Summary of HK Rental Pulse: Central Office Sluggish; Retail AEIs Help
Core Content
This report from Bank of America Merrill Lynch (BofAML) provides an analysis of the Hong Kong property market, with a focus on rental performance and investment outlook for 2013 and 2014. It highlights the sluggishness of the Central office market, the potential for positive rental reversions in decentralized areas, and the impact of retail asset enhancement initiatives (AEIs) on rental income.
Main Points
1. Rental Income Outlook
- Overall rental income growth in 1H13 was strong, with many developers and landlords reporting 10% or more growth.
- High-end retail showed particularly strong performance, with MTR's station kiosks growing by 40%, Hysan by over 20%, and HKL/Harbour City by 18-19%.
- Decentralized office rental income growth was 8-10% in 1H13, while Central office growth was considerably less.
- Retail rental income was up at a high single-digit rate, suggesting 20-25% type reversions in 2014.
2. Central Office Market
- The Central office market is sluggish and has not shown a strong rebound, due to financial market weakness.
- Landlords are willing to trade occupancy for spot rent in the short term.
- Citibank Plaza poses a medium-term competitive risk, with vacancy potentially rising to over 25% in 2014E.
- The predicted affordable level for Central office spot rent is HK$82 psf, or 7-8% below mid-2013 levels.
3. Office Market Trends
- Office spot rent growth has stalled on HK Island, partly due to the slow exodus from Central.
- Rental reversions are expected to moderate in 2014, from 30-50% in 2013 to 10-20%.
- Central office reversions could turn negative in 2H14, with HKL's average expiring rent at HK$107 psf versus spot rents below HK$100 psf.
- Uneasy equilibrium exists between Central and decentralized markets, with Central still more expensive.
4. Retail Market
- Retail sales growth in July was 9.5%, with 7M13 growth at 14.2%, but not strong.
- AEIs and trade mix upgrades have helped high-end retail maintain positive reversions.
- Times Square is expected to see a material uplift in spot rent following its AEI completion by year-end.
5. Investment Property Valuation
- Book NAV growth was 2-3% HoH in 1H13, with passing yields still solid at 4.5-5%.
- Book investment property valuations are generally reasonable, and fair valuation losses in 2014 are expected to be small.
- Cap rate changes are projected to increase, with retail cap rates rising by 50bps and office cap rates by 75bps in 2014.
Key Information
Table 1: HK Commercial Rental Outlook (2013E vs 2014E)
| Category |
2013E |
2014E |
| Central office rents |
0% |
0% |
| Office rent outside Central |
0-5% |
0% |
| Cap rate change |
0bps |
+75bps |
| Retail rents |
+5-10% |
0% |
| Cap rate change |
0bps |
+50bps |
Table 2: 1H13 Rental Income Growth for Developers/Landlords
| Company |
Overall |
HK |
China |
HK Office |
HK Retail |
| SHKP |
11% |
8% |
24% |
n/a |
n/a |
| CK |
11% |
n/a |
n/a |
10% |
14% |
| Henderson |
11% |
10% |
16% |
n/a |
n/a |
| Sino |
8% |
n/a |
n/a |
n/a |
n/a |
| Kerry |
9% |
7% |
11% |
n/a |
n/a |
| Wharf |
10% |
10% |
12% |
10% |
14% |
| Swire Prop |
7% |
7% |
20% |
5% |
7% |
| HKL |
9% |
9% |
n/a |
-8% |
~19% |
| Hysan |
+14% underlying |
+14% underlying |
n/a |
+10% underlying |
+25% underlying |
Table 3: 1H13 Rental Income Growth for Conglomerates/REIT
| Company |
Overall |
Station Kiosk |
Lee Theatre |
HKL |
Langham Retail |
Langham Office |
| MTR |
11% |
40% |
n/a |
n/a |
n/a |
n/a |
| Hutchinson |
14% |
n/a |
n/a |
n/a |
n/a |
n/a |
| Link |
8% |
n/a |
n/a |
n/a |
n/a |
n/a |
| Fortune |
+8% underlying |
n/a |
n/a |
n/a |
n/a |
n/a |
| Champion |
4% |
n/a |
n/a |
n/a |
n/a |
n/a |
Table 5: HK Office Rental Reversions
| Year |
Overall |
Central |
Wanchai/CWB |
TST |
HK East |
Kln East |
| 2013E |
23% |
7% |
37% |
39% |
45% |
65% |
| 2014E |
-2% |
-13% |
6% |
17% |
15% |
31% |
| 2015E |
1% |
-3% |
2% |
4% |
7% |
14% |
Table 6: HK Premium Prime Retail Rental Reversions
| Year |
Average Spot Rent (HK$psf) |
Rental Reversions |
| 2010 |
202 |
39% |
| 2011 |
230 |
39% |
| 2012 |
265 |
39% |
| 2013E |
281 |
23% |
| 2014E |
282 |
23% |
| 2015E |
282 |
6% |
Investment Recommendations
- Cheung Kong: Price objective of HK$131 (27% discount to forward NAV).
- Hong Kong Land: Price objective of USD7.35 (20% discount to 2014E NAV).
- Hysan: Price objective of HK$37 (40% discount to 2014E NAV).
- Swire Properties: Price objective of HK$26 (20% discount to 2014E NAV).
- Wharf: Price objective of HK$72 (20% discount to 2014E NAV).
Risks
- Downside risks include weaker-than-expected rental performance, interest rate increases, delays in project completions, and declines in property prices.
- Upside risks include stronger-than-expected rental performance, sale of non-core assets, and pre-sales performance in China.
Conclusion
The report suggests that while HK rental income growth remains solid, the Central office market is sluggish with limited spot rent growth. Decentralized office and high-end retail show more positive trends, supported by AEIs and trade mix upgrades. Investment property valuations are generally reasonable, and fair valuation losses are expected to be moderate. Cheung Kong and Swire Properties are highlighted as top picks, with positive price objectives. Overall, the HK property market is expected to remain range-bound with moderate rental reversions and increased cap rates in 2014.