units remained soft in 2Q14. Although 55 properties priced above HKD 50 million were transacted, up 3.8% q-o-q and 5.8% y-o-y, the figure was still below the ten-year (2004–2013) quarterly average of 73 transactions. Market activity in the overall market picked-up noticeably, albeit off a lower base of comparison, rising by 48.4% q-o-q and 39.9% y-o-y to 16,011 transactions.
The luxury sales market was highlighted by the launch of Grand Austin in West Kowloon and Mayfair By The Sea I and II in Tai Po, which were put up for sale towards the end of 2Q14. Response to these launches was positive. Over 60% of the 691 units at Grand Austin and over 40% of the combined 1,091 units at Mayfair By The Sea I and II were sold.
Properties seeking lower lump sum rentals attracted the strongest interest in an otherwise quiet luxury residential leasing market.
Supply
Nine luxury projects were scheduled to have been completed in 2Q14, providing 34 luxury units to the market.
Asset Performance
With buyers being drawn to the primary sales market, some vendors in the secondary market lowered asking prices, contributing to a mild 0.3% q-o-q correction in capital values. Lacklustre leasing demand, coupled with tight housing budgets, brought luxury rents down further by 2.3% q-o-q over the same period.
12-Month Outlook
Looking ahead, more new residential schemes are set to be launched for the sales market, keeping the primary sales market as the main focus of buying activity. In view of increased competition, developers are likely to need to continue to set prices at competitive levels and offer discounts to drive sales volumes. Price discounting in the
primary sales market along with interest rate uncertainty should continue to weigh on capital values. However, the decline in home prices forecasted for 2014 is now likely to be less severe than our earlier forecasts. As such, we have revised our forecast for luxury home prices to drop by 5–10% in 2014 instead of the previous 10–15%. Leasing activity is expected to remain quiet on the back of lacklustre expatriate hiring. Coupled with an increase in leasing stock amid a slow sales market, luxury rents are expected to fall further.
Hong Kong: Industrial
- Vacancy remains low with returning stock being quickly re-absorbed
- Large spaces with monthly rents below HKD 10 per sq ft see strong demand
- Owner-occupier purchases help push sales volumes and capital values higher
Demand
Visible trade improved slightly in 2014 with the total value of all exports and imports in April–May growing by 1.7% y-o-y and 3.1%, respectively. While headline trade numbers showed only moderate growth, air-freight cargo and container throughput volumes were up 7% y-o-y and 6.3% y-o-y, respectively, over the same two-month period.
In addition to the pick-up in external freight volumes, demand for warehousing space was also supported by on-going outsourcing requirements. Japanese 3PL Konoike Transport leased 58,500 sq ft in Gateway ts in Tsing Yi after securing a supply chain management mandate from a Japanese fast fashion brand while Arvato Digital Services leased the whole building at 18 Hoi Wah Road (172,600 sq ft) in Tuen Mun after being awarded a service contract with a German OEM.
Demand for warehousing space close to the Kwai Chung container port remained strong, especially for properties with floor plates over 40,000 sq ft and monthly rentals below HKD 10 per sq ft. Hong Kong-based freight forwarder, U-Freight (UFL) leased 39,100 sq ft in Gateway ts while Mitex leased 16,000 sq ft in Hopewell Logistics Centre in Kwai Chung. Both transactions were driven by expansion requirements.
Supply
There was no new supply completed in 2014. Supply will remain tight over the near term as no new supply is scheduled for completion until 2015.
Asset Performance
Landlords continued to leverage on the tight vacancy situation to push rentals to new record highs. In addition to properties in the Kwai Tsing area, strong rental growth was also recorded in secondary locations such as Tuen Mun, Fanling and Sheung Shui. Capital values continued to trend higher, buoyed by several larger en bloc purchases. Local retailers Bonjour and Chow Tai Fook each acquired buildings for owneroccupation; Bonjour acquired Harrington Building in Tsuen Wan for HKD 490 million and Chow Tai Fook acquired World Peace Centre in Kwai Chung for HKD 850 million, respectively. Logistics property fund, Goodman, acquired Central Textiles – a group of low rise industrial buildings – in Tsuen Wan for about HKD 1 billion; reportedly for redevelopment.
12-Month Outlook
Hong Kong’s visible trade is expected to steadily gather momentum over the next 6–18 months – growing by 4.7% in 2014 and 12.7% in 2015. The pick-up in external freight volumes should help offset any slowdown in demand from the local retail sector. Coupled with the absence of new supply, vacancy rates are likely to remain at low levels over the short term, supporting current rental levels. In view of the strongerthan – expected growth through 1H14, we have revised our full-year rental forecast up to a range of 5–10%. The change in interest rate expectations – most economists now expect rates to rise gradually and over a longer period of time – is likely to encourage more investors back into the market, especially owner-occupiers; something that we did not anticipate earlier in the year. With investor sentiment rising, warehouse market yields may potentially compress further given the positive spread over other industrial asset classes.
Hong Kong: Hotels 
- Visitor arrivals from Mainland China continue to show significant growth
- Hotel openings are primarily independently operated or local chains
- RevPAR growth is driven by improvements in occupancy and ADR
Demand
As at YTD May 2014, visitor arrivals continued to rise, recording a 13.6% increase on the same period last year. This is driven mainly by the Mainland Chinese market which registered 17.6% y-o-y growth. Notably, Japanese inbound visitation has improved by 3.4% y-o-y suggesting that ongoing political tensions between Mainland China and Japan are having a reduced impact on tourism. Regional markets such as South Korea (+17.5%) and Singapore (+16.4%) showed the most significant y-o-y growth as at YTD May 2014. As at YTD March 2014, visitors arriving for Meetings, Incentives, Conventions and Exhibitions (MICE) registered a 5.2% improvement y-o-y, indicating more events have taken place in the city. Leisure visitors continued to reflect a significant increase of 18.4% y-o-y during the same period. Hong Kong was voted as the Best City for Business Events for the third consecutive year in 2013, according to
the 2013–2014 readers’ poll conducted by CEI Asia, once again reaffirming Hong Kong’s status as a world class business city.
Supply
In 2014, according to the Hong Kong Tourism Board, 3,331 hotel rooms are expected to open. If all projects materialise, hotel room stock will increase by 4.8% y-o-y to 73,348 rooms. In 1H14, 843 hotel rooms have opened, all of which are independently operated or managed by local chains. Hotels to open in 2H14 include the 37-room A3
Hotel, the 29-room Residence G, the 547-room Dorsett Tsuen Wan, the 68-room The Pottinger and the 162-room Ovolo 64 Wong Chuk Hang Road. The majority of other hotels planned to open over the remainder of the year are relatively small in room count (below 150 rooms) and dominated by local brands.
Asset Performance
As at YTD May 2014, occupancy for luxury hotels in Hong Kong was registered at 79%, a 4.7 percentage point y-o-y improvement. Average Daily Rate (ADR) increased by 4.8% y-o-y to HKD 3,779 resulting in strong Revenue per Available Room (RevPAR) growth of 11.4% y-o-y to HKD 2,986. This indicates strong corporate and MICE visitation to the city. The moving annual average for RevPAR was registered at HKD 2,847 in May 2014, driven by robust occupancy and ADR.
12-Month Outlook
Despite headwinds facing some Asian economies, improvements in the United States and Europe bode well for corporate demand in Hong Kong although weak activity in the finance industry is likely to impact demand in the luxury hotel segment. Leisure demand to Hong Kong continues to be supported by inbound tourism from Mainland
China, although the Hong Kong government has voiced concerns about the strains that the rapid growth of tourism is having on its infrastructure. Nevertheless, Hong Kong will remain a vibrant business and leisure hub as its hotel market continues to trade exceptionally well although the pace of growth witnessed since the global financial crisis is likely to slow.