Monitoring the trends of the Hong Kong property market now, to help their readers make critical predictions for what is to come:

Whole-block office sales in Kowloon East remain active

News

The regional real estate investment fund Pamfleet has sold The Mark, a 20-storey office building at 164 Wai Yip Street in Kwun Tung (Kowloon East district), to a local listed company for HKD560 million (USD72 million), or HKD8,000 per sq ft (USD1,026 per sq ft) based on a total floor area of about 70,000 sq ft. The buyer, Sitoy Group Holdings, a leather goods manufacturer, has mentioned that it intends to use the property as its own headquarters, as well as leasing out office space to commercial tenants. The two sides expect to complete the transaction by 30 June 2016. Pamfleet acquired the former industrial building in January 2014 from a private investor for HKD385 million (USD49.6 million). The Mark was Pamfleet’s second project in Kwun Tong after it had earlier developed the KOHO building on Hung To Road. (Source: Mingtiandi, 17 May 2016)

Agency view (Capital markets & investment services)

Gaw Capital is planning to sell the former Cheung Fai Industrial Building located at 133 Wai Yip Street in Kwun Tong, on which it has carried out a revitalisation project. In 2013, Gaw Capital commissioned MVRDV, a Dutch architectural firm, to convert the 192,857 sq ft industrial building into office, restaurants and shops. The renovated building could attract emerging businesses, such as tech firms and alternative office space providers that are looking for spaces that are stylish, community-oriented, and non-conventional work space. The price indication is about HKD2.5 billion or HKD12,963 per sq ft.

Research view

The latest transaction by Sitoy Group Holdings demonstrates that buying interest in whole-block office developments in Kowloon East shows no signs of abating. The transaction involving The Mark building has achieved a net price increase of 45% from the previous sale in January 2014. Assuming an average achievable office rent rate for the subject property of HKD22 per sq ft per month, the yield will be 3.3%, higher than the current overall Grade A office yield of 2.9%. The trend of companies with strong cash flows purchasing for owner-occupation should continue, as this is a long-term strategic move that reduces risks and increases annual operating cash flows by removing altogether the question of rental affordability

Relocation trend continues amid a deteriorating business environment

Agency view (Office services, Hong Kong)

The drop in retail sales has prompted some luxury fashion groups to look for cost savings options by downsizing or relocating their offices. For example, Chopard, a Swiss watchmaker and jeweller, has recently relocated from Causeway Bay to Kowloon, while other luxury brands are considering cost effective locations such as Wong Chuk Hang or Kowloon. Similarly, we have observed a minor shift in law firms moving to Island East as a result of a deteriorating business environment and rising rents in Central. This could ultimately be a new trend that may continue if PRC firms continue to lease space in the central district.

Agency view (Project management)

The leasing market on Hong Kong Island is highly competitive with prospective tenants running the risk of losing their target premises if they are not able to sign the paperwork and pay deposit payments almost immediately. The situation is obviously being driven by low supplies and higher demand. The knock-on effect of this is that tenants are holding back from the appointment of project managers until after lease execution.

Research view

Hong Kong Grade A office rents have been supported so far this year by a shortage of supply and demand from mainland Chinese companies for office space in Hong Kong. In consequence, we predict a 5% increase in Grade A office rents in 2016. However, over the medium term we doubt that these factors can outweigh strong pressure on the traditional large tenants in Central, as global banks and investment banks strengthen their capital bases and reduce their operating costs, implying staff reductions. We are therefore not surprised to hear that large financial groups are trying to surrender space. In our view, the outlook for the office property market for 2017 is tougher.

Office spaces being surrendered due to unclear economic outlook

Agency view (Office services, Kowloon)

Throughout last week, the team witnessed an increasing number of replacement stocks and potential options appearing in the market. This is indirectly led by the growth of mergers and acquisitions (M&A) activity that is taking place in Asia. According to EY Transaction Advisory Services, M&A deals should grow by up to 20% this year. Companies are currently very focused on reviewing their APAC strategies and restructuring their real estate footprints. In particular, sourcing business are relocating and consolidating their show room offices in other regions and trimming their expenses. The intention to reduce both their variable and fixed costs in driving a bigger cash flow for other business decisions is a priority for these companies. Generally speaking, businesses are reluctant to make early decisions; therefore we anticipate a rather unpredictable market ahead. To name a few, surrender spaces are primarily appearing in Grade A office buildings, such as Metroplaza in Kwai Chung, Tower 6, The Gateway in Tsim Sha Tsui, Langham Place in Mong Kok and Millennium City 6 in Kwun Tong.

On the other hand, a sizable relocation (with expansion) transaction has been confirmed in Kwun Tong. The tenant has been resident in the area for a long time and has decided to expand its footprint within the district as the environment matures. Buildings with sizable floor plate (over 30,000 sq ft gross) have a unique offering (i.e. key competitive advantage) to big occupiers providing a high utilisation rate in terms of floor usage. These buildings have been continuously under the radar of big occupiers across the city they include CDW Building in Kowloon West, Manulife Financial Centre and Goldin Financial Global Centre in the East districts. We believe their unique offering will continue to dominate the attention of big occupiers that are looking to consolidate operations especially in the low office vacancy environment of Hong Kong Island.

Hong Kong economic growth decelerated in Q1 2016

News

Hong Kong’s economy contracted in the first quarter for the first time since 2014, as weak consumer spending, falling exports and decreasing asset prices weighed on the city. GDP fell 0.4% compared to the previous three months. Year-on-year (YOY) GDP growth weakened to 0.8% in Q1 2016, which is less than half the rate of 1.9% in Q4 2015. Private consumption expenditure only grew 1.1% YOY and exports from Hong Kong dropped 3.9% YOY in Q1 2016. According to the World Travel & Tourism Council, tourism revenues in Hong Kong fell 8.4% in 2015. Overall home prices have deflated 12% since their September peak. (Source: Bloomberg, Financial Times, 13 May 2016)

Research view

The domestic sector has lost momentum in the first quarter and there is a risk of that momentum slowing further this year. Investment sentiment and domestic demand are overshadowed by a weak global market, the slowing Chinese economy and a volatile stock market. Hong Kong’s retail performance has been weighed down by declines in tourist arrivals along with the relative strength of the Hong Kong dollar. Retail sales continue to contract with another 6-7% decline this year, according to Hong Kong Retail Management association estimates. This follows a 3.7% decline in 2015. Colliers Research expects shop vacancies to increase amid failing sales, and rents of prime street shops could perhaps fall by a larger extent than our original estimate of 10% this year.