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Sunday, Sep 20, 2020

Hong Kong’s protest-hit retail property market hasn’t seen the worst yet. Will shopping mall landlords finally slash rents?

In addition to the global trend of stiff competition from online retailers, Hong Kong shops have faced a sharp drop in mainland visitors and protest vandalism. Stocks of retail property owners are not yet at historic lows, showing the sector has not hit rock bottom

Just a cursory glance at the latest data on global commercial property transactions shows that the retail sector remains deeply out of favour with investors.

In a report on investment activity in the world’s leading commercial real estate markets in the third quarter of this year, property adviser JLL noted that the retail sector is still the least liquid, or actively traded, market. In the first nine months of this year, global retail transaction volumes fell 8 per cent year on year, compared with a 25 per cent increase in deals in the industrial sector.

The woes of the retail industry stem mainly from the huge disruption caused by the “Amazon effect” in the US and Britain – the world’s largest and fifth-largest retail markets respectively – as spending migrates from bricks-and-mortar stores to online channels, fuelling concerns about a “retail apocalypse” at shopping malls and on high streets.

In Hong Kong, the disruption is of a different kind and has been much more severe since the mass anti-government protests erupted in early June.

Retail sales in the territory plummeted more than 18 per cent year on year in September, following a record-breaking 23 per cent decline in August. The tourism industry, a pillar of the economy, has been decimated, with visitor arrivals down 34 per cent in September as mainland tourists – who account for 78 per cent of arrivals – fear for their safety.

Never mind the Amazon effect, Hong Kong’s retail industry is having to contend with violence and vandalism on a massive scale.

The unrest has dealt a crushing blow to a retail property market that was under strain long before the protests began.

Savills, another real estate adviser, noted in a report published last month that average prime high-street shop rents peaked as far back as the first quarter of 2013, and have since fallen 54 per cent.

This is in stark contrast to the dramatic increase in prime rents in core locations in Hong Kong’s office market over the past several years, particularly in Central, the world’s priciest office district.

While the decline in overall office rents has accelerated since the protests began, the retail sector entered the crisis in a much more vulnerable position. The “downturn has been a drawn-out affair,” Savills rightly notes.

In contrast to the 2014 Occupy protests, which were relatively peaceful and mostly confined to Central and Admiralty, the current movement is much more defiant and widespread, hitting retailers and landlords much harder and dragging Hong Kong into its first recession since 2009.

According to a report published by property adviser CBRE last month, the unrest caused overall Hong Kong high street rents to plummet 10.5 per cent quarter on quarter last quarter, the sharpest drop since the Asian financial crisis. This has forced some landlords to offer tenants temporary rental reductions of up to 20 per cent for three months or longer.

However, such concessions have so far done little to stem the rise in vacancies. As the crisis intensifies, the shock-absorbing capacity and readiness of Hong Kong’s retail property market is coming under intense scrutiny.

One of the biggest question marks is whether shopping centre landlords – most of whom, as reported by the Post last month, have so far resisted meaningful rent reductions – will start to adjust their rents and asking prices to better reflect the scale of the deterioration in the city’s retail occupier and investment markets.

While shopping mall owners are better placed to withstand the unrest because many of their properties derive a large share of their revenues from non-discretionary retail (and are often located in residential areas less exposed to the protests), landlords can ill-afford to stand firm, given the strong likelihood of a further escalation of the crisis and the unpopularity of the retail sector among international investors.

CBRE notes that, overall, shopping centre rents remained flat last quarter. Just as worryingly, capital values have barely declined since the protests erupted.

As I argued previously, Hong Kong’s excessively low rental yields – which currently stand at just over 2 per cent for prime retail assets, among the lowest globally – are putting the ravaged city at an even greater disadvantage to its main peers, particularly in Brexit Britain, where prime shopping centre yields have risen to almost 5.5 per cent.

Indeed, the only segment of Hong Kong’s retail property market that has repriced significantly is the shares of the listed landlords. The stock of Link Reit, one of the largest retail-focused real estate investment trusts, is down almost 19 per cent since early June. Yet, even the valuation discount in the equity market is not as attractive as it was at the end of last year, or in early 2016 when fears about China’s economy were rife.

The disruption in Hong Kong’s retail real estate market, while brutal for tenants, looks like it may have only just begun.

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