Once more into the breach in 2018

Hong Kong

In many ways, Hong Kong’s occasionally volatile property market is one of the most stable in the world. No matter what, it seems it performs the same way year in year out: it will be expensive. Admittedly Hong Kong isn’t alone this time around. “There’s been a huge run-up of asset values of equity markets worldwide, and there is a rising tide of concern that we’re due a correction at some point,” said Simon Smith, head of research for Savills in December, delivering the short version of 2018’s market forecast. Some of those concerns involve China’s debt, central bank deleveraging, and conflict in North Korea. “For us here in Hong Kong it’s more about a deleveraging China, as China begins to take down that debt market. That’s going to have an impact on economic growth, which could have consequences for both emerging market economies that feed China, but also places like Hong Kong. I think that’s probably the primary concern.” But what’s the long version?

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Down to business

The SAR was the most active investment market in Asia Pacific in 2017, largely due to PRC firms opening offices and propping up the Central office sector. That helped Hong Kong maintain its status as Asia’s premiere office market, and allowed all districts to reap the rewards. “Office rents in Central are 50% more expensive than in the next major global cities; 50% above major districts in New York and London. It’s an incredibly expensive place to have an office ‘downtown’,” said JLL’s head of Hong Kong markets, Alex Barnes. “Of course, we also have the biggest gap between Central and the next major office district.” Central office rents average roughly $118 per square foot per month, with Wan Chai/Causeway Bay coming in a distant second at $66 per squarefoot.

Causeway Bay

Two factors still drive the office market: decentralising is showing no signs of letting up, and co-working has just really started to blossom. New supply is concentrated in decentralised areas like Kowloon East and Wong Chuk Hang, and TST, Wan Chai and Causeway Bay remain options for MNCs looking to cut costs. “Every time someone leaves Central we find that the demand to backfill that space comes from Chinese corporates. It’s coming very quickly and it’s often coming before the space hits the market,” says Barnes. Is that backfill demand creating artificially high prices? “I don’t think so. It’s a supply-demand issue… If there’s anything artificial about the Central market it’s in how rents have not increased. Landlords are coming to grips with new demand drivers.” he noted. However, the likelihood of a rental spike is low.

A great deal of co-working spaces are outside prime central locations as well, and though it only accounts for approximately 5% of all leasing in the SAR, it will start to have an impact soon. Currently, 600,000 square feet of Grade A office space is occupied by co-working operators (Spaces, Garage Society, naked HUB) and another 500,000 square feet is under negotiation. That does not include operators in non-traditional retail locations and industrial buildings. The (expected) forthcoming second round of industrial revitalisations could look very different.

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The retail sector is once again reinventing itself. Crucial overnight PRC visitors rebounded in 2017, up 5.4% versus 2016 when they were down by 3.5%, and with them retail spending. Now that “retailtainment” is standard, diversity will be the next link in the rebound chain. Greater tenant mix will become the norm, and in prime malls, smaller shops leading to better variety — and higher turnover rents — are expected to boost the market according to Colliers International. Even the Pedder Building is considering multiple tenants as opposed to a single flagship store. Savills’ Smith sees a “return to form” for retail in 2018.

Hong Kong

On the homefront

Very simply put, home prices in Hong Kong have grown an eye-watering 450% since 2003. There are as many theories why are there are analysts, which are ultimately meaningless. With real interest rates remaining low, there’s a false sense of security out there. Employment is nearly 100%, GDP forecasts are strong, and the stock market is doing well. Most importantly, household income has risen from $22,000 to roughly $37,000 during the same period. Affordability looks good when prices are set against mortgages and rates, but is stretched once prices are set as an income ratio. That picture is far grimmer.

The residential sector is functioning on two tiers: the luxury end and the small lump sum flat. The luxury sector has been setting records, and will continue to perform well, and the wealth effect will help maintain mass sector price growth. “The increasing proportion of primary home sales that do not reflect true buying power and the prospects of further rate hikes eroding affordability probably weigh less than worries about market euphoria,” theorised Cushman & Wakefield’s Alva To, vice president and head of consulting, Greater China. “But we believe the positive factors still outweigh the negative factors at the moment." Joseph Tsang, managing director and head of capital markets at JLL. agreed. “Demand for mass residential will remain strong, though sales momentum will slow given the strong growth in housing prices this year and the expected interest rate rise. We believe residential capital values will rise by about 10% in 2018 but potentially by as much as 20% under the right circumstances.”

But Tsang is quick to point out the potentially fatal flaw in Hong Kong’s residential market: it’s weak secondary sector. Arguing it is time the government relaxed or amended its suffocating cooling measures, Tsang predicts continued low supply if the massive secondary market — 1.2 million units — isn’t unlocked, and unhealthy prices increases. Stamp duty collection and LTV ratios should be delayed for upgraders, and policy needs to make selling attractive to owners who are holding flats. Few healthy markets have as stagnant a secondary market as Hong Kong.

For 2018, Cushman & Wakefield is predicting a 10% residential price increase in the first half, with Colliers chiming in at 8-10% in the mass segment, Savills forecasting 5-10%, in luxury, and Knight Frank coming in with a modest 5% (8% in the luxury sector). “While we’re still in a period of negative real interest rates there will still be upward pressure on asset prices in Hong Kong,” finished Savills’ Smith. “That’s something we see continuing into 2018. That’s not going to change.”

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