Financials / Hong Kong 1972 HK Financials / Hong Kong 22 May 2014

Swire Properties

Swire Properties Target (HKD): 31.60 Upside: 35.9% 1972 HK 21 May price (HKD): 23.25

Initiation: a large ‘nurturing reward’ awaits 1 Buy (initiation) 2 Outperform • We see Swire Properties benefitting greatly from the final phase 3 Hold of its approach to transforming locations 4 Underperform • Pacific Place and Taikoo Place are starting to enter this phase, 5 Sell while China, Miami and others are progressing towards it • Initiating with a Buy (1) rating and target price of HKD31.60

How do we justify our view?

See important disclosures, including any required research certifications, beginning on page 143

Financials / Hong Kong 1972 HK Financials / Hong Kong 22 May 2014

Swire Properties

Swire Properties Target (HKD): 31.60 Upside: 35.9% 1972 HK 21 May price (HKD): 23.25

Initiation: a large ‘nurturing reward’ awaits 1 Buy (initiation) 2 Outperform • We see Swire Properties benefitting greatly from the final phase 3 Hold of its approach to transforming locations 4 Underperform • Pacific Place and Taikoo Place are starting to enter this phase, 5 Sell while China, Miami and others are progressing towards it • Initiating with a Buy (1) rating and target price of HKD31.60

How do we justify our view?

We forecast almost a doubling of ■ Risks both its annual gross rental income The main risks to our view would be and NAV over the 2013-20 period, to a weakened economic outlook for HKD20bn and HKD85.60/share, Hong Kong and declines in the respectively. Moreover, there could importance of the locations that Jonas Kan, CFA be upside to our forecasts. Swire Properties focuses on. (852) 2848 4439 [email protected] ■ Catalysts The following are potential share- price catalysts for the next 6-12 ■ Investment case months. We initiate coverage of Swire Share price performance 1) An improved outlook for Hong Properties with a Buy (1) rating. (HKD) (%) Kong grade-A office demand and 27 105 We see the company as having a rents: Swire Properties is the 25 96 special approach to the property largest office landlord in the city. 23 88 business, which involves investments 21 79 2) Reduced concerns about the 19 70 in transforming key locations over a outlook for Hong Kong May-13 Aug-13 Nov-13 Feb-14 May-14 period of decades. We believe this is a commercial properties and a Swire Prop (LHS) Relative to HSI (RHS) long-term and backend-loaded growing recognition that Swire business model in which the biggest Properties is a good vehicle to benefits – what we call the “nurturing 12-month range 19.02-26.90 gain exposure to this sector. Market cap (USDbn) 17.54 reward” – kick in mainly in the last 3m avg daily turnover (USDm) 7.22 phase. The benefits come from having 3) Interest by investors globally in Shares outstanding (m) 5,850 a large and expanding portfolio in gaining exposure to a potential Major shareholder Swire Pacific (82.0%) some increasingly strong and relevant narrowing of the “Hong Kong locations where it dominates. discount” on property stocks. Financial summary (HKD) Year to 31 Dec 14E 15E 16E Revenue (m) 14,931 15,551 17,331 Stage is set for company to ■ Valuation Operating profit (m) 8,718 9,571 10,306 realise its ‘nurturing reward’. We have a 6-month target price of Net profit (m) 6,760 7,502 8,352 Swire Properties has made several HKD31.60, based on a 30% discount Core EPS (fully-diluted) 1.156 1.282 1.428 important and strategic investments to our end-2014E NAV of HKD45.10. EPS change (%) 6.3 11.0 11.3 over the past 6 months, which will Daiwa vs Cons. EPS (%) 6.1 9.0 17.0 We believe there are numerous PER (x) 20.1 18.1 16.3 drive a 40% expansion (ie, 8.1m sq ft factors underpinning the structural Dividend yield (%) 2.7 2.9 3.1 on an attributable GFA basis) in the rerating we expect for Swire DPS 0.620 0.680 0.720 size of the company’s completed Properties in the coming years. PBR (x) 0.7 0.7 0.6 portfolio over 2013-20. EV/EBITDA (x) 17.3 16.1 15.0 ROE (%) 3.3 3.6 4.0

Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 143

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  Swire Properties: gross rental income from key locations

Swire Properties has achieved strong growth in gross (HKDm) rental income from its investment properties over the 25,000 past 25 years (a CAGR of 13.3% since it completed the 20,000 development of One Pacific Place in 1988), without raising funds from new equity issuance. 15,000 10,000

Despite a much higher gross rental income base now, we 5,000 forecast gross rental income to rise by a 10.5% CAGR to HKD20bn over 2013-20, driven by plans to complete a 0 further 11.6m sq ft (8.1m sq ft on an attributable GFA 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E basis, ie, 40% of its current portfolio size) of new Greater Pacific Place Island East Festival Walk properties, as well as the continued maturing and Other HK properties China Miami strengthening that we expect for the company’s Source: Company, Daiwa forecasts investments in various locations.

 Valuation  Swire Properties: PBR

The stock is trading currently at a 48% discount to our (x ) end-2014E NAV of HKD45.10/share. We believe this 1.0 Average since IPO: 0.7x + 1SD: 0.8x discount does not give much credit to the company’s - 1SD: 0.6x decades of productive investments in various locations, 0.9 Current : 0.7x nor to the greater protection we believe its portfolio 0.8 offers to property industry downcycles compared with those of its peers. 0.7

0.6 We expect these locations (especially Greater Pacific Place in Greater Central and Taikoo Place in Island 0.5 East) to become stronger in the coming years and, along Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 with the company’s portfolio expansion programme, PBR Average +1 sd -1 sd drive up its NAV to HKD85.60/share by 2020. Source: Bloomberg, Daiwa forecasts

 Earnings revisions  Swire Properties: consensus EPS-forecast revisions (2014-15)

Our 2014-16 EPS forecasts are 6-17% above the (HKD) Bloomberg consensus ones. We think the consensus has 1.40 over-estimated the impact of competition from Citibank Plaza on Swire Properties’ Pacific Place (less than 5% of 1.30 the latter’s office leases are due to expire in 2014), and under-estimated the room for improvement for Swire 1.20 Properties’ rental income from Island East and China, as well as in its property-sales profit. 1.10

Also, we believe the market may not have appreciated 1.00 fully yet the potential of the company’s portfolio- Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 expansion programme set in motion for 2014-20. 2014E consensus EPS 2015E consensus EPS Source: Bloomberg

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Contents

Valuation: world-class property company at ‘Hong Kong discount’ ...... 8 Already a world-class property company, but yet to be priced as such ...... 8 Five catalysts underpinning a structural rerating ...... 8 Investment perspectives: a valuable franchise waiting to be monetised and recognised ...... 17 Investment thesis: market uncertainties provide buying opportunity for an unusual franchise ...... 28 1. Pacific Place has come a long way and its expansion into Wanchai South should open up new opportunities ...... 35 2. Island East: set to be the largest office hub outside Central ...... 51 3. Location transformation in China finally starting to work ...... 62 4. Other upcoming locations poised to become supplementary earnings and NAV drivers ... 79 5. Good vehicle to gain exposure to Hong Kong commercial properties, especially offices .... 88 6. A play on the potential narrowing of the ‘Hong Kong discount’ ...... 96 Appendix 1: Swire Properties’ approach to property business ...... 107 Appendix 2: Swire Group and Swire Properties ...... 113 Appendix 3: the Hong Kong office market ...... 115 Appendix 4: the Hong Kong retail property market ...... 119 Appendix 5: NAV and book value breakdown ...... 123 Appendix 6: portfolio breakdown ...... 132 Appendix 7: earnings and gross rental income breakdown ...... 136

Please also see: The Hong Kong Property Toolkit: A step-by-step guide to the past, present and future of the Hong Kong Property Sector Autumn 2013 Jonas Kan, CFA (852) 2848 4439 ([email protected])

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Financial summary

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Completed investment properties in 14.1 14.1 12.9 13.2 13.7 13.9 13.9 13.9 HK (m sq ft) Blended average rent in Pacific Place 61.9 63.2 64.9 70.9 75.5 79.6 84.1 88.8 portfolio (on GFA) (HKD/sq ft) Blended average rent in Taikoo Place 29.0 30.1 33.5 37.3 38.8 40.0 42.4 44.1 portfolio (on GFA) (HKD/sq ft) Completed investment properties in 1.6 1.6 1.6 4.8 6.0 6.9 7.0 8.9 China (m sq ft) Pay-out ratio (%) 0.0 0.0 80.3 50.6 55.2 53.7 53.0 50.4

 Profit and loss (HKDm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Gross rental income 7,433 7,875 8,557 9,015 9,677 10,187 11,098 11,905 Property trading 504 400 213 4,147 2,207 3,564 3,200 4,061 Other Revenue 255 596 811 890 1,052 1,180 1,253 1,365 Total Revenue 8,192 8,871 9,581 14,052 12,936 14,931 15,551 17,331 Other income 00000000 COGS (2,080) (2,261) (2,334) (3,770) (3,531) (4,924) (4,616) (5,583) SG&A (707) (911) (1,029) (873) (974) (1,032) (1,094) (1,160) Other op.expenses (210) (224) (222) (222) (244) (257) (270) (282) Operating profit 5,195 5,475 5,996 9,187 8,187 8,718 9,571 10,306 Net-interest inc./(exp.) (1,107) (1,237) (1,477) (1,367) (1,447) (1,505) (1,565) (1,628) Assoc/forex/extraord./others 245 584 890 453 500 643 771 1,035 Pre-tax profit 4,333 4,822 5,409 8,273 7,240 7,856 8,777 9,713 Tax (512) (940) (770) (1,199) (769) (1,052) (1,229) (1,311) Min. int./pref. div./others (95) (49) (267) (142) (111) (44) (46) (49) Net profit (reported) 3,726 3,833 4,372 6,932 6,360 6,760 7,502 8,352 Net profit (adjusted) 3,726 3,833 4,372 6,932 6,360 6,760 7,502 8,352 EPS (reported)(HKD) n.a. n.a. 0.747 1.185 1.087 1.156 1.282 1.428 EPS (adjusted)(HKD) n.a. n.a. 0.747 1.185 1.087 1.156 1.282 1.428 EPS (adjusted fully-diluted)(HKD) n.a. n.a. 0.747 1.185 1.087 1.156 1.282 1.428 DPS (HKD) 0.000 0.000 0.600 0.600 0.600 0.620 0.680 0.720 EBIT 5,195 5,475 5,996 9,187 8,187 8,718 9,571 10,306 EBITDA 5,405 5,699 6,218 9,409 8,431 8,975 9,841 10,588

 Cash flow (HKDm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 4,333 4,822 5,409 8,273 7,240 7,856 8,777 9,713 Depreciation and amortisation 210 224 222 222 244 257 270 282 Tax paid (380) (420) (485) (875) (615) (842) (983) (1,049) Change in working capital 240 285 415 153 167 179 221 316 Other operational CF items 636 671 139 (1,928) 808 299 296 (16) Cash flow from operations 5,039 5,582 5,700 5,845 7,844 7,749 8,581 9,246 Capex (3,045) (3,910) (5,265) (3,004) (7,398) (7,890) (7,220) (5,560) Net (acquisitions)/disposals0018,30500000 Other investing CF items (413) (425) (1,322) (1,367) (145) (165) (185) (190) Cash flow from investing (3,458) (4,335) 11,718 (4,371) (7,543) (8,055) (7,405) (5,750) Change in debt 00000000 Net share issues/(repurchases) 00000000 Dividends paid 0 0 (12,439) (2,340) (3,393) (3,510) (3,744) (4,154) Other financing CF items 685 750 4,157 (355) (1) (217) (223) (245) Cash flow from financing 685 750 (8,282) (2,695) (3,394) (3,727) (3,967) (4,399) Forex effect/others 00000000 Change in cash 2,266 1,997 9,136 (1,221) (3,093) (4,033) (2,791) (903) Free cash flow 1,994 1,672 435 2,841 446 (141) 1,361 3,686 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (HKDm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 965 1,042 1,180 1,940 2,521 2,521 2,730 2,827 Inventory 00000000 Accounts receivable 1,233 1,168 1,945 2,930 2,522 2,869 2,915 3,261 Other current assets 3,180 5,719 7,059 7,068 8,149 8,250 8,362 8,421 Total current assets 5,378 7,929 10,184 11,938 13,192 13,640 14,007 14,509 Fixed assets 3,742 6,333 6,615 6,837 7,225 7,381 7,768 8,155 Goodwill & intangibles 0 0 000000 Other non-current assets 164,619 191,450 201,435 218,285 231,540 237,707 243,738 249,114 Total assets 173,739 205,712 218,234 237,060 251,957 258,729 265,513 271,779 Short-term debt 32,253 9,322 8,630 4,664 7,589 7,609 7,609 7,609 Accounts payable 5,071 5,199 8,088 7,155 8,007 8,198 8,329 9,319 Other current liabilities 177 379 445 710 211 245 260 265 Total current liabilities 37,501 14,900 17,163 12,529 15,807 16,052 16,198 17,193 Long-term debt 3,198 28,556 20,250 26,197 26,946 30,959 33,959 34,959 Other non-current liabilities 19,975 3,900 4,246 5,078 6,054 6,235 6,350 6,480 Total liabilities 60,674 47,356 41,659 43,804 48,807 53,246 56,507 58,632 Share capital 4,582 5,690 5,850 5,850 5,850 5,850 5,850 5,850 Reserves/R.E./others 108,062 152,187 170,193 186,764 196,500 199,107 202,567 206,648 Shareholders' equity 112,644 157,877 176,043 192,614 202,350 204,957 208,417 212,498 Minority interests 421 479 532 642 800 526 590 650 Total equity & liabilities 173,739 205,712 218,234 237,060 251,957 258,729 265,513 271,779 EV 163,022 161,683 150,606 149,977 151,927 155,459 157,993 158,570 Net debt/(cash) 34,486 36,836 27,700 28,921 32,014 36,047 38,838 39,741 BVPS (HKD) n.a. n.a. 30.093 32.925 34.590 35.035 35.627 36.324

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 16.1 8.3 8.0 46.7 (7.9) 15.4 4.2 11.4 EBITDA (YoY) 9.6 5.4 9.1 51.3 (10.4) 6.5 9.6 7.6 Operating profit (YoY) 9.9 5.4 9.5 53.2 (10.9) 6.5 9.8 7.7 Net profit (YoY) 4.7 2.9 14.1 58.6 (8.3) 6.3 11.0 11.3 Core EPS (fully-diluted) (YoY) n.a. n.a. n.a. 58.6 (8.3) 6.3 11.0 11.3 Gross-profit margin 74.6 74.5 75.6 73.2 72.7 67.0 70.3 67.8 EBITDA margin 66.0 64.2 64.9 67.0 65.2 60.1 63.3 61.1 Operating-profit margin 63.4 61.7 62.6 65.4 63.3 58.4 61.5 59.5 Net profit margin 45.5 43.2 45.6 49.3 49.2 45.3 48.2 48.2 ROAE 3.6 2.8 2.6 3.8 3.2 3.3 3.6 4.0 ROAA 2.3 2.0 2.1 3.0 2.6 2.6 2.9 3.1 ROCE 3.7 3.2 3.0 4.3 3.5 3.6 3.9 4.1 ROIC 3.3 2.6 2.6 3.7 3.2 3.2 3.4 3.6 Net debt to equity 30.6 23.3 15.7 15.0 15.8 17.6 18.6 18.7 Effective tax rate 11.8 19.5 14.2 14.5 10.6 13.4 14.0 13.5 Accounts receivable (days) 48.7 49.4 59.3 63.3 76.9 65.9 67.9 65.0 Current ratio (x) 0.1 0.5 0.6 1.0 0.8 0.8 0.9 0.8 Net interest cover (x) 4.7 4.4 4.1 6.7 5.7 5.8 6.1 6.3 Net dividend payout n.a. n.a. 80.3 50.6 55.2 53.7 53.0 50.4 Free cash flow yield 1.5 1.2 0.3 2.1 0.3 n.a. 1.0 2.7 Source: FactSet, Daiwa forecasts

 Company profile Swire Properties is the property arm of Swire Pacific, one of the largest and oldest conglomerates in Hong Kong. The company is a leading developer, owner, and operator of mixed-use developments, principally commercial properties in Hong Kong, Mainland China, and the US. At the end of 2013, it owned some 20.2m sq ft attributable GFA of completed commercial properties and had a significant presence in 2 locations in Hong Kong: Admiralty (where it has built the Pacific Place) and Island East (Taikoo Place). Swire Properties was listed on the Hong Kong stock market in January 2012.

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The company’s investment-property portfolios in these 2 areas have continued to expand, such that we describe its Pacific Place portfolio as Greater Pacific Place, which include this development’s extension into the Wanchai area. The Taikoo Place portfolio originally centred on the Cityplaza area, but the company Valuation: world-class subsequently built another cluster of buildings on the western side of Cityplaza, by redeveloping its own property company at properties and acquiring old buildings in the area. We call these 2 clusters Taikoo Place. As at the end of 2013, ‘Hong Kong discount’ Greater Pacific Place and Taikoo Place had investment properties with 4.1m sq ft and 8.6m sq ft, respectively. “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Swire Properties started to invest in commercial properties in China in 2002, and had some 6m sq ft of completed investment properties in Guangzhou and “Why should I buy real estate when the stock market is Beijing at the end of 2013. In addition, the company so easy?” has had a business presence in Miami in the US since the 1980s, while in 2011 it bought a large piece of land — Warren Buffet in Miami city centre, where it is building a large-scale commercial mixed-use development, similar to Pacific Place in Hong Kong.

Already a world-class property Swire Properties planned to list on the Hong Kong company, but yet to be priced as Stock Exchange in 2010 but subsequently abandoned such the plan. Instead, the company sold one of its main non-core commercial property assets, Festival Walk, in July 2011 for HKD18.8bn, an amount comparable to Swire Properties is the property arm of Swire Pacific what it planned to raise through an IPO. (Not rated), which is one of the oldest and largest conglomerates in Hong Kong and has diverse In January 2012, the company was listed on the Hong businesses in Hong Kong and Asia encompassing Kong stock market by introduction, which did not aviation, marine services, and industrial and trading. involve the issuance of new shares. We regard this as Swire Pacific, in turn, is part of the Swire Group, which the beginning of Swire Properties’ entry into the was founded in 1816 and is owned by John Swire & universe of global property stocks, and believe that the Sons, a private company headquartered in the UK. company is in the early days in terms of gaining recognition from the global investment community and Swire Properties was established in 1972, when the being priced appropriately. closure of Taikoo Sugar Refinery released a vast area of land on the eastern side of Hong Kong Island. The company redeveloped this land into Taikoo Shing, Five catalysts underpinning a which is a classic example of a large-scale, mass- residential development. structural rerating

Swire Properties moved into the property investment As Swire Properties owns some of the most prime business in the mid-1980s, and is now one of the commercial property assets in 2 of Hong Kong’s main largest commercial landlords in Hong Kong. At the end key commercial hubs, has a high recurrent income base of 2013, the company had 20.2m sq ft of attributable (HKD10.1bn in gross rental income for 2013, including GFA in Hong Kong, China, and overseas. share of gross rental income from jointly controlled entities), and has a differentiated approach to the Swire Properties has a differentiated approach to the property business (which has generated an impressive property business that involves investing in return on capital in the past, and is on its way to transforming key locations over a period of decades. So becoming a scalable franchise applicable to many far, it has a strong presence in 2 major areas in Hong different cities in the world), we believe the company Kong – Admiralty (where it has built its Pacific Place has the potential to be recognised by investors as a portfolio) and Island East (where it has its Taikoo Place valuable property company within the global property portfolio). space over time.

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We think the case for this is stronger after taking into 1) Book value and market NAV estimates account that the company is now entering into what we understates the true NAV see as the most rewarding phase for its investments, It appears that sometimes market NAV estimates notably in Pacific Place and Island East, and has the change to rationalise the prevailing share prices. This ability to extend its strong Hong Kong property means NAV estimates are revised up when the stock franchise to several other cities. (We note that it has price is going up or vice versa. built up a sizeable presence in the Mainland and

Miami.) The share price of Swire Properties did not perform

well in 2013 (it fell by 35% between February 2013 and In our view, Swire Properties is still at an early stage of January 2014). Our view is that many market estimates gaining investor recognition as a high-quality company of the company’s NAV were conservative at that time. in the global property stock universe. This is because it As there have been concerns about the prospects for is trading currently at a substantial 48% discount to the property market since 4Q13, we believe the current our end-2014E NAV of HKD45.10 and a 33% discount market end-2014 NAV estimates factor in further falls to its end-2013 book value of HKD34.59/share, which in property prices in Hong Kong. we believe does not fully reflect the true market value of all the company’s property and hotel assets (see page However, we argue that the Hong Kong commercial 132). property sector is currently undergoing only an

adjustment rather than being at the beginning of a We also note that the stock is trading currently at a trend reversal: we expect property prices to be resilient significant discount to other premier names in global over 2014 and beyond. property in terms of valuation metrics such as PBR,

PER and P/NAV, reflecting that it is still perceived In the following table we introduce a new approach to mainly as a Hong Kong property stock. However, we analysing the NAV of Swire Properties as implied by its contend that there is the room for this “Hong Kong prevailing share price. This method can also be used to discount” to narrow and that Swire Properties has the analyse other Hong Kong property companies. The potential to be one of the pioneers in that process. emphasis of this approach is the implied blended psf

price for these companies’ property assets to avoid While our target price of HKD31.60 implies 36% controversy over the NAV estimates, and to facilitate upside potential, we believe that there is considerable easy comparison with prices in the physical market. room for the stock’s valuation to improve further from From our analysis, it is clear that the implied values of a long-term perspective. Overall, we expect the stock to Swire Properties’ property assets are at significant undergo a structural rerating in the coming years, discounts to their values in the physical market. underpinned by the 5 following catalysts.

1) An increasing realisation that Swire Properties’ Using this analysis, the current implied psf price of the book value and current market NAV estimate do not company’s investment properties is HKD7,872/sq ft fully reflect its true NAV. based on its 20.2m sq ft of completed investment 2) Greater recognition that the company has a solid property at the end of 2013. After taking into account and growing NAV, underpinned by a significant the properties it has acquired since the end of 2013 and expansion of its completed portfolio (of 40% or the investment properties under development (which 8.1m sq ft attributable GFA) between end-2013 and will take the size of its completed investment properties 2020. to 28.3m sq ft by 2020), the current implied psf price of Swire Properties’ investment properties is only 3) The recognition that Greater Pacific Place and HKD5,622/sq ft. Island East are 2 increasingly strong and relevant locations for commercial properties in Hong Kong. 4) An increasing appreciation of the economics provided by Swire Properties’ differentiated approach to the property business. 5) The expectation that the “Hong Kong discount” on property stocks will narrow over time and that Swire Properties has the potential to be one of the pioneers in this process.

We elaborate on these 5 catalysts below.

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 Swire Properties: implied psf prices of property assets We think this grossly underestimates the value of Swire Number of shares (m) 5,850 Properties’ property assets, given that they are among Share price (HKD) 23.25 Market cap (HKDm) 136,013 the most prime in Hong Kong. The following table Net debt at Dec 2013 (HKDm) 32,014 shows the achieved psf prices of some major Enterprise value (HKDm) 168,027 commercial-property transactions in recent years. Properties under development for sale @book cost (HKDm) 8,726 From this, it is clear that HKD5,622-7,872/sq ft Other businesses @cost (HKDm) - represents only a fraction of the prices achieved by Listed assets @cost (HKDm) - Implied value of investment properties (HKDm) = (a) 159,301 these assets. However, we believe that Swire Size of attributable completed investment properties (m sq ft) = (b) 20.2 Properties’ property assets in Pacific Place and Island Total amount of attributable investment properties (m sq ft)* = (c) 28.3 East are of a higher quality than many of these Implied psf value of completed investment properties** (HKD/sq ft) = (a)/(b) 7,872 transactions. Implied psf value of investment properties*** (HKD/sq ft) = (a)/(c) 5,622

Completed investment properties (m sq ft) Hong Kong 13.7 China 6.0 Overseas 0.6 20.2 Properties to be completed/acquired Hong Kong 2.2 China 3.8 Overseas 2.1 8.1 Total size of investment properties by 2020 Hong Kong 15.9 China 9.8 Overseas 2.6 28.3 Source: Daiwa estimates

 Hong Kong: major commercial-property transactions in recent years Price Implied Date Property Area Type GFA (sq ft) Buyer Vendor (HKDm) (HKD/sq ft) cap rate Remarks Jan 2012 Exchange Tower Kowloon East Office 348,620 China Construction Bank Sino Land 2,510 7,200 4.0% En-bloc May 2012 50 Connaught Road Central Office 180,000 Agricultural Bank of China National Electronics 4,880 27,111 3.5% En-bloc Dec 2012 Exchange Tower Kowloon East Office 195,875 Hang Seng Bank Sino Land 1,560 8,000 3.8% 7 floors Oct 2012 AIA Tower Island East Office 299,615 AIA Hang Lung Properties 2,398 8,004 3.6% En-bloc (previously Stanhope House) Feb 2013 113 Argyle Street Mongkok Office 328,866 Hang Seng Bank Nan Fung (unlisted) 2,900 8,818 3.4% En-bloc Apr 2003 West Tower, One Bay East Kowloon East Office 512,000 Manulife Wheelock 4,500 8,789 4.0% En-bloc, under- construction May 2013 Kowloon Commerce Centre Kwai Chung Office 116,756 China Mobile SHK Properties 1,027 8,800 3.0% 5 floors May 2013 Citibank Plaza Central Office 78,316 Champion REIT HKSAR Government 2,160 27,581 3.0% 4 floors Dec 2013 9 Chong Yip Street Kowloon East Office 136,595 Prosperity REIT Hutchison Whampoa 1,010 7,394 3.0% En-bloc Dec 2013 DCH Commercial Centre Island East Office 389,000 Swire Properties & an CITIC Pacific 3,900 10,026 3.8% En-bloc investment fund Jul 2011 Festival Walk Kowloon Tong Retail 1,195,248 Mapletree Investment Swire Properties 18,800 18,063* 4.6% En-bloc Jan 2013 The SHARP, Sharp Street East Causeway Bay Retail 44,500 Individual investors Soundwill 1,500 33,576 1.8% Strata-title sales Feb 2013 OLIV, 15 Sharp Street East Causeway Bay Retail 37,500 Individual investors Local family 1,450 38,800 1.5% Strata-title sales Jun 2013 Kingswood Ginza mall Tin Shui Wai Retail 665,244 Fortune REIT Cheung Kong Holdings 5,849 8,792 4.1% En-bloc Jan 2014 8 Russell Street Causeway Bay Retail 81,000 Individual investors CLSA Property Fund 2,500 30,864 1.9% Strata-title sales Source: Savills, CBRE, Hong Kong Economic Times, Daiwa Note: *For the retail portion

Meanwhile, we believe that current market NAV Properties’ gross rental income from China increased estimates for Swire Properties as well as many Hong 10-fold over the past 5 years, from HKD181m for 2008 Kong property companies do not give sufficient credit to HKD1,837m for 2013. to the value of prime commercial properties developed by them in Mainland China. The income-producing capability of these assets has clearly made a significant leap in recent years. We calculate that the sector’s gross rental income from China rose by 21.1% YoY for 2013, following a 27.1% YoY increase for 2012. Swire

- 10 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: gross rental income from China  Swire Properties: NAV (2014E) (HKDm) 2008 2009 2010 2011 2012 2013 NAV Blended Taikoo Hui Guangzhou 19 19 19 322 903 1,097 NAV (HKD/ Size price Taikoo Li Sanlitun, Beijing 163 239 325 457 469 526 (HKDm) share) (%) (m sq ft) (HKD/sq ft) INDIGO, Beijing - - - - 47 214 HONG KONG Daci Temple, Chengdu ------Greater Pacific Place, Greater Central Dazhongli, Shanghai ------Office 61,225 10.5 20.4% 2.4 25,374 Taikoo Hui, Dalian ------Retail 21,824 3.7 7.3% 0.7 29,539 181 258 344 779 1,419 1,837 - Residential/ serviced apartments 9,305 1.6 3.1% 0.4 21,000 Source: Company, Daiwa estimates - Hotel 4,976 0.9 1.7% 0.4 11,245 - Car parks 996 0.2 0.3% 98,325 16.8 32.8% 4.04 24,355 In addition, we believe investors are not giving Taikoo Place, Island East sufficient credit to the old building assets Swire - Office 90,944 15.5 30.4% 8.1 11,278 Properties has acquired over the years in the 2 areas - Retail 19,461 3.3 6.5% 1.5 12,983 where it focuses. These assets clearly provide - Residential/ serviced apartments 752 0.1 0.3% 0.1 12,000 - Hotel 2,070 0.4 0.7% 0.2 10,369 significant synergies to the company’s portfolio and can - Car parks 5,936 1.0 2.0% also enhance the capital and rental income prospects of 119,163 20.4 39.8% 9.83 12,128 its entire portfolio in these 2 areas. - Old building assets in Greater Pacific 7,077 1.2 2.4% 0.3 25,015 Place and Taikoo Place* While Swire Properties does not disclose its ownership Investment properties in Greater 224,565 38.4 74.9% 14.1 15,875 of these assets in its annual reports, details of some of Pacific Place and Taikoo Place these were disclosed in the 2 IPO prospectuses it issued Other locations in HK in 2010 and 2011. As details of these assets are in the Tung Chung 2,917 0.5 1.0% 0.27 10,760 Kowloon East 2,560 0.4 0.9% 0.56 4,612 public domain, we think NAV estimates should take Wong Chuk Hang 765 0.1 0.3% 0.19 4,000 account of the value of these “hidden assets”. We thus Other investment properties in HK 5,394 0.9 1.8% 0.76 7,074 conduct a detailed analysis of almost every single asset 11,636 2.0 3.9% 1.78 6,538 owned by Swire Properties and arrive at an NAV Investment properties in HK 236,201 40.4 78.8% 15.9 14,832 estimate of HKD45.10/share (see pages 123-131 for Development properties in HK 8,140 1.4 2.7% 0.8 9,690 HK property assets 244,341 41.8 81.5% 16.8 14,574 details). Mainland China Beijing 15,216 2.6 5.1% 2.4 6,307 Guangzhou 19,559 3.3 6.5% 3.8 5,126 Chengdu 4,556 0.8 1.5% 0.8 5,774 Shanghai 7,975 1.4 2.7% 1.7 4,597 Dalian - - - -- China property assets 47,306 8.1 15.8% 8.8 5,405

Miami, UK and overseas Miami commercial property assets 6,242 1.1 2.1% 2.6 2,364 Miami residential property assets 954 0.2 0.3% 2.6 370 UK hotels 798 0.1 0.3% 0.2 3,824 7,993 1.37 2.7% 5.4 1,473

Gross NAV 299,640 51.2 100.0% 30.9 9,684 Net debt (36,047) (6.2) NAV 263,593 45.1 Source: Daiwa Note: * Includes 82,909 sq ft of old building assets which can be identified and 0.2m sq ft GFA which we assume that it already owns ** Not yet includes its Dalian Bay project

- 11 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: NAV breakdown by usage (2014E) impact on portfolio values. This means there is NAV Blended NAV (HKD/ Size price considerable upside to the true NAV of Swire (HKDm) share) (%) (m sq ft) (HKD/sq ft) Properties over time, in our view. HONG KONG Greater Pacific Place and Taikoo Place 2) Increasing recognition that Swire - Office 152,169 26.01 50.8% 10.48 14,524 - Retail 41,285 7.06 13.8% 2.24 18,449 Properties has a solid and growing NAV - Residential/ serviced apartments 10,056 1.72 3.4% 0.51 19,885 Over the past 6 months, Swire Properties has - Hotel 7,046 1.20 2.4% 0.64 10,973 undertaken several important strategic investments, - Car parks 6,932 1.18 2.3% - - - Old buildings 7,077 1.2 2.4% 0.3 25,015 which we believe illustrate the company’s commitment 224,565 38.4 74.9% 14.1 15,875 to making a major push to upgrade and expand its Other locations in HK portfolio in several of the key locations in which it has - Office 5,584 0.95 1.9% 1.41 3,971 invested over the past years. - Retail 3,527 0.60 1.2% 0.29 12,346 - Residential/ serviced apartments 2,032 0.35 0.7% 0.04 50,000 - Hotel 352 0.06 0.1% 0.05 7,437 The company’s current expansion programme should - Car parks 141 0.02 0.0% - - expand the size of its investment properties portfolio - Old buildings - - - - - by 40% to 28.3m sq ft by 2020 (ie, by 8.1m sq ft on an 11,636 1.99 3.9% 1.78 6,538 attributable basis). We forecast it to drive almost a Investment properties in HK 236,201 40.4 78.8% 15.9 14,832 Development properties in HK 8,140 1.4 2.7% 0.8 9,690 doubling of both the company’s annual gross rental HK property assets 244,341 41.8 81.5% 16.8 14,574 income (compared with the 2013 level) and NAV to HKD20.3bn and HKD85.60/share, respectively, by MAINLAND CHINA 2020. - Office 9,583 1.6 3.2% 3.0 3,200 - Retail 34,686 5.9 11.6% 4.4 7,889 - Residential/ serviced apartments 285 0.05 0.1% 0.1 3,133  Swire Properties: expansion of its completed investment - Hotel 2,402 0.4 0.8% 1.3 1,893 properties - Car parks 349 0.1 0.1% - - (m sq ft) 47,306 8.1 15.8% 8.8 5,405 30

Miami, UK and overseas 25 - Office 1,144 0.2 0.4% 0.8 1,505 20 - Retail 2,494 0.4 0.8% 1.0 2,508 - Residential/ serviced apartments 1,299 0.2 0.4% 3.0 435 15 - Hotel 2,785 0.5 0.9% 0.7 4,063 10 - Car parks 271 0.05 0.1% - - 5 7,993 1.37 2.7% 5.4 1,473 Gross NAV 299,640 51.2 100.0% 30.9 9,684 0 Net debt (36,047) (6.2) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

NAV 263,593 45.1 2014E 2015E 2016E 2017E 2018E 2019E Source: Daiwa Hong Kong China Miami UK Source: Company, Daiwa forecasts In the preceding tables, we highlight our estimates of the blended average price of Swire Properties’ property Of this 8.1m sq ft expansion in attributable GFA, some assets. We believe these are not high relative to the 2m sq ft is in Hong Kong, and mainly comprises office current market prices. Also, they do not take into space in urban areas, something that is rare among account the potential for further increases in the values peers as the supply of property sites in urban areas of Swire Properties’ property assets in Island East, (whether commercial or residential) has been limited Pacific Place (including its Wanchai South extension), in Hong Kong in recent years. Note that even before we and other locations. take into account the contribution from the many new investment properties to be completed by Swire Our estimates do not reflect a lot of the value Properties over the coming years, the gross rental yield associated with the redevelopment potential of the on the market capitalisation of Swire Properties is company’s old building assets, nor do they factor in the higher than that of many of its peers. levers they have on the value of its portfolios in these 2 areas, as generally new properties have a positive



- 12 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: implied gross rental yield on market capitalisation vs. peers SHK Properties Wharf Swire Properties Hongkong Land Henderson Land Hang Lung Properties Number of shares (m) 2,724 3,030 5,850 2,353 2,699 4,479 Share price (HKD)* 101.40 54.00 23.25 7.01 49.00 23.45 Market cap. (HKD/m) = (b) 276,244 163,625 136,013 128,646 132,251 105,037 2003 gross rental income (HKDm) = (a) 16,019 11,133 10,146 7,975 7,307 6,638 Gross yield on market cap. (%) = (a) / (b) 5.8% 6.8% 7.5% 6.2% 5.5% 6.3% Source: Companies, Daiwa   Swire Properties: implied gross rental yield on market capitalisation under different scenarios Share price (HKD) 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 Number of shares (m) 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 Market capitalisation (HKDm) 117,000 128,700 140,400 152,100 163,800 175,500 187,200 198,900 210,600 222,300 234,000 245,700 257,400 269,100 280,800 292,500 Gross rental income for 2013 (HKDm) 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 10,145 Daiwa's forecast of its gross rental 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 20,033 income in 2020 (HKDm) Gross rental yield on market cap 8.7% 7.9% 7.2% 6.7% 6.2% 5.8% 5.4% 5.1% 4.8% 4.6% 4.3% 4.1% 3.9% 3.8% 3.6% 3.5% (on 2013 gross rental income) (%) Gross rental yield on market cap 17.1% 15.6% 14.3% 13.2% 12.2% 11.4% 10.7% 10.1% 9.5% 9.0% 8.6% 8.2% 7.8% 7.4% 7.1% 6.8% (on 2013 gross rental income) (%) Source: Daiwa

3) Increasing recognition that there is  Our estimated current blended average price of Swire considerable room for rises in capital Properties’ office properties versus peers (HKD/sq ft) values and rents in Greater Pacific Place 45,000 and Island East 40,000 While there are challenges to be faced by the mall in 35,000 Pacific Place (its retail sales growth has been stagnant 30,000 since 2013), we believe that, by and large, Swire 25,000 Properties has been successful in terms of making 20,000 Greater Pacific Place and Island East stronger and 15,000 more relevant locations over time. Most importantly, 10,000 the current rentals and capital values of its properties 5,000 in these 2 locations (especially offices) are quite some 0 way from being the most prime property assets in ABGFCDE Hong Kong, although we believe there are many factors Source: Daiwa in place that will narrow the gap. Given that the A = Our estimated prices for offices in Two IFC, Central in 2012 B = Our estimated current prices for offices in Two IFC, Central company owns a very sizeable – and growing portfolio C = Our estimated current blended average price for Swire Properties' offices in the – in these 2 areas, every HKD1,000/sq ft improvement Greater Pacific Place, Greater Central D = Our estimated current blended average price for Swire Properties' offices in the Taikoo in capital value would be a sizeable sum. Place, Island East E = Prices paid by AIA for AIA Tower (previously Stanhope House) in Quarry Bay in  Swire Properties: achieved rent in office properties vs. peers October 2012 - we see this as the bottom end for Grade A office capital values in Hong Kong now, given that this building is over 50 years old (HKD/sq ft*) F = Prices paid by Agricultural Bank of China for 50 Connaught Road Central in May 2012 140 G = Prices paid by the Champion REIT for the Government's 4 floors in Citibank Plaza in May 2013 120 100 4) Increasing appreciation that Swire

80 Properties’ approach to property offers ‘superior economics’ 60 While there are many owners of property assets in 40 Asia, our view is that not many of them have proved 20 themselves to be strong managers of property assets. 0 Even fewer can be said to have developed a type of ACBED franchise in their business. Source: Daiwa A = IFC, Central In our opinion, Swire Properties’ approach to the B = Blended average passing rent in all offices in Greater Pacific Place (on GFA) C = Spot rent for office rent in Greater Pacific Place (on GFA) property business can provide superior economics D = Blended average passing rent in all offices in Taikoo Place in Island East (on GFA) when it enters into the later stages of the E = Spot rent for office rent in Taikoo Place in Island East (on GFA) transformations of the locations it focuses on. Indeed, we believe there is a solid “nurturing reward” at the - 13 - Financials / Hong Kong 1972 HK 22 May 2014

end, while the risks the company faces may well decline unachievable, even given a sharp rise in its share price over time. This would serve to enhance the risk- from the current level. Moreover, as illustrated in the adjusted return offered by the stock over time and charts in the previous pages, we think there is should allow it to gain greater investor attention. significant potential for the achieved rents and capital values of Swire Properties’ property assets to improve, We believe there is significant room for NAV especially for its offices. enhancement in Swire Properties’ property portfolio over time. As the following table shows, the blended average prices for Swire Properties’ assets do not look

 Swire Properties: implied psf price of assets under different scenarios Share price (HKD) 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 Number of shares 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 Market cap (HKDm) 117,000 128,700 140,400 152,100 163,800 175,500 187,200 198,900 210,600 222,300 234,000 245,700 257,400 269,100 280,800 292,500 Net debt at Dec 2013 (HKDm) 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 32,014 Enterprise value (HKDm) 149,014 160,714 172,414 184,114 195,814 207,514 219,214 230,914 242,614 254,314 266,014 277,714 289,414 301,114 312,814 324,514 Other assets@ cost (HKDm) 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 8,276 Implied value of investment properties 140,738 152,438 164,138 175,838 187,538 199,238 210,938 222,638 234,338 246,038 257,738 269,438 281,138 292,838 304,538 316,238 (HKDm) Completed investment properties at 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 20.2 Dec 2013 (m sq ft) Implied value psf of completed 6,955 7,533 8,111 8,689 9,268 9,846 10,424 11,002 11,580 12,158 12,737 13,315 13,893 14,471 15,049 15,628 investment properties (HKD/sq ft) Total size of investment properties by 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 28.3 2020* (m sq ft) Implied value psf of all investment 4,971 5,385 5,798 6,211 6,624 7,038 7,451 7,864 8,278 8,691 9,104 9,517 9,931 10,344 10,757 11,171 properties (HKD/sq ft) Source: Daiwa Note: *Including those being acquired and under development

5) Increasing recognition that there is the Our view is that Swire Properties is still highly room for the ‘Hong Kong discount’ to undervalued in the global property stock universe. narrow and Swire Properties is one good Although it is not the cheapest Hong Kong property way to get exposure to this theme stock, we believe there are many factors that should allow it to command significantly greater business We believe the “Hong Kong discount” applied to value over time. property stocks, including Swire Properties, will narrow over the next 6-36 months. We identify 4 Indeed, we see the coming few years as a period when potential catalysts for this and summarise them below the company is likely to create significantly more (they are detailed later in the report). business and investment values. This is provided that it 1) Increased recognition that the Hong Kong property can execute well in various areas, such as Pacific Place’s stocks provide a value opportunity, especially to extension into Wanchai South, the creation of a new global funds that are value and long-term oriented. look for Island East, an improvement in the performance of its China assets, the building up of 2) Share buybacks by Hong Kong property companies, more strategic footholds in Kowloon East, and its foray which we think are tantamount to an arbitrage into the Miami commercial property market. between the prices of these companies’ property

assets in the physical market and their share prices. Overall, our view is that Swire Properties’ 3) M&A and privatisation activity. differentiated approach to the property business is akin 4) A new pool of investing capital coming into the to a franchise and this deserves the attention of sector from the Mainland. investors who are value- and long-term oriented.

We believe the first of these catalysts is the one most likely to emerge over the coming 6-12 months and see Swire Properties as a good stock for investors to gain exposure to this theme (discussed later in this report).

- 14 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: completed investment properties (m sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Hong Kong Greater Pacific Place 4.1 4.1 4.1 4.1 4.1 4.1 4.1 4.1 Greater Taikoo Place 8.6 8.8 8.8 7.7 7.7 8.7 8.7 9.8 Tung Chung 0.2 0.2 0.2 0.3 0.3 0.3 0.3 0.3 Kowloon East - - - - 0.6 0.6 0.6 0.6 Wong Chuk Hang - - - - 0.2 0.2 0.2 0.2 The Peak and Island South 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Other areas in Hong Kong 0.8 0.7 0.7 0.7 0.7 0.7 0.7 0.7 13.7 13.9 13.9 12.9 13.6 14.6 14.6 15.7 China Taikoo Li Sanlitun 1.2 1.5 1.5 1.5 1.5 1.5 1.5 1.5 INDIGO, Beijing 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 Taikoo Hui and Beaumode Ratil Podium, Guangzhou 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 Daci Temple project, Chengdu - 0.7 0.8 0.8 0.8 0.8 0.8 0.8 Dazhongli, Shanghai - - - 1.5 1.7 1.7 1.7 1.7 Dalian Bay project, Dalian ------1.0 1.0 6.0 6.9 7.0 8.5 8.8 8.8 9.7 9.7 Miami, UK and overseas Miami 0.3 0.3 1.1 1.4 1.4 1.4 2.7 2.7 UK hotels 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.6 0.6 1.3 1.6 1.6 1.6 2.9 2.9 Total 20.2 21.3 22.2 23.0 24.0 25.0 27.3 28.3 Source: Company, Daiwa

 Valuation: Swire Properties vs. global peers Share price Book value PBR PER (as of 21 May) Market cap per share Current 3y avg Last reported FY Prospective FY Company BBG code (local curr.) (USDm) (local curr.) (x) (x) (x) (x) Simon Property SPG US 174.4 54.2 18.5 9.4 8.22 41.1 37.7 Boston Properties BXP US 119.2 18.2 36.0 3.3 3.01 29.1 62.4 Mitsubishi Estate 8802 JP 2,384 32.7 958 2.5 2.17 51.4 53.2 SHK Properties 16 HK 101.4 35.6 148.9 0.7 0.79 14.0 11.4 Swire Properties 1972 HK 23.3 17.5 34.6 0.7 0.70 21.4 20.1 Hongkong Land HKL SP 7.0 16.5 11.4 0.6 0.58 13.0 19.2 Source: Bloomberg, Daiwa

- 15 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: estimated NAV by 2020 Normalised Price per Portfolio Gross Cap Blended Blended annual Attri. no. of room / car size rental rate rental ASP property PER hotel room / park Value (m sq ft) (HKDm) (%) (HKD/sq ft) (HKD/sq ft) sales profit (x) car parks (HKDm) (HKDm) (HKD/sh) Remarks Investment properties HK gross rental income 15.5 14,587 4.0% 78.4 23,527 - - - - 364,675 62.3 Does not factor in any further rerating for Greater Pacific Place or Island East China gross rental income 9.7 4,502 5.0% 38.7 9,282 - - - - 90,040 15.4 Plaza 66 retail's passing rent was already HKD115/sq ft (gross) in 2013 Miami gross rental income 2.3 944 5.0% 34.2 8,209 - - - - 18,880 3.2 Swire Properties’ project could well be the most prime commercial property in Miami city, the US 27.5 20,033 60.7 17,222 473,595 81.0 Development properties@8-10x normalised earnings HK 2,000 10 - - 20,000 3.4 Swire Properties made a total of HKD3.43bn in property sales profit in 2012 and 2013 by selling 131 units China 500 8- - - 4,000- 0.7- Swire Properties’ latest investment in Dalian marks the beginning of its property sales business in China Miami 1,000 10 - - 10,000 1.7 Swire Properties has over 15 years’ experience in developing properties for sale in Miami 34,000 5.8 Hotels HK 453 12 5,436 0.9 Langham HK hotel was valued at HKD14m/ room at its January 2013 IPO China 839 4 3,356 0.6 Miami 606 5 3,030 0.5 UK 266 10 2,660 0.5 2,164 14,482 2.5 Car parks HK 6,600 2.0 13,200 2.3 China 3,074 0.2 615 0.1 Miami 1,025 0.2 205 0.04 10,699 14,020 2.4 Total property assets 536,097 91.6 Normalised net debt (35,000) (6.0) Swire Properties’ net debt was HKD32bn at the end of 2013 and its 2013 gross rental had already reached HKD10.1bn NAV 501,097 85.6 Source: Daiwa

- 16 - Financials / Hong Kong 1972 HK 22 May 2014

Swire Properties’ business model is about Investment perspectives: a the creation of locations valuable franchise waiting to be On a risk-adjusted basis, probably the most attractive monetised and recognised way to build a strong portfolio is to acquire large pieces of land in locations that are not yet prominent but look “In business, I look for economic castles protected by likely to be transformed into locations that have the unbreachable moats.” potential to become increasingly strong and relevant over time. Importantly, entering a strong location early “Good businesses are the ones that in some way are should provide abundant benefits over time. This is reasonably sheltered from competition. That gets to because having a large and low-cost income-producing having what I call a franchise of some sort.” property portfolio in upcoming locations should put a company in an advantageous position in terms of — Warren Buffet participating in the future growth and expansion of that location. “Location, Location, Location” Carrying this to its logical extreme, the pioneer builder Traditional wisdom holds that the key to property is of a strong location should have a lot of credentials and location. It is therefore probably no coincidence that potential to dominate, or even almost own, the location some of the world’s most valuable property companies, over time. As strong locations often continue to expand such as Mitsubishi Real Estate, Boston Properties, etc., outward, it is arguable that the organic growth are characterised by their ownership of sizeable potential available to strong locations is tremendous. portfolios in locations that are strong and relevant, and able to stay so over time. Swire Properties has not officially articulated that it has such a strategy. Nor do we think it had any grand There are 3 ways to build such a portfolio. One is to strategy from the very outset when it entered into the inherit it, another is to buy it, and the third is to create property business. However, based on its actions over it. the past few decades, its business model in property has been precisely about transforming locations, which The most straightforward way to build a strong and give it the potential to own these locations over time. relevant portfolio is to inherit the land that can be used to achieve this. However, few property companies in (See Appendix 1 for a further discussion on what we see the world begin life with such rich endowments, and as Swire Properties’ approach for the property being the recipient of an endowment is not something a business, and Appendix 2 for management’s company can manage and cultivate. Buying is the next philosophy of Swire Properties and Swire Pacific). way to go. However, in practice, this is often difficult to buy given that such portfolios or sites are often not available for sale; and when they do come on the market, the law of competition is likely to dictate that the required capital would often be bid up to a point where the winners would have to take on considerable risk. The third way is to create it. In our opinion, this constitutes the essence of Swire Properties’ approach to the property business.

- 17 - Financials / Hong Kong 1972 HK 22 May 2014

 Pacific Place: past, present, and future

Source: Company, Google, HKSAR Government, Daiwa

- 18 - Financials / Hong Kong 1972 HK 22 May 2014

 Greater Pacific Place in Greater Central

Source: Company, Google, HKSAR Government, Daiwa

- 19 - Financials / Hong Kong 1972 HK 22 May 2014

 Island East: past, present, and future

Source: Company, Google, Daiwa

- 20 - Financials / Hong Kong 1972 HK 22 May 2014

 Taikoo Place in Island East

Source: Company, Google, Daiwa

- 21 - Financials / Hong Kong 1972 HK 22 May 2014

Simple to understand, but difficult to execute

Conceptually, the theory and economics behind Swire

Properties’ approach to property are quite simple and straightforward, and we think can be illustrated by the following diagram (for further details on the company’s approach to the property business, see Appendix 1).

 The economics of Swire Properties’ approach to property

Source: Daiwa

Essentially, we believe the starting point for Swire most prime commercial areas, the IRR could well Properties when it engages in property investment in accelerate to 25% or more over time – we believe that Hong Kong is to avoid bidding for land in what are this is the sort of IRR Pacific Place is achieving currently considered the most prime locations, where currently. the land is generally not cheap, except in exceptional circumstances. Rather, it opts to buy large chunks of We think Swire Properties’ approach to location land in what are currently regarded as inferior or transformation progresses through the following 4 unproven locations, where it believes that, given the stages. proper nurturing, should grow into at least a mid-range 1) Building a strategic foothold commercial area. 2) Nurturing Achieving this would probably be enough to give the 3) Upgrading and expanding project a reasonably good IRR of over 15% for the first 10-15 years. However, if the location continues to 4) Owning and growing a location improve and be upgraded to become comparable to the - 22 - Financials / Hong Kong 1972 HK 22 May 2014

We think the main merit of this approach is that it and credibility in this kind of pursuit is so far allows the developer to continue to expand its portfolio unmatched by any other. size in a particular location, while the positive impact new projects bring are not limited to the projects Equally importantly to note, in our view, is that this themselves. Instead, they would flow through the franchise does not seem to command much, if any, entire portfolio. value in Swire Properties’ current share price. In other words, investors now do not need to pay much, if Moreover, the very fact that Swire Properties has a anything, to get the goodwill and track record Swire critical mass of property assets or even certain Properties has meticulously built up in its decades-long dominance in each area in which it operates implies investments in various key locations. that it is better positioned than others to bid for old buildings and new projects in that area, thus boosting Admittedly, the business model practised by Swire the organic growth potential of its investment property Properties is not that glamorous, as the payback tends portfolio in the area, as well as its prospects for to be slow, gradual and back-end loaded. This dominating the area over time. approach excels in the aspects of certainty, prudency, reliability, and cumulative benefits, but it does not Seen in this light, one feature of Swire Properties’ produce the kind of excitement the stock market tends approach is that it gives the developer significant to like. This is probably one reason this franchise does leverage to the upside potential of the area, but at not seem to have commanded much value in the stock modest or even progressively declining risk. This market. constitutes what we see as the “alpha” inherent in the company’s approach to property. Swire Properties’ approach has generated impressive returns over time Has Swire Properties created a kind of Having said that, we believe the business value of such franchise? a franchise is large and genuine. True, the financial While Swire Properties’ approach to property may be performance of Swire Properties may not be super- conceptually simple, it is tremendously difficult to exciting in any particular 1 or 2 years, yet if we look execute, as the process can take many decades and closely at the results it has achieved over an extended requires a lot of patience and long-term planning to put period, one would probably come to the conclusion that into practice. To many corporations of our time, the the returns from Swire Properties’ business model have time horizon and management continuity required to been a lot better than they may first appear. And Swire adopt this kind of approach to the property business Properties is probably also a much more ambitious would be difficult to achieve, in our view. We know of property company than it may appear. no other player in Hong Kong that has a similar track record to Swire Properties in this kind of pursuit. Shown below is Swire Properties’ gross rental income Indeed, there may not even be a close parallel globally. since the completion of One Pacific Place in 1988, which we see as the starting point of Swire Properties’ Herein lies the key reason we think the shares of Swire differentiated approach to running its commercial Properties deserve the attention of investors, especially property businesses. The chart shows that over the past those who are conservative and long-term-oriented. 25 years, the group’s gross rental income has grown at We believe it is arguable that Swire Properties, in the a CAGR of 13.3%, notwithstanding that included in this course of making pragmatic and sensible responses to period were 6 years of a depressed property market the circumstances it faces (which include the many downturn from 4Q97 to mid-2003 (which saw grade-A anomalies related to Hong Kong property [see also our office rents plunge by as much as 70%). Hong Kong Property Toolkit in September 2013]), might have created a different approach to running the property business which is akin to the franchise it owns.

While it is debatable whether the business model practised by Swire Properties can be transferred to other districts or cities, we think the fact remains that Swire Properties has achieved impressive results in transforming at least 2 locations in Hong Kong (Admiralty and Island East) and that its track record

- 23 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: gross rental income from key locations  Swire Properties: rental income from HK East offices versus (HKDm) HK grade-A offices 12,000 (HKDm) Island East office rental (Rebased) 4,000 income outperforms the 3,000 10,000 Office Rental Index 2,500 8,000 3,000 2,000 6,000 2,000 1,500 4,000 1,000 2,000 1,000 500 0 0 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Greater Pacific Place Island East Festival Walk Island East office rental income (LHS) Other HK properties China Miami Island East office rental income - rebased (RHS) Source: Company, Daiwa Office Rental Index (Overall HK Grade A) - rebased (RHS) Source: CEIC, Company, Daiwa Equally important to note, in our view, is that over a longer duration of time, Swire Properties’ achieved More impressive still is that this high rental-income rental income growth for both Pacific Place and Island growth was achieved without the group having to use East has far exceeded that of the overall Hong Kong external equity. In fact, Swire Pacific has not raised any grade-A office index, as shown in the following charts. external equity since it was listed in Hong Kong in 1959. This brings us to one major point: the returns  Swire Properties: rental income from Pacific Place offices provided by Swire Properties’ approach are impressive versus Central grade-A offices indeed if seen over a long-term horizon. (HKDm) Pacific Place office rental (Rebased) 2,500 income outperforms the 1,400 At the end of 2013, the book value of Swire Properties’ Office Rental Index 1,200 2,000 investment properties stood at HKD213bn, of which 1,000 some HKD35bn was from its investment properties in 1,500 800 China. However, the bulk of it came from the 1,000 600 revaluation gains it achieved over the years, and we 400 500 200 estimate the cash cost of its investments at its 2 key 0 0 locations – Pacific Place and Island East – should be under HKD45bn, yet they generated some HKD8.1bn 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 in gross rental income in 2013, we estimate. Pacific Place office rental income (LHS) Pacific Place office rental income - rebased (RHS) Office Rental Index (Central Grade A) - rebased (RHS) For the company’s Pacific Place portfolio, we estimate Source: CEIC, Company, Daiwa that the cash cost was even lower, at under HKD4bn if we exclude hotels, yet it generated some HKD3.7bn in We attribute this outperformance to 3 main factors: 1) gross rental income in 2013, based on our estimates. Swire has been able to continuously upgrade these 2 locations, 2) Swire Properties’ dominance in the area  Swire Properties: property revaluation gains over the years and the nature of these properties being mixed (HKDm) developments have given them greater protection 30,000 during industry downturns, and 3) over the years, there 20,000 has been continuous expansion of the group’s portfolio in these 2 locations. 10,000

0

(10,000)

(20,000)

(30,000) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Company, Daiwa

- 24 - Financials / Hong Kong 1972 HK 22 May 2014

Does it have extra ‘alpha’ and a ‘nurturing For the approach practised by Swire Properties, we reward’ at the back end? believe that, generally speaking, new completions tend to have a positive impact on the existing portfolio in so In all, we would highlight that, if executed well, Swire far as they often enrich the entire portfolio, adding to Properties’ approach could be a highly profitable their critical mass, or even setting new benchmarks in model. Moreover, one more merit of the company’s terms of achieved rent. Overall, it appears to us that approach is that, once the location matures and the there is an “alpha” element in Swire Properties’ group’s portfolio size in the location has reached approach to property, and the value of such alpha is critical mass, the risk it faces should decline likely to rise over time and is back-end loaded. progressively. Also, as the size of Swire’s portfolio in the location continues to expand, the value of its Most importantly, we believe that such an alpha investment properties in the area should become element tends to become increasingly important when increasingly leveraged to the quality of the new the property asset enters what we see as phase 4 of completions in the area, and this could generate extra their development, which is what we think Swire returns for the company. Properties’ Pacific Place and Island East portfolio are

now entering.

 Swire Properties: industry positioning of various locations on which it focuses

Source: Daiwa

A good time to participate in the unfolding Taken together, the required investment for these of the ‘alpha’ and the ‘nurturing reward’ projects amounted to over HKD20bn, which we see as embedded in its approach? large and unusual for a company that has been well known for its conservative and gradual approach. Note In this connection, we think the developments at Swire also that Swire Properties has committed to such Properties over the past 6 months are worth noting. In sizeable investments against a background of retrospect, we would see the past 6 months as probably considerable controversy and uncertainties the most important period for Swire Properties since surrounding the property markets of Hong Kong and its listing as it was during this period that it made China. major decisions to invest in a number of projects that are likely to have profound significance and importance Our read of these moves (see below) made by Swire to the company over time (see table below). Properties in 4Q13 is that they signal a declaration by the group that it is determined to make a major push - 25 - Financials / Hong Kong 1972 HK 22 May 2014

forward in its investments in Hong Kong, China and Miami in the coming years. This determination is important to ensure that Swire’s investments in Pacific Place and Island East can leap forward to Stage 4, the most important and rewarding phase of their developments. (See also Appendix 1 on why we believe Swire Properties is entering the 4th and potentially most rewarding phase.)

 Swire Properties: key investments made in 2013 Time Investments Locations Remarks Mar 2013 A joint-venture led by Swire Properties (20% owned) won the tender for Tung Chung, The price was notably above market expectations and reflects that Swire Properties is keen developing the site next to its Citygate mall in Tung Chung Lantau Island to strengthen its strategic foothold on Lantau Island Jul 2013 Acquired a plot of land adjacent to its Brickell City Centre (BCC) project Miami Indicates that Swire Properties is keen to strengthen its strategic foothold in Miami for the purpose of building an 80-storey mixed-use tower as phase II of its BCC project Nov 2013 Won the tender for a site in Kowloon Bay to be developed into an office Kowloon Bay Indicates that Swire Properties is keen to secure a strategic foothold in Kowloon Bay tower of 0.55m sq ft GFA Dec 2013 A joint-venture led by Swire Properties (50% owned) acquired Dah Island East This building is located right next to its Oxford House and will notably strengthen Swire Chong Hong Commercial Centre from CITIC Pacific for HKD3,900m Properties' control over the area Jan 2014 Entered into a framework agreement to jointly develop a mixed-use site China Indicates that Swire Properties is keen to expand its presence in China. This is also the first for retail and apartments in Dalian Swire project in China that has a residential component to it Feb 2014 Acquired the remaining 20% interest of Taikoo Li Sanlitun, thus raising China The profitability of Taikoo Li Sanlitun has notably improved after having been opened for Swire's stake to 100% about 5 years Paid the government a land premium of HKD1,070m to convert an Wong Chuk Hang Indicates that Swire Properties is keen to secure a strategic foothold in Wong Chuk Hang in industrial site at 8-10 Wong Chuk Hang Road (50% owned by Swire Island South Properties) into an office development (about 0.38m sq ft GFA) Entered into an agreement with the SAR Government to acquire the Island East This has unified Swire Properties' ownership in Cornwall House and will clear the way for remaining interest in Cornwall House the redevelopment of its 3 techno-centres in Island East into 2 grade-A office buildings The redevelopment of its 3 techno-centres should a significant boost to the image and quality of Swire's Island East portfolio. This will result in the creation of a 69,000-sq-ft landscaped square at the heart of its Island East portfolio Source: Company, Daiwa

 Swire Properties: expansion of its investment property portfolio in coming years (detailed breakdown in Appendix 1) 2013 2020 (m sq ft) (m sq ft) Remarks Completed investment properties in HK Pacific Place 4.1 4.1 We have not factored in the redevelopment potential of its old buildings Island East 8.6 9.8 The 3 techno-centres will be replaced by 2m sq ft. of prime grade-A office space. There will be a 69,000 sq ft new landscaped square in Island East, and Cityplaza will be revamped Tung Chung 0.2 0.3 Citygate has become one of the most successful outlets and suburban malls in Hong Kong Kowloon Bay - 0.6 Many opportunities for further landbanking in Kowloon East in 2014-20 Wong Chuk Hang - 0.2 Wong Chuk Hang has the potential to become a new decentralised grade-A office area in Hong Kong Others 0.8 0.8 Many will benefit from the upgrading of Island East and will be monetised when opportunities arise 13.7 15.7 Both Pacific Place and Island East are on their way to becoming higher-grade commercial hubs by 2020 Completed investment properties in China Beijing 2.2 2.4 Taikoo Li Sanlitun should be the strongest mall in the embassy area, and INDIGO is located in an upcoming district in Beijing Guangzhou 3.8 3.8 Should remain one of the strongest, if not the strongest, high-end mall in Guangzhou over the next 5 years Chengdu - 0.8 The performance of the 2 malls managed by Wharf and Swire Properties at the heart of the Chunxi Road retail hub could symbolise the victory of modern malls over department stores and high-street retailing, which still dominate retail spending in China Shanghai - 1.7 Could drive the eastward expansion of the Nanjing Road commercial hub Dalian - 1.0 Swire Properties’ first China project that has residential flats for sale 6.0 9.7 Swire Properties’ attributable China portfolio could expand by over 4m sq ft if it buys out the stakes of its JV partners, as it did for Taikoo Li Sanlitun Completed investment properties in Miami, the UK, and other countries Miami 0.3 2.7 Swire Properties is on its way to becoming one of the largest landlord and residential developers in the Miami city centre UK and others 0.2 0.2 Swire Properties has its own hotel in the UK. Meanwhile, it has been looking at expanding into new cities such as Jakarta and Singapore 0.5 2.9 Total 20.2 28.3 Swire Properties will undergo an ambitious and sizeable expansion in Miami over the next few years

Gross rental income - Subsidiary level 9,653 18,222 Impressive, but even stronger if we take into account the additional contribution at the JV level which is not as obvious - Joint-venture level 492 1,811 Contributions from these areas would become even stronger and more visible if Swire Properties raises its stakes in them and turns them into subsidiary companies Total 10,145 20,033 Source: Daiwa

- 26 - Financials / Hong Kong 1972 HK 22 May 2014

In terms of business value, we believe Swire Properties’ approach offers significant upside potential over time and does not come with that much risk, whether in an operational or financial sense. As such, we think the stock deserves the attention of investors, especially those who are long-term-oriented and focused on solid fundamentals and business value.

In addition, we believe our investment thesis on Swire Properties might well give another perspective on the Hong Kong real-estate companies, as they generally have business values and asset values far above their stock-market valuations, and some have developed their own approach to the property business.

This leads to what we see as the other investment perspective on Swire Properties stock: it can be seen as a way to gain exposure to what we see as the potential narrowing of the “Hong Kong discount” in the valuation of listed property companies in Hong Kong.

- 27 - Financials / Hong Kong 1972 HK 22 May 2014

 Share price performance of Swire Properties vs. the HSI since Investment thesis: market listing in January 2012 (Rebased) uncertainties provide buying 180 opportunity for an unusual 160 franchise 140 120 “The future is never clear; you pay a very high price in 100 the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.” 80 60 — Warren Buffet Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Swire Properties HSI Back to where it all started Source: Bloomberg, Daiwa

With Swire Properties pursuing a differentiated approach to the property business (to the point that it Has the cycle really ended? Perhaps not resembles a special franchise), we see its public listing We do not think there has been any significant on the Hong Kong Stock Exchange in January 2012 (by deterioration in Swire Properties’ corporate way of introduction, with no new shares issued and no fundamentals over the past 12 months. If anything, we new equity capital being raised) as providing an believe the company’s prospects and position in the interesting addition to the universe of global property industry have improved considerably since then, as the stocks. group made various major investments in 2013 which should further strengthen its Island East portfolio and In retrospect, while the public listing of Swire secured for it a strategic foothold in Kowloon East. Properties did attract some market attention (its share price rose by 70% from the date of listing to February All things considered, we attribute the decline in Swire 2013), the stock’s outperformance has not been Properties’ share price since February 2013 more to sustained since February 2013. Indeed, after peaking at general concerns about the Hong Kong property cycle in HKD29.35 in February 2013, Swire Properties’ share the midst of a potential change in US monetary policy and price has drifted down and had corrected by some 35% the background of a considerable rise in prices and rents at one point, though it has recovered somewhat in for Hong Kong commercial properties since mid-2003. recent weeks.  Swire Properties: share price performance vs. other property  Swire Properties: share price performance since listing in investors since listing in January 2012 January 2012 (Rebased) (HKD) 220 35 180

30 140

25 100

20 60 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 15 Swire Properties Wharf Hang Lung Properties Hysan 10 Hongkong Land Great Eagle Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Source: Bloomberg, Daiwa

Source: Bloomberg, Daiwa In our view, the Hong Kong property sector is now entering a period of uncertainty and adjustment. However, upon closer inspection, we think the current situation for Hong Kong property is more complex and subtle than that, and that a lot of concerns have been more than discounted in the current valuations of Hong Kong property stocks. (See Appendices 3 and 4 on our analysis about the state of the Hong Kong office and retail property sector.) - 28 - Financials / Hong Kong 1972 HK 22 May 2014

There is now a disconnect between share  What is the current position of Hong Kong property? What the market seems to prices and the physical market be fearing The unwinding of a massive bubble We take the view that there is currently a disconnect Worst case Market in the doldrums for multi-years Base case Back to normal and steady growth path after the excesses at between the physical market and Hong Kong property some of the top-end assets have been removed and more mid- stock prices, in that the pricing of the property assets in end assets become available in the market the stock market seems to be far less than the value Optimistic case The correction and adjustment phase in the commercial property they command in the physical market. market ends in 6-12 months Very optimistic case The correction and adjustment phase in the commercial property market ends in 3-6 months While such a situation has existed for years, the gap has Source: Daiwa widened significantly in recent years, and we would attribute this as much to issues related to the capital Various factors at work to pre-empt the market as to fundamental issues in the physical formation of an asset bubble property markets. In all likelihood, the evolution of the Hong Kong property landscape in the next few years should be an In our opinion, this gap constitutes an anomaly and interesting development in the property industry. In potential mispricing whereby potential considerable retrospect, we believe that over the past 10 years, Hong investment value can be unlocked. (See also section 6 Kong property has had nearly all the favourable on page 96, as well as Hong Kong Property Toolkit.) ingredients available for the formation of a massive asset bubble. However, this also needs to be seen in the  Hong Kong: major investors’ PBR context that, immediately before the arrival of such PBR (x ) Weighted average PBR of six major investors “recipes for bubbles”, there was a 6-year depressive 1.6 property market downturn which was the most severe 1.4 Current PBR: 0.62x in Hong Kong in recent years; and the major players in 1.2 Hong Kong property still have vivid memories of that +1SD: 0.98x 1.0 downturn and would try hard to avoid it occurring 0.8 again. 0.6 -1SD: 0.63x 0.4 Average since We would note that the major players in Hong Kong 1990: 0.80x 0.2 property – be they developers, banks, government, 0.0 individuals, etc. – are no strangers to the boom and

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 bust in property, as many of them have been in the

Source: Company, Daiwa estimate industry for more than 4 decades and are survivors of some of the most severe property market crises the Now could just be an interim adjustment world has seen in the past. period in a structural upcycle which has Our view is that the major industry participants in yet to fully run its course Hong Kong property, by and large, have had a We believe that, fundamentally, now is an opportune responsible and sophisticated response to the time to accumulate premier commercial property unusually loose interest rate environment over the past landlords in Hong Kong, for the following reasons. few years. Nor was the valuation uplift over the last few years of commercial properties owned by the Hong First, now could just be an interim adjustment Kong property companies caused mainly by the low period of a structural upcycle which has yet to interest rates, in our view. run its course. We believe the Hong Kong property sector is undergoing a transition or adjustment Valuations of property assets prepare for currently, rather than a trend reversal. As a real-estate an eventual rise in interest rates market, Hong Kong’s current situation is unusual in many respects, not least in that there could be some In general, the cap rates valuers have used to value fundamental metamorphosis happening in the city’s rental properties in the territory have not changed that property landscape, with the position and relative much in the past few years despite the sharp drop in position of many areas being re-defined, driven by US interest rates. Hong Kong’s evolution from medium-sized city in Asia to being an integral part of China’s mega-sized In Hong Kong, apart from the REITs, the property economy. (See our Hong Kong Strategy report of 22 companies generally do not disclose the cap rates for March 2o13 for more details.) individual buildings. However, as the valuers used by the H-REITs are from the same group of international - 29 - Financials / Hong Kong 1972 HK 22 May 2014

property consultants used by the major property  Cap rate of various property assets of Sunlight REIT since 2007 (%) 4.62 companies, we believe the cap rates being used for the 4.50 4.80 5 4.50 4.50 4.50 4.50 4.50 properties owned by the H-REITs (we use Sunlight 4.50 4.80 4.40 4.40 4.40 4 4.21 4.47 4.40 REIT for illustrative purposes) are broadly similar to 4.20 4.00 3.85 3.81 4.20 3.85 those being used to value the property assets of the 3 2.07 Hong Kong property companies. We think this suggests 2 1.30 1.13 1.40 some bias towards the conservative side for the 1 0.36 0.26 0.38 0.38 valuation of the property assets of the major Hong 0 Kong property companies, given that the property Sep-06 (IPO 30-Jun-07 30-Jun-09 30-Jun-11 30-Jun-13 31-Dec-13 assets they own are generally of a higher quality than valuation) those owned by the H-REITs. 248 Queen’s Road East (office portion) Sheung Shui Centre Shopping Arcade Metro City Phase I 3M HIBOR In any case, our observation is that, changes in the 5YR Exchange Fund Notes valuations of rental properties in Hong Kong in recent Source: Company years have mostly been driven by changes in rents, and we think the following summary of the cap rates used Admittedly, rate hikes and US tapering are still issues for Sunlight REIT’s (435 HK, HKD3.14, Buy [1]) of concern for the Hong Kong property market and property assets during 2006-2013 reflects the situation property stocks. Our cap rate calculation model, faced by other listed property companies in Hong however, has always been based on normalised US Kong. interest rates which we assume to be 3.5%. Shown below are the details on how we derive our cap rates for By and large, the cap rate used to value Sunlight REIT’s commercial properties in Hong Kong and China. major property assets has been broadly unchanged over the past few years despite the 300bp-plus decline Our base case calls for a 4-6% gross cap rate for Hong in 3-month Hibor and the yield for 5-Year Exchange Kong commercial properties (currently, we do not use a Fund Notes in Hong Kong, showing that the changes in rate lower than 4% for any commercial property assets their valuations over this period were driven mainly by in Hong Kong) and for China, the range we use is 5-9% changes in achieved rents and the rental outlook. (currently, we also do not use any number lower than 5% for commercial properties in China). We see 4-6% For all the headwinds the Hong Kong property market for Hong Kong and 5-9% for China as still reasonable has had to face, it seems that many companies have ranges even under a situation of US interest rates anticipated the challenges and prepared for them. In normalising. our opinion, there are structural factors behind the across-the-board rise in rents and capital values in all  Our cap rate assumptions for Hong Kong commercial property Normal cases Hong Kong property asset classes since 2013, and low Exceptional Bottom Upper Exceptional interest rates may not have been the main driver (see cases end end cases also Hong Kong Property Toolkit). Normalised risk-free rate 3.50% 3.50% 3.50% 3.50% Risk premium for property assets 2.00% 2.00% 2.00% 2.0% Risk premium related to HK property assets' 2.00% 2.00% 2.00% 2.0% As such, what the industry is undergoing could be vulnerability to external factors merely an adjustment period to wipe out the excesses Risk premium related to government factors 2.00% 2.00% 2.00% 2.0% caused by the top end of the market having risen too Growth prospects -1.0% -0.5% 0.0% 0.0% far, too fast, rather than a reversal of the structural Asset enhancement/ redevelopment potential -1.5% -1.5% -1.0% -0.5% upcycle. Scarcity value -1.0% -0.5% 0.0% 0.0% Fiscal situation of the market participants -0.5% -0.5% -0.5% -0.5% Liquidity and soundness of the financial -0.5% -0.5% -0.5% 0.0% institutions Tax factor -0.5% -0.5% -0.5% -0.5% Liquidity and transparency factors -1.0% -1.0% -0.5% -0.5% Flow-through and rental adjustment -0.5% -0.5% -0.5% -0.5% consideration* 3.00% 4.00% 6.00% 7.0% Source: Daiwa Note: * the industry practice in HK is that landlords can charge tenants additional fees on top of the base rent to cover various expenses such as air-conditioning, security and cleaning etc. and it is possible that nearly all the gross rental income can be collected by the landlord. Meanwhile, the lease term in HK is short by international standards (generally 3 years) and there are few regulatory and institutional barriers against upward revisions in rents which work well for landlords in markets which have generally rising rents over time.

- 30 - Financials / Hong Kong 1972 HK 22 May 2014

 Our cap rate assumptions for China commercial properties  Range of office rents in Hong Kong Normal cases (HKD/sq ft)* Exceptional Bottom Upper Exceptional 140 cases end end cases 120 Normalised risk free rate 3.50% 3.50% 3.50% 3.50% 100 Risk premium for property assets 2.00% 2.00% 2.00% 2.0% 80 Risk premium related to the China property 2.50% 2.50% 2.00% 2.0% 60 sector 40 Risk premium related to government factors 2.50% 2.50% 2.00% 2.0% Growth prospects -4.5% -4.0% -2.5% 1.0% 20 Asset enhancement/ redevelopment potential -0.5% -0.5% 0.0% 0.0% 0 Scarcity value -1.0% -0.5% 0.0% 1.0% IFC II IFC

Fiscal situation of the market participants -0.5% -0.5% 0.0% 0.5% Land HK East

Liquidity and soundness of the financial 0.0% 0.0% 0.5% 1.0% Place Hysan tower Sunlight REIT Times Square Times Citibank Plaza Citibank Prosperity REIT Prosperity Prosperity Place Prosperity institutions East Island One Gateway Towers Gateway One Pacific Place Metropolis Tower Metropolis Exchange Square Exchange 248 Queen's Road Road 248 Queen's Tax factor 0.0% 0.0% 0.5% 1.0% *Based on GFA Centre Eagle Great Liquidity and transparency factors 0.0% 0.0% 0.5% 1.0% office Langham Place Flow-through consideration 0.0% 0.0% 0.5% 1.0% Source: Companies, Daiwa estimates 4.00% 5.00% 9.00% 16.0% Source: Daiwa  The range of retail rents in Hong Kong (HKD/sq ft) * The coming years should be favourable for 800 asset managers 700

Second, we would still see ample opportunities 600 for competent property asset managers and 500 developers, even if the industry enters a period of prolonged adjustment. It is important not to 400 overlook the fact that, for competent managers and 300 developers of commercial property assets, a stable 200 overall property environment is favourable for them, 100 perhaps far more so than the stock market seems to 0

have realised. CK HLP Swire SHKP Hysan MTRC Wharf HK Land HK Landmark Sino Land Sino New World Henderson Pacific Place Harbour City Harbour

We believe the range of capital values and rents in the REIT Fortune Sunlight REIT Sunlight The Link REIT REIT Link The Champion REIT Champion Hong Kong property sector are among the highest in Estates Chinese Metro City Phase 1 Phase City Metro the world, meaning that there is room for a substantial uplift in rents or capital values if the manager of the St Russell in shop st High asset can elevate the position of the property to a Arcade Shopping Shui Sheung higher category. This is especially the case for CWB/TST in st major in shop st High commercial properties where the supply outlook is Source: Companies, Daiwa estimates likely to remain constrained in the foreseeable future. Note: *Based on GFA

Indeed, we think we may be seeing some initial signs Third, even if the overall environment facing that the adjustment period for Hong Kong office the commercial property sector deteriorates, property is coming to an end. Our view is that Hong we believe Swire Properties’ position would be Kong’s office sector was the first among major Hong well-protected. This is because of its unique Kong property asset classes to enter an adjustment approach to property which creates what we refer to as period. If it turns out that Hong Kong office rents a “nurturing reward”, which we think will become more gradually climb out of the doldrums of recent years, visible in the years to come. this would bode well for the medium-term outlook for other property asset classes in Hong Kong (see also Indeed, one merit of Swire Properties’ approach to the section 5 on pages 88-95, as well as Appendices 3 and property business is that, to an extent, its approach can 4). counter-balance the cyclicality of the property sector — its portfolio’s performance tends to be more resilient during bad times, and when the good times arrive the company’s achieved rental growth should be helped by its improving position in the commercial property sector.

- 31 - Financials / Hong Kong 1972 HK 22 May 2014

 Achieved office rents in Pacific Place versus other major Fifth, the “nurturing reward” facing Swire buildings in Central and the overall market Properties is too big to be ignored by investors. (HKD/sq ft) From a broader perspective, we believe that now may 200 only be the beginning of a phase when Swire 150 Properties’ portfolios in Pacific Place and Island East reach critical mass and are on their way to moving up 100 further in their respective positions in the Hong Kong 50 commercial property market.

0 We think it is important to note that Swire Properties’

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 portfolios in both Pacific Place and Island East have One Pacific Place Citibank Plaza now grown to sizes that offer considerable critical One Exchange Square Central mass, with 4.1m sq ft GFA for Greater Pacific Place and Overall HK 8.6m sq ft for Island East at the end of 2013 (we Source: CBRE, CEIC, Daiwa exclude Somerset House which is under- redevelopment, and have not taken into account the  Achieved office rents in Island East versus other major buildings in Hong Kong and the overall market additional GFA from Swire Properties’ acquisition of a (HKD/sq ft) 50% stake in Dah Chong Hong Commercial Centre in 150 January 2014).

100 This means that the benefits related to upgrading the location can be magnified significantly as the benefits

50 related to any increase in rent or capital value in the area will be accorded to a vast portfolio of 4.1m sq ft in Greater Pacific Place and 8.8m sq ft in Island East (this 0 would rise to 9.8m sq ft of GFA if we add back the 1m 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 sq ft GFA from Somerset House that is undergoing a One Island East Devon House Central redevelopment. Note that 9.8m sq ft is before taking Hong Kong East Overall HK into account the redevelopment potential of the old

Source: CBRE, CEIC, Daiwa buildings Swire Properties has accumulated over the past 2 decades or more). Fourth, the portfolio expansion factor would also mitigate the impact of potential rate hikes Importantly, we believe that this “nurturing reward” and industry weaknesses. We believe the next few will take many years to unfold and there are factors years will be a period of major completions of new that may lead to this unfolding lasting for a decade or rental properties for Swire Properties, and we estimate more. Estimating the precise value of the nurturing that the size of its investment property portfolio will reward is difficult, but a conservative estimate of the expand by 40% from 20.2m sq ft at the end of 2013 to more concrete factors would amount to 28m sq ft by 2020. This volume expansion factor HKD11.60/share, in our view. Moreover, there are would mitigate any adverse developments in the Hong other important factors that we have not yet tried to Kong commercial property market, in our view. put a value on (see the table below).

 Swire Properties: expansion of its investment properties portfolio in the coming years* (m sq ft) 30

25

20

15

10

5

0 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Hong Kong China Miami UK

Source: Company, Daiwa; Note:*On attributable floor GFA - 32 - Financials / Hong Kong 1972 HK 22 May 2014

 Potential NAV enhancement for Swire Properties would take a decade or more to fully transform the HKDm HKD/share several major streets in Wanchai South. i) HKD3,000/sq ft rise in the blended capital value for its properties 12,111 2.1 in Greater Pacific Place (current assumption: HKD24,355/sq ft blended average) While for commercial reasons Swire Properties has not ii) HKD3,000/sq ft rise in the blended capital value for its properties 29,490 5.0 disclosed its hidden landbank of old buildings, we in Island East (current assumption; HKD12,128/sq ft blended average) believe that the number of old buildings it has acquired iii) HKD2,000/sq ft rise in the blended capital value for its China 17,504 3.0 in Wanchai South, Island East, and possibly the Mid- property assets (current assumption: HKD5,405/sq ft blended average) levels and other areas is sizeable, given that it has been iv) 0.3m sq ft more than our assumed GFA that can be developed 3,690 0.6 doing this for more than 2 decades. from its landbank of old buildings in Wanchai South v) 0.3m sq ft more than our assumed GFA that can be developed 2,520 0.4 In Swire Properties’ 2 IPO prospectuses, in 2010 and from its landbank of old buildings in Island East vi) HKD1,000/sq ft rise in the blended capital value for its 2,400 0.4 2011, the company disclosed some of the old buildings commercial properties in Miami it owned, and we see these providing strong synergies 67,715 11.6 with the existing buildings it owns in the area. vii) Swire Properties becomes one of the largest players in Kowloon ?? East commercial properties Specifically, we have identified 8 streets in Wanchai viii) Swire Properties becomes a leading force in the transformation ??South and 5 streets in Island East which we believe of Tung Chung and the Lantau Island offer considerable strategic importance to the viii) Wong Chuk Hang emerges as a decentralised commercial hub ?? and Swire Properties becomes a leading player in this location company’s Pacific Place and Island East portfolio. We ix) Swire Properties becomes a major niche player for high-end ??believe the additional Wanchai South component residential properties in Hong Kong would strengthen Swire Properties’ Greater Pacific x) Swire Properties becomes one of the strongest players in the ??Place portfolio and that the coming few years may well commercial property market of Miami xi) Swire Properties' approach becomes a scalable franchise which ??be the most exciting period in terms of the can be applied to many more cities around the world development of Island East as a commercial hub. Source: Daiwa In other words, we see 2020 as being still the early We see the coming years as an important and phases, rather than the peaks, for Greater Pacific Place potentially rewarding period for Swire Properties. On and Island East in terms of their positions as strong our estimates, the company’s projects on hand are commercial property locations. enough to ensure that it can enjoy a sustained increase in recurrent rental income and NAV (CAGRs of 11.6% Stock is trading at an attractive valuation and 9.8%, respectively) in the years up to 2020, with the potential for upside from: 1) a more rapid maturing We estimate Swire Properties’ true NAV to be of the various locations into which it has invested, 2) HKD45.10/share, and it is now trading at a hefty 49% the realisation of the potential from the “hidden assets” discount to our estimate of its end-2014E NAV. While on its balance sheet (such as the many old buildings it NAV-based valuations are subject to changes in owns that have redevelopment potential) and the brand assumptions, we do not see our assumptions as value from high-end residential developments, and 3) aggressive (see Valuation section on page 8). In any the potential for new investment opportunities for case, we believe Swire Properties’ current valuation is applying Swire Properties’ approach to the property low in terms of PBR and that its book value is business to more cities. conservative. We supplement our asset-based valuation with analysis about the yield on market capitalisation While we forecast Swire Properties’ gross rental income (gross rental income divided by market capitalisation). to reach the HKD20bn mark by 2020, the company is  Swire Properties: PBR likely to be still far below its peak in terms of gross (x ) rental income and asset value, even by 2020. This is 1.0 Average since IPO: 0.7x because we believe both Greater Pacific Place and + 1SD: 0.8x - 1SD: 0.6x Island East are just about to enter into the most 0.9 Current : 0.7x important and most rewarding phases of their development, with the redevelopments of the 3 techno- 0.8 centres (Swire Properties’ term for high-end industrial 0.7 buildings) in Island East due to be completed only by about 2019. 0.6

0.5 As for Greater Pacific Place, we believe that Swire Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14

Properties has several redevelopment plans in Wanchai PBR Average +1 sd -1 sd South which have yet to be announced, and we think it Source: Company, Bloomberg, Daiwa

- 33 - Financials / Hong Kong 1972 HK 22 May 2014

Outlined in the following table are our forecasts for Swire locations, 2) its greater protection against the property Properties’ gross rental income up to 2020. Based on the downcycle, and 3) its earnings and NAV growth company’s gross rental income of HKD10,289m for 2013 potential in the coming years. (including gross rental from joint ventures), it currently offers an 8.9% gross yield on market capitalisation. We We therefore initiate coverage of Swire Properties with a forecast this figure to reach 17.3% by 2020. Buy (1) rating and 6-month target price of HKD31.60, based on a 30% discount to our end-2014E NAV of  Swire Properties: yield on market capitalisation HKD45.1. Our target discount is in line with the 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E historical NAV discount of leading property investors Total gross rental 10,289 11,014 11,852 12,800 13,761 15,719 17,953 20,033 income (HKDm)* (a) such as Hongkong Land (not rated) and does not factor Share price 19.8 19.8 19.8 19.8 19.8 19.8 19.8 19.8 in any rerating related to the franchise value associated No. of shares 5,850 5,850 5,850 5,850 5,850 5,850 5,850 5,850 with Swire Properties’ differentiated approach to Market cap (HKDm) (b) 115,83 115,83 115,83 115,83 115,83 115,83 115,83 115,83 0 0 0 0 0 0 0 0 property. We also believe Swire Properties’ NAV is Gross yield on market 8.9% 9.5% 10.2% 11.1% 11.9% 13.6% 15.5% 17.3% increasing and that there is the scope for its NAV cap (%) discount to narrow over time. The key risks to our call Source: Daiwa are deteriorations in the economic outlook and office Note: * Including gross rental income at joint-venture level demand in Hong Kong. Besides, it is likely that there will

be considerable new supply of commercial sites in the Valuation affected by the ‘Hong Kong Kowloon East area, which could pose a threat to Swire discount’ Properties’ Island East portfolio. Retail sales growth in It is unfortunate that Swire Properties’ entry into the the Pacific Place mall was flat in 2013 and 1Q14 and this “harvesting phase” of its multi-decade investment in mall could be vulnerable to decline in luxury retail key locations coincides with a time when the Hong spending by mainland tourists and competition from Kong property sector is entering into a transition other high-end malls such as the IFC mall. period, and when Hong Kong property stocks appear to be facing an identity challenge as an asset class for Six reasons why now is the time to buy institutional equity investors (see section 5). Swire Properties

Our positive view on the outlook for Swire Properties’ However, we believe the commercial property sector’s share price is predicated on the following 6 factors. performance in 2014 will be more resilient than many expect, and that the merits and strengths of Swire 1) Pacific Place in Greater Central has come a long way Properties’ portfolio in Pacific Place and Island East will in terms of the location being upgraded, and its become increasingly visible to the market in the coming expansion into Wanchai South should open up years. We also think there are significant opportunities many new opportunities. available in the commercial property sectors of both Hong 2) Taikoo Place in Island East is undergoing a Kong and China (see also our analyses of the Hong Kong transformation that will see it become the largest office and retail property sectors in appendices 3 and 4). office hub outside Central. 3) Swire Properties’ approach to transforming We see scope for the high NAV discount in the locations is starting to bear fruit in China, where the valuation of Hong Kong property stocks to narrow, and company is set to become one of the largest players believe Swire Properties is a good vehicle through in commercial property. which to gain exposure to the potential investment 4) Various up-and-coming locations will serve as theme of a narrowing of the “Hong Kong discount” in supplementary drivers for growth in earnings and the valuation of the property stocks. NAV.

Hence, we believe that the uncertainties related to the 5) We see Swire Properties as a good vehicle through outlook of the sector provide a good opportunity to buy which to gain exposure to the Hong Kong Swire Properties, especially for conservative and long- commercial property sector, especially offices, term investors and those who view prime commercial which could surprise on the upside in terms of properties in Hong Kong and China as an attractive way demand and rent. to gain exposure to the potential scale of the country’s 6) We believe Swire Properties is a vehicle through which economy. to gain exposure to a potential reduction in the “Hong Kong discount” in the valuation of property stocks. In our opinion, Swire Properties’ prevailing valuation does not incorporate the following factors: 1) the credit We elaborate on these factors in the following section it is due for its decades-long investment in various of this report.

- 34 - Financials / Hong Kong 1972 HK 22 May 2014

Place’s extension into Wanchai South will take at 1. Pacific Place has come a long least 5 years to unfold fully. More importantly, way and its expansion into infrastructure developments and government policies may well result in many more opportunities Wanchai South should open up for commercial properties in the Admiralty- new opportunities Wanchai area in the coming 10-20 years.

The positioning of Pacific Place in Hong Kong’s Phase 1 (1989-2003): from unproven new commercial property sector has continued to change area to fringe Central over the years, which is unusual among commercial Everything started in an open land auction on 18 April property assets. In the mid-1980s, when Swire 1985, when Swire Properties acquired the first piece of Properties bought its 2 sites in Admiralty, the area was land for Pacific Place. This was a landmark event in the seen by many as one that was unproven for commercial history of Hong Kong property in that the city had just properties. It was, at best, fringe Central as a location started to emerge from a sharp property downturn that for offices, and simply a bold experiment as a location began in 1981 and market opinions were mixed at that for retail property. time as to whether the property sector was undergoing a short-lived recovery or a genuine renaissance.  The evolution of Pacific Place Period The location 1980s The former Victoria Barracks, a large piece of land close to the edge of Central A bold acquisition 1990s Pacific Place became recognised as one of the most high-end integrated The bidding in that land auction was fierce and the commercial property complexes in Hong Kong, with Pacific Place offices being bidding lasted hours. Indeed, the time from the first seen as a major office area in fringe Central 2000s It becomes an integral part of Central area and Pacific Place's eastward bid to the last set a record for a Hong Kong land expansion is driving the expansion of the boundary of Greater Central auction at that time. Swire Properties placed the By 2020 The eastward expansion into Wanchai South continues to improve the scale winning bid of HKD703m. This looks very cheap today and importance of this new cluster of commercial properties within the Greater Central area, which will be helped by the completion of 2 rail lines (South Island (amounting to less than one year of gross rental income Line by 2015 and Shatin-Central Link over 2018-20) from One Pacific Place alone, one of the two office 2030s Redevelopment of the 3 government buildings in North Wanchai and potentially towers in Pacific Place), but at that time the achieved some other sites could improve the scale and importance of this cluster in the Greater Central CBD price far exceeded market expectations. Source: Daiwa While Swire group has an image of being very We, however, believe that the evolution of Pacific Place conservative in managing its business, it has its own is important in understanding Swire Properties as a views on what is strategically important and has property company. For it is arguable that Admiralty exhibited considerable resolve when it sees an was the starting point as well as a force in shaping the opportunity present itself. In our opinion, the case of company’s differentiated way of running its property the Pacific Place site, as well as that of Tat Yee Avenue business. in 1993 (where it built Festival Walk), suggests that Swire Properties knows where its core competence in In this section we trace the development of Pacific property lies and it has a long-term vision of what it is Place in detail in order to illustrate 3 major points: going to build and own. 1. The transformation of an area is not a straightforward process. It takes a lot of effort to In 1986, Swire Properties completed its acquisition of position and fine-tune the property asset and Swire the site for Pacific Place by acquiring an adjacent site Properties has demonstrated that it has the for HKD1,050m. Altogether, Swire Properties paid requisite mindset and skills. HKD1,753m for the 2 sites, which have a GFA of 4.5m sq ft. This translates into an AV of HKD390/sq ft, while 2. There are many factors supporting the increasing we estimate that the total development cost of the importance of Pacific Place as a commercial hub, whole of Pacific Place was about HKD5.4bn, or and the business model practised by Swire HKD1,200/sq ft. Properties should give it some protection against an industry downcycle. Establishes itself as a distinct area for 3. Pacific Place has come a long way since its early commercial properties in the early 1990s days, but it is probably still far from reaching its Phase one of Pacific Place was completed in 1988 and peak. We think that Swire Properties has already Phase two in 1990. The timing of the completion of established Wanchai South as an extension of Pacific Place was not ideal, as One Pacific Place was Pacific Place, the whole area has opened up new completed just after the 4 June 1989 crackdown in opportunities for Swire Properties, and Pacific - 35 - Financials / Hong Kong 1972 HK 22 May 2014

Tiananmen Square, and the Hong Kong office market office space in Three Pacific Place was an important was facing an abundant supply of prime grade-A offices milestone in the evolution of the Pacific Place portfolio, in the early 1990s (Citibank Plaza, Central Plaza, and for the following reasons. Pacific Place were among the major buildings 1. By and large, the company has succeeded in getting completed at that time). Meanwhile, the positioning of the market to perceive Three Pacific Place as an Pacific Place mall was seen as too high end by some at extension of its Pacific Place portfolio. that time. 2. It has boosted the critical mass of office space in These challenges were overcome, and by the mid-1990s, Pacific Place by 40% to 2.2m sq ft, in addition to Pacific Place mall established itself as one of the top extending the catchment population of its mall and high-end malls in Hong Kong. Meanwhile, Pacific Place hotel properties in Pacific Place. had become recognised as a grade-A office area, albeit 3. It has enriched its Pacific Place office portfolio, as as a fringe Central location, with achieved rents being Three Pacific Place provides a cheaper alternative to at a discount to grade-A offices in Central, such as newcomers to the portfolio as well as existing Citibank Plaza and Exchange Square. However, by the tenants in Pacific Place. This has significant long- mid-1990s, Pacific Place was generally recognised as term implications for the organic growth potential one of the most high-end and successful large-scale of the Pacific Place portfolio, in our view. integrated mixed property complexes in Hong Kong. Rents for Pacific Place did not rise as fast and by as In common with grade-A offices in Central, Pacific much as for some premier grade-A office buildings in Place office rents came under pressure during the 6- Central during the phase of robust finance sector year downward spiral in grade-A office rents from expansion, from 2005-10. Apart from the fact that 4Q97 to mid-2003. However, during this downcycle Pacific Place has not been finance-centric in Pacific Place’s office space maintained a comparatively positioning in the past, we think this was partly more stable tenant profile than the major buildings in because it took time for the market to lease the Central. By not focusing on large, multi-floor additional space from Three Pacific Place and to get investment-bank tenants, it appears that the Pacific achieved rents there to be closer to those in its Pacific Place office portfolio did not suffer as much as other Place portfolio. Central buildings from the fierce price war that took place among Central landlords at the time. However, this could have been a blessing in disguise, as it has ensured that rents in the Pacific Place area are Phase 2 (2003-10): establishes Wanchai well-supported by tenants, which has also resulted in South as an extension of Pacific Place high tenant stability and stickiness, in our view. In our opinion, the completion of Three Pacific Place in 2004 was an important event in the evolution of Swire The benefits seem to have flowed in over the Properties’ Pacific Place portfolio. Although it was subsequent years, as Pacific Place office rents were located just a few minutes’ walk from Pacific Place, it relatively less affected by the global financial crisis and was separated by a road from Pacific Place. The the downsizing of the finance industry after 2009. prevailing perception was it that it was located in a not- so-desirable area on the fringes of Wanchai and the Indeed, the relative positioning of Pacific Place in the area therefore could not be seen as an extension of office market rose during the correction phase in the Pacific Place. Compounding the challenge was the fact Central office market (2012-13), which illustrates an that the timing of the completion of Three Pacific Place important characteristic of Swire Properties’ portfolio: was not ideal, in that pre-leasing had to start in about its achieved rent tends to be more resilient during a 2002, when Hong Kong was still struggling with the downturn, and it is often during uncertain times in the economic recession that started in 1998. sector that the relative positioning and image of the company’s portfolio would improve. However, Swire Properties did what it could to integrate Three Pacific Place into the Pacific Place Phase 3 (2010-now): Pacific Place becomes portfolio (by building a pedestrian walkway linking it a more important commercial hub, with a with the Admiralty MTRC Station and the Pacific Place, narrowing rental gap with Central and improving the ambience of the area surrounding While office rents in Citibank Plaza used to range from the building), and eventually it was leased out, mainly HKD10-20/sq ft above those in Pacific Place in the past, to multinational corporations and international the situation has reversed in recent years, with rents at tenants, such as Societe Generale, Philips, and Bank of One and Two Pacific Place becoming HKD10-20/sq ft New York. In our opinion, the leasing out of all the

- 36 - Financials / Hong Kong 1972 HK 22 May 2014

above those at Citibank Plaza. As such, in terms of from being in a new area of fringe Central into an achieved rents, that for Pacific Place in recent years has integral part of the Greater Central office market. In become comparable to the premier buildings in Central, addition, its achieved rent is close to many premier excluding the 5 newest AAA buildings (One and Two buildings in Central (such as Exchange Square) that IFC, Chater House, Cheung Kong Centre, and AIA used to command a considerable rental premium to it. Central), which are much newer properties. We expect the relative strength of Pacific Place to be at  Achieved office rent in Pacific Place vs. other major buildings least maintained. Apart from the HKD2bn in Central and the overall market “contemporisation programme” for Pacific Place, which (HKD/sq ft) was initiated by Swire Properties and has given the 200 mall and offices a new appearance (refurbishment of 150 the mall has been completed while that for the two office towers will be wrapped up in about 6 months’ 100 time), there will be continuous new developments to 50 strengthen the Pacific Place portfolio.

0 Projects that have been completed include 28

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Hennessey Road and 8 Queen’s Road East, which One Pacific Place Citibank Plaza added some 0.15m sq ft and 0.08m sq ft of GFA, One Exchange Square Central respectively, to Swire Properties’ Pacific Place portfolio Overall HK in 2013. The floor plates of these buildings (at less than Source: CBRE, CEIC, Daiwa 10,000 sq ft/floor) are smaller than that of Pacific Place, and as such are somewhat different products.  Achieved office rent in Pacific Place vs. Exchange Square From the perspective of the evolution of its Pacific Prem/(Disc) 10% Place portfolio, we see the additions of these types of 0% buildings to the Pacific Place portfolio as a positive step -10% -20% for the following reasons. -30% -40% 1) They enhance the choices its Pacific Place portfolio -50% offers to prospective tenants. -60% -70% 2) We believe that demand for office space in Central -80% in the future will be greater for small spaces,

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ranging from 3,000-5,000 sq ft. In hindsight, Sheung Wan would be the most natural location One Pacific Place vs One Exchange Square for the emergence of more of these buildings.

Source: CBRE, CEIC, Daiwa However, as there seems to be no major landlord working on building up a more sizeable portfolio in  Achieved office rent in Pacific Place vs. Citibank Plaza Sheung Wan, it appears to us that most of this Prem/(Disc) demand will go to Wanchai South in the future. 30% 20% Ability to expand continuously is 10% important to a commercial portfolio 0% In our opinion, it is important not to underestimate the -10% impact of size expansion and the continuous upgrading -20% of a commercial portfolio. The following chart shows -30% the gross rental income of the Pacific Place portfolio

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 compared with that of the Hong Kong grade-A office market. It illustrates that the growth in Swire One Pacific Place vs Citibank Plaza Properties’ gross rental income from Pacific Place since its completion has been far greater than the rise in Source: CBRE, CEIC, Daiwa grade-A office rents over the corresponding period

(since 1989). In other words, after being open for more than 20 years, and despite the competition from many new buildings in Central and other locations, Pacific Place has remained an important building and has developed

- 37 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: rental income from Pacific Place offices vs. Indeed, we believe that the strategy of Swire Properties Central grade-A offices is to anchor phase one of its project with a sizeable (HKDm) Pacific Place office rental (Rebased) retail component, while the subsequent expansion of 2,500 income outperforms the 1,400 Office Rental Index its portfolio is often driven by having more office 1,200 2,000 space . 1,000 1,500 800 Once the size of an office property in an area reaches 1,000 600 400 critical mass, it tends to have a positive impact on the 500 200 relative appeal of the location, so that a continuous 0 0 upgrading of the area can develop into a self- perpetuating process. Importantly, this appears to be 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Pacific Place office rental income (LHS) the current situation with the Pacific Place portfolio. Pacific Place office rental income - rebased (RHS) Office Rental Index (Central Grade A) - rebased (RHS) Phase 4 (2014-25): Wanchai extension Source: CEIC, Company, Daiwa would make Greater Pacific Place a more We attribute this to the combined effects of two factors. important cluster in Greater Central First, the positioning of Pacific Place as a commercial One important feature of Swire Properties’ way of hub is being continuously upgraded as the location is running its investment property portfolio is that it becoming more mature and as tenants come to actively pursues expansion in the size of the portfolios appreciate the synergies related to an integrated in its key locations over time. We believe this results in mixed-use property complex. We believe that such the following benefits: 1) it allows the portfolio to portfolio-specific factors help to limit the downside to continue to attract new tenants, 2) it helps to prevent rents in the portfolio during a downcycle and give it an tenants from leaving the portfolio due to them not extra boost when the overall cycle is in its favour. The having enough space to expand or needing to cut costs, achieved rents of Pacific Place offices compared with and 3) it provides more choices to occupiers and those of other buildings and areas have improved cheaper alternatives to tenants that would like a space steadily over the past 20 years, which we think reflects in the portfolio. In short, controlled and well-managed the special economics associated with Swire Properties’ expansion helps to ensure that the portfolio continues portfolio. to be updated and upgraded, which is important in ensuring that it can become stronger and more relevant The second important factor to note, in our view, is over time. that there has been continued expansion in the size of Swire Properties’ portfolio in both Pacific Place and In this light, we see the Wanchai South expansion of Island East which, apart from improving the critical Pacific Place as a key factor in the development of mass and attractiveness of the portfolio, should have Pacific Place as a location. Indeed, we believe that the helped provide an extra impetus to rental growth. eastward expansion of Pacific Place into Wanchai South will help to create a more important cluster in In our opinion, achieving gross rental income growth the Greater Central commercial hub and office market. by having more office area is often easier than having More importantly, we believe Swire Properties is on the more retail space. Retail rental depends on the trade verge of a new chapter in the development of Pacific mix and retail sales, which in turn depend on consumer Place. For we observe that Swire Properties has already perceptions and preferences, and hence is hard to succeeded in getting the market to accept Three Pacific manage and forecast, and takes considerably longer to Place and probably its 2 newer buildings (8 Queen’s reach the maturity stage (ie, the point at which the Road East and 28 Hennessy Road) as well as an asset takes on a life of its own and creates its own extension of the Pacific Place portfolio. momentum for further growth). As a rule of thumb, 2-3 leasing cycles are required for this process to unfold for We believe that the Wanchai South extension of Pacific retail space, which translates into 9 years based on the Place is beginning to take shape and expect it to gain standard 3-year lease term in Hong Kong. greater critical mass in the years to come. This should provide further impetus to the upgrading of Swire By contrast, the time needed to nurture demand for Properties’ Pacific Place portfolio. office properties can be very short once the area has established its identity in the market. Our observation is that, once an area becomes known as a high-end location for offices, it can attract corporations from other areas and companies trying to enter a market.

- 38 - Financials / Hong Kong 1972 HK 22 May 2014

Future: an even Greater Pacific Place redevelopment, this would amount to property assets Based on media reports and our market research, Swire of some 0.9m sq ft in GFA in early 2012. Presumably, Properties has been acquiring old properties in the Swire Properties’ old-building landbank in Wanchai vicinity of Pacific Place for many years, perhaps more South would have only increased in value since early than 2 decades. 2012.

Although the company has chosen not to disclose its ownership of these assets on commercial grounds, it disclosed that its old-building assets had a carrying value of about HKD5.4bn on its balance sheet when it was listed in early 2012. Assuming an average price of HKD6,000/sq ft and no increase in the plot ratio after

 Swire Properties: Pacific Place portfolio Serviced Year of Office Retail Hotel apartments Total Cumulative No. of No. of Properties Area completion GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) rooms car parks One Pacific Place Admiralty 1988 863,266 - - - 863,266 863,266 - - The Mall, Pacific Place Admiralty 1988 - 711,182 - - 711,182 1,574,448 - 470 JW Marriott HK Admiralty 1988 - - 515,904 - 515,904 2,090,352 602 - Two Pacific Place Admiralty 1990 695,510 - - - 695,510 2,785,862 - - Pacific Place apartments Admiralty 1990 - - - 443,075 443,075 3,228,937 - - Conrad HK Admiralty 1990 - - 555,590 - 555,590 3,784,527 513 - Island Shangri-la HK Admiralty 1991 - - 605,728 - 605,728 4,390,255 565 - Three Pacific Place Wanchai 2004 627,657 - - - 627,657 5,017,912 - 111 21-29 Wing Fung Street Wanchai 2006 - 14,039 - - 14,039 5,031,951 - - The Upper House Admiralty 2009 - - 158,738 - 158,738 5,190,689 117 - Star Crest, 9 Star Street Admiralty 2009 - 13,112 - - 13,112 5,203,801 - - 28 Hennessy Road Wanchai 2012 145,390 - - - 145,390 5,349,191 83 - 8 Queen's Road East Wanchai 2012 81,346 - - - 81,346 5,430,537 - - 2,413,169 738,333 1,835,960 443,075 5,430,537 1,880 581 Three Pacific Place extension?* Wanchai Four and Five Pacific Place?# Wanchai Source: Company, Daiwa Notes: *Subject to government approval #From the redevelopment of the many sites Swire has assembled in the area over the past two decades ##Based on the full size of these hotels, which better illustrate the scale of Pacific Place. However, Swire Properties wholly owns only the Upper House and has 20% stakes in the other 3 hotels.

Moreover, although Swire Properties did not officially  Swire Properties: old buildings owned in Wanchai as disclose its ownership of these old buildings, its 2 IPO disclosed in the 2 listing prospectuses Per May 2010 prospectus Per Dec 2011 prospectus prospectuses (from May 2010 and November 2011 Property GFA Valuation GFA Valuation respectively) contain some details about the old (sq ft) (HKDm) Ref. no* (sq ft) (HKDm) Ref. no* buildings it owned at those times, and we found that Three Pacific Place 156,000 n.a. n.a. 156,000 n.a. n.a. extension* (12-18 Wing Fung these included assets in several major streets close to Street) Three Pacific Place. Meanwhile, we have seen media 8-10 Wing Fung Street 2,100 43 44 15,180 242 42 reports about the company acquiring units in old G/F-2/F, Regal Court, 12-18 1,855 42 45 3,800 356 43 Wing Fung Street buildings in the area from time to time, and we believe 1-3/F, Lok Moon Mansion, 9,970 158 46 9,970 214 44 Swire Properties has remained active in terms of 29-31 Queen's Road East acquiring old buildings in this area. G/F, 1/F, and Basement, 11,474 134 58 11,474 172 45 Tung Hey Building, 12-22 Queen's Road East G/F, Wing Fung Street 646 18 59 646 23 46 G/F and Cockloft, Vincent n.a. n.a. n.a. 949 37 47 Mansion, 7 Star Street G/F, 3 Star Street n.a. n.a. n.a. 1,056 28 48 Source: Company, Daiwa Note: *The reference number in the valuation report in the respective prospectus

- 39 - Financials / Hong Kong 1972 HK 22 May 2014

Clustering around 3 major streets – to be The combined site areas of these 8 streets may be expanded to 8 or more? larger than the current size of Pacific Place. The whole area is packed with old buildings, for which we The properties on which Swire Properties disclosed its estimate that the total GFA is larger than the combined ownership in its 2 prospectuses are clustered around 3 GFA of Pacific Place in Admiralty, which has a GFA of major streets: Queen’s Road East, Wing Fung Street, 4.6m sq ft based on 100% ownership. Of course, we and Star Street. These are close to Three Pacific Place would not expect Swire Properties to be able to acquire and the 2 other residential properties the company has all the old buildings in the area. However, the point is developed in the area in the past: Star Crest and 5 Star that if it could acquire 20-30% of them, this would Street. amount to a sizeable addition and enrich the Pacific

Place portfolio. Moreover, based on the properties for Meanwhile, on our visits to the area we have observed which it has already disclosed ownership in its IPO that the street-level shops in many of the nearby side prospectuses, it has already acquired many strategic streets have changed over the years, with a lot more sites in the vicinity. contemporary fashion, furniture, and F&B outlets now.

While Swire Properties has never declared its strategy related to the Wanchai South expansion of Pacific

Place, we believe it could be one of acquiring as many ground-floor spaces in old buildings as possible and then renting them out to trendy and contemporary

F&B or fashion retailers. This should help to create a better image for the whole area over time. After securing the ground-floor spaces of these old buildings as footholds and acquiring more than 20% of the units in the buildings, the company can effectively pre-empt any other developer from having unified ownership of a building and take its time in acquiring the remaining units when the opportunity arises. Based on the current regulations related to acquiring old buildings, a developer needs to own 20% or more of the building in order to take the remaining owners to court to gain full ownership of the building.

“The 8 streets in Wanchai South”

As Swire Properties has been working on acquiring old buildings in the area for over 20 years, and given that

1998-2003 was a long, sharp downcycle for residential property, we would not be surprised if the company had acquired numerous units in many of the old buildings in the Wanchai South.

If we take the view that the buildings that have trendy and high-end F&B, fashion, and furniture retailers on the ground floors are likely to be buildings where Swire

Properties has acquired some units or ground-floor shops, then the streets in Wanchai South where the company may have acquired some old buildings include Moon Street, Sun Street, and St. Francis Street.

Moreover, as Anton Street and Landale Street are just next to 28 Hennessey Road and close to Three Pacific

Place and 8 Queen’s Road East (now known as Generali

Tower), they are 2 additional streets where Swire

Properties may have some hidden landbank or would be interested in acquiring units.

- 40 - Financials / Hong Kong 1972 HK 22 May 2014

 Greater Pacific Place in Greater Central

Source: Company, Google, HKSAR Government, Daiwa

- 41 - Financials / Hong Kong 1972 HK 22 May 2014

 Greater Pacific Place

Source: Daiwa

- 42 - Financials / Hong Kong 1972 HK 22 May 2014

 Old buildings where the ground floors or the whole buildings are owned by Swire Properties

Source: Company, Daiwa

- 43 - Financials / Hong Kong 1972 HK 22 May 2014

 The 8 main streets of Wanchai

Source: Daiwa

- 44 - Financials / Hong Kong 1972 HK 22 May 2014

 The 8 main streets of Wanchai (cont’d)

Source: Daiwa

- 45 - Financials / Hong Kong 1972 HK 22 May 2014

 Contemporary shops in the 8 main streets of Wanchai South

Source: Daiwa

- 46 - Financials / Hong Kong 1972 HK 22 May 2014

Could Wanchai South become like the side Swire Properties seems to have been working on streets of Tokyo’s Omotesando area? something along these lines in recent years. We note that Taikoo Li Sanlitun in Beijing is one of the few At this point, it is hard to envisage how this Wanchai retail malls in China made up mainly of separate South area will look in the future. We have been blocks. Located next to Taikoo Li Sanlitun is the watching the evolution of these streets for many years, famous Salitun bar street and one of the most vibrant and there are a lot more upscale boutiques and entertainment areas of the city at night time. restaurants today, making it a much more vibrant area Meanwhile, Swire Properties’ Sino-Ocean Taikoo Li in than before. Indeed, it is one of only a few places in Chengdu is another retail mall composed of blocks of Hong Kong that we believe has the potential to retail complexes. resemble Tokyo’s Omotesando area.

We consider outdoor malls innovative and Of course, Wanchai South currently does not look entrepreneurial in the field of retail property, as we anything like the main street of Omotesando, which is believe that this kind of retail format engenders some known as one of the most foremost “architectural opportunities as well as challenges, and there may not showcase” streets in the world, featuring a multitude of be any property company in the world that can claim to flagship stores of some of the world’s major fashion have mastered the required skill-set. That said, Swire brands, such as Louis Vuitton, Prada, Tod’s, and Dior. Properties has worked on this kind of retail format for Omotesando’s side streets, meanwhile, feature a wide years, and it has turned around Taikoo Li Sanlitun variety of small cafes, bars, galleries, and restaurants, from a non-performing retail property asset back in as well as boutiques specialising in everything from 2008 into a fairly profitable and promising retail handbags and postcards to vintage glass bottles and property asset in China, generating some HKD526m in many kinds of collectibles. gross rental income for 2013, based on our estimates.

The area is also home to the Kiddyland toy store and In any case, we believe that for an office area with the Laforet shopping centre (popular with young critical mass there is natural demand for after-work women), as well as The Oriental Bazaar, which is F&B and entertainment. The Lan Kwai Fong area in popular with overseas tourists. We view Omotesando Central is a classic example of this, and we believe that as a special area in global retailing and one of the few as Swire Properties’ office portfolio in Pacific Place areas that has a young, fashionable, trendy and upscale continues to expand this will create natural demand for flavour. Needless to say, any property company that night-time F&B and entertainment over time. As such, owns a sizeable piece of this kind of area would own while some may think it far-fetched to think of some of the world’s most valuable retail-property Wanchai South becoming anything like the side streets assets. Even side-street retail spaces in this kind of area of Omotesando, we believe that it has the potential to should be valuable retail property assets. become at least a niche dining and entertainment area

for people working in the Admiralty-Wanchai area. Of course, retail areas such as Omotesando cannot be built and created easily. They require decades of evolution to emerge gradually and naturally. After all, Will Wanchai South be known for boutique globally, there are probably only a handful of streets offices and residential developments? that even come close to Omotesando. That said, we This brings us to another point. Given the current believe that the Wanchai South area has strong retail property landscape in Wanchai South (which is potential, because it is located next to Pacific Place, characterised by many blocks of old buildings), we which is among Hong Kong’s most well-established think it would be difficult to acquire many sites that are high-end malls, and behind Wanchai South lies one of large enough to accommodate grade-A office buildings Hong Kong’s most luxury residential areas. with a 20,000-sq-ft floor plate targeting large multinationals, which was the typical office building We note that “creating streets” is a skill set that product in Hong Kong in the past. probably no property company in the world can claim to have mastered, although it is well-known that the While Swire Properties may still be able to acquire sites per-square-foot rent that can be commanded by the that are large enough to build 1-2 more Three Pacific world’s most famous streets – such as Fifth Avenue, the Place-like buildings in the area over time (after all, the Champs-Elysees, Bond Street, Russell Street, and site of Three Pacific Place was the result of the Canton Road – is substantially higher than any other redevelopment of old buildings), we do not think it retail format by a wide margin. could do much more than that. However, we do not necessarily see this as a disadvantage for the Wanchai South area. For we believe that, in the future, the Hong

- 47 - Financials / Hong Kong 1972 HK 22 May 2014

Kong office market will see demand for office space in  Hong Kong: size of the various major mixed property more modern and fashionable boutique-style office developments Serviced buildings. GFA Retail Office apartments Hotel Total (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) Wanchai South may well be better-placed Swire Properties’ Island 1.48 8.37 - 0.20 10.04 East portfolio (end-2013) than Sheung Wan Swire Properties’ Island 1.55 9.55 0.06 0.20 11.37 In recent years, there has been demand from asset- East portfolio (end-2020) Harbour City 2.05 4.26 0.67 1.37 8.35 management and financial-service companies for HK Land's Central portfolio 1.17 5.19 - 0.18 6.54 buildings with small floor plates of 5,000-8,000 sq ft. Pacific Place* 0.71 2.41 0.44 1.85 5.41 Given that these firms’ leased office areas are not that IFC 0.64 2.87 0.27 0.26 4.04 large, they may well be able to afford higher per- Source: Companies, Daiwa square-foot rents. In London’s West End, for example, *includes 28 Hennessy Road and 8 Queen's Road East (Generali Tower) many firms do not lease large office areas, and so even if they pay a high per-square-foot rent for their office In any case, given Swire Properties’ large and growing premises, their total office bills may not be that large presence in the area, it should be the property company relative to the office’s total operating costs. that can afford to make the highest bid for land or buildings available for sale in the area. One may wonder whether this type of demand will be met in Sheung Wan, given this area’s proximity to Catalysts for the next breakthrough: Central. However, there are not many quality niche government, transport factors office buildings in Sheung Wan and we do not know of Overall, we believe that expanding into Wanchai South any major landlords working on rejuvenating the area. will open up a new array of opportunities for These factors might help the future development and strengthening Swire Properties’ Pacific Place portfolio. upgrading of Wanchai South. More importantly, we expect government decisions and plans and transport infrastructure developments in We believe that this is one factor that has helped to Hong Kong to lend support to the importance of boost the occupancy rate in Swire Properties’ 28 Admiralty as a location. Hennessy Road from 74% at the end of 2013 to over 95% currently. Meanwhile, we also believe that there To begin with, the government decided some years ago are considerable opportunities in Wanchai South for not to sell the Tamar sites in Admiralty. These could developing boutique-style luxury residential units or have led to several new buildings that competed head- serviced apartments. A case in point is the 5 Star Street to-head with Pacific Place for tenants. Instead, the project, a residential development sold by Swire government opted to use the sites to build a new Properties in the past, which achieved a good price of government headquarters, which was completed in more than HKD25,000/sq ft. 2012.

Wanchai South should enrich and Meanwhile, we think the further development of the strengthen the Pacific Place portfolio rail sector will help to increase the importance of Overall, we see niche retail, office, and residential and Admiralty. Both the South Island Line and the Shatin- serviced apartments as potentially promising Central Link will end at Admiralty, making the area developments in the Wanchai South area, and believe one of the 2 locations (the other being Central) that is that such developments will complement, enrich, and the intersection point for up to 4 subway lines. These strengthen Swire Properties’ Pacific Place portfolio. developments should mean that Pacific Place becomes an increasingly important part of the Greater Central Currently, the total size of the Pacific Place portfolio is area over the next 5-10 years. 5.4m sq ft (with hotel GFA counted on a 100%-owned basis, which we think best reflects the scale of its portfolio). Based on attributable floor area, Swire Properties currently owns 4.1m sq ft of GFA in Pacific Place. Importantly, if the company were able to develop Four, Five and Six Pacific Place over time, we would not be surprised if by 2020 its Pacific Place portfolio were comparable to Hongkong Land’s Central portfolio, which we estimate has a total GFA of 6.4m sq ft.

- 48 - Financials / Hong Kong 1972 HK 22 May 2014

 Wanchai South: new developments  Admiralty: the station where 4 subway lines cross Events Year Developers Remarks Completion of The 2015 Hopewell/ A large-scale residential development with Avenue Sino 1,300 units Land/URA The Avenue will also have a retail area of about 86,000 sq ft, which will be connected to the subway and should enhance the accessibility of Wanchai South Completion of the South 2015 HK Gov’t/ The terminus is Admiralty station. This will Island Line MTRC significantly improve the accessibility of Admiralty and Wanchai to people living in the southern part of Hong Kong Island Renovation of Hopewell 2016 Hopewell Centre Completion of Hopewell 2018 Hopewell 1.1m sq ft GFA, with 1,024 hotel rooms and Centre II 0.3m sq ft of retail area The government may 2015- HK Gov’t The site could be developed into about 0.36m tender the office site in 2020 sq ft of offices and would be an opportunity for the Tamar Basin Swire Properties to expand its Pacific Place portfolio Source: MTR, Daiwa Completion of phase two 2020 HK Gov’t/ The terminus is Admiralty station. This will of the Shatin-Central Link MTRC significantly improve the accessibility of Admiralty station: the terminus for the Shatin-Central Link Admiralty and Wanchai to people living in Kowloon and the New Territories The government is due to 2020 SAR The redevelopment of the 3 government complete the relocation of buildings in Wanchai could provide sites for the Immigration developing up to about 2m sq ft of offices Department to Tseung Kwan O Source: Daiwa

Admiralty station: the terminus for the South Island Line

Source: MTR, Daiwa

We see considerable room for further value creation in Pacific Place In our opinion, one characteristic of Hong Kong’s commercial property market is that, in terms of achieved rent and price, it may have one of the widest ranges globally. As a result, companies with the skills to upgrade properties and an entire location can unlock Source: MTR, Daiwa significant investment value.

Pacific Place and Admiralty is a case in point. Step by step, Pacific Place has been transformed from a new area into an integral part of Greater Central and perhaps even a frontier for the future growth of the area as a commercial hub. We believe that one contributing factor is Swire Properties’ approach to the property business. Herein lies one important source of investment value for Swire Properties’ share price, in our view.

We believe that Pacific Place’s emergence as a portfolio on a par with most grade-A offices in Central (barring the 5 AAA properties) is a recent phenomenon and that

- 49 - Financials / Hong Kong 1972 HK 22 May 2014

the Wanchai South portion of Pacific Place is still in the upward trend in the portfolio’s positioning over the early phase of being integrated into the Greater Central long term. Also, we note that a commercial property commercial hub. While the spot asking rent in Pacific portfolio like Pacific Place does not need to appeal to Place has come close to that of many buildings in all types of commercial tenant, but should be able to Central, our view is that there is still a gap between the attract a growing pool of a certain type of commercial passing rents of Pacific Place’s major office tenants and tenant and corporation over time. the asking spot rent in the development for new tenants. This means there is still room for the overall In our opinion, provided that a commercial property rents and capital values of Pacific Place to catch up portfolio like Pacific Place can gain and sustain critical with those in Central and that there would be mass with reasonably premier corporations, shoppers additional upside if Pacific Place could move up in the and travellers and can attract newcomers, the property ranks of prime developments in Hong Kong’s assets will maintain their market positioning over time. commercial property sector. Also, we believe that high-end commercial properties do not need to be able to appeal to all, and the critical Admittedly, asking rents in Citibank Plaza are likely to mass number of loyal customers needed to support be very competitive in 2014. However, we think Pacific such properties is smaller than many observers believe. Place’s office space will be little affected by this, as the number of office leases in Pacific Place due to expire We estimate that, if the average ticket size in a this year is small (we estimate it to be under 5% of the shopping mall is HKD2,500, then Pacific Place only total). Also, Pacific Place’s offices have many long-term needs about 10,000 purchases a day (about 40% of tenants, and as Pacific Place is a mixed development daily purchases at the Sogo Hong Kong department with ancillary facilities, this should enhance its store in 2013) to maintain its current annual retail competitiveness over pure office developments. sales, which we estimate to be about USD1.1bn. Likewise, about 200-300 corporations renting office The return on Swire Properties’ HKD2bn space within it would probably be enough for Pacific “contemporisation programme” for Pacific Place is Place to sustain its current levels of rental income and hard to quantify. However, we think that the occupancy. “contemporised” Pacific Place should at least protect the development when competing with newer All in all, we believe the benefits from Pacific Place’s properties, as it should help to refresh both the mall rising position in the Hong Kong commercial property and office components of Pacific Place, making them sector are still unfolding and the portfolio has more comparable to the new properties. considerable upside potential in terms of its valuation and rental income. We estimate the blended average Admittedly, retail sales growth in Pacific Place was flat value for the offices in the Greater Pacific Place to be for 2013, and lagged behind the overall market in 2013 HKD66/sq ft (on GFA) in 2013, and we believe that it and 1Q14. Structurally, however, we believe there are still features some leases where the passing rents are still many favourable factors working for Admiralty and below the market’s. As such, there should be scope for Pacific Place as a commercial hub. the office rental gap between One Pacific Place and its Wanchai extension to narrow over time. It is true that the Pacific Place mall may need fine- tuning in terms of positioning and tenant profile if On our estimates, Pacific Place contributed some momentum in its retail sales growth is to return. HKD3.7bn to Swire Properties’ gross rental income in However, we think these are comparatively minor and 2013, and we forecast the contribution of Pacific Place addressable issues. In hindsight, the Pacific Place mall to the company’s gross rental income to reach might have been upgraded too quickly, but we believe HKD5.7bn by 2020. the portfolio as a whole is still moving along a promising path. We see the imminent transformation  Pacific Place: KPIs of Wanchai and the completion of new rail lines as 9M12 2012 1Q13 1H13 9M13 2013 1Q14 Pacific Place offices positive external factors that should offset many short- Occupancy 98% 97% 97% 97% 97% 91% 91% term issues faced by the Pacific Place portfolio. New and renewed area 175,135 215,720 351,628 418,676 441,523 466,831 41,852 let (sq ft) Near-term transition issues: a price worth Reversion (%) +34% +32% +36% +29% +27% +27% +8% Spot rents (HKD/sq ft) 95-110 95-110 95-110 90-110 90-110 90-110 90-110 paying for continuous portfolio upgrading Pacific Place mall In our view, Swire Properties has made continuous Occupancy 100% 100% 100% 100% 100% 100% 100% Retail sales growth (%) +2.4% +0.3% -1.0% +1.9% +2.1% +0.7% 0% efforts to upgrade the Pacific Place portfolio and some Source: Company, Daiwa near-term hitches are an acceptable price to pay for an - 50 - Financials / Hong Kong 1972 HK 22 May 2014

commercial properties in it, the area was seen by many 2. Island East: set to be the largest as a run-down location. Our research shows that Swire office hub outside Central Properties’ transformation of Island East has undergone 4 phases and is now entering a 5th one. Island East is another area where Swire Properties has  The evolution of Island East a significant presence. Indeed, we believe the Period The location’s evolution company’s development of its Island East portfolio on 1970s A dockyard in a remote part of Hong Kong Island the eastern side of Hong Kong Island represents an 1980s Became a residential area, with Taikoo Shing recognised as a classic mass residential housing estate for the middle and upper-middle class, with more even more significant illustration of the company’s than 12,000 residential units differentiated approach to value creation in the 1990s Island East first started as an office location for banks' back offices but later property business. became recognised as a new area for decentralised offices 2000s Island East became the first large-scale commercial centre outside Central, with a GFA of over 8m sq ft of office space When Swire Properties embarked on redeveloping the By 2020 Could become a premier and the largest commercial hub outside Central old Taikoo Shipyard into a large-scale private Could be a major commercial hub with sizeable office spaces alongside a vibrant retail area, hotels, as well as cultural and entertainment components residential estate, the area was regarded by many as a Source: Daiwa remote area in the eastern end of Hong Kong Island. When Swire Properties first decided to build

 Swire Properties: Island East portfolio

Source: Company Note: 1) Acquired and transaction completed in January 2014. 2) Under redevelopment 3) Under development 4) In February 2014, the company reached an agreement with the HKSAR Government to acquire its interest in Cornwall House. The agreement provides for the exchange of 10 floors of grade-A office space in Cityplaza Three (about 205,000 sq ft) for all the areas in Cornwall House currently owned and occupied by the HKSAR Government, consisting principally of 8 floors in the building (about 187,000 sq ft). The company expects to complete the transaction on or before 30 December 2016

- 51 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: Island East portfolio — detailed breakdown (end-March 2014) Techno Serviced Year of Office Centres Retail Hotel apartments Total Cumulative No. of No. of Properties Area completion GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) rooms car parks Commercial areas, Taikoo Shing Island East 1977-1985 - - 311,079 - - 311,079 311,079 3,826 Warwick House Island East 1979 - 554,934 - - - 554,934 866,013 Cityplaza Island East 1983 - - 1,105,227 - - 1,105,227 1,971,240 834 Cornwall House Island East 1984 - 338,369 - - - 338,369 2,309,609 Somerset House Island East 1988 - 923,364 - - - 923,364 3,232,973 285 Cityplaza Four Island East 1991 447,709 - - - - 447,709 3,680,682 217 Cityplaza Three* Island East 1992 423,785 - - - - 423,785 4,104,467 Devon House Island East 1993 803,448 - - - - 803,448 4,907,915 311 PCCW Tower Island East 1994 310,074 - - - - 310,074 5,217,989 Dorset House Island East 1994 609,540 - - - - 609,540 5,827,529 215 Cityplaza One Island East 1997 628,785 - - - - 628,785 6,456,314 Lincoln House Island East 1998 333,350 - - - - 333,350 6,789,664 164 Oxford House Island East 1999 501,249 - - - - 501,249 7,290,913 182 Cambridge House Island East 2003 268,793 - - - - 268,793 7,559,706 One Island East Island East 2008 1,537,011 - - - - 1,537,011 9,096,717 The EAST Island East 2009 - - - 199,633 - 199,633 9,296,350 345 Dah Chong Hong Commercial Centre Island East 2013 194,500 - - - - 194,500 9,490,850 Cornwall House (8 extra floors)* Island East 2014 - 187,000 - - - 187,000 9,677,850 Sub-total 6,058,244 2,003,667 1,416,306 199,633 - 9,677,850

17-27 Tong Chong Street Island East 2014 - - 12,471 - 62,658 Redevelopment of the Somerset House Island East 2017 1,000,000 - - - - Redevelopment of Cornwall and Warwick House Island East 2019 1,080,303 - - - - 8,138,547 - 1,428,777 199,633 62,658 Source: Company, Daiwa Note: * we have adjusted the data for the 10 floors given to the government

Before we describe the 4 major phases so far of Swire positive effect on the area’s long-term Properties’ transformation of Island East, we highlight transformation. the following 4 points: 1. Like Pacific Place, the company’s transformation of Phase 1 (1970s-1980s): from barren land to Island East has not been straightforward, in our premier mass residential area view. It has taken considerable effort to position, Like major groups in global property, such as fine-tune and adapt the asset, and, as with Pacific Mitsubishi Estates, Boston Properties and Hongkong Place, Swire Properties has demonstrated that it has Land, Swire Properties’ Island East portfolio has the approach and skills to do this. benefited from rich land endowments while the 2. There are many factors backing the growing company has not had to tie up substantial capital importance of Island East as a commercial hub, and upfront to buy large parcels of land in the area. Swire Properties’ business model should give it some protection from property-industry That said, we believe the inherent advantages Swire downcycles. Properties has obtained from its land endowments are much smaller than for the above-mentioned 3. Island East has come a long way but is still far from companies. Most of the land that Swire Properties reaching its peak as a major commercial hub, in our owns is in Island East, and within that portfolio a view. We believe the coming years will be an number of buildings were redevelopments from important phase for the area, given that Swire buildings that the company acquired from third parties Properties has kick-started the redevelopment of 3 at a time when the area was far from being an techno-centres at the heart of its portfolio which will upmarket commercial district. In addition, the result in some 2m sq ft GFA of grade-A office space company had to bid in open auctions to get the sites for and the opening of a 69,000-sq ft landscaped its Pacific Place portfolio, and the land for its eastward square by 2019. This should give the area an entirely expansion of Pacific Place came from old buildings, new face and spur its transformation into a more which took Swire Properties many years to acquire. up-market commercial hub. 4. Swire Properties’ concerted efforts to upgrade Indeed, in the 1970s, Island East, located at the eastern Cityplaza and improve the ambience of the area, end of Hong Kong Island and close to an hour by car with a hotel, serviced apartments and more vibrant from Central at that time, was seen by many as an old, retail and entertainment venues, should have a rundown area. That said, from the 1970s to mid-1980s, - 52 - Financials / Hong Kong 1972 HK 22 May 2014

Swire Properties used its large bundle of shipyard land Phase 3 (late 1990s to 2008): establishes in Quarry Bay to build one of the largest private itself as an emerging core office area residential estates in Hong Kong, known as Taikoo Our observation is that the completion of the various Shing. Note that even though Taikoo Shing was aforementioned new buildings attracted new types of completed more than 30 years ago, it is seen by many tenants to Island East, and resulted in the image of the as the benchmark for mid-to-high end private area being gradually changed from one mainly for back residential estates in Hong Kong. offices into an office area for certain types of MNCs and

corporations. Phase 2 (late 1980s to mid-1990s): Island East starts off as an area for back offices Compared with Cityplaza 3 and 4, the buildings Apart from Taikoo Shing, the main developments Swire completed by Swire Properties in this area from the Properties had in Island East were 3 industrial mid-1990s onwards generally had large floor-plates buildings– Warwick House, Cornwall House and and higher technical specifications. We note that some Somerset House. Although the company has called of Swire Properties’ target customers during this period these buildings techno-centres in recent years, they were major commercial banks seeking to shift their were industrial buildings in the 1980s when there were back offices to Island East in order to take advantage of few commercial developments in Island East. the substantial savings on rent. In our view, this strategy made commercial sense and, as a result, Swire In retrospect, the building of the Island East portfolio Properties’ Island East portfolio attracted tenants from started with the completion of its retail mall, Cityplaza, the areas of engineering, construction, advertising, in 1983, which was followed by the completion of 2 telecom, and technology, in addition to the back offices other office buildings, Cityplaza 4 and Cityplaza 3, in of commercial banks. 1991 and 1992, respectively. These were large floor- plate office buildings and attracted a favourable initial By the mid-1990s, the size of Swire Properties’ office response from international and local companies, portfolio in Island East had begun to reach critical which were more budget-conscious than the premier mass, with a total GFA of over 5m sq ft, or over 3m sq ft multinationals and financial institutions but wanted to excluding the 3 techno-centres. This size represented a reside in single-landlord office buildings. reasonable critical mass, and we observe that the surrounding environment of Island East began to see This favourable response prompted Swire Properties to major changes, with the retail outlets going more further utilise its old buildings in the area and acquire a upmarket and many more ancillary services and number of old buildings (such as Toppan Buildings and industries serving office tenants becoming available. SCMP Building), which it redeveloped into new buildings such as Devon House, Dorsett House and While in the early 1990s, the image of Island East was Hongkong Telecom Tower (now PCCW Tower) in 1993- that it was an area for back offices, by the mid-1990s, 95. Island East had emerged as another established core location for offices alongside Wanchai, Causeway Bay  Island East complexes and Tsimshatsui.

In any case, by the mid-1990s, Swire Properties had embarked on several initiatives, which resulted in the building of several more office buildings, including Lincoln House, Cambridge House, Oxford House, and Cityplaza One (from redevelopment), which together added over 1.6m sq ft GFA to Swire Properties’ grade-A office portfolio in Island East.

By 2003, when Cambridge House was completed, we estimate that Swire’s grade-A office portfolio in Island East (based on 100% ownership of all the buildings in Source: Company its portfolio, which we think better illustrates the scale of the portfolio) had risen to a GFA of over 6.5m sq ft (comparable in size to Hongkong Land’s Central portfolio, which is now about 6.4m sq ft), even excluding the 3 techno-centres.

- 53 - Financials / Hong Kong 1972 HK 22 May 2014

Also note that alongside the improving position of  Spot office rents in One Island East vs. other buildings and Island East as an office location, achieved rents in the Hong Kong overall area continued to edge up, from a low-teen base in the (HKD/sq ft) early 1990s to over HKD30/sq ft from the mid-2000s 70 onward. 60 50  Achieved office rents in Island East versus other major 40 buildings in Hong Kong and the overall market 30 (HKD/sq ft) 20 150 10 0 100 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 One Island East Devon House 50 Hong Kong East Overall HK Source: CBRE, CEIC, Daiwa

0 In our opinion, the completion of One Island East was 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 the catalyst for the upgrading of the area. While the One Island East Devon House Central abundant new supply of offices in Kowloon East had Hong Kong East Overall HK posed a threat to Swire Properties’ Island East portfolio

Source: CBRE, CEIC, Daiwa from the late 2000s onwards, we believe that by and large, Swire Properties’ portfolio defended itself well Phase 4 (2008 to now): core office area against the competition, with its achieved occupancy comparable to Wanchai, Causeway Bay, TST rate in the area holding firm above 90% throughout the period. In our opinion, since the mid 2000s, momentum has been building for Island East, with Swire Properties In any case, spot rents in Kowloon East have moved up giving an extra push towards making the area a key rapidly since 2011 after many major buildings were commercial hub by completing One Island East in leased. With prime buildings in Kowloon East now 2008. This development has set a new benchmark for commanding rents of HKD35/sq ft or more, we believe office rents and office standards in the area. there would be strong rental support for grade-A office rents in Island East at the HKD40-50/sq ft level, as With a total GFA of 1.54m sq ft, One Island East was tenants would require rental savings of at least HKD10- one of only 2 mega-sized grade-A office buildings 15/sq ft to justify the cost of relocating their offices. completed in Hong Kong in the second half of the 2000s (the other major office building being ICC – Our read is that the achieved rental reversions for International Commerce Centre – in West Kowloon). Swire Properties’ Island East office portfolio have been In retrospect, One Island East benefited from the surge sustained at 98% or more over the past few quarters, in grade-A office rents in Central prior to the Lehman which bodes well for the rental income contribution crisis. from its Island East offices over the next few years.

One Island East has attracted a number of commercial Phase 5 (now- 2020): the largest non- and investment banks which have relocated their mid- Central office hub on Hong Kong Island? office functions there, and resulted in achieved rents in the area breaking the HKD60/sq ft mark – as high as In our opinion, the development of Swire Properties’ rents for premier buildings in Wanchai and Causeway Island East portfolio has reached an important and surpassing the peak office rents achieved in juncture. In some ways, the company’s Island East Tsimshatsui. portfolio is arguably better positioned than its Pacific Place portfolio, in the sense that there is not much absolute downside for its achieved rents, in our view. As such, the scope for a rental uplift is considerably greater than for its Pacific Place portfolio, given office rentals in Island East are about half those for Pacific Place and the buildings in Island East are newer.

Generally, we view office space as being closer to a commodity compared with retail space. However, Swire Properties’ Island East experience demonstrates - 54 - Financials / Hong Kong 1972 HK 22 May 2014

that it is possible to create a location, and one way to with the government on buying out the latter’s 0.18m make office space less of a commodity is to create an sq ft of GFA in the Cornwall Building. This transaction integrated portfolio and continue to upgrade that should pave the way for Swire Properties to go ahead location. with phase 2 of the redevelopment plan of its 3 techno- centres, which involves turning Cornwall Building and In our opinion, the transformation of Island East is still Warwick House into one mega-building of about 1m sq far from over. We believe the area has become an ft GFA, resulting in the creation of a large landscaped established office location for multinationals, and is square (comparable to Statute Square in Central in now ranked as one of the 4 core office districts in Hong size) at the heart of Taikoo Place. Kong for multinationals, alongside Wanchai, Causeway Bay and Tsimshatsui. However, we think the whole The largest and youngest mixed-use area is on its way to becoming more important, and commercial property portfolio in HK? believe One Island East already illustrates that its In this light, we believe that in 3-5 years’ time, Island achieved rent can be as high as that for premier East will have a new face. Only a limited number of buildings in any other areas outside Central. new office buildings have been completed in Hong

Kong over the past 10 years. As the office specification In our opinion, Swire Properties is now making the requirements of financial tenants have continued to necessary investments to ensure that Island East can rise, the number of office buildings that can meet the be further upgraded into an even more attractive needs of modern financial firms and MNCs may location for commercial properties. We believe Swire continue to diminish. As such, we would not be Properties is trying to achieve this by doing various surprised if, a few years down the road, Swire things. Properties’ Island East portfolio becomes well accepted

by firms in the finance arena and is regarded as one of One of these is the redevelopment of its 3 industrial the most important office portfolios in Hong Kong. buildings or techno-centres in the area into grade-A offices. Note that Swire Properties has recently settled

 Swire Properties: proposed redevelopment of techno-centres

Source: Company

Besides, we think Swire Properties will do other things buildings in the Quarry Bay area, the latest one being to make the location more attractive. With Swire the Dah Chong Hong Commercial Centre in January Properties a champion of integrated mixed property 2014. developments, we see it improving the image of the area by adding hotels and serviced apartments or “The 5 streets in Island East” residential properties. We also expect the group to As in Wanchai South, Swire Properties has been upgrade Cityplaza after it has completed its acquiring a lot of old buildings in several streets in “contemporisation programme” for Pacific Place. Island East. The following table shows the old buildings that Swire Properties owned in Island East as Moreover, like the situation in Wanchai, Swire at May 2010 and December 2011, according to Properties has been quietly acquiring a lot of old information in its IPO prospectuses. However, we

- 55 - Financials / Hong Kong 1972 HK 22 May 2014

believe the company owns a lot more old buildings in  Old buildings owned by Swire Properties in Island East as the area than it has disclosed, and that the scale of its disclosed in its 2 listing prospectuses Per May 2010 Prospectus Per Dec 2011 Prospectus existing properties in the area means it is in a strong GFA Valuation GFA Valuation position to acquire more property assets in the area for Properties (sq ft) (HKDm) Ref. no* (sq ft) (HKDm) Ref. no* redevelopment. 14 shops on G/F, Sea View 5,603 97 49 5,603 200 50 Building, 29-41 Tong Chong Street Shops at lower G/F, 12A-12H 4,999 119 50 - - - Westlands Road Unit 2-3, G/F, Westlands Centre 17,248 80 60 17,248 127 52 3 shops on G/F, Hoi Wan 1,382 28 62 1,382 40 53 Building, Quarry Bay Shop 14A, G/F, Hoi Kwong 5,603 27 49 425 27 49 Court, 13-15 Hoi Kwong Street, Quarry Bay Various shops, Westlands n.a. n.a. n.a. 4,999 190 51 Garden Source: Company, Daiwa Note: *their reference number in the valuation report in the respective Prospectus

- 56 - Financials / Hong Kong 1972 HK 22 May 2014

 Taikoo Place in Island East

Source: Company, Google, Daiwa

- 57 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: Island East portfolio

Source: Company, Daiwa

 Swire Properties: Island East portfolio

Source: Company Note: 1) Acquired and transaction completed in January 2014. 2) Under redevelopment 3) Under development 4) In February 2014, the company reached an agreement with the HKSAR Government to acquire its interest in Cornwall House. The agreement provides for the exchange of 10 floors of grade-A office space in Cityplaza Three (about 205,000 sq ft) for all the areas in Cornwall House currently owned and occupied by the HKSAR Government, consisting principally of eight floors in the building (about 187,000 sq ft).The company expects to complete the transaction on or before 30 December 2016

- 58 - Financials / Hong Kong 1972 HK 22 May 2014

 Taikoo Place and the ‘5 streets of Swire Properties in Island East’

Source: Daiwa

- 59 - Financials / Hong Kong 1972 HK 22 May 2014

 The 5 main streets in the Taikoo Place, Island East

Source: Daiwa

- 60 - Financials / Hong Kong 1972 HK 22 May 2014

In our opinion, there are abundant opportunities and  Key performance indicators – Island East possibilities in the area for a competent asset manager 9M12 2012 1Q13 1H13 9M13 2013 1Q14 Cityplaza Mall like Swire Properties. Apart from grade-A offices, we Occupancy 100% 100% 100% 100% 100% 100% 100% think there is considerable room for residential, retail Retail sales growth +6.8% +6.0% +3.5% +2.9% +2.7% +2.4% -5.6% and hotel developments in the area which would fit (%) Cityplaza offices well together, just like the situation in Pacific Place. Occupancy 98% 98% 99% 99% 98% 97% 98% New and renewed 188,118 191,928 189,835 256,854 284,184 286,030 223,470 The chart below shows the growth in gross rental area let (sq ft) Reversion (%) +30% +30% +54% +51% +52% +53% +26% income of Swire Properties’ Island East portfolio over Spot rents low-mid low-mid low-mid low-mid low-mid low-mid low- the years. Such growth has far exceeded that for Hong (HKD/sq ft) 40s 40s 40s 40s 40s 40s mid40s Taikoo Place Kong grade-A office rents overall, attesting to the Occupancy 98% 99% 99% 99% 99% 99% 99% growing importance and expanding portfolio size of New and renewed 564,459 571,226 281,830 325,447 413,090 429,664 401,833 Swire Properties’ Island East portfolio. area let (sq ft) Reversion (%) +30% +29% +52% +51% +48% +48% +26% Spot rents low-mid low-mid low-mid low-mid low-mid low-mid low-  Swire Properties: rental income from Island East offices vs. (HKD/sq ft) 40s 40s 40s 40s 40s 40s mid40s Hong Kong grade-A offices One Island East Occupancy 100% 100% 98% 100% 100% 100% 99% (HKDm) Island East office rental (Rebased) 4,000 income outperforms the 3,000 New and renewed NA NA 36,697 63,872 67,415 67,415 110,459 Office Rental Index area let (sq ft) 2,500 Reversion (%) +51% +51% +82% +85% +85% +85% +17% 3,000 2,000 Spot rents mid 50s- mid 50s- mid 50s- mid 50s- mid 50s- mid 50s- mid50s- (HKD/sq ft) high 60s high 60s high 60s high 60s high 60s high 60s high60s 2,000 1,500 Techno-centres 1,000 Occupancy 97% 100% 100% 100% 100% 100% 99% 1,000 New and renewed 153,683 153,683 204,981 204,981 237,911 237,911 61,061 500 area let (sq ft) 0 0 Reversion (%) +20% +20% +25% +25% +25% +25% +13% Spot rents low-mid low-mid low-mid low-mid low-mid low-mid mid20s

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 (HKD/sq ft) 20s 20s 20s 20s 20s 20s Island East office rental income (LHS) Source: Company, Daiwa Island East office rental income - rebased (RHS) Office Rental Index (Overall HK Grade A) - rebased (RHS) Source: CEIC, Company, Daiwa

In our view, the benefits for Swire Properties of Island East’s rising position in the Hong Kong commercial property sector are still unfolding, and we think market rents and capital values in Island East have scope to increase substantially over time, especially after the completion of the redevelopment of Swire Properties’ 3 techno-centres by 2019, which should give a new face to the whole area.

On our estimates, Island East contributed some HKD4.4bn to Swire Properties’ gross rental income in 2013 (which reflects the loss of income as a result of the redevelopment of Somerset House), and we forecast the contribution of Island East to the company’s gross rental income to reach HKD8.2bn by 2020 after the full completion of its 3 techno-centres.

- 61 - Financials / Hong Kong 1972 HK 22 May 2014

developments and there are many differences between 3. Location transformation in these 2 markets. As such, applying the Hong Kong China finally starting to work model to China would not be straightforward. Indeed, Swire Properties has undergone a long learning curve Overall, we see Swire Properties as a strong player in in China, since it started its investments in China Hong Kong’s commercial property sector in that its property back in 2002, when it formed a joint venture exposure to an industry-wide downturn is mitigated by with the Guangzhou Daily Group to redevelop a major its strong market position in the 2 locations in which its site owned by this partner in Tianhe. portfolio is concentrated (ie, Island East and Pacific  Swire Properties: investments in China property Place). Also, we see upside potential for rents from the Date Major events rising strength, scale and importance of these 2 2002 Acquired the land for Taikoo Hui locations, as well as the incorporation of new areas into 2006 Acquired a 50% stake in the Dazhongli project in Shanghai from HKR International its portfolio (similar to what the company has been 2007 Acquired 80% stake in Sanlitun Village, Beijing doing in terms of integrating Wanchai South into its 2008 Formed a 50/50 joint-venture with Sino-Ocean to take a 50% stake in the INDIGO project in Beijing Pacific Place portfolio). Opening of Sanlitun Village South and The Opposite House 2010 Opening of Sanlitun Village North We would also highlight that there is a range of Formed a 50/50 joint-venture with Sino-Ocean to acquire the Daci Temple site in achieved rents for the company’s properties in these Chengdu 2011 Opening of Taikoo Hui locations, and that, to an extent, the quality of an asset Opening of INDIGO's office tower, ONE INDIGO can be improved through AEI, such as hardware Mar-12 Phased opening of the mall of INDIGO Beijing upgrades, tenant repositioning, etc. This means that Jan-13 Opening of Mandarin Oriental Guangzhou at Taikoo Hui even if overall market rents are flat, a landlord still has Apr-13 Renamed its mixed-use commercial property project in Beijing from "Beijing ways to realise substantial value by raising achieved Sanlitun Village" to "Taikoo Li Sanlitun" Aug-13 Sold 89% Pinnacle One (office of the Daci Temple project) for CNY2.1bn rents for lower-tier assets in the area to bring them into Jan-14 Signed a framework agreement with CITIC Real Estate and Dalian Port Real Estate line with the portfolio average. to jointly develop (Swire will has a 50% stake) a project in the Zhongshan District of the Dalian city's CBD. Feb-14 Acquired the remaining 20% stake in Taikoo Li Sanlitun from Gaw Capital Partners More importantly, we believe that what Swire Source: Company, Daiwa Properties has done in Admiralty and Island East epitomises a different kind of business model to run Swire Properties’ China investments have not had an the property business; and in our mind, these 2 cases easy ride, with the progress of its China projects being illustrate that the room for value creation is respectable slow in the early years due to issues with resettlement over a 5-10 year horizon, and could be substantial over and many others. That said, like the situation faced by a multi-decade horizon. Swire Pacific in property and other businesses, the group has managed to find ways out; and in recent Can Swire Properties apply its business years, there have been signs that, finally, it is starting model to China? to reap the returns from its China investments. In our opinion, whether Swire Properties’ approach can be applied to China represents one very important Most importantly, investors in Swire Properties now do strategic question for the company. We believe that in not have to bear the cost and uncertainties related to many ways, the approach adopted by Swire Properties the incubation of commercial properties, as Swire represents adaptations and responses to the unique Properties has been building its China footprint for environment in the Hong Kong property sector, which over a decade now, and is beginning to move into stage is characterised by, among other things, a wide range of 2 of its development cycle. rents and capital values among different locations, a restrained new supply at the very top end of the Swire Properties has also been building on its China market, the location of the main CBD area being very presence, which began with Taikoo Hui in Guangzhou, entrenched among people’s minds for a long time, and and has now extended to 6 projects in 5 cities in China. the influx of some high-margin and well-capitalised By 2020, the group’s completed GFA in China should tenants in both the office and retail space in recent increase to more than half that of Hong Kong, and we years. see it as an important new growth driver for the group in the medium-to-long term. It goes without saying that the China and Hong Kong property markets are in different stages of

- 62 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: China property portfolio

Source: Company, Daiwa

 Swire Properties: expansion of China portfolio Project Area Year of completion Office GFA (sq ft) Retail GFA (sq ft) Residential GFA (sq ft) Hotel GFA (sq ft)/ (rooms) Total GFA (sq ft) Hui Fang Guangzhou 2008 0 90,847 0 0 90,847 Taikoo Li Sanlitun Beijing 2008 0 1,296,308 0 169,463 (99) 1,465,771 Taikoo Hui Guangzhou 2011 1,731,766 1,472,730 51,517 584,184 (263) 3,840,197 INDIGO Beijing 2012 595,464 939,493 0 358,269 (185) 1,893,226 Daci Temple Chengdu 2014 0 1,141,598 82,076 163,828 (100) 1,387,502 Dazongli Shanghai 2016 1,844,842 1,081,362 0 543,194 (200) 3,469,398 Dalian Port Dalian 2018 0 952,968 0 0 952,968 Total 4,172,072 6,975,306 133,593 1,818,938 (847) 13,099,909 Source: Company

- 63 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: China portfolio* Serviced Year of Office Retail Hotel apartments Total Cumulative No. of No. of Properties Area completion GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) rooms car parks Guangzhou The Mall, Taikoo Hui Guangzhou 2011 - 1,472,730 - - 1,472,730 1,472,730 718 Taikoo Hui Towers 1& 2 Guangzhou 2011 1,731,766 - - - 1,731,766 3,204,496 - Serviced apartments Guangzhou 2011 - - - 51,517 51,517 3,256,013 - Mandarin Oriental, Guangzhou Guangzhou 2012 - - 584,184 - 584,184 3,840,197 263 - 1,731,766 1,472,730 584,184 51,517 3,840,197 Taikoo Li Sanlitun Village South Beijing 2008 - 776,909 - - 776,909 776,909 451 Village North Beijing 2008 - 519,399 - - 519,399 1,296,308 410 The Opposite House Beijing 2008 - - 169,463 - 169,463 1,465,771 99 32 - 1,296,308 169,463 - 1,465,771 INDIGO The Mall Beijing - 939,493 - - 939,493 939,493 617 ONE INDIGO Beijing 595,464 - - - 595,464 1,534,957 392 EAST, Beijing Beijing - - 358,269 - 358,269 1,893,226 185 236 595,464 939,493 358,269 - 1,893,226 Daci Temple The Mall Chengdu - 1,141,598 - - 1,141,598 1,141,598 1,000 Serviced apartments Chengdu - - - 82,076 82,076 1,223,674 Office towers Chengdu 1,324,575 - - - 1,324,575 2,548,249 Hotel Chengdu - - 163,878 - 163,878 2,712,127 71 1,324,575 1,141,598 163,878 82,076 2,712,127 Source: Company, Daiwa Note: *On a 100% ownership basis

- 64 - Financials / Hong Kong 1972 HK 22 May 2014

Commercial property assets require nurturing, and projects. It has so far secured 6 projects in 5 Chinese cities are famous for having an abundant strategically important cities in China – Beijing, supply of commercial property space. It would take Guangzhou, Chengdu, Shanghai and Dalian – and has several leasing cycles for Swire Properties’ China rolled out 4 of them so far. projects to mature. However, having recently visited all of the company’s projects in China and assessed their Above all, while many cities in China may now be rental income and retail sales performance over the facing a structural over-supply of commercial property past few years, we believe Swire Properties has made space, we believe the top-tier segment of large-scale considerable progress already, and that this deserves commercial properties managed by a single landlord investors’ attention. over the long term is much less crowded, probably due partly to the substantial capital required and the fact  Swire Properties: key performance indicators for China projects that many local players have yet to build up the 9M12 2012 1Q13 1H13 9M13 2013 1Q14 required expertise this segment. Taikoo Hui Offices Occupancy 77% 79% 82% 85% 86% 89%93% New and renewed area 18,206 21,812 5,007 9,890 11,413 16,879 6,438 In our opinion, in terms of serious long-term players in let (sq m) prime real estate in major cities commercial properties Reversion (%) n.a. n.a. n.a. n.a. n.a. n.a. n.a. Spot rents (CNY/sq m) mid-high mid-high mid-high mid-high mid-high mid-high mid-high in China (in the sense that the companies are 100s 100s 100s 100s 100s 100s 100s committed to own and manage the properties for the Taikoo Hui Mall Occupancy 100% 99% 100% 99% 99% 99%99% long term), there are probably not more than 10 major Retail sales growth (%) n.a. n.a. +33.1% +28.8% +25.6% +24.9% +13.1% players in the entire country, and our view is that the Taikoo Li Sanlitun scale of the China economy and cities is more than Occupancy 93% 94% 93% 92% 94% 94%94% Retail sales growth (%) n.a. n.a. +12.7% +15.5% +16.0% +17.0% +20.5% enough to accommodate 10 major players. INDIGO Mall Occupancy 83% 84% 87% 88% 95% 96%94% As things stand today, we estimate Swire Properties Retail sales growth (%) n.a. n.a. n.a. n.a. n.a. n.a. +106.3% ONE INDIGO ranks among the established players in the China Occupancy 91% 95% 91% 95% 97% 97%96% commercial property sector and offers solid credentials New and renewed area 22,274 24,194 442 2,800 3,409 3,409 2,953 to be among a major player in the prime commercial let (sq m) Reversion (%) n.a. n.a. n.a. n.a. n.a. n.a. n.a. real estate sector of China. Spot rents (CNY/sq m) low 100s- low-mid low-mid low-mid low-mid low-mid mid-high mid 200s 200s 200s 200s 200s 200s 200s In our opinion, prime commercial real-estate Source: Company, Daiwa developments need to be nurtured, and the most important aspect is not so much the immediate Set to become one of the largest players in financial returns from these buildings during the first China commercial property lease, but their potential to continue to improve their Our analysis shows Swire Properties’ approach to position in the industry and generate much stronger developing its commercial property businesses in returns over time. China is similar to its approach in Hong Kong, in that the company also began in China with a strategic  Portfolio size of major players in prime commercial property in China (end-2013) foothold in a location for which it saw long-term SHK Hang Lung Henderson Swire Wharf Hysan Hongkong potential. Compared with Hong Kong, the company’s Properties Properties Land Properties Land strategy in China has tilted more towards locations that (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) are more proven as locations for commercial Completed investment properties properties. Office 3.1 1.4 4.1 2.0 1.5 0.2 - Retail 5.2 6.8 2.5 3.0 2.2 0.3 - Serviced 0.3 - - 0.1 - 0.2 - That said, we observe that Swire Properties has still apartments/ avoided bidding aggressively for the most prime residential Industrial ------commercial property sites in the most recognised Hotels 0.9 - - 0.9 - - 0.2 prime commercial hubs, and that it has been keeping 9.5 8.2 6.7 6.0 3.6 0.7 0.2 its investment costs in China under control. We Source: Companies, Daiwa estimates these costs amount to about HKD24bn so far.

More importantly, we believe Swire Properties is close to completing the first phase of its China strategy, which revolves around securing a number of major sites, building up teams of people, and rolling out the

- 65 - Financials / Hong Kong 1972 HK 22 May 2014

 Hong Kong Property companies: gross rental income from China in 2013 (HKDm) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Wharf Lai Fung Sino Land Hutchison Whampoa Properties Hang Lung Hang Cheung Kong Cheung Hui Xian REIT SHK Properties New World Dev Kerry Properties Kerry Swire Properties Henderson Land Henderson

Source: Companies, Daiwa

 Hang Lung Properties: growth in retail sales of Grand Gateway 66 (HKDm) 4th lease 5th lease 5,000 3rd lease 4,000 2nd lease 3,000

2,000 1st lease

1,000

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Daiwa estimates based on disclosed gross rental income and occupancy cost

While Swire Properties encountered some hitches in its first few years in China, we believe it has passed through the learning period now that it has opened 4 major mixed property complexes already, and with a 5th – Daci Temple in Chengdu – scheduled to open in 2H14 and 2 others in Shanghai and Dalian. We go on to examine these one by one.

- 66 - Financials / Hong Kong 1972 HK 22 May 2014

Guangzhou: has established itself as one of the largest number of luxury international brands the most prime retail malls in the city among its tenants). Moreover, the other major players in the industry have not been able to secure large sites In our opinion, Swire Properties has come a long way in the Tianhe area, which is an existing commercial in China since it started there in 2002. In terms of hub in the Guangzhou city and where Taikoo Hui is competition, the area where Swire Properties has the located. Admittedly, the Pearl River New Town has best position relative to other China property been planned to be the city’s new CBD. developers is Guangzhou, where its Taikoo Hui already ranks as the top commercial property complex in the city as of today in terms of its tenant profile (ie, it has

 Taikoo Hui, Guangzhou

Source: Company, Google, Daiwa

- 67 - Financials / Hong Kong 1972 HK 22 May 2014

Has established itself as a leading player in Guangzhou integrated property complexes Structurally, while the Pearl River New Town area is planned to be the CBD of Guangzhou and the area is taking shape, our impression is that currently, the area is mainly an office location and does not have a strong retail flavour. Things could start to change when the mall portion of the joint-venture among SHK Properties, KWG Property and Guangzhou R&F is completed, but this will be in 2016 or later; and it often takes years for a retail property asset to mature.

We have observed that many planners for CBDs in China do not seem to have strong expertise in retail property, and as a result most CBDs in Chinese cities have not yet achieved a strong flow of retail customers, especially in the evening. It remains to be seen whether the Pearl River New Town can break out from this constraint, and even if it can eventually, this is likely to take a number of years.

In this light, by virtue of the fact that Swire Properties’ Taikoo Hui is now part of one of the most vibrant retail hubs in the city, it may well be able to maintain its position as one of the top mall in the city for some time. One observation we have about the Guangzhou retail property market is that while the city has considerable population and wealth, higher-end retailing is underdeveloped, especially when compared with Shanghai and Beijing, and one might say that Chengdu is already far ahead of Guangzhou.

Swire Properties’ Taikoo Hui is the first higher-end retail mall to be completed in Guangzhou. There are no other major comparables at the moment and we believe it will take some years before other malls of a comparable size and positioning are completed in the Guangzhou city centre. This implies that the Taikoo Hui mall should benefit from a favourable operating environment for some years to come.

We estimate tenant sales in Taikoo Hui to be about CNY1.5-2bn a year but note that in Beijing, Shanghai, Hangzhou, Shenzhen and Chengdu, the top malls or department stores already currently have retail sales as high as CNY3-7bn a year. In this light, we think there is considerable room for achieved retail sales – and hence rental income – for Taikoo Hui to increase over time, provided that it is able to continue to fine-tune its tenant mix to bring out the high-end spending potential of the city. We estimate that this mall in Taikoo Hui had a gross rental income contribution of HKD793m in 2013, which was 3x the gross rental income contribution we estimate it had in 2011.

- 68 - Financials / Hong Kong 1972 HK 22 May 2014

Beijing: has gone through a learning period – after a bumpy start, now on track

Swire Properties entered the Beijing property market in

2008, when it acquired an uncompleted retail property project from an investment fund called Village. We consider this project, called Taikoo Li Sanlitun, as a prime one in terms of location, as it is located at the

Embassy area of Beijing where many expatriates live and is just 15-20 minutes by car from the Chaoyang

CBD in Beijing.

That said, in terms of management, the project posed several challenges for Swire Properties, as it is not a conventional multi-storey indoor mall with large floors.

Instead, it consists of a number of retail blocks, which is a relatively new format for retail properties in China and a kind of retail property format which Swire

Properties has never worked on before. It comprises 2 parts: Village South and Village North. Our read is that

Swire Properties’ strategy is to position these 2 parts differently, with Village South being more mid-market and Village North being more high-end.

Like Pacific Place mall and Festival Walk when they were first completed, the tenants’ initial response to

Taikoo Li Sanlitun was not strong, especially the section in the Village North. However, Swire Properties has been able to address the problems over time. This has resulted in strong growth in Taikoo Li Sanlitun’s gross rental income to HKD526m for 2013, representing a 223% increase from HKD163m in 2008

(on our estimates). It achieved retail sales growth ranging from 2.7-17% YoY over the 4 quarters in 2013 and 20.5% YoY for 1Q14.

Taiko Li Sanlitun is now considered an established commercial property in Beijing, and the top commercial property near the embassy area, as well as the second and third ring road areas. We believe

Taikoo Li Sanlitun is on track to become an increasingly important retail complex near these areas, and that many positive factors work in its favour.

As it is close to the embassy area, it is well-located to capture retail spending from the large expatriate community in Beijing. In addition, as it is just 15-20 minutes by car from the Chaoyang CBD and has a number of new offices and residential projects in the vicinity, it should be a good retail catchment area.

Finally, Taikoo Li Sanlitun is next to Beijing’s well- known Sanlitun Bar Street, which is similar to Hong

Kong’s Lan Kwai Fong area.

- 69 - Financials / Hong Kong 1972 HK 22 May 2014

 Taikoo Li Sanlitun

Source: Company, Google, Daiwa

In our view, Swire Properties’ experience with Taikoo Li Sanlitun has also enhanced the company’s expertise in developing and managing more mid-market malls (we even venture to say that Taikoo Li Sanlitun is the first mid-market product for Swire Properties in China), as well as to experiment with a new retail format consisting of blocks of retail blocks. This experience may have been a contributor to Swire Properties’ decision to adopt the current design related to its Daci Temple project in Chengdu, which also comprises blocks of outdoor malls. - 70 - Financials / Hong Kong 1972 HK 22 May 2014

INDIGO Compared with Taikoo Li Sanlitun, the location of INDIGO is not as well-established, as it is a new area. That said, this area is considered an up-and-coming one in Beijing, with some corporations and families (particularly young families) having located there over the past few years.

 INDIGO

Source: Company, Google, Daiwa

- 71 - Financials / Hong Kong 1972 HK 22 May 2014

In our opinion, Swire Properties’ investment in INDIGO secures it early entry into a potentially important location in Beijing over time. When INDIGO was first opened in 2012, it could be said that it was ahead of its time, given that the population and commercial activities around the area had not yet matured to the point where they could support a large- scale mall together with a business hotel and office towers.

Over the past 2 years, however, the area has continued to evolve with corporations and high-income groups moving in. Note also that retail sales for INDIGO have continued to improve over the past 18 months, and as such, we think it is in line to become the most prime commercial complex in the area.

One issue for the Beijing retail property market is that the city is extremely large in terms of geographical size and the population as well as commercial activities in the city are spread out over a great distance. Traffic is also an issue for the city.

Against this background, we think it is more difficult to find the dominant retail areas one can find in Shanghai. We see the Beijing retail property market as a multi-centred one and the embassy and eastern areas as among the most important locations in the city. By virtue of the fact that Swire Properties owns 2 major malls in the above 2 areas of Beijing city, we consider its longer-term positioning as promising.

- 72 - Financials / Hong Kong 1972 HK 22 May 2014

Chengdu: on track for a promising start and there is likely to continue to be further retail space In comparison, Swire Properties’ position in Chengdu completed in Chengdu over the next few years. That is arguably more challenging but also more interesting said, we do not hold a pessimistic view on the prospects than that in Guangzhou and Beijing. Admittedly, the for both Swire Properties’ Daci Temple project and Chengdu commercial property market is characterised Wharf’s Chengdu IFS. by an abundant supply of commercial property space,

 Daci Temple project, Chengdu

Source: Company, Google, Daiwa

- 73 - Financials / Hong Kong 1972 HK 22 May 2014

In our view, competition in the retail property sector is arguably 2 of the strongest managers of retail often as much between different districts as between properties in Hong Kong. Combined, these 2 malls individual properties. have a scale which is far larger than any other major mall in a city centre of a major city in China. In other While more supply in an area means that tenants have words, we think Chengdu is home to the strongest mall more choice and bargaining power, an abundant operators in China. supply situation might not be without benefits for those areas in which there is an over-supply, in so far as more  Combined size of Chengdu IFS and Daci Temple project supply can strengthen an area as a retail hub because Sino-Ocean Chengdu IFS Taikoo Li Chengdu Combined more choice generally attracts more shoppers. Also, GFA (sq ft) GFA (sq ft) GFA (sq ft) many new retailers may give an area a try because of Retail 2,315,000 1,141,598 3,456,598 the abundant availability of space and the potential of Office 2,932,000 1,324,575 4,256,575 the area as a retail hub. Serviced apartments 440,000 163,828 603,828 Hotel 774,000 82,076 856,076 Total 6,461,000 2,712,077 9,173,077 In our opinion, one major theme in the China retail Source: Swire Properties, Wharf Holdings, Daiwa property sector is the battle between modern malls and high-street and department stores. In the case of Hong Second, the Chuanxi Road cluster in Chengdu could Kong, while department stores and high-street shops well be one of the strongest, if not the strongest, retail were the main retail format in the 1970s and 1980s, hub in China. According to recent media reports in shopping malls established themselves as the main China, annual retail sales in the Chuanxi Road cluster retail format in the 1990s, and their position has are already over CNY10bn, which should rank among further strengthened in the 2000s and 2010s. the highest in the country.

We think this situation could be replicated in major We believe the completion of Wharf’s Chengdu IFS and cities in China, and believe Chengdu could be among Swire’s Sino-Ocean Taikoo Sanlitun will expand the the first areas where shopping malls emerge as retail offerings in the Chuanxi Road area notably and winners. We see 2 reasons for this. strengthen the area as a retail hub. In our opinion, Wharf’s Chengdu IFS and Swire’s Daci Temple project First, Chengdu is the only city in China where there are could be a main catalyst driving a consolidation of 2 mega malls located right in the heart of the most retail spending in malls versus department stores and important established retail hub of the city. And these high street shops in Chengdu. 2 malls are managed by Wharf and Swire Properties,

- 74 - Financials / Hong Kong 1972 HK 22 May 2014

Shanghai: a location with considerable potential  Dazhongli

Source: Company, Google, Daiwa

Swire Properties also occupies a prime location in We would also note that there is still a sizeable gap Shanghai, given that Nanjing Road (close to its between the achieved retail sales in major malls in Dazhongli project) has long been one of the most Hong Kong versus those in Shanghai, and we believe vibrant retail streets in Shanghai – and even in China. that over time, the retail market potential of Shanghai While the Shanghai retail property market is may not be smaller than that of Hong Kong. If Hong competitive, with many strong players already having Kong can support 10 or more successful retail malls, we established a presence there, we think the size of do not see any reason why this could not be possible in Shanghai’s population and wealth would allow it to Shanghai. Moreover, Swire’s Dazhongli project in support at least a few more major retail malls.

- 75 - Financials / Hong Kong 1972 HK 22 May 2014

Shanghai was acquired in 2002, and the cost does not Dalian: the company’s first China project look high by today’s standards. with a residential component

 Tenant sales of selected retail properties in Hong Kong & Although Swire Properties did not have an easy start in China in 2013 China commercial properties, the growth in gross rental (HKDbn) income from China it has achieved in the recent years 40 suggests to us that it has been able to make continuous 35 progress. As such, we would not be surprised if the 30 company rolls out more such large-scale mixed- 25 20 development projects in China in the years to come. 15 10 Note that in January 2014, Swire Properties announced 5 that it was forming a joint venture with CITIC Property 0 and another mainland entity to develop a mixed-use property project in Dalian (295,000sq m in GFA) Parc 66 Parc Plaza 66 Sogo HK 66 which is Swire Properties’ 6th mixed-use property Harbour City Harbour Time Square Nanning MIXc

Grand Gateway project in China, and the first with a residential Shenzhen MIXc Hangzhou MIXc

Source: Companies, Daiwa component. We see this as a sign that Swire Properties Note: Hong Kong malls: Harbour City, Times Square, Sogo HK; China malls: Shenzhen is committed to further developing its China MIXc, Grand Gateway 66, Plaza 66, Hangzhou MIXc, Nanning MIXc and Parc 66 businesses, and we would not be surprised if it takes on

 Swire Properties: gross rental income from China more projects with a residential component in the years to come. (HKDm)

5,000 Considerable room for value creation over 4,000 time 3,000 Overall, we see significant room for value creation for 2,000 Swire Properties’ commercial properties in China. The

1,000 take-off point could be just a few years away and could represent important earnings and NAV drivers for the 0 company.

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Taikoo Li Sanlitun Taikoo Hui INDIGO Daci Temple Dazhongli Several of Swire Properties’ major projects in China are

joint ventures, which have the benefits of lowering the Source: Company, Daiwa forecasts risk and capital commitments for Swire Properties in the initial years. That said, the company’s presence in The execution on the Dazhongli joint-venture project China’s retail property sectors would be enlarged remains to be seen, and it is Swire Properties’ first joint rapidly if it bought out its partners in these projects. with HKR International (Not rated). On the whole, Swire Properties has a record of buying out its joint- however, we believe this project has considerable venture partners, with the latest such move being its potential, if only because it is one of the few major acquisition of the remaining 20% stake in Taikoo Li large-scale mixed property projects in Shanghai’s city Sanlitun from Gaw Capital Partners. Should the centre. company move to buy out its other joint-venture partners in China, or should these joint-venture In all, we believe Swire Properties has been making partners want to exit, the scale of Swire Properties’ progress with the execution of its China property businesses in China could increase significantly. projects. While the execution related to Taikoo Hui in Guangzhou took a long time (about 10 years), the Our view is that prime commercial real estate is a good development of its other projects in Beijing and way to gain exposure to the scale of China’s economy Chengdu was quicker, and we believe having a and its property market. So far, Swire Properties has domestic company like Sino Ocean as a partner could secured a foothold in China and appears to be moving have speeded up the pace at which Swire Properties on a promising track, especially for Taikoo Hui in can navigate through the bureaucracy in China. We Guangzhou. There will likely be trial and error believe Swire Properties may continue to look for good elements, and it took the company a long time to get its working partners for its China investments. Taikoo Hui project up and running. That said, the company has been learning and adapting and we are seeing it starting to produce results.

- 76 - Financials / Hong Kong 1972 HK 22 May 2014

Above all, we believe Swire Properties is entering a  Swire Properties: gross rental income from China take-off stage in China, and we expect to see its China (HKDm) 2008 2009 2010 2011 2012 2013 Taikoo Hui Guangzhou 19 19 19 322 903 1,097 investments becoming supplementary earnings and Taikoo Li Sanlitun, Beijing 163 239 325 457 469 526 NAV drivers for the company in coming years, with INDIGO, Beijing - - - - 47 214 substantial room for value creation in the medium-to- Daci Temple, Chengdu ------long term. Dazhongli, Shanghai ------Taikoo Hui, Dalian ------181 258 344 779 1,419 1,837  Swire Properties: China rental income growth Source: Company, Daiwa estimates (HKDm) 2,000

1,600

1,200

800

400

0 2008 2009 2010 2011 2012 2013 China retail rental income China office rental income

Source: Company, Daiwa

Swire Properties: summary of China investments Serviced Total Valuation Attrib. valuation Office Retail apartments ex-hotels Hotels Total 2011 2012 2013 2011 2012 2013 Property Stake Area GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) (HKDm) (HKDm) (HKDm) (HKDm) (HKDm) (HKDm)

Taikoo Li Sanlitun 100% Beijing - 1,296,308 - 1,296,308 169,463 1,465,771 8,975 9,790 10,239 8,975 9,790 10,239 INDIGO 50% Beijing 595,464 939,493 - 1,534,957 385,269 1,920,226 4,650 5,166 5,556 2,325 2,583 2,778 Taikoo Hui 97% Guangzhou 1,731,766 1,472,730 51,517 3,256,013 584,184 3,840,197 12,014 12,983 13,862 11,654 12,594 13,446 Hui Fang 100% Guangzhou - 90,847 - 90,847 - 90,847 -- Daci Temple project 50% Chengdu 1,115,000 1,141,598 82,076 2,338,674 - 2,338,674 2,071 2,256 4,823 1,036 1,128 2,412 Dazhongli project 50% Shanghai 1,844,842 1,081,362 - 2,926,204 543,194 3,469,398 12,442 13,750 15,292 6,221 6,875 7,646 Dalian Port project 50% Dalian - 1,905,936 - 1,905,936 - 1,905,936 -- 5,287,072 7,928,274 133,593 13,348,939 1,682,110 15,031,049 40,152 43,945 49,772 30,210 32,970 36,521 Source: Company, Daiwa

- 77 - Financials / Hong Kong 1972 HK 22 May 2014

 Portfolio size of the major players in prime commercial properties in Hong Kong and China at 31 December 2013 SHK Swire Henderson Hang Lung Hongkong Properties Properties Land Wharf Properties Land Hysan (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) Completed investment properties HK 28.6 13.7 10.2 12.1 5.1 6.5 4.5 China 9.5 6.0 6.7 3.6 8.2 0.2 0.7 Overseas 0.4 0.6 - 0.0 - 4.2 - 38.5 20.2 16.9 15.8 13.3 10.9 5.2

HK Office 10.0 10.0 3.4 5.5 1.9 5.2 2.3 Retail 10.6 2.5 4.4 3.5 2.5 1.2 1.5 Serviced apartments/ residential 0.9 0.5 0.5 0.8 0.7 - 0.7 Industrial 3.6 - 0.9 1.1 - - - Hotels 3.5 0.7 1.0 1.4 - 0.2 - 28.6 13.7 10.2 12.1 5.1 6.5 4.5 China Office 3.1 2.0 4.1 1.5 1.4 - 0.2 Retail 5.2 3.0 2.5 2.2 6.8 - 0.3 Serviced 0.3 0.1 - - - - 0.2 apartments/ residential Industrial ------Hotels 0.9 0.9 - - - 0.2 - 9.5 6.0 6.7 3.6 8.2 0.2 0.7 Source: Companies, Daiwa

- 78 - Financials / Hong Kong 1972 HK 22 May 2014

Swire Properties: residential properties in Mid-levels West 4. Other upcoming locations poised to become supplementary earnings and NAV drivers

In our opinion, the progress Swire Properties has achieved in China shows that the applicability of the company’s business model may not be confined to Pacific Place and Island East. Indeed, with the experience gained from Pacific Place, Island East and China, the company might have gained considerable experience in terms of applying its business model to other locations or cities, making its property franchise increasingly scalable.

Also, our analysis shows the company has other locations it is nurturing – at least 6, as things stand at this point. In our view, these 6 locations/areas could be considered hidden assets. Source: Company i) High-end residential properties in As it has done with its commercial properties, Swire Hong Kong and China Properties’ approach to its residential properties has also been to concentrate on specific locations. Much of In our opinion, one under-utilised asset of Swire its current residential development landbank for sale is Properties is its brand name in residential property. concentrated in Hong Kong’s Mid-levels, and is close to We see Swire Properties as a reputed brand in the Robinson Place, a classic project it developed in the Hong Kong residential property sector, underpinned by 1990s. As with its commercial properties, we believe the number of classic projects it has developed in the Swire Properties has also been acquiring old buildings past, including Taikoo Shing, Robinson Place, The in the vicinity of Robinson Place and we see its current Albany and Opus. Its products tend to have their own Mid-level residential landbank as a result of its efforts character and may not appeal to everyone; but for to accumulate old buildings in the vicinity over the past those who like them there are few alternatives, and this 2 decades. is already translating into pricing power for its residential property projects. We believe the ASPs achieved by the company’s various Mid-levels projects such as Argenta and Azura (well  Swire Properties: Opus over HKD25,000/sq ft) are commendable, especially given the large lump sum involved and the stamp duties entailed. Our analysis indicates a feature of these high-end residential projects is that while the number of units involved is small, the amount of profits the company can make is material. For example, in 2012 and 2013, Swire Properties generated some HKD3.4bn in property-sales profit but that came largely from the sale of 131 units in Azura and Argenta.

 Swire Properties: key performance indicators – residential projects Total no. No. of units sold of units 9M12 2012 1Q13 1H13 9M13 2013 1Q14 Azura 126 103 108 111 111 118 119 120 Argenta 30 - 6 7 7 10 13 16 Dunbar Place 53 - - 21 21 24 34 44 ASIA 123 111 111 112 112 122 122 - Mount Parker ------58 Source: Daiwa Residences Source: Company, Daiwa

- 79 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: property-sales profit in 2012 and 2013 terms of the leases and other considerations such as Operating Operating floor plates and competitive dynamics. Revenue profit margin (HKDm) (HKDm) (%) Remarks 2012 4,147 2,395 57.8% Mainly from 98 units of Azura In this connection, we would view it positively if Swire 2013 2,207 1,035 46.9% Mainly from 21 units of Azura and Properties could secure some residential development 12 units of Argenta opportunities in the area, especially given both Star Source: Company, Daiwa Crest and 5 Star Street have turned out to be lucrative

projects for the company. Our view is that Swire Properties has the capital, skill- set and brand to do more in the niche high-end Swire Properties: residential properties in Island East residential property segment in Hong Kong, and the Mount Parker Residences current pipeline it has built up should be sufficient to help sustain its property-sales profits in the coming years.

 Swire Properties: residential projects for property trading in Hong Kong (January 2014) Actual/expected ASP No. of No. of construction Attributable (HKD/sq units units Project completion date GFA (sq ft) ft) sold unsold 5 Star Street 2010 408 AZURA 2012 24,480 30,610 119 7 ARGENTA 2013 66,765 32,306 1317 Dunbar Place 2013 76,432 21,127 34 19 Mount Parker Residences 2013 151,954 92 33 Seymour Road (Phase 1) 2014 165,792 127 Cheung Sha, South Lantau 2015 218,000 33 Seymour Road (Phase 2) 2016 195,531 197 Total 899,362 166 459 Source: Company

Source: Company The future: integrating a residential component into key locations? In this light, Swire Properties recently entered into an In our opinion, the brand equity Swire Properties has agreement with CITIC Property and another Mainland built up over the years is a hidden asset, and we believe entity to develop jointly a mixed-use property project one way the company can monetise this brand equity is in Dalian is an important development. This project is by accumulating old building sites near those locations Swire Properties’ first China project with a residential where it is already strong in commercial properties. A component to it so far, and marks the beginning of the case in point is the Mount Parker Residences in Island company’s exposure to high-end residential East that it recently put on the market. developments in China.

As well as helping to balance the company’s high In addition, Swire Properties is one of the owners of a exposure to asset-intensive commercial properties, one large-scale residential property project in the Yau Tong of the merits of the company’s residential property- Shipyard in Kowloon (across the harbour from Island trading business is that it can also help to transform East). This project has obtained Town Planning Board and upgrade the key locations it focuses on, in our approval for redevelopment and will go ahead once the view. We believe that having more high-end residences land premium is fixed. With the total GFA likely to be near an area also has a positive impact on the profile of over 4m sq ft, on our estimate, this project could the entire area, and would bring benefits to the become the largest residential project in Kowloon East company’s retail, hotel and office businesses. in the years to come. Separately, it was reported in the South China Morning Post some years ago that Swire Along these lines, we believe Wanchai South is an area Properties also owns agricultural land on Lantau where Swire Properties could pursue many residential Island, which could also constitute a source of hidden development opportunities in the coming years. The landbank for its residential property-trading company has been accumulating old buildings in the businesses. vicinity of Pacific Place for many years, but converting some of the buildings there into commercial In sum, while residential property development is developments may not be the best approach, given the currently still a small component of Swire Properties’ business, we believe it has the potential to become a

- 80 - Financials / Hong Kong 1972 HK 22 May 2014

more important supplementary earnings driver in a Citygate: from a struggling asset to the few years’ time, especially given that the company has most successful outlet mall in Hong Kong also quietly built up a reasonably sizeable residential Swire Properties and 4 other consortium members won property landbank in Miami (which we discuss the tender for Package One of the Tung Chung Station elsewhere in this report). project in 1995, which included a mixed-use property

project along with a sizeable residential component ii) Suburban malls in Hong Kong and that became known as Tung Chung Crescent. This site Lantau Island was awarded before 1997, and at that time the general While Pacific Place mall’s retail sales in 2013 were flat expectations were that Tung Chung could be developed YoY and underperformed Hong Kong’s overall retail into a new town for middle class residents who wanted sales, we consider it too early to conclude that Swire to upgrade into larger-sized homes in an area with a Properties’ capability in managing retail property better physical environment in the New Territories, but assets is on the decline. After all, Pacific Place has still connected to the city through subways. enjoyed a number of good years already, and its achieved rents are still among the highest in Hong As it turned out, however, upgrade demand was Kong, according to our analysis. undermined significantly by the residential property market crash in 1997, and many of the buyers of the Swire Properties’ business model for retail is not private residential units at Tung Chung Station were necessarily that of striving to always be the top in terms first-time home buyers whose appetite to spend was of retail sales. In our opinion, its malls tend to be subsequently hit by the correction in residential oriented towards cultivating customer loyalty and property prices that occurred over 1997-2003. preference among a certain social segment and people with certain tastes and preferences. To the extent that As a result, the Tung Chung retail property market did the population of this social group could continue to not turn out to be as vibrant as the consortium might increase over time, so could the retail sales and rental have expected when it submitted the bid, and hence the income of the company’s malls, as well as the image Citygate mall faced a problem related to its proper and vibrancy of the whole mixed property project. positioning from the outset.

In our view, one of the merits of this type of mall is  Swire Properties: Citygate mall that, while such malls may not be top performers within Hong Kong’s retail property market in terms of retail sales, their performances tend to be resilient against fluctuations in the economic environment. In other words, we see Swire Properties’ business model as trying to promote gradual but sustained rental income growth.

The challenge the company may face is that not many cities have a critical mass of people with a predilection for the kind of products that Swire Properties provides. That said, we think it is fair to say that for people who have a preference for Swire Properties’ products, it is not easy to find comparables. Further, Swire Properties is able to fine-tune its products so that while some of its retail products may not have worked initially, many have been able to establish solid position in their respective retail property markets eventually.

This appears to be the situation for Festival Walk in Hong Kong and Taikoo Li Sanlitun in Beijing. We believe the situation is also similar for Citygate on Lantau Island.

Source: Company, Daiwa

- 81 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: investment in Lantau (GFA/sq ft) would not be surprised if Swire Properties becomes one Project Office Retail Residential Hotel Total of the major players in the development of Lantau Tung Chung Crescent 0 36,053 0 0 36,053 Citygate 160,552 462,439 0 0622,991 Island, and Lantau could well be another location on MTRC Tung Chung 0 0 0 0 0 which it focuses. Novotel Citygate 0 0 0 236,653 236,653 Total 160,552 498,492 0 236,653 895,697 iii) A major player in Miami’s commercial Source: Company property sector  Swire Properties: key performance indicators – Citygate mall Miami is another location that could become important 9M12 2012 1Q13 1H13 9M13 2013 1Q14 for Swire Properties over time. While it may appear Citygate mall Occupancy 100% 100% 100% 100% 100% 100% 100% odd that the company has projects in Miami, it has a Retail sales growth +21.6% +21.2% +19.2% +19.2% +16.5% +13.5% +7.5% long history of investing in the Miami area, as its (%) parent, Swire Pacific, has been a bottler of Coca-Cola Source: Company, Daiwa for several regions in the southern US for several decades. Also, Swire Properties is not new to the It probably attests to the property management residential property market in Miami, as it has had capability of Swire Properties (it owns 20% of the residential projects there for more than a decade. Citygate, but it has been the principal manager of this asset) that issues related to Citygate were finally fixed.  Residential property projects developed by Swire Properties Over the past few years, Citygate has changed its in Miami position to become Hong Kong’s first outlet mall, and Year Project Stake GFA (m sq ft) has been able to ride on the increase in tourist 2001 Three Tequesta point 100% 0.51 spending in Hong Kong. Indeed, we believe Citygate 2002 Courts Brickell Key 100% 0.46 2004 Jade Residences 63% 0.65 has now become the most vibrant suburban mall in 2005 The Cartonell 100% 0.56 Hong Kong, and its retail sales growth in 2013 (20% 2008 ASIA 100% 0.32 YoY) demonstrates its increasing strength in the Hong Source: Company, Daiwa Kong retail property sector.  Swire Properties: current residential landbank in Miami and vicinity In this connection, we note that in 2013, a consortium Project Area Stake GFA (sq ft) led by Swire Properties (which has the same South Brickell Key Miami 100% 421,800 shareholding structure as the consortium that owns the Fort Lauderdale site Fort Lauderdale 75% 787,414 Citygate) secured a strategic interest in the Citygate ASIA Miami 100% 5,359 project in Tung Chung by acquiring an adjacent site. River Court Fort Lauderdale 75% 12,586 The price paid by Swire Properties, of HKD2,328m Brickell City Centre Miami 100% 1,564,000 2,791,159 HKD4,314/sq ft, was substantially above prevailing Source: Company, Daiwa market expectations and we think illustrates how determined the company was to get it. That said, the size and scale of Swire Properties’ past projects in Miami cannot be compared with its current Will Tung Chung become a more important main project, Brickell City Centre, which is a sizeable location? site in the Brickell financial district of Miami. While Tung Chung is a fringe area now, the government is considering many options for Lantau We believe the development of Swire Properties’ China Island. Given this, Tung Chung could be an important businesses tells us something about the management commercial hub over the long term, providing philosophy of the Swire group. Although Miami has opportunities that are suitable for Swire Properties, in never been an important component of the company’s our view. businesses, it has maintained a presence in this market, and when opportunities arose in 2011 and 2013, Swire We believe Swire Properties probably considers Lantau Properties scaled up its investments significantly in Island as a location of strategic interest. Its parent Miami. company, Swire Pacific, is the major shareholder in Cathay Pacific, which has a sizeable business presence Brickell City Centre represents a departure from the in the Hong Kong International Airport-Tung Chung other major projects Swire Properties has taken on in area. Miami, in that the site is regarded as a prime site in the centre of Miami city. That said, we estimate the average Also, many years ago, Swire group confirmed in a land cost for the project was less than HKD100/sq ft. report in the South China Morning Post that it owned As such, we believe the company has secured a low-cost some agricultural land on Lantau Island. Thus, we entry into a very prime site in Miami and estimate the

- 82 - Financials / Hong Kong 1972 HK 22 May 2014

built-in pre-tax margin for this project is likely to be premier property companies in the US, it could result over 30%. in investors taking another look at the valuation gap between Hong Kong and US property companies. While Swire Properties’ property investments in Miami are small compared with those in Hong Kong, the Overall, while the Brickell City Centre project is a niche company has made a strategic decision in recent years project for Swire Properties based on its small to increase its investments in Miami. Also, the absolute contribution to our estimated value of the company’s size and scale of its investments are not small for the total assets, its significance may extend well beyond Miami property market. that.

A future landmark in Miami city? As the company has already built up a 2.8m sq ft Our analysis indicates that with Brickell City Centre, residential property landbank in Miami, the project Swire Properties has embarked on one of the largest should help to supplement Swire Properties’ profit mixed-use commercial property projects in the heart of from property trading after it has used up its current Miami city. The company expanded the scale of the residential landbank in the Mid-levels of Hong Kong. project in 2013 by acquiring land adjacent to Brickell City Centre, which it plans to develop into an 80-storey Investment in Brickell City Centre in mixed-use development that is likely to become a Miami landmark in Miami city.  Brickell City Centre

We see this investment as a sign that Swire Properties is serious about building up its presence in Miami city.

We estimate that Miami accounts for less than 10% of the company’s total assets but that Brickell City Centre will be a material supplementary earnings driver for Swire Properties over the medium term.

Significance of Miami project may extend beyond its size The company’s Brickell City Centre project is significant in 3 major ways, in our view.

First, its investment in Brickell City Centre may mark the beginning of a larger long-term presence for Swire Properties in Miami, and the company could become a more sizeable player in Miami city over time (given it has been involved in the Miami property business for 2 decades). In this context, we note that Swire Properties’ current positions in areas such as Admiralty and Island East all started with a single project.

Second, the Miami investment could be a showcase for what Swire Properties is doing outside Hong Kong. The company’s China experience illustrates that it can Source: Company, Google, Daiwa execute projects outside Hong Kong, and Miami may be another example of this. In our view, demonstrating  Swire Properties: hotel investments in Miami that it can apply its property expertise outside Hong Hotels No. of rooms Kong is an important consideration to take into EAST, Miami 351 account in Swire Properties’ valuation. Mandarin Oriental, Miami 245 Brickell City Centre, Miami 264

Source: Company Third, the Brickell City Centre project could lead some investors to consider whether there is an anomaly in the valuation of Hong Kong property stocks, including Swire Properties. This is because, if this project were to gain as good a reputation as those developed by - 83 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: investments in Brickell City Centre to enable it to raise equity capital to fund more Brickell City Centre, Miami (under development) Attributable GFA (sq ft) property investments when it finds attractive Serviced apartments 102,000 Hotels 218,000 opportunities. Retail 505,000 Office 982,000 Kowloon East investment Residential (for trading) 1,128,000  Swire Properties: office investment in Kowloon East Total 2,935,000 Acquisition Land cost Attributable Source: Company, Daiwa Project price (HKD/sq ft) GFA (sq ft) Wang Chiu Road and Lam Lee Street HKD2.64bn 4,753 555,000 iv) Kowloon East: another area where the Source: Company, Daiwa company may have a strategic interest  Office market in Kowloon and Hong Kong Island Kowloon East is another area where Swire Properties may be able to use its expertise. The company acquired a site in Wang Chiu Road for HKD2,640m in November 2013. The price was considered as high at that time, but looked reasonable after Mapletree Investment acquired another site in the area for HKD3,769m (HKD5,708/sq ft) in January this year.

We believe that it is in the strategic interest of Swire Properties to see Kowloon East become an office area complementing Island East rather than under-cutting it. If the company were to be a sizeable player in the office markets of both Island East and Kowloon East, then it would be one of the largest owners of grade-A offices outside Central.

We see Swire Properties’ investment in Kowloon East as an important strategic step and believe the area offers the company many opportunities to put into practice what it has done elsewhere. In our view, one rationale behind Swire Properties’ listing on the Hong Source: Daiwa Kong stock market could be to have a platform in place

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 Swire Properties: presence in Island East and Kowloon East

Source: Company, Google, Daiwa v) Wong Chuk Hang: another potentially settled the land premium related to developing its important location over the medium 50%-owned Wong Chuk Hang building into an office term development, which we think represents the first step in the company’s investments in Wong Chuk Hang. As noted above, Swire Properties owns many old buildings in Hong Kong, especially in Wanchai South In the past, Wong Chuk Hang was mainly an industrial and Island East, although it does not disclose details area. However, it has been undergoing a change over about them. In our view, a key aspect of these recent years, and may be the only area on Hong Kong properties is that their strategic value for the company Island that can be developed into another grade-A exceeds their direct commercial value. This is because office hub, and we expect to see major changes in their redevelopment could enhance the value of Swire Wong Chuk Hang over the coming years. One main Properties’ entire portfolio in the area, and so these catalyst is likely to be the opening of the South Island assets should command strategic values as well. Line due by 2016, which will make the area only 15-20 minutes’ ride away by MTR from Pacific Place in Wong Chuk Hang is another area that has the potential Admiralty, where the South Island Line will terminate. to become a more important commercial district over the medium-to-long term. Swire Properties recently - 85 - Financials / Hong Kong 1972 HK 22 May 2014

 The Wong Chuk Hang area and the South Island Line While the company does not have meaningful presences in either Singapore or Jakarta, it has stated that it has been looking into opportunities in these cities and other cities in Asia as well. In our opinion, Hongkong Land’s experience demonstrates that Hong Kong-based companies can establish a meaningful presence in at least the commercial property sectors of various ASEAN markets.

We believe Swire Properties will pursue opportunities in ASEAN property markets as supplementary drivers for its earnings and NAV growth over the medium-to- long term.

vi) Hotel business In addition, we believe Swire Properties’ investments in Source: MTR, Daiwa hotels carry some potential in the long term. However, at this stage, we see hotels as more of a strategic  The Wong Chuk Hang area investment for Swire Properties, as a necessary component of its large mixed-use property development complexes.

Still, we believe the hotel industry globally is in the midst of a major structural change. Outbound tourists from China, which have increased sharply in recent years, have already brought about a significant boost to the global luxury retail industry, and should have a favourable impact on the hospitality industry globally over time.

In the past, luxury hotels were niche products for a Source: Savills very small number of people, but in recent years the Singapore, Jakarta and other number of people who can and are willing to pay for a stay in a luxury hotel has risen considerably. Thus, we opportunities in Asia believe Swire Properties’ hotel business could become Swire Properties’ business model is applicable not only more meaningful in terms of its contribution to to Hong Kong but to other property markets too, in our earnings and NAV in the future, as it owns and view. As discussed in this report, we are seeing growing manages over 3,500 hotel rooms in more than 5 cities evidence that the company can apply its business already (shown in the ensuing table). model in China and Miami, and hence believe its model could be applied to other property markets in Asia. While we do not expect the company’s hotel business to become an important profit contributor in the near By way of background, we note that Hongkong Land’s future, it should no longer be regarded as a small expansion into Singapore and ASEAN countries in business. The company’s hotel assets are carried in its recent years has been one of the most successful books at cost and subject to depreciation annually, and examples of a Hong Kong-based property company hence we see hidden value in these assets. broadening its presence across Asia. While we do not expect Swire Properties to pursue a Swire Properties is still at the very initial stage of its separate listing of its hotel business any time soon, we regional expansion. It acquired 8 residential units at note that some Hong Kong companies have realised the Hampton Court in Singapore in December 2012 and NAVs of their hotel operations through listings, and opened a representative office in Jakarta in August that the listing valuations were quite high. 2013. For example, Langham Hotel Hong Kong was valued at HKD12.5m/room in its IPO prospectus, which is higher than the HKD8-12m/room we use for Swire Properties’

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3 hotels in Pacific Place. Yet we do not consider the developers, Swire Properties’ model takes longer to quality and potential of the Pacific Place hotels as execute, and the payback is more gradual, but we inferior to that of Langham Hotel Hong Kong. consider it as a gradual but certain approach. Above all, the returns have been steady as well as incremental,  Swire Properties: global hotel portfolio and have tended to grow over time. Year of Hotels Location completion GFA (sq ft) Rooms JW Marriott Admiralty, HK 1988 525,904 602 Its model has worked very well in Admiralty and Island Conrad Admiralty, HK 1990 444,490 513 East; and, after a learning period, it has started to work Island Shangri-la Admiralty, HK 1991 605,728 565 in China. Against this background, we believe the Novotel Citygate Tung Chung, HK 2005 236,653 440 company’s model should also work in Miami, Kowloon The Upper House Admiralty, HK 2009 158,738 117 East, Lantau Island, Wong Chuk Hang, and could work EAST Hong Kong Taikoo Shing, HK 2009 199,633 345 Hong Kong total 2,171,146 2,582 even in Singapore, Jakarta and other cities globally in The Opposite House Beijing, China 2007 169,463 99 the long term. Mandarin Oriental Guangzhou, China 2012 584,184 263 EAST Beijing Beijing, China 2012 358,269 369 In sum, we believe Swire Properties is one of the few China total 1,111,916 731 property companies in Asia that is more than merely an Avon Gorge Hotel Bristol, UK 1855 87,608 75 The Magdalen Chapter Exeter, UK 2001 36,001 59 asset owner, and believe it possesses a skill set and Hotel Seattle Brighton, UK 2003 48,416 71 product that is scalable and can be rolled out in many The Montpellier Chapter Cheltenham, UK 2010 36,662 61 markets outside Hong Kong. UK total 208,687 266 Mandarin Oriental Miami US 2000 345,000 326 We believe that the market is not ascribing to the share Source: Company price any value for these attributes, and we see this

 Facades of some of Swire Properties’ hotels extra value as an investment strength for Swire Properties relative to its Hong Kong peers. Also, we believe Swire Properties is in an increasingly strong position to ride on the present opportunities in Hong Kong’s commercial property market, as we discuss in the following section.

Source: Company, Google, Daiwa

More than merely an asset owner Our view is that Swire Properties’ differentiated business model for property development resembles a value-creation machine. Compared with the business models adopted by other Hong Kong property

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 Can Hong Kong achieve and maintain any of the following 5 5. Good vehicle to gain exposure attributes? to Hong Kong commercial properties, especially offices

We see Swire Properties as a good vehicle through which to gain exposure to the Hong Kong commercial property sector in the coming years, for the following reasons. i) HK offers a favourable environment for asset managers in the coming years In our opinion, how observers see the future of the Hong Kong’s commercial property sector will hinge on their view of the broad upcycle since 2H03 (whether it is driven just by exceptionally low interest rates or there are some important structural factors at work), as well as Hong Kong as a city (whether it is already on the decline or it can continue to evolve into a stronger and more important metropolitan city).

One characteristic of the Hong Kong commercial 1. China’s all-round international financial centre property sector in the 11 years since mid-2003 has been 2. The commercial gateway to China the sharp rises in prices and rents for top-end 3. The retail hub of Chinese consumers 4. Chinese corporations’ springboard to overseas commercial properties, especially over 2005-12. This 5. An important force in some of China’s major sectors has coincided with a period of exceptionally low Source: Daiwa interest rates and the start of QE in the US following the Lehman crisis in 2008. However, while low interest The top-end segment was exceptionally rates have certainly had a favourable impact, we do not strong over 2005-12 believe this upcycle has been driven primarily by the monetary environment. Hong Kong property can be seen as a sector created by decades of cumulative under-supply of land in a city Rather, we believe it is related to a fundamental that has been able to bounce back in every economic metamorphosis in the commercial property sector, downturn, and to continue to move up the economic which is moving from a sector serving a medium-sized value chain. One consequence of this is that players in city in Asia with a population of 7m into one serving a the top-end segment of the market are very strong, much larger population and a much larger-sized while the stock of physical properties at the top end (be economy (ie, that of Mainland China). it office, retail, or residential) is limited (see our Hong Kong Property Toolkit).

In this light, we see the rise in rents for a few major office buildings and premier malls as the market’s way of saying that some new demand is coming and the existing stock of prime property assets in Hong Kong are far too small relative to the scale of demand that is coming up. In our opinion, the rises in prices and rents for top-tier property assets in Hong Kong in recent years (this seems to have applied across the board to all property asset classes, be it residential, office, retail, and hotels) reflect a sharp rise in the number of people and entities with strong purchasing power and rent- paying capability.

The residential market has been dominated by wealthy individuals from the Mainland, while the retail market has seen the arrival of first-tier international chains - 88 - Financials / Hong Kong 1972 HK 22 May 2014

and the watches and jewellery trade. In the office Coming years should be favourable for segment, there has been aggressive expansion by the mid-range assets and the asset managers international banks (prior to the Lehman crisis), and in Top-tier property assets have seen significant rises in hotels there has been an increase in the number of capital values and rents over the past 10 years. We guests and corporations (some from the Mainland, believe further increases will need to be augmented by some from overseas) with larger hotel-room budgets continued rapid rises in the number of people and than in the past. entities that have high purchasing power and rent-

paying ability, but we have not seen any signs of this A period of adjustment or the beginning of happening yet. a secular downturn? Admittedly, all the above trends have run into excesses Against this background, we do not expect the coming or resistance. The government’s various measures and years to be a period of rapid growth in either overall stamp duties, for example, have curbed additional rents or capital values. Nor do we expect major declines purchases from wealthy Mainland buyers. The in rents or prices. We believe that top-end prices and international banks have generally been downsizing rents are supported by the relative scarcity of really since the Lehman crisis, and the watches and jewellery prime property assets, and that there is a growing trades have found that they have over-expanded and critical mass of wealthy people, large corporations and have not been prepared for the decline in luxury retail affluent shoppers that can support the prices and rents spending in China. of top-end assets.

One may say that the office segment was the first to  What is the current position of Hong Kong property? What the market seems to The unwinding of a massive bubble enter an adjustment period, followed by retail, both have feared driven by natural market forces. Since 2011, rental and Worst case Market doldrums lasting for a number of years demand growth in both the office and retail segments Base case Returns to a normal and steady price growth path after the has been driven mainly by mid-range assets such as excesses in some of the top-end assets have been removed, and more mid-range assets become available in the market decentralised offices and suburban malls. Optimistic case The correction and adjustment phase in the commercial property market ends in 6-12 months However, in terms of residential properties, it appears Very optimistic case The correction and adjustment phase in the commercial property that there has not been enough supply in the mid-range market ends in 3-6 months Source: Daiwa (probably because of the lack of land conversions, which accounted for about two-thirds of Hong Kong’s  Hong Kong property prices YTD and Daiwa’s forecasts land supply prior to 1997) to restrain prices at the top 2014 YTD 2014E 2015E end. Still, government administrative measures since Rents February 2013 have compelled the industry to enter a Prime shopping malls +3.8% +6% +3% period of adjustment. In this sense, developments in Overall retail +3.8% +6% +3% Central grade-A office +0.5% - +5% the residential property sector represent a departure Overall office +0.4% +5% +8% from those in the office and retail property sectors. Mass-residential property -0.3% -5% - Luxury-residential property -1.1% -10% - While all property segments have entered a period of Prices Mass-residential property -0.8% -5% - adjustment, we have yet to see major declines in prices Luxury-residential property -1.2% -10% - and rents, even though it is likely that all industry Source: CEIC, CBRE, Jones Lang La Salle, Savills, Midland, Centa-City leading index, participants have now built in the expectation that the Daiwa forecasts US will implement rate hikes sooner or later. This lends support to our view that there have been real forces We believe the main implication of this is that the behind the development of Hong Kong’s physical coming years will provide the most favourable property market in recent years, with low interest rates environment for mid-tier assets and competent asset probably not the main performance driver. Indeed, we managers. For we see significant upside potential (in note that Asia’s central banks have been proactive in terms of both rents and capital values) for those lower- finding ways to pre-empt asset bubbles, and hence the tier assets that can be upgraded to higher-grade ones. rise in property-related borrowing in Hong Kong has This would also imply that there is considerable value probably been far more restrained than it might for competent property-asset managers to unlock. otherwise have been.

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The rises in the prices and rents for top-end trend has been set and that there are now ample commercial properties may have reached a point where opportunities awaiting landlords that can deliver significant further increases have become difficult. For alternative products. in absolute levels, they are among the highest in the world. In terms of square feet they are small and held This is also the reason we are optimistic about Island by well-capitalised corporations or families, which are East and Pacific Place over the long term. We see among some of the main reasons we expect their prices Island East as the largest office hub outside Central and and rents to be resilient to adverse developments. Pacific Place becoming a more important part of the Greater Central commercial hub, notwithstanding the  Office stock in selected financial centres’ core CBDs near-term challenges it faces in terms of retail sales (m sq ft) growth in the mall and the higher asking rents in 500 Pacific Place offices compared with Citibank Plaza. 400 ii) Youngest office stock in HK and strong 300 record in mixed-development projects 200 One structural feature of the commercial property 100 market is that there have not been many new completions in recent years. There have been only 3 0 Manhattan, London Sydney Hong Kong Singapore Beijing Shanghai major completions of sizeable grade-A office buildings NY in the established core markets in the past decade: Two CBD Decentralised districts IFC in Central, Hysan Place in Causeway Bay, and One

Source: Knight Frank Island East in Island East. Note: CBD – central business district Therefore, some buildings may face an ageing issue, That said, rises from present levels would need a new with it being challenging for them to meet the technical group of buyers or tenants whose rent-paying capacity specifications for some types of businesses, such as is stronger than that of the strongest players currently, finance or IT. Swire Properties should be in a which we do not expect to happen in the immediate favourable competitive position in this regard, as it has future. Meanwhile, we believe that the rises in top-end completed the largest amount of new office space in the commercial properties’ rents and prices have forced past few years, and should continue to do so in the market participants to look for alternatives, and that coming years. In this sense, in the office market, Swire the market has now accepted many alternatives. This Properties may resemble an airline with the youngest should serve to limit prices and rents in the top-end and the most modern fleet. segment.

This is where Swire Properties comes in. For we believe the company is creating alternatives to the most premier office buildings in Central. We believe the

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 Swire Properties: Island East portfolio Techno Serviced Year of Office centres Retail Hotel apartments Total Cumulative No. of No. of Property Area completion GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) GFA (sq ft) rooms car parks Commercial areas, Taikoo Shing Island East 1977-1985 - - 311,079 - - 311,079 311,079 3,826 Warwick House Island East 1979 - 554,934 - - - 554,934 866,013 Cityplaza Island East 1983 - - 1,105,227 - - 1,105,227 1,971,240 834 Cornwall House Island East 1984 - 338,369 - - - 338,369 2,309,609 Somerset House Island East 1988 - 923,364 - - - 923,364 3,232,973 285 Cityplaza Four Island East 1991 447,709 - - - - 447,709 3,680,682 217 Cityplaza Three* Island East 1992 423,785 - - - - 423,785 4,104,467 Devon House Island East 1993 803,448 - - - - 803,448 4,907,915 311 PCCW Tower Island East 1994 310,074 - - - - 310,074 5,217,989 Dorset House Island East 1994 609,540 - - - - 609,540 5,827,529 215 Cityplaza One Island East 1997 628,785 - - - - 628,785 6,456,314 Lincoln House Island East 1998 333,350 - - - - 333,350 6,789,664 164 Oxford House Island East 1999 501,249 - - - - 501,249 7,290,913 182 Cambridge House Island East 2003 268,793 - - - - 268,793 7,559,706 One Island East Island East 2008 1,537,011 - - - - 1,537,011 9,096,717 The EAST Island East 2009 - - - 199,633 - 199,633 9,296,350 345 Dah Chong Hong Building Island East 2013 194,500 - - - - 194,500 9,490,850 Cornwall House (8 extra floors)* Island East 2014 - 187,000 - - - 187,000 9,677,850 Sub-total 6,058,244 2,003,667 1,416,306 199,633 - 9,677,850

17-27 Tong Chong Street Island East 2014 - - 12,471 - 62,658 Redevelopment of the Somerset House Island East 2017 1,000,000 - - - - Redevelopment of Cornwall and Warwick House Island East 2019 1,080,303 - - - - 8,138,547 - 1,428,777 199,633 62,658 Source: Company, Daiwa Note: *Adjusted for the 10 floors given to the government

A champion of mixed-property  Swire Properties: Pacific Place portfolio developments Meanwhile, we believe Swire Properties has done well in terms of developing and managing integrated property complexes (often with retail and office space, and hotels and serviced apartments). Although this kind of mixed development is not so common in Europe or the US, it is quite a common format for property projects in Hong Kong, China, and elsewhere in Asia.

Swire Properties is one of the pioneers of this kind of mixed-development project in Hong Kong, and Pacific Place is arguably the first such type of development in the city. Before the completion of Pacific Place, the main property projects in Hong Kong that could be classified as mixed developments were Harbour City and The Landmark. However, Harbour City and The Source: Company Landmark initially do not appear to have been managed in a way designed to create synergies among This brings us to a major point. We think developing the various different components. what appears to be a high-end mixed property complex is not that difficult. However, having the “software” to We believe the results achieved at Pacific Place ensure the various components create synergies and surprised many in the industry, and it has led to many ensuring that there is good interaction among the industry participants paying a lot more attention to various users of the different components of the realising the potential synergies from the various complex is much more challenging. Indeed, China is components of a mixed property development. full of examples of projects that look like high-end mixed property complexes but do not have any life of their own, in that the property does not seem to function in a way that can make it a more vibrant and productive property asset over time.

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We think it is in this area that Swire Properties has Similarly, in Island East, we believe that Swire done better than many others. Our view is that, if Properties is trying to strengthen the hotel (The East, executed well, there are genuine synergies that can be completed by Swire Properties in 2008, was the first realised from the various components of a mixed- hotel project there) and retail components of the area, property development and these can help to better and make the area more vibrant. If the company protect the asset during cyclical downturns and achieves this, it could lead to a strengthening in the enhance its prospects to improve more when there is competitiveness of its Island East portfolio. an industry upturn. Consequently, Island East could well become a much more valuable commercial hub, in our view. We believe one reason Pacific Place office rents have performed better than those in Citibank Plaza in recent iii) Island East could become a gold mine if years is that the latter is largely a pure office Swire Properties can continue to development, while Pacific Place has more to offer, upgrade it which puts it in a better position to retain tenants and attract new ones. The size of Swire Properties’ Island East portfolio has continued to expand, and in our view it has now

In this connection, Hongkong Land seems to have been reached critical mass, with some 10m sq ft of office, focusing on managing its entire Central portfolio as an retail, and hotel space in total GFA (based on 100% ownership of the buildings in the portfolio). integrated mixed-use development in recent years. We think its ability to strengthen the retail and hotel In our opinion, Swire Properties can now manage aspects of its Central portfolio has been an important Island East as an integrated mixed development. We factor in terms of ensuring that the portfolio performs well, notwithstanding the competition from many think the company has critical mass in terms of office area, which will be strengthened in the coming few newer buildings in the district. years, with the 3 techno-centres being converted into In our view, many property companies in Asia are just grade-A offices like One Island East. We believe that in the coming years, one main focus of Swire Properties asset owners. There are not that many players that have demonstrated the ability to create synergies will be the strengthening of its retail and probably residential components, so that it can really become a among the various components of mixed-property hub instead of merely a collection of property assets. complexes. We believe Swire Properties’ proven expertise in this area will put it in a more favourable Meanwhile, there is still a wide gap between retail rents position than its peers in the commercial property sector in the coming years. Indeed, our observation is in Cityplaza and those in Pacific Place. Although the that the company is likely to build upon its expertise in GFA of the mall in Pacific Place is only about 64% of that of Cityplaza, the gross rental income generated by these areas in the years ahead. For we believe that one major part of its Wanchai portfolio will be that of the mall in Pacific Place used to be much larger than that of Cityplaza. This means there should be having a variety of retail offerings relative to Pacific considerable upside in the achieved rent for Cityplaza if Place in Admiralty, which should help to enrich and strengthen its Pacific Place mall. the development is upgraded. Indeed, Swire Properties is now working on a major revamp of Cityplaza.

A quiet transformation has been taking place in  Gross rental income of Pacific Place Mall vs Cityplaza Mall Wanchai South, which now includes trendy and (HKDm) fashionable F&B outlets and shops. We believe that 1,600 Swire Properties’ long-term plan may be to develop a 1,400 Lan Kwai Fong equivalent in Wanchai South. This 1,200 should be attractive to some of its office, hotel and 1,000 shopping-mall customers. 800 600 Over time, it is not inconceivable that the style and 400 image of Wanchai South could bear some resemblance 200 0 to the side streets in the Omotesando area in Tokyo, 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 which is an upmarket area for fashion, high-end residential property, and commercial activity, while Pacific Place Mall Cityplaza Mall there are also many small boutiques and flagship stores Source: Company, Daiwa of the major international brands.

- 92 - Financials / Hong Kong 1972 HK 22 May 2014

 Pacific Place mall 4) There are signs that Mainland financial firms are exploring opportunities in Hong Kong. This could be related to Beijing’s stated aim of pursuing financial reforms and the internationalisation of the Renminbi. While many of these companies require office space of 3,000-4,000 sq ft, the arrival in Hong Kong of 50 or more of them would make a difference to sentiment and expectations in the market, in our view. There is also the chance that over time these companies would require space of 5,000-10,000 sq ft. 5) According to the April Property Market Monitor of Jones Lang LaSalle, net take-up in the overall grade- A office market reached 115,200 sq ft in March 2014, while Central had a net take-up of 21,100 sq ft, and Central has seen a net take-up of office space for several months. While most activity in the Source: Daiwa market stems from relocations, there are signs that some sectors may have modest demand for new  Cityplaza (PROD: change to Cityplaza) office space. Mainland financial institutions are one major category. 6) IPO activity has picked up in recent years, and the China Government recently allowed mutual market access between Hong Kong and Shanghai, which we think means that Hong Kong will have an important role to play in China’s financial reform and capital account opening. These factors should have a positive impact on office demand over time.

 Hong Kong: major office leasing transactions in recent months Building Floor GFA Rent Tenant (sq ft) (HKD/sq ft/month) One Island East n.a. 10,000 50 Facebook AIA Central 12/F whole floor 12,288 130 Cinda Asset Management Exchange Square Upper floors 3,385 135 A China property company Two IFC Mid-zone whole 22,000 90 Guosen Securities Source: Daiwa floor CCB Tower 22/F whole floor 7,400 100 Guoyuan Securities Two Exchange 45/F whole floor 13,107 130 A brokerage arm of China iv) Grade-A office sector offers room for Square Merchants Bank positive surprises Citibank Tower Mid-zone joint 30,000 70 United Overseas Bank floors While the market generally is cautious on the outlook Bank of America 24/F whole floor 14,000 65 Shanghai Pudong for the office market, there have been some positive Tower Development Bank signs recently. The Center Half floor on 77/F 14,500 60 A China energy company Man Yee Building 13/F whole floor 11,463 80 Brown Brothers Harriman 1) The occupancy rate in IFC has improved to about Two Exchange 18/F whole floor 13,107 120 China Securities Co (an 98% currently from about 92% in mid-2003. Square affiliate of CITIC Securities) Source: HKET, Daiwa 2) Some small tenants have expanded, which resulted in 28 Hennessey Road’s occupancy rate rising to 94% at the end of February from 74% at the end of 2013. 3) Citibank Plaza leased out a few floors in the first 2 months of 2014. We think its strategy to consider attracting non-Central tenants to upgrade is a positive development for it and the industry as a whole.

- 93 - Financials / Hong Kong 1972 HK 22 May 2014

 Central grade-A office rentals by Chinese financial institutions In this light, the recent news that Deutsche Bank is to in recent months return 3 floors (about 100,000 sq ft of GFA in the ICC Building Floor Area Rent Tenant (sq ft) (HKD/sq to SHK Properties) may be a sign that the downsizing ft/month)* by investment banks is coming to an end. We note that AIA Central 12/F whole floor 12,288 130 Cinda Asset Management while it is often the investment banks that push up Two IFC Mid-zone whole 22,000 90 Guosen Securities floor office rents in premier buildings, this industry does not CCB Tower 22/F whole floor 7,400 100 Guoyuan Securities occupy that much space in the Hong Kong grade-A Two Exchange 45/F whole floor 13,107 130 A brokerage arm of China office market. Square Merchants Bank Bank of America 24/F whole floor 14,000 65 Shanghai Pudong Tower Development Bank We estimate that investment banks occupy no more Two Exchange 18/F whole floor 13,107 120 China Securities Co (affiliate of than 4m sq ft GFA of office space in Hong Kong out of a Square CITIC Securities) total of more than 60m sq ft of grade-A office space in Two Pacific Place 35/F whole floor 22,000 100 China United Credit Finance Group the city. It is true that weakness in the investment

Source: Hong Kong Economic Times, Daiwa banking industry would deprive the grade-A office Note: * rents quoted are from media reports and may not have adjusted for rent-free sector of one main driver of rental growth, but the periods and other incentives grade-A office market is deeper and broader than that,

in our opinion. In our opinion, the current issue in the Hong Kong grade-A office market is mainly an adjustment Over the past few years, the main weakness in the problem, ie, to address issues related to the anomaly grade-A office market has been in the more investment during 2005-10, when rents for the most prime bank-centric buildings, such as IFC, Cheung Kong buildings in Central had at one point risen to almost 3x Centre, and Citibank Plaza. Hongkong Land’s portfolio those of Causeway Bay. This means that the rental and Pacific Place, which focus more on other finance premium Central commands relative to other areas was tenants, have been more resilient. at unprecedented levels during this period, and this warrants adjustment, in our view. We therefore believe that the problem in the Hong

Kong Central grade-A office market is now confined to Over the past few years, rents in Central have fallen no more than a handful of buildings. Downsizing by while rents in the decentralised areas have risen. We investment banks has been taking place for several believe the rental gap between Central and other years, and unless there are major corporate failures, we locations has returned to the levels before 2005 and the do not expect this factor to have much of an additional adjustment that had been required in Central is more adverse impact on the grade-A office market. or less over.

 Office rents in major grade-A office locations Therefore, we believe the worst scenario for the grade- A office market is that it remains in the doldrums for (HKD/sq ft) 120 some time, with activity driven mainly by tenants 100 moving from one building to the other, and little new incremental demand for office space. 80

60 However, we are not seeing rents fall sharply. Given 40 that currently the grade-A office vacancy rate outside 20 Central is at around an all-time low, and that the 0 vacant space in Central is concentrated in Citibank Plaza, it would be a positive development if some of Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Central Wan Chai & Causeway Bay Citibank Plaza’s vacant areas were to be filled by North Point Tsim Sha Tsui tenants from other locations moving to Citibank Plaza.

Source: CEIC, Daiwa  Grade-A office vacancy rates (March 2014) District Vacancy rate In retrospect, one of the main reasons for the Overall 4.4% unprecedented rental premium in the Central grade-A Central 4.4% Wanchai/Causeway Bay 3.0% office market over 2005-10 was the aggressive Hong Kong East 1.6% expansion by investment banks. However, market Tsimshatsui 2.3% forces to correct the problem of this over-expansion by Kowloon East 6.7% the banks should have been set in motion by the Source: Jones Lang LaSalle

Lehman crisis in 2008, and hence should have been at work for a number of years.

- 94 - Financials / Hong Kong 1972 HK 22 May 2014

Against this backdrop, we believe that once we see  Hong Kong: completed grade-A office portfolios of major more solid signs of demand for office space picking up, landlords market sentiment will change quickly. This has GFA (m sq ft) happened before in Hong Kong. New demand in the 12 grade-A office market is likely to come mainly from 10 tenants looking for space of 3,000-5,000 sq ft. 8 However, as the vacancy rate in the overall sector is not 6 that high, demand from 30-50 such new tenants would 4 be enough to have an impact on the office market. 2 0 We view the pick-up in demand from Mainland China Wharf Hysan Land REIT Land financial institutions as an important development, Swire Hongkong Hutchison Whampoa Champion Henderson Henderson and believe that the Shanghai Hong Kong Connect Properties* recently announced by the Hong Kong and Shanghai SHK Properties Stock Exchange is a sign that Hong Kong will continue Source: CEIC, Daiwa Note: * excluding 1m sq ft at Somerset House, which is under redevelopment. to play an important role in China’s financial reforms in the coming years. This can only be positive for office  Gross rental income from Hong Kong office segment in 2013 demand in Hong Kong over time, in our view. (HKDm)

Indeed, we contend that the office sector is likely to be 6,000 the first segment to come out of the adjustment period 5,000 in the Hong Kong property market, and we recently 4,000 revised up our forecasts for the office property market (see Will the adjustment period ends in the coming 3,000 months?, published 14 May 2014). 2,000

1,000  Recent revisions to Daiwa's Hong Kong property price forecasts for 2014* 0 Previous Revised Change Swire Properties Hongkong Land SHK Properties Wharf Rents Prime shopping malls +6% +6% Unchanged Source: Companies, Daiwa Overall retail +6% +6% Unchanged Central grade-A office -5% - +5 pp Overall office +3% +5% +2 pp Mass-residential property -10% -5% +5 pp Luxury-residential property -15% -10% +5 pp Prices Mass-residential property -10% -5% +5 pp Luxury-residential property -15% -10% +5 pp

Source: CEIC, CBRE, Jones Lang La Salle, Savills, Midland, Centa-City leading index, Daiwa forecasts Note: * these revisions were made and published on 14 May 2014

In sum, we see Swire Properties as a good vehicle through which to gain exposure to this theme, as the company is the largest owner of office properties in Hong Kong, with a balanced portfolio in Central and non-Central areas. (See Appendix 3 for more information on the Hong Kong office market.)

- 95 - Financials / Hong Kong 1972 HK 22 May 2014

 Hong Kong property companies: gross rental income from 6. A play on the potential China Interim/ Dec 2012 Dec 2013 Change narrowing of the ‘Hong Kong final (HKDm) (HKDm) YoY (%) Gross rental income from China discount’ Hang Lung Properties F 3,082 3,526 14.4% Swire Properties F 1,373 1,623 18.2% SHK Properties I 987 1,573 59.4% We reiterate our view that the valuation of Hong Kong Henderson Land F 1,162 1,303 12.1% property stocks is an anomaly in the global property Wharf F 1,005 1,261 25.5% industry (see Hong Kong Property Toolkit). While the Kerry Properties F 989 1,211 22.4% Hutchison F 351 421 19.9% performance of Hong Kong’s physical property market New World Group I 358 367 2.5% has been among the strongest worldwide in recent Cheung Kong F 275 322 17.1% years, and given that the property companies in the city Total 9,582 11,607 21.1% generally have entered harvesting periods for their Source: Companies, Daiwa China investments and have achieved continuous  Hong Kong property companies: China property-sales profit growth in their book values and NAVs over the past few Interim/ Dec 2012 Dec 2013 Change years, the benefits have not been reflected in share- final (HKDm) (HKDm) YoY (%) price valuations, in our view. China property sales profit (pre-tax) Cheung Kong F 4,566 5,700 24.8% Wharf F 4,147 4,215 1.6% Indeed, few if any major developed markets have New World Group I 1,597 3,092 93.6% property stocks trading at such large discounts to the SHK properties I 738 2,559 246.7% value of their underlying assets: premiums to NAV are Kerry Properties F 407 1,647 305.2% Hongkong Land* F 483 1,083 124.1% not uncommon. Henderson Land F 80 408 410.0% Total 12,018 18,705 55.6% This “Hong Kong discount” has existed for years. Source: Companies, Daiwa However, the discount has widened in recent years, Note: Including Macau although these companies’ recurrent earnings and  Hong Kong property companies: net gearing ratios financial profiles have never been better. Interim/ Dec 2012 Dec 2013 Final (%) (%)  Hong Kong: major developers’ PBRs Net gearing ratio Weighted-average PBR of four developers Cheung Kong F 7.3% 2.3% (x ) SHK Properties I 16.5% 12.9% 3.0 Wharf F 21.7% 20.4% Current PBR: 0.74x Wheelock F 13.4% 21.1% 2.5 Henderson Land F 17.2% 17.2% +2 SD: 2.02x Swire Properties F 15.0% 15.8% 2.0 MTRC F 11.0% 11.8% +1 SD: 1.64x Hongkong Land F 13.0% 11.0% 1.5 Average: 1.25x Hang Lung Properties F Net cash 0.5% Kerry Properties F 22.4% 31.0% 1.0 -1 SD: 0.87x Sino Land I Net cash Net cash 0.5 New World Development I 35.2% 35.1% -2 SD: 0.49x Great Eagle F Net cash Net cash 0.0 Hysan F 6.2% 5.3% Champion REIT F 20.4% 23.4%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Fortune REIT F 28.3% 32.7% Source: Companies, Daiwa estimates Regal REIT F 29.9% 29.8% Sunlight REIT I 25.9% 25.2% Prosperity REIT F 22.4% 20.9%  Hong Kong: major investors’ PBRs Average 19.1% 18.6% Source: Companies, Daiwa Weighted average PBR of six major investors PBR (x) 1.6 1.4 Current PBR: 0.62x Why is there a ‘Hong Kong discount’? 1.2 +1SD: 0.98x It is beyond the scope of this report to analyse in detail 1.0 the reasons for this phenomenon, although we believe 0.8 the main reasons are not due to inferior asset quality or 0.6 -1SD: 0.63x the prospects for earnings and NAV growth. 0.4 Average since 1990: 0.80x 0.2 We see the anomalies in Hong Kong’s physical property 0.0 market (such as the very wide range of prices and

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 rents, and ASPs seem unreasonably high for the very Source: Companies, Daiwa estimates limited amount of space at the top end), as well as

- 96 - Financials / Hong Kong 1972 HK 22 May 2014

concerns about macroeconomic factors and the current ‘Insider purchases’ have reached position in the property cycle (such as the pending rise unprecedentedly high levels in US interest rates, the peaking of property prices) as In our opinion, this capital market issue has led to contributing factors; but we think the reasons go investors ignoring the expansion in recurrent income deeper. and increase in business value that Hong Kong property companies have achieved in the recent years; Our view is that the discount probably stems more so much so, that for many of them, their share prices from issues in Hong Kong’s capital market than from have not risen much since 2006 and have traded fundamental and structural issues relating to the assets generally within ranges, despite a continuous increase owned by, and operating performance of, Hong Kong in book values, NAV, recurrent rental income as well as property companies. We believe Hong Kong property dividends paid. companies, many of which are family-owned (including Swire Properties), are now facing an “identity Ironically, the fact that the Hong Kong property challenge” in that they have sizeable earnings and asset companies have been successful in growing their bases, yet they differ from other global property earnings, book value, and NAV over the past 10 years companies in many ways. (Swire Properties is might have affected their valuations, as a larger asset comparatively much closer to the major global players and earnings base requires an increase in investing but still its valuation has not been able to escape the capital to maintain past valuation levels. Yet when the “Hong Kong discount” – see page 8). required new investing capital does not come, lower valuations result. We believe sufficient funds have not yet been invested in Hong Kong property stocks to bring about similar valuations to their global peers, and they are not currently perceived as close comparables to global property stocks.

In our opinion, the issue has been compounded by the fact that IPOs in Hong Kong of very large corporations from China over recent years have elevated Hong Kong’s equity market capitalisation to a level comparable with major world stock markets; yet the development of Hong Kong’s secondary trading market has lagged behind, in that there has not been a corresponding increase in anchored investing capital for the secondary trading of the shares listed on Hong Kong’s market.

 Hang Seng Index: constituents by market capitalisation (HKDtn) 20

15

10

5

0 2003 2013

R eal Estate Investment & Services (H K) Real Estate Investment & Services (China) Banks Casino and Gaming Conglomerate Consumer Discretionary/Staples Electronic & Electrical Equipment Financial Services Industrial Transportation Information Techonology Life Insurance Media Mining Oil , Gas & Consumable Fuels Telecommuncations Travel & Leisure Utilities

Source: Bloomberg, Daiwa

- 97 - Financials / Hong Kong 1972 HK 22 May 2014

 Hong Kong property companies: share-price performances involved has reached unprecedentedly high levels, since 2006 involving over USD5bn, on our estimates. (HKD) Cheung Kong (HKD) SHKP 160  Buying by families and other group companies in the listed 200 vehicles in the past 5 years 140 Family What they bought Amount involved 120 150 Lee Shau Kee Henderson Land - Over USD2bn 100 Kwok family SHK Properties - Over USD500m 80 100 - Over USD1.2bn for exercising their 60 bonus warrants 40 50 Li Ka Shing Cheung Kong - Over USD500m 20 Cheng family New World - Over USD560m for the New World Development rights issue 0 0 Wheelock Wharf - Over USD1.2bn Hang Lung Group Hang Lung Properties - Over USD300m Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Source: Companies, Daiwa

Henderson Land Sino Land (HKD) (HKD) We also observe that in the past few months, there 80 30 have been some unusual steps in terms of capital 70 25 management taken by various Hong Kong property 60 companies. Some may have been motivated mainly by 50 20 the family wanting to buy more of the company’s 40 15 30 shares. However, some could well be intended to let 10 20 shareholders gain a more tangible share of the 10 5 company’s profits. 0 0  Some ‘unusual’ steps in capital management by the major Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Hong Kong property companies in recent months Company Capital management actions Hang Lung Properties Hongkong Land SHK Properties Declared a 1-for-12 2-year bonus warrant at an exercise price of (HKD) (USD) HKD98.60/share to raise HKD22.2bn 45 9 New World Offered to privatise New World China Land at HKD6.80, which costs up to 40 8 Development HKD18.6bn 35 7 Declared a 1-for-3 rights issue at HKD6.20/share to raise about HKD13bn 30 6 Hutchison Sold a 24.95% stake in AS Watson to Temasek for HKD44bn 25 5 Whampoa Declared a HKD7/share special dividend involving paying out HKD29.8bn in 20 4 cash, of which HKD14.9bn will go to Cheung Kong 15 3 Cheung Kong Cheung Kong declared a HKD7/share special dividend, involving paying out 10 2 HKD16.2bn in cash. The amount of cash to be received by the Li family will 5 1 be HKD7bn. 0 0 Henderson Land Declared a 1-for-10 bonus issue in both 2012 and 2013. Kept its DPS unchanged at HKD1.06 for both 2012 and 2013, and guides

Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 for its 2014 DPS to at least be maintained at the 2013 level. Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Source: Companies, Daiwa Link REIT (HKD) Wharf (HKD) The merits and demerits of family control and 50 90 45 80 management is a complex subject. We appreciate that 40 70 generally speaking, many Western property companies 35 60 do not have major shareholders, and many are run by 30 50 25 professionals who see investors as the most important 40 20 stakeholders in the company. 15 30 10 20 5 10 By contrast, Hong Kong families generally have control 0 0 over the listed vehicle. They often focus more on long- term wealth-building for the generations to come. The Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 focus seems often to fall more on the long-term Source: Bloomberg development of the business, and they often appear more ready to take on investments requiring 15-20- We believe that such a divergence between business year horizons, which is longer than some investors like. value and share prices has caught the attention of many major shareholders of these companies. And in terms of “insider purchases” for these companies, the amount

- 98 - Financials / Hong Kong 1972 HK 22 May 2014

It is probably fair to say that some family companies in Overall, we can see that there are many challenges Hong Kong and Asia might have over-used equity, and associated with removing the “Hong Kong discount” on their capital-allocation discipline may not be as robust the valuation of property stocks. That said, it is not as some investors might want. It is also probably fair to inconceivable that this discount will narrow. In recent say that, in general, Hong Kong property companies years, two Hong Kong property companies seem to place greater emphasis on growing the size of their have shaken off the “Hong Kong discount”, at least for business and the assets they own rather than the per- a certain period. share value of the company. One was Hang Lung Properties from 2006-11, when it Still, we do not think it is fair to say that the Hong went from being an almost unknown name in global Kong property companies have been taking advantage property to the 6th-largest property stock in the world of minority shareholders for their own benefit. In terms in terms of market capitalisation at one point. It traded of at least transparency and disclosure, the Hong Kong consistently at a premium to its NAV as well as to the property companies have improved considerably over valuations of its peers over the period. the past 10 years.  Hang Lung Properties: price/NAV Also, we believe Hong Kong property companies are (Disc)/prem Hang Lung Properties (disc)/prem to NAV generally serious about growing their businesses and 40% are financially prudent. They are generally experienced Current NAV disc: -48.9% players with over 4 decades of experience in the field 20% and have survived some of the sharpest property 0% +1SD: -9.1% Avg since 1990= market downturns the industry has seen. Collectively, (20% ) they own some of the most prime real-estate assets in -28.5% Hong Kong and China, which offer a way to gain (40% ) exposure to the rise in scale of the economies and (60% ) -1SD: -47.9% property markets of Hong Kong and China, in our view. (80% )

In any case, these families appear committed to 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 building family wealth over time and we think this fits Source: Datastream, Daiwa forecasts with the objectives of long-term investors. Despite these and the large amount of “insider purchases” in The other was The Link REIT, which, for most of the the recent years, the “Hong Kong discount” on the time since its IPO in 4Q05, has traded at a premium to valuation of these companies has persisted. its reported NAV. Before the sell-off in REITs globally in 2Q13 (due to concerns about US tapering and the Is breaking away from the ‘Hong Kong interest-rate outlook), The Link REIT’s DPU yield in discount’ inconceivable? early 2013 was compressed to among the lowest for a We expect the major Hong Kong property companies to REIT in Asia, and at the time was not much higher remain family-run for the foreseeable future, and think than the premier REITs globally. there will always be some differences in the way the families and investors look at their respective In other words, although The Link REIT owns the companies. bottom segment of Hong Kong retail property assets, its stock-market valuation has been the highest ever In Asia, many families probably put great emphasis on achieved by a Hong Kong property company, and at growing the size of the business; owning more prime one point was almost comparable to the most highly property assets over time for posterity and ensuring valued property companies in the world. that the listed vehicles are financially super-strong and super-safe. However, investors are likely to focus more on the growth in per share value of the company and its capital -allocation discipline.

We believe that such differences are hard to fully reconcile and believe the discount to the valuations for the Hong Kong property stocks is likely to last. However, a legitimate question would be whether the discount needs to be as wide as it is now?

- 99 - Financials / Hong Kong 1972 HK 22 May 2014

 The Link REIT: PBR Kong as well as the Hong Kong property companies’ (x ) investment in China’s commercial property sector as 2.0 Current PBR: 1.08x attractive themes for investors. 1.8 1.6 We believe the Hong Kong property companies are +1 SD: 1.42x 1.4 attractive vehicles through which to gain exposure to Average since these themes although they are not being seen as such. 1.2 IPO: 1.24x

1.0 -1 SD: 1.05x However, the cases of Hang Lung Properties and The 0.8 Link REIT illustrate what kind of upside to valuations 0.6 is possible for Hong Kong property companies that can Jul 13 Jul Jul 12 Jul Jul 11 Jul Jul 10 Jul Jul 09 Jul Jul 08 Jul Jul 07 Jul Jul 06 Jul appeal to strong global investors. Mar 14 Mar Mar 13 Mar Mar 12 Mar Mar 11 Mar Mar 10 Mar Mar 09 Mar Mar 08 Mar Mar 07 Mar Mar 06 Mar Nov 13 Nov 12 Nov 11 Nov 10 Nov 09 Nov 08 Nov 07 Nov 06 Nov 05

Source: Company, Bloomberg, Daiwa  A snapshot of the major shareholders of Hang Lung Properties  The Link REIT: DPU yield history Name % interest No. of shares held Filing date Hang Lung Group 52.95% 2,374,690,240 17-Feb-14 (% ) JP Morgan Chase 5.94% 266,282,463 23-Apr-14 8 Oppenheimer Funds 5.01% 224,617,800 19-Mar-14 7 Aberdeen 4.28% 191,970,302 31-Mar-14 Norges Bank 1.62% 72,880,215 31-Dec-13 6 +1SD: 5.32% T Rowe Price 1.52% 67,949,000 31-Mar-14 Dodge & Cox 1.24% 55,399,300 31-Mar-14 5 Average: 4.63% Vanguard Group 1.11% 49,744,785 31-Mar-14 4 Harbor Capital 1.07% 47,920,000 31-Mar-14 -1SD: 3.93% State Street 1.05% 47,315,999 1-May-14 3 Source: Bloomberg 2  A snapshot of the major shareholders of The Link REIT Jul 13 Jul Jul 12 Jul Jul 11 Jul Jul 10 Jul Jul 09 Jul Jul 08 Jul Jul 07 Jul Jul 06 Jul Mar 14 Mar Mar 13 Mar Mar 12 Mar Mar 11 Mar Mar 10 Mar Mar 09 Mar Mar 08 Mar Mar 07 Mar Mar 06 Mar Nov 13 Nov 12 Nov 11 Nov 10 Nov 09 Nov 08 Nov 07 Nov 06 Nov 05 Name % interest No. of shares held Filing date Source: Company, Datastream, Daiwa Capital Group 11.96% 276,405,646 31-Mar-14 Blackrock 6.58% 151,967,645 30-Apr-14 Bank of New York Mellon 4.94% 114,179,920 13-Aug-12 Admittedly, the valuations of both stocks have declined Commonwealth Bank of Australia 4.93% 113,970,948 30-Nov-13 in recent months, yet they are still trading at premiums Citigroup 4.90% 113,264,428 14-Jun-13 JP Morgan Chase 4.11% 94,952,251 28-Feb-14 relative to other Hong Kong property stocks. We Nomura 3.78% 87,443,383 31-Dec-13 believe they illustrate that it is not impossible for some Vanguard Group 1.55% 35,848,504 31-Mar-14 Hong Kong property stocks to be seen as comparable to State Street 1.30% 30,133,965 1-May-14 the premier stocks in property globally by some Morgan Stanley 1.10% 25,413,927 31-Mar-14 Source: Bloomberg investors, and the main reason for the “Hong Kong discount” is probably not the assets they own. Potential catalyst 2: buybacks or ‘arbitrage

between physical market and share prices’ Below, we list what we see as 4 potential catalysts for a narrowing of the NAV discount of Hong Kong property Another important point is that the physical property companies. market in Hong Kong has been strong in recent years, and resilient against various economic concerns in Potential catalyst 1: recognition by global 2014 so far. This suggests to us that there is a clear disconnect between the physical market and share value funds prices. The shareholders of Hang Lung Properties and The Link REIT include some major names that are known However, currently there seems to be no mechanism to to be long-term investors who invest globally, and who arbitrage between the two. Hence, one may say that take a multi-year view on quality companies with one of the most difficult tasks in the physical market is sound and reliable managements. to buy the prime property assets in Hong Kong (even if one is willing to offer a sizeable premium), yet in the In our opinion, the physical Hong Kong property stock market these assets are available in abundance at market is at an interesting juncture, as few property significant discounts to the physical market. markets in the world have experienced a situation where the economies they are serving see a significant In this light, one may wonder if the discount on Hong leap forward within a short period of time. We also see Kong property stocks would narrow if only the property the high range of commercial property rents in Hong - 100 - Financials / Hong Kong 1972 HK 22 May 2014

companies could undertake some form of “arbitrage” announce that it would pursue a strategy of selling between physical market prices and share prices. This non-core assets (it has disposed of 1 property so far) could be done, for example, by selling non-core assets and to buy back units, as it judged that this would be in at low cap rates of say 3% or less and buying back their the interest of unit holders. own stock, which is yielding more than 3.5% and trading at notable NAV discounts. We see this an interesting development, and believe that professional managers of property companies such In our opinion, this would create a powerful and as REITs should always be mindful of all the ways to sustainable force to narrow the wide discount between enhance value for unit holders, and the potential physical market prices and share prices. Indeed, from a opportunities associated with asset disposals and unit pure financing perspective, one may wonder whether buyback. these Hong Kong property companies would be able to enhance shareholder value just by arbitraging between The REITs in Australia have demonstrated that unit the debt market and share prices by leveraging on their buybacks can enhance shareholder value and are often very strong ability to raise debt at low rates (by welcomed by investors. Our view is that if the H-REITs issuing perpetual bonds, for example) to buy back their were to take this option more seriously, this would help shares as the dividend yield may well be higher than to improve the valuation of the sector and reduce the financing cost of their perpetual debt. concerns related to the external management of the REITs, which can lead to conflicts of interest between That said, there is no tradition of share buybacks in unit holders and the managers of the assets (which may Hong Kong. While a share buyback is seen by many as favour holding on to assets to get more fees). a basic and legitimate method to ensure effective and responsible capital management in the Western world, Will the change in capital management be in Hong Kong it may be seen as artificial share-price pioneered by the niche developers? manipulation. Small-cap property companies in Hong Kong tend to trade at relatively large NAV discounts. While they are We see a share buyback as one of the easiest and most regarded by many investors as lower-tier companies effective actions a major shareholder can take to compared with the large-cap players, we believe advance the interests of minority shareholders, and it another reason for their large NAV discounts is that can benefit major shareholders too. As such, we think it Hong Kong property is a capital-intensive industry and is worthwhile keeping it as an option to improve capital securing long-term funds (for 5 years or more) can be management. difficult.

Conceptually, we believe share buybacks and paying Hence, small-cap companies are in constant need of cash dividends are just different ways to reward equity capital if they bid for land on the open market. shareholders. In some cases, shareholders may benefit Historically, however, many such companies have more from share buybacks than from receiving a cash readily issued new shares, rather than safeguard the dividend. value of their equity, even when their share prices were at significant discounts to the value of their underlying However, there seems to be a significant gap between assets. how family-run companies and institutional shareholders see this. While we believe share buybacks For family property companies that can issue a large would be an effective and equitable way to narrow the number of shares before the family’s control is discounts of Hong Kong property stocks, and would threatened, and that are not particularly concerned work well for both the family as well as long-term about NAV dilution, we think it is legitimate for investors, the cultural gap would take time to bridge investors to be concerned about the company and we do not assume that this can become widely continuing to issue new shares to dilute its NAV and accepted in the immediate future. EPS. Hence, we believe companies must be mindful of protecting the value of their equity in order for their Will professional managements result in shares to command lasting value in the secondary some narrowing of the ‘cultural gap’? market. In recent years, a few Hong Kong property companies have been willing to try to become more minority- CSI Properties (497 HK) is an up-and-coming property shareholder-friendly, as well as more professional and company which initiated a series of share buybacks rigorous in terms of capital management. Sunlight between 14-24 April 2014. We believe its buyback REIT was the first Hong Kong property company to exercise, which was larger than the buybacks

- 101 - Financials / Hong Kong 1972 HK 22 May 2014

undertaken by Sunlight REIT since 2012, reflects a investors’ lack of confidence in the management to departure from the usual capital management practice work in the interests of all shareholders. On the face of of Hong Kong property companies. It remains to be it, investors are right to be concerned if the growth in a seen whether share buybacks will be sustained among company’s NAV does not yield tangible benefits for all property companies. shareholders and potentially increase the demand for the shares among other investors. However, we do think that this could be the beginning of a cultural change, whereby Hong Kong property This brings us to another important point: a property companies pay more attention to capital management company’s ability to achieve consistent growth in book and safeguarding a continuous rise in NAV – the things value and NAV is a highly valued attribute in stock long-term investors care about the most, in our view. markets globally. While Hong Kong property companies score quite well on this metric, their shares  CSI Properties: share buybacks are not valued highly on the local stock market. In our Date No. of shares Avg price Total amount % of issued opinion, a share buyback is one way to address this bought (m) (HKD) (HKDm) shares 14-Apr-14 14.0 0.276 3.9 0.15% issue. 15-Apr-14 25.0 0.275 6.9 0.26% 16-Apr-14 3.0 0.280 0.8 0.03% Buybacks: an effective way of unlocking the 17-Apr-14 40.1 0.277 11.1 0.42% hidden value of Hong Kong property stocks 22-Apr-14 27.0 0.276 7.4 0.28% 23-Apr-14 80.0 0.275 22.0 0.84% A share buyback can create value in a sustained way for 24-Apr-14 60.0 0.275 16.5 0.63% patient, long-term investors, in our view. And herein Total 249.1 0.275 68.6 2.62% lies one main merit of carrying out a share buyback (or Source: HKEx selling non-core assets at NAV to raise funds to buy back shares at a discount). In our opinion, the root cause of the high NAV discount for Hong Kong property companies is not that their While a shareholding family can buy shares in the open asset quality is poor; rather, we believe one of the main market, this by itself would not benefit the per share issues is their capital management, which may over- value of the company. By contrast, even if the emphasise asset accumulation and using equity capital magnitude is small, a share buyback should benefit all to raise funds. In this light, we see the recent initiation shareholders – be it the major shareholders or the of share buybacks by some Hong Kong property small ones. In our opinion, this is fair and, most companies as an important development. And we think importantly, is a sign that a company does care about it is possible that the cultural change related to the the value of its own equity. capital management of Hong Kong property companies may begin with the niche property companies. We see a share buyback as a sign that a company is prepared to use its balance sheet to protect the value of Putting the merits of a share buyback into its equity; and we believe a company needs to believe in perspective the value of its own shares first before investors can be Granted, some companies may take the view that share expected to pay for it. In this light, a share buyback can buybacks would reduce liquidity in their shares and provide an anchor for the value of the shares. that investing the capital elsewhere would create more value for the company. To the extent that one can reliably assess the balance sheet and cash flow of a company as well as its book As far as the value of the free float goes, there are 2 value and NAV, an investor can get an estimate of the separate considerations. As well as the number of floor price of the shares. We think the ability to assess public shares, the other parameter is the value of the the floor value of the shares is important to investors shares. In our opinion, the poor liquidity of the shares because if a company can trade at a 60-70% discount to in some companies may not be a result of a low number NAV, there may be no strong reason the discount of shares, but rather a lack of demand in the market. In cannot widen to 80% or more if there is no take-over theory, if demand for the shares were strong enough, opportunity in the market, and if the company is totally the share price would eventually be bid up to a point indifferent as to how its stock is being priced relative to where even long-term investors would sell – and this its business value. would create liquidity. Admittedly, if a company can deploy capital to invest in As such, low demand for a company’s shares may not projects to create value, this would be better for the be caused mainly by investors’ concerns about its NAV company in the long run. Still, we think a share and NAV growth. Instead, it could be caused by buyback should be one option to consider.

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To begin with, new investments always carry risk and back shares at a substantial discount to its book value one might need to wait for a few years or more before should represent a simple, safe and immediately the benefits can flow in; and before that comes, the effective way to achieve an enhancement of company would be vulnerable to changes in the shareholder value. This, too, can serve as a signal that external environment which its management cannot the company will do what it can to safeguard control. shareholders’ interests and that it is putting money where its mouth is. Sending such a signal should be of By way of contrast, buying back shares when they are no less importance than the financing impact of a share trading notably below book value would immediately buyback. enhance the per-share value of the company and this is straightforward and almost risk-free. From the Share buybacks as an alternative to cash viewpoint of maximising the per-share value of the dividends company for the lowest possible risk, we think share Another important issue is that a share buyback can be buybacks are a legitimate method and that considered one of the ways to reward shareholders and managements should not ignore them entirely. act as an alternative to the payment of a cash dividend. In general, we believe minority shareholders and What is the balance between pursuing investors prefer companies to pay regular dividends growth and maximising per-share value? except in unusual situations where shareholders In some ways, the issue of the proper amount of share believe the management is so good in deploying capital buybacks also brings us to a fundamental question that it is better to leave all of the company’s capital for about what a company’s management should do. Of it to invest. course, the primary mandate of a company is to invest for the future to create value for shareholders. That Payment of a cash dividend, however, would mean that said, it is sometimes not that easy to draw a clear line the per-share value of the company and the capital it between what are sound and accretive investments for can deploy would be lowered by the amount of cash all shareholders and what are investments made more that it has paid out to shareholders. Under such for their own sake or just an expansion in asset circumstances, we believe a share buyback in lieu of a ownership. cash dividend payment could be considered an option to pursue, especially when the stock is trading at a Similarly, it is also sometimes hard to draw a clear line significant discount to NAV. between a share buyback as a reflection of management lacking imagination and capability to deploy capital In this case, we believe it may well enhance the and or a share buyback as a step undertaken by the interests of shareholders more if the cash for dividend company’s management to ensure that shareholder payment is partially or fully used (at the discretion of value is maximised and that its stock is priced at a level shareholders) to buy back shares instead of simply that does not deviate too much from its business value. paying out as a dividend.

While it is probably not very desirable for a company to We believe it would not be harmful to minority focus on merely accumulating assets without shareholders if they were given the option to choose consideration being paid to other factors, equally it is between receiving a cash dividend or letting the not very desirable for the property company to be company use the same amount for a share buyback. concerned only with enhancing per-share value Meanwhile, if the major family shareholders elected to through a share buyback. let the company use the dividend the family is entitled to for a share buyback (which should benefit Carried to the logical extreme, a share buyback themselves as well as the minority shareholders), we amounts to the company doing nothing but buying would interpret this as an honourable gesture to back shares at a discount. In theory, this would result minority shareholders and an effective counter-balance in the company trading at or close to NAV, but then the against criticism that the family may not bother that company would have no business at all. much about the interests of minority shareholders.

In all, striking a proper balance between the pursuit of In our opinion, such action amounts to the family growth and the maximisation of the per-share value is “putting its money where its mouth is” because rather not simple or clear-cut. However, we believe that, than merely using family money to buy the shares in conceptually, if the mandate of a company’s the open market, using the funds for a share buyback management is really that of maximising shareholder can bring tangible benefits to minority shareholders. value, then one should always be mindful that buying Even if the magnitude is small, we see this as a good

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signal that the management and family shareholders of modest negative impact on minority shareholders, in the company are trying to do what they can to advance so far as the per-share value of the company (which is and protect the interests of minority shareholders and often what long-term investors care about the most) are committed to creating a situation where their can be adversely affected. interests are aligned with those of the minority shareholders and long-term investors. A standard dividend re-investment programme has the benefit of resulting in the company having more cash It also signals that the management does put an on hand. Yet financially, virtually all major Hong Kong emphasis on growing the per-share value of the property companies do not need more cash on hand, company instead of merely expanding its assets, which especially as they tend to have good access to the should be welcomed by long-term investors. banking market. As such, we believe that using the same amount for a share buyback is a better way of Can a buyback be seen as a different kind enhancing the value of the company. of ‘dividend re-investment’ programme? From our perspective, a share buyback is one option Admittedly, shareholders would have greater flexibility management can consider to enhance a company’s if they just received a cash dividend, as they are then effective capital management and represents a sign free to use the cash dividend they receive to buy more that greater care is being given to the interests of shares in the company in the open market. That said, minority investors, especially those who are long-term- we believe that, to long-term investors, allowing the oriented. We believe that, at least conceptually, company to use the cash dividend for a share buyback embarking on a share buyback scheme would work for would have one benefit which a cash dividend cannot all shareholders especially when the funding comes provide. For a systematic share buyback means that from the cash dividends which the company would there would be a mechanism in place to continuously have paid out, hence would not affect the company’s enhance the per-share value of the company, which is ability to pursue new investments. what we see as the most effective way to get the “Hong Kong discount” in property stocks’ valuations to In our opinion, in some ways, a share buyback narrow over time. programme could be construed as a different kind of “dividend re-investment programme” where existing Of course, it appears that there is a large cultural gap shareholders make use of the company’s balance sheet here related to the implementation of such a and earnings to enhance the value of the shares for all programme, but logically we do not see why this could shareholders. not be seen as at least an option to consider by Hong Kong property companies. It may not have a significant Such a practice – in the form of letting all shareholders immediate impact, but we think this is not the main choose between receiving cash or the company using point. The main point is to signal that there was a the same amount for a share buyback – is without mechanism in place to narrow the large gap between precedence in Hong Kong and probably elsewhere. share prices and the underlying business value and There could be administrative issues involved, but NAV of the Hong Kong property companies, and to conceptually we think it is quite simple and actually show that the family is committed to growing the per- just resembles a kind of “dividend re-investment share value of the company continuously, which we programme” without involving the company issuing believe would be welcomed by both long-term and new shares. value-oriented investors.

While we like the concept of a “dividend re-investment Herein also lies what we see as potentially the most programme” (which was pioneered by The Link REIT important catalyst or mechanism to narrow the “Hong in Hong Kong), we think one pitfall of it is that when Kong discount” for Hong Kong property companies. the company’s stock is trading at below its book value (which the Hong Kong property companies are at the Potential catalyst 3: privatisation and M&A; moment), such a programme would have a dilutive but regulatory changes may be necessary impact on the company’s book value. The most straightforward way to remove the “Hong Kong discount” is through M&A activities such as take- For a similar reason, the family electing to receive overs or privatisations. While this works overseas, it shares in lieu of cash for the dividends they are entitled appears that its applicability is much more constrained to (a practice that has been adopted by various families in the Hong Kong context. in Hong Kong), while showing the family’s confidence and commitment in the company, may actually have a

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To begin with, the listed property companies in Hong We also reckon that how to divide a family’s wealth Kong are generally controlled by various families, among different brothers and sisters will become an meaning that involuntary take-overs are almost increasingly important issue over time. It appears to us impossible. Of course, tight family control should mean that some families’ second or third generations may that privatisation may well be pursued at some point. want to seek pursuits other than running the family However, in practice, this does not seem easy to business, and this could create voluntary M&A and execute in the Hong Kong context. Ironically, it could privatisation opportunities. be caused by regulation originally intended to protect the interests of minority shareholders. That is, in Hong Our observation is that, for the major property Kong, according to regulations governing privatisation, companies, many are keen to build up a sizeable 10% of the public free float can veto a privatisation business presence in the Mainland over time, and this deal. Effectively, this means that a large outside will probably mean that they would want at least one shareholder owning over 2-3% of a company may well listing platform available. This might reduce the chance be enough to block a potential privatisation offer from of them privatising the company, especially given that a family. the lump-sums involved for privatisation for the large caps can run into tens of billions of dollars. Although the regulation was originally intended as a way to protect minority shareholders, it might have From this perspective, we would see M&A and unintended consequences in terms of undermining the privatisation more likely to happen among the small major shareholders’ incentive and interest in pursuing and medium-sized property companies. Indeed, given privatisation deals. As a result, investors aiming to take that such a wide discount exists between the share advantage of value opportunities in Hong Kong prices and underlying NAV of pretty much any Hong property stocks could end up being deprived of one Kong property company, we think this would attract a major way that can be counted on in other stock lot of interest and bidding, should any small or markets (such as the US) for correcting a mis-pricing medium-sized property company or any company rich situation. in property assets be willing to be consider M&A opportunities. Due to cultural and other factors, In our opinion, having a robust mechanism to price however, we think that such deals would more likely be equities and protect minority shareholders’ interests voluntary and a result of bilateral negotiations rather are both important to the effective and healthy than open bidding. functioning of a capital market, which should mean that patient buyers of stocks with long-term value, as Potential catalyst 4: a new pool of investing well as many other types of investors, would find it capital from the Mainland attractive to invest in this market. Another important development to note is the latest Mutual Market Access that has been established Despite the fact that the original regulations governing between the Hong Kong and Shanghai stock exchanges, privatisation in Hong Kong were probably based on which will become effective in about 6 months’ time. good intentions, it appears that they might have ended This could bring a new group of investors into the up undermining the attractiveness of the market to Hong Kong market. long-term investors. In our opinion, if M&A and privatisation activity picked up markedly in the Hong The size of financial assets in China is anything but Kong stock market, some changes in regulations would small (China’s bank deposits now exceed USD2otn) probably be necessary. and this potential investing capital is currently almost entirely outside the global capital markets. More privatisation and M&A expected over time No one can be certain at this stage what Mainland That said, structurally, we do see some factors at work investment institutions and individuals would want to which might boost the potential for M&A and own. Moreover, it will take some time before Mainland privatisation opportunities in Hong Kong over time. investment institutions and individuals become We believe the managements of many property familiar with companies outside of China. companies are now being passed on to the second or third generations, many of whom have studied That said, we think that this development will bring a overseas and may well have different perspectives on new pool of investors to the Hong Kong family-owned corporate finance issues as well as the importance of property companies, especially given that many of listing or family control. them have been well-known in China as some of the wealthiest Chinese in the world.

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Culturally, Chinese seem to have a greater propensity In addition, we believe Swire Properties offers to park wealth in property than other people, and as investors good exposure to the current stage of the such we think Hong Kong family companies might Hong Kong property market, whereby we believe mid- become a suitable asset class for those Mainland range or mid-to-high end assets, in which Swire Chinese who want to store and build wealth for Properties has a large presence, will offer among the themselves and their grandchildren. This is probably best value-creation opportunities over the coming what these Hong Kong family property companies put years. Specifically, we think the sector’s greatest considerable emphasis on also. investment opportunity over the coming years lies in owners of property assets that also have the asset Can Swire Properties partially break away management capability to transform lower-tier assets from the ‘Hong Kong discount’? into viable alternatives to Hong Kong’s most prime Our view is that a narrowing of the “Hong Kong property assets, which we believe will be in demand. discount” in the valuation of Hong Kong property stocks is not impossible, and some Hong Kong Based on our analysis, we believe Swire Properties can property stocks are better placed than others in terms be considered as one of the strongest property asset of getting exposure to this potential theme. We think managers in Hong Kong, given its success in Swire Properties has considerable potential in this transforming Pacific Place and Island East. Generally, regard, for the following reasons. property companies that have demonstrated a strong capability in managing property assets can command a First, Swire Properties’ earnings come largely from higher valuation in global equity markets, and we see income-producing assets, which are closer to the major this as positive for the valuation of Swire Properties players in the Western world and are easy for global over time. investors to understand and analyse. Last but not least, Swire Properties currently does not Second, Swire Properties’ property assets are high- have significant free float, as some 82% of its shares are quality, concentrating on a few major locations. Such held by its major shareholder, Swire Pacific. Given its characteristics bear a resemblance to major names in differentiated business model and the quality of the global property, such as Boston Property or Mitsubishi assets it owns, we think Swire Properties is in a good Real Estate, and we believe that it is easier for these position to attract sustained interest from global merits to be appreciated by global investors. property funds and global investors. These factors bode well for it being a major stock to focus on to gain Third, while Swire Properties is still a family-controlled exposure to the investment theme of a narrowing in the property company, the Swire Pacific Group has been a “Hong Kong discount” in its valuation, in our view. listed company run by professional managers for many  A snapshot of the major shareholders of Swire Properties decades, and we believe its track record will alleviate Name % interest No. of shares held Filing date many concerns that may otherwise be applied to other Swire Pacific 82.00% 4,796,765,835 31-Dec-13 family-controlled property companies. Swire Aberdeen 2.28% 133,344,984 31-Mar-14 Properties has declared a policy of distributing about Schroders 1.51% 88,115,410 31-Mar-14 Blackrock 0.38% 22,288,773 30-Apr-14 50% of its underlying earnings as dividends, and we Vanguard Group 0.31% 18,165,499 31-Mar-14 believe that this clear dividend policy makes it closer to Norges Bank 0.24% 14,077,359 31-Dec-13 the global REITs than many other Hong Kong property ING Groep 0.15% 8,798,382 31-Mar-14 Morgan Stanley 0.12% 7,256,100 31-Dec-13 companies, and strengthens its appeal to global FIL 0.09% 5,056,934 31-Oct-13 investors. Prudential Financial 0.06% 3,517,600 28-Feb-14 Source: Bloomberg Fourth, as elaborated in this report, Swire Properties has practised a differentiated business model, which has worked well in 2 locations in Hong Kong. We see this as a scalable franchise which has already been applied to other cities and areas with varying degrees of success. Such characteristics are unique among global property stocks, and we believe this will help Swire Properties shares attract the attention of global investors.

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 Global property stocks ranked by market capitalisation Appendix 1: Swire Properties’ (USDbn) 60 approach to property business 50 40 Listed in February 2012 (by way of a spin-off from 30 20 parent company Swire Pacific), Swire Properties is a 10 relative newcomer to the universe of global listed 0 property securities. However, it is a long-established COLI Wharf Ventas HCP Inc Vornado player in Hong Kong property, having engaged in the ProLogis Brookfield Health Care Swire Pacific Swire business for well over 4 decades. Indeed, Swire Kong Cheung Weyerhaeuser Public Storage Mitsui Fudosan Simon Property SHK Properties Anerican Tower Westfield Group Swire Properties Swire Mitsubishi Estate Sumitomo Realty Unibail-Rodamco Boston Properties Properties ranks as one of the largest owners of Equity Residential commercial properties in Hong Kong, with gross rental General Prop Growth income of HKD10.3bn in 2013 and total investment Avalonbay Communities property assets of HKD213bn at the end of 2013. Source: Bloomberg, Daiwa

 Total gross rental income in 2013 In this light, we believe the public listing of Swire (HKDm) Properties in February 2012 heralded an interesting 18,000 addition to the global universe of listed property 15,000 companies. In our view, Swire Properties’ business 12,000 model represents a different approach in the realm of 9,000 the property business. 6,000 3,000 0 Simply put, we think the business model of Swire Properties revolves around using mixed-use property Wharf Hysan developments to transform locations, with the goal of Lai Fung Sino Land creating and owning locations that grow in importance Fortune REIT Cheung Kong Cheung Sunlight REIT Hui Xian REIT The Link REIT SHK Properties New World Dev Hongkong Land Kerry Properties Kerry Champion REIT Swire Properties Henderson Land Henderson over time. Wing Tai Properties Hutchison Whampoa Lai Sun Development

Hang Lung Hang Properties

Source: Companies, Daiwa The process of transforming a location can take decades to run its course. We think the process can be  Gross rental income from Hong Kong in 2013 viewed as having 4 stages, summarised as follows: (HKDm) 14,000 I: Building a strategic foothold 12,000 10,000 II: Nurturing 8,000 III. Upgrading and expanding 6,000 IV. Owning and growing a location 4,000 2,000 0  The Swire approach: 4 phases of investment property Phase Remarks Wharf Hysan I. Building a strategic foothold Acquiring a large and strategically important site which can Soundwill Sino Land form the foundation for a long-term transformation of a Fortune REIT Cheung Kong Cheung Sunlight REIT location. The Link REIT SHK Properties New World Dev Hongkong Land Kerry Properties Kerry Prosperity REIT Champion REIT Swire Properties Henderson Land Henderson II. Nurturing Executing and managing well the initial property (usually one Wing Tai Properties

Hutchison Whampoa anchored with a larger retail component). Lai Sun Development Hang Lung Hang Properties III. Upgrading and expanding Moving up the positioning of the initial portfolio and Source: Companies, Daiwa supplementing this with new developments in the vicinity, resulting in a large and growing portfolio. IV. Owning and growing a Maximising the commercial value of the location it created With a market capitalisation of over USD15bn, Swire location and now dominates. Properties is one of the world’s largest property Striving to attract the best possible customers and tenants. companies in terms of market capitalisation, on our Source: Daiwa estimates.

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 The economics of Swire Properties’ approach to property

Source: Daiwa

We believe there are some “special economics” When Swire Properties entered the China market in associated with this business model which become 2002, it made some adjustments to its approach, increasingly apparent with the passage of time. chiefly by favouring locations that were far more Crucially, there is the promise of a kind of “nurturing proven than Island East was back in the late 1980s. We reward” at the final phase, where Swire Properties believe Tianhe in Guangzhou and the embassy area in essentially owns the locations, and hence can be the Beijing were already prime locations (when Swire principal driver of the continuous upgrading and Properties secured these sites), while the Daci Temple expansion of the location’s boundaries. The economics site in Chengdu and Dazhongli site in Shanghai were associated with the Swire approach are summarised arguably among the most prime sites in their respective below. markets. i) Relatively low entry costs and risks Meanwhile, we consider the site of its INDIGO project In Hong Kong, both the Victoria Barracks (Admiralty) in Beijing as an unproven location, albeit more and Island East were not prime locations for established than Island East was in the 1980s. commercial properties when Swire Properties first However, we would say that Swire Properties’ strategy established a presence in these areas. While Swire in China is an adaptation of its approach rather than a Properties paid record prices for the 2 unproven fundamental change. Victoria Barracks sites, we think one key feature of the Swire approach is that the company does not bid We see Swire Properties’ strategy for China as an aggressively for the most prime sites, ie, those that attempt by the company to optimise the risk/reward would leave it little scope to create value by improving trade-off while ensuring it has scope to upgrade the the location. location in question. Given there are far fewer constraints on the supply of prime commercial

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property in China than in Hong Kong, and demand for We think one merit of the mixed-use property model is commercial property in China cities is far less than in that, if executed well, it can generate a desirable type of Hong Kong, we think it is sensible for Swire Properties customer traffic for the mall. For example, occupants of to start off in China by targeting locations which are hotel rooms are very mobile and tend to have limited reasonably well-established. time in a given location. Hence, hotels can be a very important part of a development in terms of providing The scope for an absolute-dollar improvement in rent a steady stream of shoppers with spending power to and capital value is also an important part of the Swire malls, even though on a standalone basis they may not approach, in our view. We believe this is one reason contribute much to profits. The office portion of a why Swire Properties paid top dollar for the 2 Victoria development can bring similar benefits. Barracks sites. Since the absolute land price for commercial property sites in China is low when In our opinion, one of the challenges in transforming a compared with other major cities globally, we think it is location is kick-starting this virtuous cycle. We believe logical for Swire Properties to start with prime sites in that a mixed-use development can be more effective China. than a pure retail or office development in this regard. In other words, while hotels may not contribute much We think the same applies to Miami, which is not to profits, they can be considered a “necessary cost” in generally considered to be a proven financial or realising a location’s long-term potential. commercial hub. Given land prices in Miami are low (less than USD20/sq ft, on our estimates), even for the Once a location has settled into a path of ongoing prime sites that Swire Properties acquired, it was a upgrades, the developer can add new properties to the commercially sound decision by the company to start area, which expand the scale and enhance the establishing its presence there by acquiring prime sites. competitiveness of its portfolio while increasing the group’s leverage to the upside potential in rent and Put another way, we think that one consideration capital values. In turn, the proportion of “necessary central to Swire Properties’ approach is balancing the costs” related to hotels declines over time. company’s scope to improve the land with the cost of that land. In our view, this is reflected in the fact that  Pacific Place: an example of a mixed-use property complex all the locations in which Swire Properties has invested feature direct links with mass-transit lines (and many could see additional lines being linked up in future). Hence, if the “product” is good enough, the location should be able to attract more of the affluent and aspiring group of the citizens to visit its malls. This would help to improve the image and profile of its mall, and in turn have a positive spill-over effect on the image of the entire complex over time.

But, as we see it, Swire Properties’ approach goes beyond passively relying on subway lines to bring in people. In our opinion, one characteristic of the company’s approach in enhancing these locations is to embark on large-scale mixed developments. ii) Using mixed-use property Source: Company developments to drive the upgrading of a location iii) Extra returns over and above upside for Swire Properties is arguably the Hong Kong market’s the broader industry major proponent of large-scale mixed-use We believe Swire Properties’ approach involves “special development. The company typically starts with a economics” that, assuming solid execution, ensure that large-scale mixed-use development project (often the upside potential of its property assets (in terms of anchored by a sizeable retail component) at a transport both rental and capital value) goes beyond the upside hub and then works on executing well on building and provided by the overall industry. In our view, this managing the property, improving the image of the additional upside stems the following factors. surrounding area, as well as quietly acquiring land in the vicinity.

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First, the land and hence the total development cost of company is now starting to enter this phase with such a project should be considerably lower than would Pacific Place and Island East (see pages 35-61 for our be required for a similar plot of land in a well- detailed analysis of these locations). established prime location. Therefore, apart from the overall upside associated with the sector, the income- Easy to understand, difficult to execute producing capability of the asset should benefit from The transformation of a location cannot be the gradual “rerating” of the location and the property accomplished within a few years. Rather, it is a long- asset over time (reflecting the transformation from, term process that rests on changing the perceptions of say, an isolated property in a new area into a sizeable people and companies. portfolio of assets in an increasingly prominent location). For a developer’s properties to have any chance of driving the transformation of a location, they must first Second, we believe the model can help the company be of a certain scale (we think the minimum size is realise considerable synergies and cumulative benefits. about 1.5m sq ft GFA initially). Ideally, the portfolio In our view, the various components of a mixed- should have a GFA of 4m sq ft or more and continue to property development (typically consisting of retail, grow in order to have a lasting impact on the office, hotels and serviced apartments) should, if transformation of the area. At the same time, the assets managed properly, offer synergies that combine to must be carefully managed and monitored for an increase the “stickiness” of the office occupiers and extended period. In other words, this is an investment retail customers, ie, make them less inclined to head requiring significant capital, focus, and patience. for competing developments. Despite the seemingly attractive economics, few iv) Increasing returns over time property companies in the world have shown that they The benefits associated with the successful upgrading can execute well on this kind of strategy. In our of a location tend to be cumulative, such that other opinion, this is because the manager is required to take external factors come into play once the upgrade has a multi-decade view of the business, which many reached a certain level. By this we mean that if the companies today have little scope to do. group has a sizeable and expanding portfolio in a location, the return profile of the investment can be  Size of major mixed-property developments in Hong Kong Serviced amplified because the additional benefits associated Retail Office apartments Hotel Total with a further upgrading of the location would be GFA (m sq ft) (m sq ft) (m sq ft) (m sq ft) (m sq ft) spread over a much larger portfolio. Hence, as the Swire's Island East portfolio 1.48 8.37 - 0.20 10.04 location matures, the recurrent income received by the (end-2013) Swire's Island East portfolio 1.55 9.55 0.06 0.20 11.37 developer keeps growing, ensuring that the returns (end-2020) provided by this model are cumulative while the risks Harbour City 2.05 4.26 0.67 1.37 8.35 borne by the developer decline over time. HK Land's Central portfolio 1.17 5.19 - 0.18 6.54 Pacific Place* 0.71 2.41 0.44 1.85 5.41 IFC 0.64 2.87 0.27 0.26 4.04 v) A ‘nurturing reward’ awaits in the final Source: Companies, Daiwa phase Note: *Includes 28 Hennessy Road and 8 Queen's Road East (Generali Tower) The developer behind the transformation of a location can ultimately claim to have created the location and An anomaly in global property hence be viewed as the de-facto owner. To the extent We view Swire Properties as an anomaly in global that it has the largest proportion of relatively low-cost property, in that the company’s history is characterised income-producing property assets in the location, it by a meticulous focus on investing in a few major follows that the developer should be better placed than locations in Hong Kong and, more latterly, attempting others to acquire land to further expand the boundaries to replicate this approach in select cities in China and of the location. As the definition of the boundary of a the US. district tends to be quite fluid, there is a tendency for strong locations to continue to expand their Granted, the company’s distinctive approach to the geographical boundaries over time. property business may not be the result of any grand design from the outset. It is more likely to be the New developments, if carefully planned and executed, cumulative result of many years of pragmatic business can enrich a location and potentially kick-start a decisions made in response to the circumstances of the virtuous cycle that can continue for many years. In a time, together with the management’s tradition of nutshell, this is the “nurturing reward” that can result focusing on perfecting its products. from Swire Properties’ approach. In our view, the - 110 - Financials / Hong Kong 1972 HK 22 May 2014

A valuable franchise ‘for free’ Swire Properties’ historical investments in its Our view is that, in the course of responding and commercial property assets have generated significant adapting to market conditions over the years, Swire returns for shareholders, especially as its shareholders Properties has accumulated valuable experience from have not had to put in additional equity capital to fund pursuing its own approach to the property business. the expansion of its portfolio. In other words, we see its While the successful transformation of a location commercial property assets, and its approach to involves factors that are beyond the control of a commercial property investment, as a cash-generating, company, we believe that Swire Properties has wealth-creating machine that has served well not just demonstrated that it has the patience and dedication to the Swire family but long-term investors as well. adhere to its strategy. More than an asset owner Hence, we contend that Swire Properties has acquired Conceptually, we see no reason why Swire Properties the most goodwill and experience in the Hong Kong cannot transfer its track record of managing property property industry – if not globally – in executing this assets in Hong Kong to other cities. Having already strategy. Such a track record is important to the moved to apply these skills to new markets such as business model, in our view, because if the developer China and Miami, the company could in future look to can attract to a location other players (such as do the same in Jakarta and Singapore, in our view. developers/retailers/hoteliers/government bodies) that share a similar vision, the area’s transformation In our opinion, the growth in business scale and net can gain additional impetus. profit achieved by global giants such as Simon Property and Westfield show the extent to which a property Put simply, we view Swire Properties’ track record of company that has a proven command of scalable skills transforming locations as akin to a franchise that is not can expand the scale of its property assets. We believe yet fully appreciated by investors. As we have Swire Properties’ business model is well suited to cities established, executing this model successfully is easier with the following characteristics. said than done, and we think these difficulties represent entry barriers to companies seeking to 1. A wide range of market rents and capital values for replicate Swire Properties’ approach. At the same time, property assets. the model is back-end loaded, such that returns can accelerate over time while the risks to the developer 2. A growing population and/or economy. can decline. Moreover, the model, once mastered, 3. An economy that is steadily moving up the value should be transferable to other cities. These benefits chain. contribute to the “special economics” associated with this model, in our opinion. 4. A critical mass of people and companies that are willing to pay for quality (and such a critical mass A cash-generating, wealth-creating can continue to expand). machine Hong Kong has ticked all 4 boxes historically, and we Swire Pacific has never had to raise equity capital in expect it to continue to do so irrespective of Hong Kong. Rather, the equity capital used to expand movements in US interest rates. Moreover, these same the company’s earnings and asset base over the past characteristics likely apply to the China cities in which few decades has come from its retained earnings and Swire Properties has established a presence (Beijing, revaluation gains on its property assets (as at the end of Guangzhou, Shanghai, Chengdu and Dalian), as well as 2013, Swire Properties’ property assets on the book Miami. As such, we believe that Swire Properties is totalled HKD213bn, before taking into account the positioned to replicate its Hong Kong experience in value of its hotel assets). other markets.

We estimate that the historical cost of Swire Properties’ Swire Properties is serious and ambitious Pacific Place portfolio (excluding hotels and its Wanchai extension) is less than HKD4bn. Yet this about its core business portfolio generated an annual gross rental of We contend that Swire Properties is more ambitious HKD3.3bn in 2013, on our estimates. When it sold about its core business than is recognised by investors. Festival Walk for HKD18.8bn in August 2011, the While Swire Properties had some endowment land to company made a net gain of HKD8.6bn, and we begin with, it has consistently acquired and developed estimate that the pre-tax profit margin on its original property assets over the years while focusing on 50% stake was more than 70% (it bought out CITIC locations that it believes hold long-term strategic value Pacific’s 50% stake in Festival Walk in 2006). - 111 - Financials / Hong Kong 1972 HK 22 May 2014

(Admiralty, Island East and, to an extent, Festival Walk).

While Swire Pacific and Swire Properties may not put much store by their stock-market valuations, they are nevertheless serious about their property business, in our view. The underlying value of the business should, of course, be a major parameter in the valuation of the shares over time. In terms of the management of its core businesses, we think the Swire Pacific ranks highly not just among Hong Kong companies but probably global conglomerates as well.

In sum, we think Swire Pacific group merits attention from long-term investors for its management philosophy, and believe this factor has long-term implications for the value of Swire Properties shares.

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Swire Group has been owned by the same family. In Appendix 2: Swire Group and our view, one feature of Swire Pacific is that it has Swire Properties demonstrated an unusual level of management continuity and focus in terms of business pursuits. We “Esse Quam Videri” * also think it is unusual that over such a long period, — Cicero Swire Pacific’s business interests have not changed that much, with many of its developments and new “Invest within your circle of competence. It’s not how businesses being mainly extensions of the businesses it big the circle that counts, it’s how well you define the knows well. parameters.” — Warren Buffet The company’s major businesses have always been trading and transport. In terms of its transport business, it started with shipping but branched out into *This Latin phrase literally means “to be, rather than to aviation in the late 1940s. It added property to its core seem to be” and is the motto for the Swire group. businesses in the 1970s. However, its property business shared some history with the other Focusing on its key traditional businesses established businesses of the group, in that its whole As one of the oldest conglomerates in Hong Kong (the Taikoo Shing residential development was built on land other 3 are Jardine Matheson, Hutchison Whampoa that previously belonged to Taikoo Sugar Refinery and and Wheelock), Swire Pacific is one of the most well- Taikoo Shipyard. established business groups in Hong Kong, with its establishment dating back to 1816, when it started as a One could argue that over so many decades, Swire small import-and-export trading firm in Liverpool, UK. Pacific has remained focused on a few traditional businesses, and what it has done is mainly adapt them We do not believe many large corporations globally to modern times. have lasted for 200 years, yet throughout these years,

 Current structure of the Swire Group

John Swire & Sons

60.2% voting rights 47.1% share capital

Swire Pacific (19 HK, 87 HK)

Property Div ision Av iation Div ision Bev erages Division Marine Serv ices Division Trading & Industrial Div ision

45%

- 11 Coca-Cola production Swire Pacific Offshore 82% 100% Swire Resources group Swire Properties Cathay Pacific facilities in China, 1 in HK, - provide support services to - distribution and retailing of (1972 HK) (293 HK) and 2 each in Taiwan and the international offshore sports and casual footw ear US energy industry and apparel Taikoo Motors group Taikoo Sugar 20.1% 30% Cam pbell Swire Swire Foods HongkongUnited 50% Air China Dockyards Swire Pacific Cold (753 HK) - ship repair and harbour Storage group towage services in HK Akzo Nobel SwirePaints Swire Waste Management

75% Hong Kong Aircraft Engineering "HAECO" (44 HK)

Source: Company, compiled by Daiwa

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If entrepreneurial spirit and its seeming ability to get However, given the current environment for Hong into the right businesses at the right time are the Kong’s commercial-property industry (where top-end characteristics that define Hutchison Whampoa (Not rents may not rise much further and where there is still rated), one may say that the defining trait of Swire a wide gap between the rents and capital values of top- Pacific is its unwavering focus on developing the tier assets versus the rest of the overall property businesses it knows well. industry), we believe Swire Properties’ business model has its own appeal, especially for conservative investors Strong record of organic business growth looking for long-term stories.

Indeed, for many of its businesses, Swire Pacific has Admittedly, Swire Properties’ approach is not glamorous demonstrated that once it decides to enter into a in the near term, as it has taken, and will continue to business, it does not change its mind easily and will take, many years for the effects of its nurturing efforts to continue to look for ways to grow that business. As fully materialise. That said, we believe Swire Properties’ such, one characteristic of Swire Pacific seems to be its approach to the property business has its merits, not ability to grow many businesses organically and least because it involves lower risks and its portfolio can continuously. often be upgraded continuously, notwithstanding the cyclicality and volatility of the overall broader property For example, Cathay Pacific started off as a small market. airline in Asia in the 1950s, but became one of the world’s most profitable airlines from the late 1980s, Also, we do not think Swire Properties’ approach is and has remained one of the world’s most profitable easy to execute. However, it has demonstrated that it and premier airlines globally, despite the many can make its portfolio relatively resilient against problems and challenges the industry has faced over cyclical downturns in the industry, and that it is well- the years. positioned to ride on the industry recovery when it finally comes. In our opinion, the merits and strengths Likewise, HAECO started off as a small aircraft- of Swire Properties’ approach to the property business maintenance company in Hong Kong several decades tend to show themselves most clearly after a few cycles. ago, and has grown into a major player in the global aircraft-maintenance industry. It has also become a Well-suited to prudent investors looking pioneer in the industry in terms of exploring and for long-term value creation utilising available human and land resources in The company’s business model is not for those looking Mainland China to enhance its competitiveness. to make a fast buck, in our view. However, the pay-off

could be handsome over a 10-20 year horizon. But for all the significant progress these businesses Moreover, once the location’s development enters what have achieved, when one looks back, they also faced we see as the 3rd or 4th phase, the risks appear limited challenges and hiccups along the way. However, it and might well diminish over time. As such, this appears Swire Pacific has often been able to address approach works well for a well-capitalised property many of the problems and challenges it has faced. company that has its own vision about its property Thus, we believe it is fair to say that as long as the business and products, and which aims to see steadily broad direction of its businesses and overall strategy growing returns over time. are right, the company is capable of doing reasonably well over time. As with all business strategies, there are pros and cons. But we think this model is a good one for the Swire Swire Properties’ approach to property: family and conservative investors looking for long-term gradual but certain value creation and considerable protection against This brings us to how we see the company’s property adverse developments in the market. business. It does not appear to want to be a “high flyer”  Swire Properties: shareholding structure as at May 2014 and its focus seems to be more about ensuring “gradual Name % shareholding but certain” results over time. We believe the company Swire Pacific 82.00% is not that bothered at being perceived as a top industry Aberdeen 2.28% Schroders 1.51% performer. Instead, its focus is on ensuring that it has a Blackrock 0.38% quality and sustainable product, and that it has its own Vanguard Group 0.31% group of customers that like the product, and that this Norges Bank 0.24% ING Groep 0.15% group is likely to increase over time. Morgan Stanley 0.12% FIL 0.09% This model may not suit every investor. Nor is it the Prudential Financial 0.06% most attractive for stock investors at all times. Source: Company, Bloomberg - 114 - Financials / Hong Kong 1972 HK 22 May 2014

The office upcycle since 2H03 has been underpinned Appendix 3: the Hong Kong office by developments in Hong Kong’s financial markets, as market a surge in IPOs from China since 2005 has led to a dramatic expansion in Hong Kong’s stock market The Hong Kong office market began to take shape in capitalisation. Indeed, in recent years, Hong Kong has the 1970s, as the city gradually moved from being a been the No.1 equity market globally for IPOs several manufacturing centre to a business and financial hub. times. From the early 1990s, it started to become known as the gateway to China, with a growing number of foreign Against this background, we saw a sharp rise in rents in companies using their Hong Kong offices to manage a few premier grade-A office buildings in Hong Kong to their businesses over the whole of China. about 3x those of Causeway Bay offices at one point, a phenomenon not seen in the past. The development of the Hong Kong office market, however, faced a major setback between 4Q97 and  Average market cap of the Hong Kong stock market mid-2003, as the city saw its worst property market (HKDbn) downturn in decades. While the downturn in the 25,000 property market started off focusing on the residential 20,000 side, it quickly developed into a kind of mid-life crisis for the entire Hong Kong economy, which resulted in a 15,000 70% decline in grade-A office rents in Hong Kong, from 10,000 the peak levels in 1997 to bottoming out in mid-2003 – the largest magnitude of decline the Hong Kong office 5,000 sector has ever seen and quite unusual for the rental 0 market, in our view. 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013  Office rents in major grade-A office locations in Hong Kong Source: Bloomberg, Daiwa

(HKD/sq ft) 120 Then came the Lehman crisis in 2008, which was 100 accompanied by corporate failures for a few major financial institutions and resulted in the downsizing of 80 investment banks some time after. In the broadest 60 sense, we see the development in the office market 40 since 2010 as a reaction to what we saw over 2005-10. 20 0 The Hong Kong grade-A office market used to be a Central-led market, in that it was generally rising rents Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Central Wan Chai & Causeway Bay in Central that led to demand spilling over to other North Point Tsim Sha Tsui districts, and Central rents were the trendsetters for the whole sector. Source: CEIC, Daiwa

We think this puts into perspective what happened to In retrospect, the main significance of the surge in the property market in the 10 years after 2003. It Central office rents over 2005-10 was that it forced appears that many things in the world move in many grade-A office tenants to reassess their long-term pendulum swings, and this is probably an apt office requirements in terms of location. description of the Hong Kong office market. Many of them appear to have come to the realisation While several grade-A office buildings engaged in a that it was not a must to be in Central, and that they vicious price war from 2001 to 1H03 to win premier could accept moving to Kowloon if the building was financial-company tenants, which resulted in rents at good enough. With this in mind, International Two IFC falling to about HKD20/sq ft at one point in Commerce Centre (ICC) in West Kowloon appears to 2002, the situation reversed dramatically since 2H03 show acceptance by the investment bank sector that for the Hong Kong grade-A office market after the West Kowloon is a credible alternative. And Landmark Mainland introduced strong policy support for Hong East in East Kowloon shows that the insurance, Kong and kick-started the Individual Visit Scheme accounting and consumer sectors consider Kowloon (IVS). East to be a credible alternative.

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This trend, together with the cost-cutting focus of many office districts (Central, Wanchai, Causeway Bay, multinationals after the global financial crisis, has Island East, and Tsimshatsui) should remain limited resulted in the major redistribution office space in for the foreseeable future. Hong Kong, with quite a lot of non-finance companies deciding to move out of Central. We think the worst-case scenario for the Hong Kong office market would be the market doldrums This then created another anomaly in the Hong Kong continuing into 2015 and beyond. However, we do not office market during 2011-13 in that, for the first time expect office rents to fall much from here, and think in Hong Kong’s office market, non-Central markets the Central office market is stabilising, notwithstanding performed notably better than those in Central. While that there is still sizeable vacant space in Citibank the Central office market was soft from 2011-13, rents Plaza. Meanwhile, if there is only a moderate pick-up in outside Central kept on rising. As such, the overall demand, this could well be sufficient to drive a change situation of the Hong Kong grade-A office market is not in overall sentiment and outlook for the Hong Kong bad currently, in our view. grade-A office market.

 Grade-A office vacancy rates (March 2014) Since January 2014, we have been seeing the following District Vacancy rate Overall 4.4% positive signs in the grade-A office market. Central 4.4% 1) The occupancy rate at IFC has notably improved to Wanchai/Causeway Bay 3.0% Hong Kong East 1.6% about 98% currently, versus about 92% 12 months Tsimshatsui 2.3% ago. Kowloon East 6.7% Source: Jones Lang LaSalle 2) There are some signs of new demand from smaller tenants, resulting in 28 Hennessy Road improving In our opinion, the second anomaly in the Hong Kong its occupancy rate to over 96% now, versus 74% as office market that emerged over 2011-13 (characterised at the end of 2013. by a divergence between the performance of Central 3) Citibank Plaza leased a few floors in the first 2 and non-Central areas) was arguably the free market’s months of 2014; we think Citibank Plaza’s response to the first anomaly that emerged in 2005-10 manager’s latest moves to consider attracting non- (characterised by rents in a few buildings in Central Central tenants to upgrade to Citibank Plaza is a becoming almost 3x those of Causeway Bay offices). positive development for it and the industry as a Importantly, this adjustment has been in place for whole. more than 3 years and we think it is now coming to an end, given that the rental gap between Central and 4) There are signs that Mainland financial firms are other locations (such as Wanchai-Causeway Bay) has exploring business opportunities in Hong Kong, returned to a normal level of about 30-80%. which we think could be related to Beijing’s stated objectives that the China Government will pursue Meanwhile, rents in Kowloon East have risen financial reforms, including the internationalisation considerably since the late-2000s, with asking rents for of the Renminbi. While many of them demand office prime buildings in the area at about HKD35/sq ft now space of 3,000-4,000 sq ft, 50 or more arriving in versus as low as just over HKD10/sq ft in 2009 and Hong Kong could have a positive impact on 2010. This makes rents in many buildings in Island sentiment and expectations for office space, and East and Tsimshatsui look reasonable by comparison. over time we think more Mainland financial companies could demand space of 5,000-10,000 sq In our opinion, the current state of the Hong Kong ft. grade-A office market is arguably healthier than during 5) IPO activity in Hong Kong has picked up in recent the pre-2008 days. That is, many office occupiers are months and Beijing has now finally allowed mutual staying where they are and paying the rents they are market access between the Shanghai and Hong paying because they have considered many options but Kong stock exchanges. have judged that paying their current rent is the most appropriate for their business.

Admittedly, there has been much sign of incremental new demand in the office market over the past 2 years, but we think there has also been no major further downsizing by the major office occupiers (other than the investment banks) and new supply in the 5 core

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 Major office lease transactions in Hong Kong in recent months with the largest amount of single-landlord office Rent GFA (HKD/sq buildings outside of Central since the late 2000s. Building Floor (sq ft) ft/month) Tenant One Island East n.a. 10,000 50 Facebook Interestingly though, compared with the world’s major AIA Central 12/F whole floor 12,288 130 Cinda Asset Management financial centres and business hubs, Hong Kong’s Exchange Square Upper floors 3,385 135 A Chinese property company current level of grade-A office stock is not that large Two IFC Mid-zone whole 22,000 90 Guosen Securities floor and is still much smaller than that of London or New CCB Tower 22/F whole floor 7,400 100 Guoyuan Securities York, based on figures from Knight Frank. While Two Exchange 45/F whole floor 13,107 130 A brokerage arm of China grade-A office rents in Central are among the world’s Square Merchants Bank Citibank Tower Mid-zone joint 30,000 70 United Overseas Bank highest, we think this is supported by the fact that both floors the absolute and relative sizes of the Central grade-A Bank of America 24/F whole floor 14,000 65 Shanghai Pudong office sector are still moderate compared with London Tower Development Bank and New York. The Center Half floor on 77/F 14,500 60 A Chinese energy company Man Yee Building 13/F whole floor 11,463 80 Brown Brothers Harriman Two Exchange 18/F whole floor 13,107 120 China Securities Co (affiliate of  Office stock in selected financial centres’ core CBD areas as Square CITIC Securities) at 2013 Source: HKET, Daiwa (m sq ft) 500  IPO activity in Hong Kong 400 (HKDbn) (No.) 500 140 300 120 400 200 100 100 300 80

200 60 0 Manhattan, London Sydney Hong Kong Singapore Beijing Shanghai 40 NY 100 20 CBD Decentralised districts

0 0 Source: Knight Frank 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Funds raised through IPOs (LHS) No. of newly listed companies (RHS)  Percentage of office stock in selected financial centres’ core Source: HKEx, Daiwa CBD areas as at 2013

In the meantime, we believe Swire Properties is in a 100% good position to strengthen its competitive position in 80% the Hong Kong office market. In fact, one could say that Swire Properties’ entire portfolio has been built on 60% the assumption that the market would need 40% alternatives to Central office space, which it believed was likely to become too expensive for many sectors. 20% 0% Pacific Place started off as an alternative to Central and Manhattan, London Sydney Hong Kong Singapore Beijing Shanghai NY has already become an established core office location CBD Decentralised districts

within the Greater Central area. We believe the extension of Pacific Place into Wanchai South has Source: Knight Frank helped to provide some lower-rent options for tenants that want to be in its portfolio, but would accept a less Our view is that, going forward, Central is likely to be a prime location. The extension of Pacific Place into market where volume growth in terms of total stock of Wanchai South also offers some buildings that have grade-A offices will be relatively restrained over the smaller floor plates, which should suit certain types of coming years, but the psf rental will remain relatively tenants, such as those that were previously in offices in high, which should be good for offices in Wanchai Central. South where the uplift in rent could be considerable if achieved rents can get close to the Pacific Place level. Meanwhile, we think Swire Properties’ Island East provides an alternative for tenants looking for offices On the other hand, we expect to see continuous volume outside of Central. Island East has become the district expansion in Hong Kong’s decentralised areas and think Island East and Kowloon East (hence, Swire

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Properties’ developments) will account for a major part of this process.

In our view, the Hong Kong grade-A office market is evolving into one that consists of 5 layers, and that its different locations will focus on different types of tenants. Our assessment is that Swire Properties is well-positioned to gain exposure to the opportunities in the Hong Kong office market because:

1) We see Greater Pacific Place becoming a more important cluster within the Greater Central office market. 2) We believe Island East will become the largest office hub outside Central on Hong Kong Island, and we see Swire Properties’ entire Island East portfolio as being one mega-sized mixed-use property project in this area.

 Daiwa’s 5-layer breakdown of the Hong Kong office market – by size Current size Size by 2019E Size by 2029E (m sq ft)* (m sq ft)* (m sq ft)* 1 Greater Central 23.3 24.2 28.6 2 The four established core office areas 23.5 24.8 27.2 3 Kowloon East 9.3 13.5 25.5 4 The 5 satellite office areas 7.8 8.9 9.4 5 Rest of the market 1.0 1.7 1.7 65.0 73.1 92.4 Central 13.6 14.4 15.8 Admiralty & Pacific Place's Wanchai extension 4.7 4.8 4.8 Sheung Wan 3.2 3.2 3.2 West Kowloon 1.9 1.9 4.9 23.3 24.2 28.6 Wanchai 6.3 6.5 7.8 Causeway Bay 3.4 3.5 3.5 Tsimshatsui 6.0 6.3 6.3 Island East 7.7 8.4 9.5 23.5 24.8 27.2 Kowloon East 9.3 13.5 25.5

Kwai Chung & Tsuen Wan 1.5 1.9 2.2 Tsimshatsui East 3.5 3.5 3.5 Cheung Sha Wan 0.6 0.9 0.9 Mongkok 1.2 1.2 1.2 Hunghom 1.0 1.4 1.6 7.8 8.9 9.4 Other areas 1.0 1.7 1.7 Total 65.0 73.1 92.4 Source: Daiwa forecasts Note: Greater Central: Central, Admiralty, Pacific Place's Wanchai extension, West Kowloon, Sheung Wan Four established core office areas: Wanchai, Causeway Bay, Tsimshatsui, Island East Kowloon East: Kowloon Bay, Kwun Tong and Kai Tak redevelopment Five satellite office areas: Mongkok, Hunghom, Tsimshatsui East, Kwai Chung & Tsuen Wan; Cheung Sha Wan Rest of the market: Wong Chuk Hang, Tuen Mun, Shatin, Sheung Shui Note: *Denotes net floor area as at the end of 2012

- 118 - Financials / Hong Kong 1972 HK 22 May 2014

 Retail sales growth and contribution from Mainland tourists Appendix 4: the Hong Kong retail (HKDm) property market 500,000 35% 400,000 25% In our opinion, the Mainland’s Individual Visit Scheme 300,000 15% (IVS) is transforming Hong Kong’s retail-property 200,000 sector by expanding the “catchment areas” of the city’s 5% retail properties to include potentially the entire 100,000 population of China over time. In the eyes of 0 (5%) international retailers, Hong Kong’s retail property 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 market could go from one that serves some 7m people Visitor spending - from PRC (ex-hotel & meal) (LHS) to one reaching potentially 1bn or more consumers. HK retail sales (LHS) % (RHS) A potential quantum leap in the scale of Source: CEIC, Daiwa Hong Kong’s retail property sector  Retail Individual Visit Scheme coverage* This transformation process will not happen overnight (Population: m) and may well take decades to unfold fully. During this 1,400 30% process, there will be times when there are cyclical 1,200 downturns or upswings. Still, if this underlying 25% 1,000 structural uptrend is long-lasting, then it is likely to 20% 800 reassert itself from time to time. 15% 600 10% We think the uptrend will assert itself, given that the 400 current number of Mainland visitors to Hong Kong 200 5% represents still only a small portion of the population 0 0% 2003 2004 2005 2006 2007 2008 2009 2010 in China, and that the transport infrastructure linking Hong Kong and China will improve notably in coming Individual Visit Scheme Total (LHS) All China Total (LHS) % (RHS)

years. Source: CEIC, Daiwa * no new additions since 2010

- 119 - Financials / Hong Kong 1972 HK 22 May 2014

 Cities included in the IVS

Changchun

Shenyang Beijing

Dalian Tianjin Shijiazhuang

Jinan

Zhengzhou Wuxi Nanjing Suzhou Hefei Shanghai Chengdu Hangzhou Ningbo Wuhan Chongqing Taizhou Nanchang Changsha Fuzhou Guiyang Quanzhou Dongguan Xiamen Cities added in 2003 Kunming Huizhou Cities added in 2004 Guangzhou Nanning Foshan Shenzhen Cities added in 2005 Jiangmen Cities added in 2006 Zhuhai Zhongshan Cities added in 2007 Haikou

Source: Daiwa

Some slowdown in retail sales looks back, we think some luxury items (watches and inevitable jewellery especially) are likely to have over-expanded their stores over 2010-12, and it could take time for the The past 10 years have been exceptionally strong for market to address these issues. the Hong Kong retail-property sector, thanks to the introduction of the IVS. But the surge in the number of  Retail sales for Harbour City and Times Square Mainland visitors coming to Hong Kong as a result of (HKDbn) the IVS has led to some social discontent in the city, 40 which we think could dampen the desire of some 35 Mainland visitors. 30 25 Also, as the base for Hong Kong retail sales is going up 20 every year, it looks like some slowdown in the growth 15 10 momentum of Hong Kong’s retail sales is inevitable in 5 the near future, and would most probably be healthy. 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 It is also likely that luxury retail spending in Mainland China will become more subdued in the future, due to Harbour City Times Square the government’s crackdown on corruption. Looking Source: Wharf, Daiwa

- 120 - Financials / Hong Kong 1972 HK 22 May 2014

On the whole, we see 2014 and 2015 as periods of  Expansion of international retailers in the New Territories in adjustment and consolidation for the Hong Kong retail recent years property market, just as the 2009-13 period was a period of adjustment for the grade-A office market. That said, we think several points are worth noting.

Rents for top retail assets should remain stable While overall sentiment toward the Hong Kong retail property market in terms of retail sales outlook has turned more cautious, we note that prime retail space is still sought after. Indeed, many international retailers are still keen to secure space in prime areas, such as Causeway Bay. We expect rents and the capital values of these prime retail property assets to remain stable in 2014 and beyond, although rents for selected Source: Savills high-street shops in second-tier streets in prime areas (such as Causeway Bay and Tsimshatsui) are likely to  Hong Kong: gross rental income for retail properties in the 12 face downward pressure as the landlords have probably months ended December 2013 Interim/ Dec 2012 Dec 2013 Change pushed up the rents too much over the past few years Final (HKDm) (HKDm) YoY (%) on the basis that they would become first-tier streets; Harbour City Final 4,232 4,909 16.0% however, this has not materialised. Times Square Final 1,356 1,492 10.0% Plaza Hollywood Final 420 475 13.0% Hysan portfolio Final 1,250 1,678 34.2%  Major retail leasing transactions in Causeway Bay in recent HK Land Central portfolio Final 1,200 1,411 17.5% months (past 6 months) Hysan Final 1,250 1,678 34.2% Event Remarks Langham Place Mall Final 589 688 16.8% H&M is to open a 46,000 sq ft flagship store in Sizeable commitment by an international Fortune REIT Final 1,114 1,317 18.3% Hang Lung Centre in 2015 retailer Total 11,412 13,649 19.6% Prada has leased 15,000 sq ft in the Plaza Sizeable commitment by an international Source: Companies, Daiwa 2000 in Russell Street to open in 2015 retailer Source: HKET, Daiwa Transport infrastructure between Hong Suburban malls are doing well Kong and Mainland will be a positive Also, we believe many international retailers have We also think the expansion of the transport changed the way they see the New Territories, and now infrastructure linking Hong Kong and Mainland China consider it an important market. This is supported by will start to bear fruit in the next few years, especially the change that we have been seeing in consumption as the Express Rail Link is scheduled to open by 2017 patterns, in that many consumers are now coming and the Macau-Hong Kong-Zhuhai Bridge is due to across the border from the Mainland on day trips to open at about the same time. buy daily goods and necessities. Based on information from the Hong Kong property companies, the malls in We think these developments will significantly improve the New Territories are generally doing well and many the accessibility of Hong Kong to people living on the spaces in industrial buildings are now being converted Mainland. Hence, although the growth rate of into low-end retail areas. Mainland tourist numbers to Hong Kong may slow over the next 1-2 years (due to transport and hotel For example, some 25% of the floor space in Prosperity infrastructure bottlenecks, and as some anti-Mainland- Place in Kwun Tong is now being used for retail space tourist sentiment has emerged in Hong Kong in recent and the ratio is likely to exceed 50% within the next 2 months), we think the longer-term structural trend is years. In our opinion, the fact that lower-tier assets are still positive. doing well and being upgraded are signs that the underlying demand in the market is healthy and solid. Hong Kong companies have been expanding into China’s commercial As such, we see the likely slowdown in retail-sales property sector growth in 2014 as a sign of consolidation and According to the end-December 2013 results of the adjustment, rather than a signal of a major reversal in Hong Kong property companies, nearly all of them saw consumption trends. notable growth in the gross rental incomes from their China properties. We believe that managing retail

- 121 - Financials / Hong Kong 1972 HK 22 May 2014

properties is an area in which the Hong Kong property  Major retail malls in the urban areas companies have an edge, and expect them to be among GFA (sq ft) the major players in China’s commercial property 2,000,000 sector in the foreseeable future. 1,500,000

1,000,000  Hong Kong Property companies: gross rental incomes from China in the 12 months ended December 2013 500,000

(HKDm) 0 4,000 3,500 3,000

2,500 (Mapletree) APM (SHKP) APM 2,000 Walk Festival Langham PlaceLangham (Champion REIT)(Champion City Plaza (Swire) 1,500 Elements (MTRC) Pacific Place (Swire) Place Pacific Harbour City (Wharf) City Harbour IFC Mall (SHKP/HLD)

1,000 Times Square (Wharf) 500 Source: Companies, Daiwa estimates 0

Wharf Meanwhile, we believe there is now a significant gap in Lai Fung Sino Land Hutchison Whampoa Properties Hang Lung Hang the achieved rents of Pacific Place mall and Cityplaza. Cheung Kong Cheung Hui Xian REIT SHK Properties New World Dev Kerry Properties Kerry

Swire Properties Based on the 2011 IPO prospectus of Swire Properties, Henderson Land Henderson the achieved rental level in the mall in Pacific Place was Source: Companies, Daiwa already about 3x that of its Cityplaza mall, and we

estimate that such a gap has continued to persist in Swire Properties: steady Hong Kong recent years. operation and growing rental contribution from China However, we see considerable room for Cityplaza to Even though the retail sales growth at Pacific Place was gradually catch up, as we expect Island East to become flat YoY for 2013, this mall has done well for many a more vibrant commercial hub in the years to come. years. We note that the performance of high-end malls Swire Properties has already started a major revamp of tends to be more volatile than that of mass-market its Cityplaza mall which will be completed in the next malls given that they are more dependent on the few years. An increase in the rental-income spending of a smaller group of customers. While the contribution from the Cityplaza mall should help Pacific Place mall might need some fine-tuning in provide the impetus for a rise in Swire Properties’ retail terms of tenant mix and positioning, we think it still rental income. has many factors that work for it in the medium-to- long term. While we reckon the retail sales In addition, we expect Swire Properties retail rental performance for IFC mall has been better than the mall income from China to achieve sustained growth in the in Pacific Place in recent years, the situation remains years to come, due to the maturing of existing malls that there will be virtually no new supply of retail malls (such as Taikoo Hui, Taikoo Li Sanlitun, INDIGO) and in Hong Kong Island in the foreseeable future. new properties (such as Daci Temple in Chengdu and Dazhongli in Shanghai). All these factors should help We also expect the continued expansion of Pacific Place sustain the growth of Swire Properties’ rental income into Wanchai South to help create captive customers from retail in the next few years. for the mall in Pacific Place. Also, the high-street shops in the several major streets in Wanchai South should Finally, we observe that Swire Properties has many help enrich the retail offerings in the Greater Pacific projects which involve street-style commercial malls Place area. In addition, the start of operations of the (such as Taikoo Li Sanlitun and Sino-Ocean Taikoo Li South Island Line and Shatin-Central Link from 2018 in Chengdu), and it owns many high street shopping onwards should help bring more people to the spaces in various streets in Wanchai and Island East. Admiralty area, which would benefit Pacific Place. Globally, high street shops command the highest rents On the whole, we believe that Pacific Place will remain and capital values among all retail property assets, and an important retail property in Hong Kong for the we believe that the company’s ownership of high-street foreseeable future. shop assets and its expertise in managing them constitutes another “hidden asset” of the company.

- 122 - Financials / Hong Kong 1972 HK 22 May 2014

Appendix 5: NAV and book value breakdown

 Swire Properties: NAV (2014E) NAV NAV (HKD/ Size Blended price (HKDm) share) (%) (m sq ft) (HKD/sq ft) HONG KONG A.Greater Pacific Place, Greater Central - Office 61,225 10.5 20.4% 2.4 25,374 - Retail 21,824 3.7 7.3% 0.7 29,539 - Residential/ serviced apartments 9,305 1.6 3.1% 0.4 21,000 - Hotel 4,976 0.9 1.7% 0.4 11,245 - Car parks 996 0.2 0.3% 98,325 16.8 32.8% 4.04 24,355 B.Taikoo Place, Island East - Office 90,944 15.5 30.4% 8.1 11,278 - Retail 19,461 3.3 6.5% 1.5 12,983 - Residential/ serviced apartments 752 0.1 0.3% 0.1 12,000 - Hotel 2,070 0.4 0.7% 0.2 10,369 - Car parks 5,936 1.0 2.0% 119,163 20.4 39.8% 9.83 12,128

C. Old building assets in Greater Pacific Place and Taikoo Place* 7,077 1.2 2.4% 0.3 25,015 D. Investment properties in Greater Pacific Place and Taikoo Place 224,565 38.4 74.9% 14.1 15,875 Other locations in HK Tung Chung 2,917 0.5 1.0% 0.27 10,760 Kowloon East 2,560 0.4 0.9% 0.56 4,612 Wong Chuk Hang 765 0.1 0.3% 0.19 4,000 Other investment properties in HK 5,394 0.9 1.8% 0.76 7,074 11,636 2.0 3.9% 1.78 6,538 Investment properties in HK 236,201 40.4 78.8% 15.9 14,832 Development properties in HK 8,140 1.4 2.7% 0.8 9,690 HK property assets 244,341 41.8 81.5% 16.8 14,574

E.Mainland China Beijing 15,216 2.6 5.1% 2.4 6,307 Guangzhou 19,559 3.3 6.5% 3.8 5,126 Chengdu 4,556 0.8 1.5% 0.8 5,774 Shanghai 7,975 1.4 2.7% 1.7 4,597 Dalian - - - - - China property assets 47,306 8.1 15.8% 8.8 5,405

F.Miami, UK and overseas Miami commercial property assets 6,242 1.1 2.1% 2.6 2,364 Miami residential property assets 954 0.2 0.3% 2.6 370 UK hotels 798 0.1 0.3% 0.2 3,824 7,993 1.37 2.7% 5.4 1,473

Gross NAV 299,640 51.2 100.0% 30.9 9,684 Net debt (36,047) (6.2) NAV 263,593 45.1 Source: Daiwa estimates Note: * Includes 82,909 sq ft of old building assets which can be identified and 0.2m sq ft GFA which we assume that it already owns ** Not yet includes its Dalian Bay project



- 123 - Financials / Hong Kong 1972 HK 22 May 2014

 A. End-2014E NAV breakdown – Greater Pacific Place Present Value per Year of Stake Total Attr. Spot rent* Cap rate** value No. of room NAV Assets Area completion (%) GFA (sq ft) GFA (sq ft) (HKD/sq ft) (%) (HKD/sq ft) rooms (HKDm) (HKDm) (HKD/share) Office One Pacific Place Admiralty 1988 100% 863,266 863,266 90 4.0% 27,000 - - 23,308 4.0 Two Pacific Place Admiralty 1990 100% 695,510 695,510 90 4.0% 27,000 - - 18,779 3.2 Three Pacific Place S. Wanchai 2004 100% 627,353 627,353 80 4.0% 24,000 - - 15,056 2.6 28 Hennessy Road S. Wanchai 2012 100% 145,390 145,390 60 4.0% 18,000 - - 2,617 0.4 8 Queen's Road East S. Wanchai 2013 100% 81,346 81,346 60 4.0% 18,000 - - 1,464 0.3 2,412,865 2,412,865 25,374 61,225 10.5 Retail The Mall, Pacific Place Admiralty 1988 100% 711,182 711,182 100 4.0% 30,000 - - 21,335 3.6 StarCrest S. Wanchai 1999 100% 13,112 13,112 60 4.0% 18,000 - - 236 0.04 21-29 Wing Fung Street S. Wanchai 2006 100% 14,039 14,039 60 4.0% 18,000 - - 253 0.04 738,333 738,333 29,559 21,824 3.7 Serviced apartments/ Residential Pacific Place Apartments Admiralty 1990 100% 443,075 443,075 70 4.0% 21,000 - - 9,305 1.6 443,075 443,075 21,000 9,305 1.59 Hotels The Upper House Admiralty 2009 100% 158,738 105,019 - - - - 117 11 1,287 0.2 JW Marriott Hotel Admiralty 1988 20% 525,904 105,181 - - - - 602 10 1,204 0.2 Conrad HK Hotel Admiralty 1990 20% 555,590 111,118 - - - - 513 11 1,129 0.2 Island Shangri-La Hotel Admiralty 1991 20% 605,728 121,146 - - - - 565 12 1,356 0.2 1,845,960 442,463 11,245 4,976 0.9 Car parks 664 1.5 996 0.2 996 0.2 Total 5,440,233 4,036,736 24,358 98,325 16.8 Source: Daiwa estimates Note:* based on gross floor area ** gross cap rate

- 124 - Financials / Hong Kong 1972 HK 22 May 2014

 B.End-2014E NAV – Island East Present Value per Year of Stake Total Attr. Spot rent* Cap rate** value No. of room NAV Assets Area completion (%) GFA (sq ft) GFA (sq ft) (HKD/sq ft) (%) (HKD/sq ft) rooms (HKDm) (HKDm) (HKD/share) Office Warwick House*** Island East 1979 100% 554,934 554,934 25 4.5% 6,667 - - 3,700 0.6 Cornwall House#*** Island East 1984 100% 525,369 525,369 25 4.5% 6,667 - - 3,502 0.6 Cityplaza One Island East 1987 100% 628,785 628,785 40 4.5% 10,667 - - 6,707 1.1 Somerset House*** Island East 1988 100% 923,364 923,364 25 4.5% 6,667 - - 6,156 1.1 Cityplaza Four Island East 1991 100% 447,709 447,709 40 4.5% 10,667 - - 4,776 0.8 Cityplaza Three# Island East 1992 100% 423,785 423,785 40 4.5% 10,667 - - 4,520 0.8 Devon House Island East 1993 100% 803,448 803,448 45 4.5% 12,000 - - 9,641 1.6 PCCW Tower Island East 1994 50% 620,148 310,074 45 4.5% 12,000 - - 3,721 0.6 Dorset House Island East 1994 100% 609,540 609,540 45 4.5% 12,000 - - 7,314 1.3 Lincoln House Island East 1998 100% 333,350 333,350 45 4.5% 12,000 - - 4,000 0.7 Oxford House Island East 1999 100% 501,249 501,249 45 4.5% 12,000 - - 6,015 1.0 Cambridge House Island East 2003 100% 268,793 268,793 45 4.5% 12,000 - - 3,226 0.6 One Island East Island East 2008 100% 1,537,011 1,537,011 60 4.0% 18,000 - - 27,666 4.7 DCH Commercial Centre Island East 2013 50% 389,000 194,500 40 4.5% 10,667 - - 2,075 0.4 Somerset House Island East 2017 100% ------redevelopment*** Cornwall and Warwick Island East 2019 100% ------House redevelopment*** 8,177,485 8,061,911 11,281 90,944 15.5 Retail Taikoo Shing Island East 1977-85 100% 331,079 331,079 45 4.5% 12,000 - - 3,973 0.7 Cityplaza Island East 1983 100% 1,105,227 1,105,227 50 4.5% 13,333 - - 14,736 2.5 17-27 Tong Chong Street Island East 2014 100% 62,658 62,658 45 4.5% 12,000 - - 752 0.1 1,498,964 1,498,964 12,983 19,461 3.3 Serviced apartments/ Residential 17-27 Tong Chong Street Island East 2014 100% 62,658 62,658 40 4.0% 12,000 - - 752 0.1 62,658 62,658 12,000 - - 752 0.1 Hotels EAST Hong Kong Island East 2009 100% 199,633 199,633 345 6 2,070 0.4 199,633 199,633 10,369 2,070 0.4 Car parks 5,936 1 5,936 1.0 5,936 1.0 Total 9,938,740 9,823,166 12,131 119,163 20.4 Source: Daiwa estimates Note:* based on gross floor area ** gross cap rate ***to be redeveloped into 2 grade-A office towers

 C.End-2014E NAV breakdown – old buildings Present Value per Stake Total Attr. Spot rent* Cap rate** value No. of room NAV Assets Area Usage (%) GFA (sq ft) GFA (sq ft) (HKD/sq ft) (%) (HKD/sq ft) rooms (HKDm) (HKDm) (HKD/share) Wanchai South 8-10 Wing Fung Street Wanchai South Shops 100% 15,180 15,180 200 4.0% 60,000 - - 911 0.16 12-18 Wing Fung Street Wanchai South Shops 100% 3,800 3,800 200 4.0% 60,000 - - 228 0.04 G/F, 1 Wing Fung Street Wanchai South Shops 100% 646 646 200 4.0% 60,000 - - 39 0.01 12-22 Queen's Road East Wanchai South Shops 100% 11,474 11,474 200 4.0% 60,000 - - 688 0.12 29-31 Queen's Road East Wanchai South Shops 100% 9,970 9,970 200 4.0% 60,000 - - 598 0.10 3 Star Street Wanchai South Shops 100% 1,056 1,056 200 4.0% 60,000 - - 63 0.01 7 Star Street Wanchai South Shops 100% 949 949 200 4.0% 60,000 - - 57 0.01 Others Wanchai South Shops/ resi. 100% 100,000 100,000 15,000 - - 1,500 0.26 143,075 143,075 28,548 4,085 0.70 Island East G/F, 29-41 Tong Chong Street Island East Shops 100% 5,603 5,603 150 4.0% 45,000 - - 252 0.04 12A-12H Westlands Road Island East Shops 100% 4,999 4,999 150 4.0% 45,000 - - 225 0.04 G/F, Westlands Centre Island East Shops 100% 17,248 17,248 150 4.0% 45,000 - - 776 0.13 G/F, Hoi Wan Building Island East Shops 100% 1,382 1,382 150 4.0% 45,000 - - 62 0.01 13-15 Hoi Kwong Street Island East Shops 100% 5,603 5,603 150 4.0% 45,000 - - 252 0.04 Various shops, Westlands Garden Island East Shops 100% 4,999 4,999 150 4.0% 45,000 - - 225 0.04 Others Island East Shops/ resi. 100% 100,000 100,000 - 12,000 - - 1,200 0.21 139,834 139,834 21,401 2,993 0.51 Total 282,909 282,909 25,015 7,077 1.21 Source: Daiwa estimates Note:* based on gross floor area ** gross cap rate - 125 - Financials / Hong Kong 1972 HK 22 May 2014

 D.End-2014E NAV breakdown by usage – other Hong Kong assets outside Greater Pacific Place and Taikoo Place Present Value per Year of Stake Total Attr. Spot rent* Cap rate** value No. of room NAV Assets Area completion (%) GFA (sq ft) GFA (sq ft) (HKD/sq ft) (%) (HKD/sq ft) rooms (HKDm) (HKDm) (HKD/share) Office 625 King's Road Island East 1998 50% 301,065 150,533 35 4.5% 9,333 - - 1,405 0.2 Citygate Tung Chung 1999 20% 160,522 32,104 18 5.0% 4,320 - - 139 0.0 New Kowloon Inland Lot Kowloon Bay 2017 100% 555,000 555,000 6312 4,612 - - 2,560 0.4 8-10 Wong Chuk Hang Road Wong Chuk 2018 50% 382,500 191,250 Hang 4,000 - - 765 0.1 1,399,087 928,887 5,241 4,868 0.8 Retail Island Place Island East 1996 60% 150,223 90,134 45 4.5% 12,000 - - 1,082 0.2 Belair Monte Fanling 1998 8% 47,751 3,820 20 5.0% 4,800 - - 18 0.0 Tung Chung Crescent Tung Chung 1998 20% 36,053 7,211 35 4.5% 9,333 - - 67 0.0 Citygate Tung Chung 1999 20% 462,439 92,488 80 4.5% 21,333 - - 1,973 0.3 Citygate Phase II Tung Chung 2017 20% 460,000 92,000 - - 4,200 - - 386 0.1 1,156,466 285,652 12,346 3,527 0.6 Serviced apartments/residential Eredine, 38 Mount Kellet The Peak 1965 100% 23,224 23,224 50,000 - - 1,161 0.20 Road House B, 36 Island Road, Island South 1980 100% 2,644 2,644 50,000 - - 132 0.02 Deep Water Bay Rocky Bank, 6 Deep Water Island South 1981 100% 14,768 14,768 50,000 - - 738 0.13 Bay Road 40,636 40,636 50,000 - - 2,032 0.35 Hotels Novotel Citygate Tung Chung 2005 20% 236,653 47,331 440 4 352 0.06 236,653 47,331 7,437 352 0.06 Industrial/ office 4-6 Tsing Tim Street Tsing Yi 1962 100% 246,657 246,657 1,500 - - 370 0.06 8-12 Tsing Tim Street Tsing Yi 1962 100% 230,734 230,734 1,500 - - 346 0.06 477,391 477,391 1,500 716 0.12 Car parks 283 0.5 141 0.0 141 0.02 Total 2,832,842 1,779,897 6,538 11,636 1.99 Source: Daiwa estimates Note:* based on gross floor area ** gross cap rate

 End-2014E NAV breakdown by location – other Hong Kong assets outside Greater Pacific Place and Taikoo Place Attr. NAV Assets GFA (sq ft) (HKDm) (HKD/share) Tung Chung - Office 32,104 139 0.02 - Retail 191,698 2,427 0.41 - Residential/ serviced apartments - -- - Hotel 47,331 352 0.06 - Car parks - - - 271,133 2,917 0.50 Kowloon East - Office 555,000 2,560 0.44 555,000 2,560 0.44 Wong Chuk Hang - Office 191,250 765 0.13 191,250 765 0.13 Island East - Office 150,533 1,405 0.24 - Retail 90,134 1,082 0.18 240,666 2,487 0.43 The Peak and Island South - Residential 40,636 2,032 0.35 40,636 2,032 0.35 Others - Industrial/ office 477,391 716 0.122 - Retail 3,820 18 0.003 - Car parks - 141 0.02 481,211 876 0.15 Total 1,779,897 11,636 1.99 Source: Daiwa estimates

- 126 - Financials / Hong Kong 1972 HK 22 May 2014

 End-2014E NAV breakdown by usage – other Hong Kong assets outside Greater Pacific Place and Taikoo Place Attr. NAV Assets GFA (sq ft) (HKDm) (HKD/share) Office/industrial 1,406,278 5,584 0.95 Retail 285,652 3,527 0.60 Residential/ serviced apartments 40,636 2,032 0.35 Hotel 47,331 352 0.06 Car parks 141 0.02 Total 1,779,897 11,636 1.99 Source: Daiwa estimates 

- 127 - Financials / Hong Kong 1972 HK 22 May 2014

 E. End-2014E NAV breakdown – China assets

Spot rent* Cap. Present Value per Year of Stake Total Attr. (CNY/ (CNY/ rate** value No. of room NAV (HKD/ Asset Area completion (%) GFA (sq ft) GFA (sq ft) sq m) sq ft) (%) (CNY/ sq ft) rooms (HKDm) (CNYm) FX (HKDm) share) Taikoo Li Sanlitun, Beijing Village South Beijing 2007 100% 776,909 776,909 450 42 6.0% 8,358 - - 6,493 1.20 7,792 1.3 Village North Beijing 2007 100% 519,399 519,399 300 28 6.0% 5,572 - - 2,894 1.20 3,473 0.6 The Opposite House Beijing 2007 100% 169,463 169,463 - - - - 99 2.5 248 1.20 297 0.1 Car parks Beijing 2007 100% ------861 0.1 86 1.20 103 0.02 1,465,771 1,465,771 7,959 11,665 2.0 INDIGO, Beijing INDIGO Beijing 2012 50% 939,493 469,747 200 19 6.5% 3,429 - - 1,611 1.20 1,933 0.3 ONE INDIGO Beijing 2012 50% 595,464 297,732 200 19 7.0% 3,184 - - 948 1.20 1,138 0.2 EAST Beijing Beijing 2012 50% 358,269 179,135 - - - - 369 2.0 369 1.20 443 0.1 Car parks Beijing 2012 50% ------617 0.1 31 1.20 37 0.01 1,893,226 946,613 3,751 3,550 0.6 Taikoo Hui, Guangzhou The Mall, Taiko Hui Guangzhou 2011 97% 1,472,730 1,428,548 350 33 5.0% 7,801 - - 11,144 1.20 13,373 2.3 Taikoo Hui Towers Guangzhou 2011 97% 1,731,766 1,679,813 120 11 6.0% 2,229 - - 3,744 1.20 4,493 0.8 Serviced apartments Guangzhou 2012 97% 51,517 49,971 160 15 6.0% 2,972 - - 149 1.20 178 0.0 Mandarin Oriental Guangzhou 2012 97% 584,184 566,658 - - - - 263 2.5 638 1.20 765 0.1 Guangzhou Car parks Guangzhou 2012 97% ------718 0.1 70 1.20 84 0.01 3,840,197 3,724,991 5,072 18,893 3.2 Beaumonde Retail Podium, Guangzhou 75 Tianhe Road Guangzhou 2008 100% 90,847 90,847 350 33 6.5% 6,001 - - 545 1.20 654 0.1 Car parks Guangzhou 2008 100% ------100 0.1 10 1.20 12 0.002 90,847 90,847 7,333 666 0.11 Daci Temple Project, Chengdu Sino Ocean Taikoo Li Chengdu 2014 50% 1,141,598 570,799 350 33 6.0% 6,101 - - 3,482 1.2 4,179 0.7 Chengdu Pinnacle One# Chengdu 2014 50% 190,494 95,247 - - - 1,014 - - 97 1.2 116 0.02 Serviced apartments Chengdu 2014 50% 82,076 41,038 150 14 6.5% 2,172 - - 89 1.2 107 0.02 The Temple House Chengdu 2014 50% 163,828 81,914 - - - - 100 2 86 1.2 103 0.02 Car parks Chengdu 2014 50% ------1,000 0.1 43 1.2 51 0.01 1,577,996 788,998 5,774 4,556 0.78 Dazhongli project, Shanghai The Mall, Dazhongli Shanghai 2016 50% 1,081,362 540,681 350 33 6.0% 5,059 - - 2,735 1.2 3,282 0.6 Office towers Shanghai 2016 50% 1,844,842 922,421 250 23 6.0% 3,467 - - 3,198 1.2 3,837 0.66 Hotels Shanghai 2016 50% 543,194 271,597 - - - - 600 3.0 662 1.2 794 0.14 Car parks Shanghai 2016 50% ------1,200 0.1 51 1.2 62 0.01 3,469,398 1,734,699 4,597 7,975 1.36 Dalian Bay project, Dalian The Mall, Dalian Bay Dalian 2019 50% 1,905,936 952,968 ------Residential towers Dalian 2019 50% 1,272,778 636,389 ------3,178,714 1,589,357 -- - -- Total^ 12,337,435 8,751,919 4,504 47,306 8.1 Source: Daiwa estimates Note:* based on gross floor area ** gross cap rate ^before taking into account the Dalian Bay project. If the mall from this project is included, Swire Properties' attributable GFA of investment properties in China will rise to 9.7m sq ft.

 End-2014E NAV breakdown by usage – China assets Attr. NAV Assets GFA (sq ft) (HKDm) (HKD/share) Office 2,995,213 9,583 1.6 Retail 4,396,930 34,686 5.9 Residential/ serviced apartments 91,009 285 0.05 Hotel 1,268,767 2,402 0.4 Car parks - 349 0.1 Total^ 8,751,919 47,306 8.1 Source: Daiwa estimates ^before taking into account the Dalian Bay project. If the mall from this project is included, Swire Properties' attributable GFA of investment properties in China will rise to 9.7m sq ft.

- 128 - Financials / Hong Kong 1972 HK 22 May 2014

 F. End-2014E NAV breakdown – Miami Present Value per Year of Stake Total Attr. Spot rent* Cap rate** value No. of room NAV Assets Area completion (%) GFA (sq ft) GFA (sq ft) (HKD/sq ft) (%) (HKD/sq ft) rooms (HKDm) (HKDm) (HKD/share) Office Brickell City Centre Phase 1 Miami 2015 100% 260,000 260,000 23.4 6.0% 1,741 - - 453 0.1 Brickell City Centre Phase 2 Miami 2018 100% 500,000 500,000 23.4 6.0% 1,382 - - 691 0.1 760,000 760,000 1,505 1,144 0.2 Retail Brickell City Centre Phase 1 Miami 2015 87.5% 565,000 494,375 31 6.0% 2,815 - - 1,392 0.2 Brickell City Centre Phase 2 Miami 2108 100% 500,000 500,000 31 6.0% 2,205 - - 1,103 0.2 1,065,000 994,375 2,508 2,494 0.4 Serviced apartments/ Residential Brickell City Centre Phase 1 Miami 2015 100% 109,000 109,000 20 6.0% 1,551 - - 169 0.03 Brickell City Centre Phase 2 Miami 2108 100% 300,000 300,000 20 6.0% 588 - - 176 0.03 409,000 409,000 845 - - 345 0.06 Hotels Mandarin Oriental Miami 2000 75% 345,000 258,750 326 4 978 0.2 Hotel in Brickell City Centre Phase 1 Miami 2018 100% 218,000 218,000 273 4 1,009 0.2 563,000 476,750 4,168 1,987 0.34 2,797,000 2,640,125 2,261 5,970 1.02 Residential South Brickell Key Miami 2020 100% 421,800 421,800 195 82 0.0 Development site in Fort Lauderdale Ft. Lauderdale/ 2020 75% 787,414 590,561 195 115 0.0 Miami Brickell City Centre Phase 1 Miami 2016 100% 1,114,000 1,114,000 648 - - 722 0.1 Brickell City Centre Phase 2 Miami 2019 100% 450,000 450,000 515 - - 232 0.0 2,773,214 2,576,361 954 0.16 Car parks South Brickell Key Miami 395 0.2 50 0.01 Development site in Fort Lauderdale Ft. Lauderdale/ 1,050 0.2 132 0.02 Miami Brickell City Centre 1,465 0.2 271 0.05 2,910 271 0.05 Total 2,832,842 1,779,897 1,379 7,195 1.23 Source: Daiwa estimates Note:* based on gross floor area ** gross cap rate

 End-2014E NAV breakdown by usage – Miami Attr. NAV Assets GFA (sq ft) (HKDm) (HKD/share) Commercial properties, Miami Office 760,000 1,144 0.2 Retail 994,375 2,494 0.4 Residential/ serviced apartments 409,000 345 0.1 Hotel 476,750 1,987 0.3 Car parks - 271 0.05 2,640,125 6,242 1.1 Residential properties, Miami and 2,576,361 954 0.16 Fort Lauderdale 7,195 1.2 Source: Daiwa estimates

- 129 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: NAV breakdown by usage (2014E) NAV NAV (HKD/ Size Blended price (HKDm) share) (%) (m sq ft) (HKD/sq ft) HONG KONG Greater Pacific Place and Taikoo Place - Office 152,169 26.01 50.8% 10.48 14,524 - Retail 41,285 7.06 13.8% 2.24 18,449 - Residential/ serviced apartments 10,056 1.72 3.4% 0.51 19,885 - Hotel 7,046 1.20 2.4% 0.64 10,973 - Car parks 6,932 1.18 2.3% - - - Old buildings 7,077 1.2 2.4% 0.3 25,015 224,565 38.4 74.9% 14.1 15,875 Other locations in HK - Office 5,584 0.95 1.9% 1.41 3,971 - Retail 3,527 0.60 1.2% 0.29 12,346 - Residential/ serviced apartments 2,032 0.35 0.7% 0.04 50,000 - Hotel 352 0.06 0.1% 0.05 7,437 - Car parks 141 0.02 0.0% - - - Old buildings - - - - - 11,636 1.99 3.9% 1.78 6,538 Investment properties in HK 236,201 40.4 78.8% 15.9 14,832 Development properties in HK 8,140 1.4 2.7% 0.8 9,690 HK property assets 244,341 41.8 81.5% 16.8 14,574

MAINLAND CHINA - Office 9,583 1.6 3.2% 3.0 3,200 - Retail 34,686 5.9 11.6% 4.4 7,889 - Residential/ serviced apartments 285 0.05 0.1% 0.1 3,133 - Hotel 2,402 0.4 0.8% 1.3 1,893 - Car parks 349 0.1 0.1% - - 47,306 8.1 15.8% 8.8 5,405

Miami, UK and overseas - Office 1,144 0.2 0.4% 0.8 1,505 - Retail 2,494 0.4 0.8% 1.0 2,508 - Residential/ serviced apartments 1,299 0.2 0.4% 3.0 435 - Hotel 2,785 0.5 0.9% 0.7 4,063 - Car parks 271 0.05 0.1% - - 7,993 1.37 2.7% 5.4 1,473 Gross NAV 299,640 51.2 100.0% 30.9 9,684 Net debt (36,047) (6.2) NAV 263,593 45.1 Source: Daiwa estimates

- 130 - Financials / Hong Kong 1972 HK 22 May 2014

 The end-2013 book value of Swire Properties  Our estimated breakdown of the end-2013 book value of Swire Properties (HKDm) (HKD/share) (HKDm) (m sq ft) (HKD/sq ft) Current assets Cash on hand 2,521 Cash on hand 2,521 0.4 Trade and other receivables 2,522 Properties under development and for sale 8,020 1.4 Other current assets 129 Trade and other receivables 2,522 0.4 Others 226 Other current assets 129 0.0 Investment properties 13,192 2.3 Completed investment properties in Hong Kong 165,180 12.4 13,317 Non-current assets Investment properties under development in Hong Kong Investment properties 213,708 36.5 - Somerset House redevelopment 9,908 1.0 9,908 Property, plant and equipment 7,225 1.2 - Kowloon East project 2,640 0.6 4,757 Joint-venture companies 16,379 2.8 17-27 Tong Chong Street 526 0.6 840 Associated companies 521 0.1 Investment properties in China 25,989 5.2 5,007 Properties held for development 706 0.1 Old buildings 7,500 0.43 17,606 Others 226 0.04 Miami commercial properties 1845 2.64 5,970 238,765 40.8 Others 120 Total assets 251,957 43.1 213,708 22.8 9,356 Property, plant and equipment Current liabilities Hotels Short term loans 828 0.1 The Upper House 901 0.1 8,578 Trade and other payables 8,007 1.4 EAST Hong Kong 1,449 0.2 7,258 Long-term loans due within one year 6,761 1.2 Mandarin Oriental, Miami 978 0.3 3,780 Other current liabilities 211 0.0 UK hotels 378 0.2 1,890 15,807 2.7 The Opposite House 248 0.2 1,463 Non-current liabilities Mandarin Oriental, Guangzhou 765 0.6 1,350 Long-term loans and bonds 13,598 2.3 Hotel in Brickell City Centre 515 0.2 2,360 Loans due to Swire Finance 13,348 2.3 5,233 1.7 3,047 Deferred tax liabilities 5,604 1.0 Others 1,992 Other non-current liabilities 450 0.1 7,225 1.7 4,207 33,000 5.6 Joint-venture companies Minority interests 800 0.1 - Daci Temple project, Chengdu (excluding hotels) 2,412 1.28 1,881 Equity attributable to shareholders - Dazhongli project, Shanghai (excluding hotels) 7,646 1.46 5,226 Share capital 5,850 1.0 - INDIGO, Beijing (excluding hotels) 2,778 0.77 3,620 Reserves 196,500 33.6 -Hotel in Daci Temple, Chengdu 31 0.08 377 202,350 34.6 -Hotels in Dazhongli, Shanghai 238 0.27 877 Total liabilities 251,957 43.1 -Hotel in INDIGO, Beijing 133 0.18 742 - Citygate project 634 0.12 5,085  Our estimated breakdown of the end-2013 book value of Swire - Citygate site 186 0.09 2,024 Properties - Wong Chuk Hang project 287 0.19 1,500 (HKDm) (m sq ft) (HKD/sq ft) - PCCW Tower 1,145 0.31 3,692 HK investment properties 181,396 14.9 12,166 - 625 King's Road 529 0.15 3,517 Old buildings 7,500.0 0.3 25,000 - Tung Chung Crescent 57 0.007 7,971 China investment properties 38,825 8.8 4,412 -Novotel Citygate hotel 99 0.05 2,083 Miami investment properties 1,845 2.2 853 -Belair Monte 9 0.004 2,356 Miami development properties 908 1.2 736 - Dah Chong Hong Commercial Centre 195 0.19 1,003 HK development properties 7,818 0.8 9,773 16,379 5.17 3,170 Hotels Associated companies UK hotels 378 0.2 1,890 - 20% stake in Island Shangri-la Hotel 188 0.12 1,552 HK hotels 2,871 0.7 4,161 - 20% stake in JW Marriott Hotel 161 0.11 1,531 China hotels 1,415 1.3 1,088 - 20% stake in Novotel Citygate 172 0.11 1,548 Miami hotels 1,493 0.5 2,985 521 0.34 1,544 6,156 2.7 2,289 Properties under development for sale Property assets 244,447 30.9 - Hong Kong residential property developments 7,818 0.80 9,773 Cash on hand 2,521 - Miami residential property developments 202 0.45 449 Trade and other receivables 2,522 - Freeehold land in US 706 - - Other current assets 129 8,726 1.3 6,981 251,957

Others 2,338 251,957

Source: Company, Daiwa estimates

- 131 - Financials / Hong Kong 1972 HK 22 May 2014

Appendix 6: portfolio breakdown

 Swire Properties: completed investment properties (sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E A.Hong Kong 13,652,227 13,871,804 13,853,804 12,865,288 13,611,538 14,611,538 14,611,538 15,692,054 B.China 5,968,960 6,905,097 7,028,049 8,493,083 8,756,736 8,756,736 9,709,704 9,709,704 C.Miami 345,000 345,000 1,099,375 1,426,375 1,426,375 1,426,375 2,726,375 2,726,375 D.UK 208,687 208,687 208,687 208,687 208,687 208,687 208,687 208,687 Total 20,174,874 21,330,588 22,189,915 22,993,433 24,003,336 25,003,336 27,256,304 28,336,820 Source: Company, Daiwa

 Swire Properties: completed investment properties (m sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Hong Kong Greater Pacific Place 4.1 4.1 4.1 4.1 4.1 4.1 4.1 4.1 Greater Taikoo Place 8.6 8.8 8.8 7.7 7.7 8.7 8.7 9.8 Tung Chung 0.2 0.2 0.2 0.3 0.3 0.3 0.3 0.3 Kowloon East - - - - 0.6 0.6 0.6 0.6 Wong Chuk Hang - - - - 0.2 0.2 0.2 0.2 The Peak and Island South 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Other areas in Hong Kong 0.8 0.7 0.7 0.7 0.7 0.7 0.7 0.7 13.7 13.9 13.9 12.9 13.6 14.6 14.6 15.7 China Taikoo Li Sanlitun 1.2 1.5 1.5 1.5 1.5 1.5 1.5 1.5 INDIGO, Beijing 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 Taikoo Hui and Beaumode Ratil Podium, Guangzhou 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 Daci Temple project, Chengdu - 0.7 0.8 0.8 0.8 0.8 0.8 0.8 Dazhongli, Shanghai - - - 1.5 1.7 1.7 1.7 1.7 Dalian Bay project, Dalian ------1.0 1.0 6.0 6.9 7.0 8.5 8.8 8.8 9.7 9.7 Miami, UK and overseas Miami 0.3 0.3 1.1 1.4 1.4 1.4 2.7 2.7 UK hotels 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.6 0.6 1.3 1.6 1.6 1.6 2.9 2.9 Total 20.2 21.3 22.2 23.0 24.0 25.0 27.3 28.3 Source: Company, Daiwa estimates

- 132 - Financials / Hong Kong 1972 HK 22 May 2014

 A.Swire Properties: Hong Kong portfolio (sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Pacific Place Offices One Pacific Place 863,266 863,266 863,266 863,266 863,266 863,266 863,266 863,266 Two Pacific Place 695,510 695,510 695,510 695,510 695,510 695,510 695,510 695,510 Three Pacific Place 627,657 627,657 627,657 627,657 627,657 627,657 627,657 627,657 8 Queen's Road East 145,390 145,390 145,390 145,390 145,390 145,390 145,390 145,390 28 Hennessy Road 81,346 81,346 81,346 81,346 81,346 81,346 81,346 81,346 Retail The Mall 711,182 711,182 711,182 711,182 711,182 711,182 711,182 711,182 Star Crest 13,112 13,112 13,112 13,112 13,112 13,112 13,112 13,112 21-29 Wing Fung Street 14,039 14,039 14,039 14,039 14,039 14,039 14,039 14,039 8-10 Wing Fung Street* 15,180 15,180 15,180 15,180 15,180 15,180 15,180 15,180 12-18 Wing Fung Street* 3,800 3,800 3,800 3,800 3,800 3,800 3,800 3,800 G/F 1 Wing Fung Street* 646 646 646 646 646 646 646 646 12-22 Queen's Road East* 11,474 11,474 11,474 11,474 11,474 11,474 11,474 11,474 29-31 Queen's Road East* 9,970 9,970 9,970 9,970 9,970 9,970 9,970 9,970 3 Star Street* 1,056 1,056 1,056 1,056 1,056 1,056 1,056 1,056 7 Star Street* 949 949 949 949 949 949 949 949 Serviced apartments Pacific Place Apartments 443,075 443,075 443,075 443,075 443,075 443,075 443,075 443,075 Hotels The Upper House 105,019 105,019 105,019 105,019 105,019 105,019 105,019 105,019 JW Marriott 105,181 105,181 105,181 105,181 105,181 105,181 105,181 105,181 Conrad 111,118 111,118 111,118 111,118 111,118 111,118 111,118 111,118 Island-Shangri-la 121,146 121,146 121,146 121,146 121,146 121,146 121,146 121,146 Sub-total (Pacific Place) 4,080,116 4,080,116 4,080,116 4,080,116 4,080,116 4,080,116 4,080,116 4,080,116 Island East Offices Warwick House 554,934 554,934 554,934 - - - - 554,934 Cornwall House 338,582 338,582 525,582 - - - - 525,582 Cityplaza One 628,785 628,785 628,785 628,785 628,785 628,785 628,785 628,785 Somerset House - - - - - 1,000,000 1,000,000 1,000,000 Cityplaza Four 556,431 556,431 556,431 556,431 556,431 556,431 556,431 556,431 Cityplaza Three 447,714 447,714 242,714 242,714 242,714 242,714 242,714 242,714 Devon House 803,452 803,448 803,448 803,448 803,448 803,448 803,448 803,448 PCCW Tower 310,074 310,074 310,074 310,074 310,074 310,074 310,074 310,074 Dorset House 609,540 609,540 609,540 609,540 609,540 609,540 609,540 609,540 Lincoln House 333,353 333,350 333,350 333,350 333,350 333,350 333,350 333,350 Oxford House 501,253 501,249 501,249 501,249 501,249 501,249 501,249 501,249 Cambridge House 268,795 268,793 268,793 268,793 268,793 268,793 268,793 268,793 One Island East 1,537,011 1,537,011 1,537,011 1,537,011 1,537,011 1,537,011 1,537,011 1,537,011 Dah Chong Hong Commercial Centre - 194,500 194,500 194,500 194,500 194,500 194,500 194,500 Retail Taikoo Shing 1-x 331,079 331,079 331,079 331,079 331,079 331,079 331,079 331,079 Cityplaza 1,105,227 1,105,227 1,105,227 1,105,227 1,105,227 1,105,227 1,105,227 1,105,227 G/F, 29-41 Tong Chong Street* 5,603 5,603 5,603 5,603 5,603 5,603 5,603 5,603 12A-12H Westlands Road* 4,999 4,999 4,999 4,999 4,999 4,999 4,999 4,999 G/F Westlands Centre* 17,248 17,248 17,248 17,248 17,248 17,248 17,248 17,248 G/F, Hoi Wan Building* 1,382 1,382 1,382 1,382 1,382 1,382 1,382 1,382 13-15 Hoi Kwong Street* 5,603 5,603 5,603 5,603 5,603 5,603 5,603 5,603 Various shops, Westlands Garden* 4,999 4,999 4,999 4,999 4,999 4,999 4,999 4,999 17-27 Tong Chong Street - 12,349 12,349 12,349 12,349 12,349 12,349 12,349 Serviced apartments 17-27 Tong Chong Street - 62,741 62,741 62,741 62,741 62,741 62,741 62,741 Hotels East Hong Kong 199,633 199,633 199,633 199,633 199,633 199,633 199,633 199,633 Sub-total (Island East) 8,565,697 8,835,274 8,817,274 7,736,758 7,736,758 8,736,758 8,736,758 9,817,274 Source: Company, Daiwa estimates, * not disclosed in its annual reports but details can be found in its IPO prospectus

- 133 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: Hong Kong portfolio (cont’d) (sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Tung Chung Offices Citygate 32,104 32,104 32,104 32,104 32,104 32,104 32,104 32,104 Retail Tung Chung Crescent 7,211 7,211 7,211 7,211 7,211 7,211 7,211 7,211 Citygate 92,486 92,486 92,486 92,486 92,486 92,486 92,486 92,486 Citygate Phase II - - - 92,000 92,000 92,000 92,000 92,000 Hotels Novotel Citygate 47,331 47,331 47,331 47,331 47,331 47,331 47,331 47,331 Sub-total (Tung Chung) 179,132 179,132 179,132 271,132 271,132 271,132 271,132 271,132 Kowloon East Offices New Kowloon Land lot 6312 - - - - 555,000 555,000 555,000 555,000 Sub-total (Kowloon East) - - - - 555,000 555,000 555,000 555,000 Wong Chuk Hang 8-10 Wong Chuk Hang Road - - - - 191,250 191,250 191,250 191,250 Sub-total (Wong Chuk Hang) - - - - 191,250 191,250 191,250 191,250 The Peak and Island South Eredine, 38 Mount Kellet Road 23,224 23,224 23,224 23,224 23,224 23,224 23,224 23,224 House B, 36 Island Road, Deep Water Bay Road 17,412 17,412 17,412 17,412 17,412 17,412 17,412 17,412 Rocky Bank, 6 Deep Water Bay Road 14,768 14,768 14,768 14,768 14,768 14,768 14,768 14,768 Sub-total (The Peak and Island South 55,404 55,404 55,404 55,404 55,404 55,404 55,404 55,404 Other areas 625 King's Road 150,533 150,533 150,533 150,533 150,533 150,533 150,533 150,533 Island Place 90,134 90,134 90,134 90,134 90,134 90,134 90,134 90,134 Belair Monte 3,820 3,820 3,820 3,820 3,820 3,820 3,820 3,820 4-6 Tsing Tim Street, Tsing Yi* 246,657 246,657 246,657 246,657 246,657 246,657 246,657 246,657 8-12 Tsing Tim Street, Tsing Yi* 230,734 230,734 230,734 230,734 230,734 230,734 230,734 230,734 Others 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 Sub-total (Other areas) 771,878 721,878 721,878 721,878 721,878 721,878 721,878 721,878 Total (Hong Kong) 13,652,227 13,871,804 13,853,804 12,865,288 13,611,538 14,611,538 14,611,538 15,692,054 Source: Company, Daiwa estimates

- 134 - Financials / Hong Kong 1972 HK 22 May 2014

 B.Swire Properties: China portfolio (sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Taikoo Li Sanlitun, Beijing Village South 621,527 776,909 776,909 776,909 776,909 776,909 776,909 776,909 Village North 415,519 519,399 519,399 519,399 519,399 519,399 519,399 519,399 The Opposite House 169,463 169,463 169,463 169,463 169,463 169,463 169,463 169,463 Sub-total (Taikoo Li Sanlitun, Beijing) 1,206,509 1,465,771 1,465,771 1,465,771 1,465,771 1,465,771 1,465,771 1,465,771 INDIGO, Beijing INDIGO 469,747 469,747 469,747 469,747 469,747 469,747 469,747 469,747 ONE INDIGO 297,732 297,732 297,732 297,732 297,732 297,732 297,732 297,732 EAST Beijing 179,135 179,135 179,135 179,135 179,135 179,135 179,135 179,135 Sub-total (NDIGO, Beijing) 946,613 946,613 946,613 946,613 946,613 946,613 946,613 946,613 Taikoo Hui, Guangzhou The Mall, Taikoo Hui 1,428,548 1,428,548 1,428,548 1,428,548 1,428,548 1,428,548 1,428,548 1,428,548 Taikoo Hui Towers 1,679,813 1,679,813 1,679,813 1,679,813 1,679,813 1,679,813 1,679,813 1,679,813 Serviced apartments 49,971 49,971 49,971 49,971 49,971 49,971 49,971 49,971 Mandarin Oriental, Guangzhou 566,658 566,658 566,658 566,658 566,658 566,658 566,658 566,658 Sub-total (Taikoo Hui, Guangzhou) 3,724,991 3,724,991 3,724,991 3,724,991 3,724,991 3,724,991 3,724,991 3,724,991 Beaumode Retail podium 75 Tianhe Road 90,847 90,847 90,847 90,847 90,847 90,847 90,847 90,847 Sub-total (Beaumode Retail podium) 90,847 90,847 90,847 90,847 90,847 90,847 90,847 90,847 Daci Temple project, Chengdu Since Ocean Takoo Li Chengdu - 601,934 601,934 601,934 601,934 601,934 601,934 601,934 Pinnacle One - 74,941 74,941 74,941 74,941 74,941 74,941 74,941 Serviced apartments - - 41,038 41,038 41,038 41,038 41,038 41,038 The Temple House - - 81,914 81,914 81,914 81,914 81,914 81,914 Sub-total (Daci Temple project, Chengdu) - 676,875 799,827 799,827 799,827 799,827 799,827 799,827 Dazhongli project, Shanghai The Mall, Dazhongli - - - 539,330 539,330 539,330 539,330 539,330 Office towers - - - 925,704 925,704 925,704 925,704 925,704 Hotels - - - - 263,654 263,654 263,654 263,654 Sub-total (Dazhongli project, Shanghai) - - - 1,465,034 1,728,688 1,728,688 1,728,688 1,728,688 Dalian Bay project, Dalian The Mall, Dalian Bay ------952,968 952,968 Sub-total (Dalian Bay project, Dalian) ------952,968 952,968 Total ( China) 5,968,960 6,905,097 7,028,049 8,493,083 8,756,736 8,756,736 9,709,704 9,709,704 Source: Company, Daiwa estimates

 C.Swire Properties: Miami portfolio (sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Mandarin Oriental, Miami Mandarin Oriental, Miami 345,000 345,000 345,000 345,000 345,000 345,000 345,000 345,000 Sub-total (Mandarin Oriental, Miami) 345,000 345,000 345,000 345,000 345,000 345,000 345,000 345,000 Brickell City Centre Retail for Phase 1 - - 494,375 494,375 494,375 494,375 494,375 494,375 Offices for Phase 1 - - 260,000 260,000 260,000 260,000 260,000 260,000 Serviced apartments for Phase 1 - - - 109,000 109,000 109,000 109,000 109,000 Hotel for Phase 1 - - - 218,000 218,000 218,000 218,000 218,000 Phase 2: retail/ office/ hotel/ serviced apartments ------1,300,000 1,300,000 Sub-total (Brickell City Centre) - - 754,375 1,081,375 1,081,375 1,081,375 2,381,375 2,381,375 Total (Miami) 345,000 345,000 1,099,375 1,426,375 1,426,375 1,426,375 2,726,375 2,726,375 Source: Company, Daiwa estimates

 D.Swire Properties: UK portfolio (sq ft) 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E The Montepellier Chapter, Chelterham 36,662 36,662 36,662 36,662 36,662 36,662 36,662 36,662 The Magdalen Chapter, Exeter 36,001 36,001 36,001 36,001 36,001 36,001 36,001 36,001 Hotel Seattle, Brighton 48,416 48,416 48,416 48,416 48,416 48,416 48,416 48,416 Avon Gorge Hotel, Bristol 87,608 87,608 87,608 87,608 87,608 87,608 87,608 87,608 Total (UK) 208,687 208,687 208,687 208,687 208,687 208,687 208,687 208,687 Source: Company, Daiwa estimates

- 135 - Financials / Hong Kong 1972 HK 22 May 2014

Appendix 7: earnings and gross rental income breakdown

 Swire Properties: earnings breakdown (HKDm) FY12 FY13 FY14E FY15E FY16E Hong Kong Office 4,798 5,098 5,394 5,728 5,948 Retail 2,496 2,614 2,664 2,803 2,986 Festival Walk - - - - - Residential 332 319 344 360 373 7,626 8,030 8,403 8,891 9,307 China Office 194 270 303 332 357 Retail 1,179 1,347 1,455 1,582 1,698 Residential - 6 7 10 12 1,372 1,623 1,765 1,924 2,067 - - - - - Miami - - - - - Office - - - 51 96 Retail - - - 189 359 Residential - - - 24 45 - - - 263 501

Consolidated gross rental income 8,998 9,654 10,168 11,078 11,875 Others 17 22 19 20 21

Revenue from property investment 9,015 9,676 10,187 11,098 11,905 Property trading 4,147 2,207 3,564 3,200 4,061 Hotels 782 942 1,065 1,135 1,245 Others 108 110 115 118 120 Consolidated revenue 14,052 12,935 14,931 15,551 17,331

Consolidated EBIT 9,388 8,234 8,718 9,571 10,306 Share of profits from jointly-controlled entities 92 278 447 551 789 Share of profits from associated companies 160 175 196 220 246 Net interest expenses (1,367) (1,447) (1,505) (1,565) (1,628) Profit before tax 8,273 7,240 7,855 8,776 9,714 Tax (1,199) (769) (1,052) (1,229) (1,311) Profit after tax 7,074 6,471 6,803 7,548 8,402 Minority interests (142) (111) (43) (46) (49) Underlying net profit 6,932 6,360 6,760 7,502 8,353

Consolidated gross rental income 8,998 9,655 10,168 11,078 11,875 Share of gross rental income from jces and associates 310 490 653 774 925 Total gross rental income 9,308 10,145 10,821 11,852 12,800 Source: Company, Daiwa estimates 

- 136 - Financials / Hong Kong 1972 HK 22 May 2014

 Our forecasts on Swire Properties’ gross rental income – breakdown by area (HKDm) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E A.Greater Pacific Place 2,250 2,305 2,171 1,941 1,727 1,812 2,209 2,656 2,813 2,997 3,201 3,401 3,490 3,717 3,915 4,140 4,369 4,628 4,918 5,274 5,763 B. Taikoo Place 1,869 1,909 1,884 1,789 1,663 1,747 1,967 2,306 2,994 3,328 3,452 3,839 4,271 4,447 4,711 4,986 5,188 5,434 6,301 7,229 8,195 Other investment 598 648 656 642 671 706 739 845 943 1,025 1,065 755 129 144 155 166 178 247 401 594 629 properties in HK C.China ------181 258 344 779 1,419 1,837 2,040 2,297 2,564 2,951 3,434 3,985 4,502 Miami ------263 501 501 666 871 944 4,716 4,863 4,711 4,372 4,061 4,264 4,915 5,807 6,931 7,608 8,061 8,774 9,308 10,145 10,821 11,852 12,800 13,761 15,719 17,953 20,033 % breakdown Greater Pacific Place 47.7% 47.4% 46.1% 44.4% 42.5% 42.5% 44.9% 45.7% 40.6% 39.4% 39.7% 38.8% 37.5% 36.6% 36.2% 34.9% 34.1% 33.6% 31.3% 29.4% 28.8% Greater Taikoo Place 39.6% 39.3% 40.0% 40.9% 41.0% 41.0% 40.0% 39.7% 43.2% 43.7% 42.8% 43.8% 45.9% 43.8% 43.5% 42.1% 40.5% 39.5% 40.1% 40.3% 40.9% Other investment 12.7% 13.3% 13.9% 14.7% 16.5% 16.6% 15.0% 14.6% 13.6% 13.5% 13.2% 8.6% 1.4% 1.4% 1.4% 1.4% 1.4% 1.8% 2.5% 3.3% 3.1% properties in HK China ------2.6% 3.4% 4.3% 8.9% 15.2% 18.1% 18.9% 19.4% 20.0% 21.4% 21.8% 22.2% 22.5% Miami ------2.2% 3.9% 3.6% 4.2% 4.8% 4.7% Source: Daiwa

 Our forecasts on Swire Properties’ gross rental income – breakdown by geographical region (HKDm) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Hong Kong 4,716 4,863 4,711 4,372 4,061 4,264 4,915 5,807 6,750 7,350 7,717 7,995 7,889 8,309 8,781 9,292 9,735 10,309 11,619 13,097 14,587 China ------181 258 344 779 1,419 1,837 2,040 2,297 2,564 2,951 3,434 3,985 4,502 Miami ------263 501 501 666 871 944 4,716 4,863 4,711 4,372 4,061 4,264 4,915 5,807 6,931 7,608 8,061 8,774 9,308 10,145 10,821 11,852 12,800 13,761 15,719 17,953 20,033 % breakdown Hong Kong 100% 100% 100% 100% 100% 100% 100% 100% 97.4% 96.6% 95.7% 91.1% 84.8% 81.9% 81.1% 78.4% 76.1% 74.9% 73.9% 73.0% 72.8% China ------2.6% 3.4% 4.3% 8.9% 15.2% 18.1% 18.9% 19.4% 20.0% 21.4% 21.8% 22.2% 22.5% Miami ------2.2% 3.9% 3.6% 4.2% 4.8% 4.7% Source: Daiwa

 A.Swire Properties: gross rental income from Greater Pacific Place (HKDm) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Pacific Place - Office 1,069 1,079 1,010 821 625 645 946 1,286 1,458 1,624 1,657 1,702 1,731 1,909 2,057 2,222 2,378 2,535 2,698 2,908 3,231 - Retail 809 879 876 884 914 960 1,001 1,109 1,074 1,118 1,260 1,414 1,457 1,521 1,559 1,611 1,674 1,764 1,875 2,005 2,152 - Serviced apartments/ 372 348 285 236 187 207 262 261 281 256 284 285 302 287 299 307 317 330 344 361 380 residential 2,250 2,305 2,171 1,941 1,727 1,812 2,209 2,656 2,813 2,997 3,201 3,401 3,490 3,717 3,915 4,140 4,369 4,628 4,918 5,274 5,763 % breakdown Pacific Place - Office 47.5% 46.8% 46.5% 42.3% 36.2% 35.6% 42.8% 48.4% 51.8% 54.2% 51.8% 50.0% 49.6% 51.4% 52.5% 53.7% 54.4% 54.8% 54.9% 55.1% 56.1% - Retail 36.0% 38.1% 40.3% 45.5% 52.9% 53.0% 45.3% 41.8% 38.2% 37.3% 39.4% 41.6% 41.8% 40.9% 39.8% 38.9% 38.3% 38.1% 38.1% 38.0% 37.3% - Serviced apartments/ 16.5% 15.1% 13.1% 12.1% 10.8% 11.4% 11.9% 9.8% 10.0% 8.6% 8.9% 8.4% 8.6% 7.7% 7.6% 7.4% 7.3% 7.1% 7.0% 6.8% 6.6% residential Source: Daiwa

 B. Swire Properties: gross rental income from Taikoo Place (HKDm) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Taikoo Place - Office 1,278 1,281 1,234 1,180 1,017 1,078 1,266 1,522 2,186 2,529 2,615 2,889 3,249 3,373 3,613 3,795 3,877 4,012 4,733 5,485 6,242 - Retail 590 628 650 609 646 669 702 783 808 799 837 950 1,022 1,074 1,085 1,170 1,288 1,399 1,542 1,716 1,924 - Serviced apartments/ ------13 21 24 24 26 27 29 residential 1,869 1,909 1,884 1,789 1,663 1,747 1,967 2,306 2,994 3,328 3,452 3,839 4,271 4,447 4,711 4,986 5,188 5,434 6,301 7,229 8,195 % breakdown Taikoo Place - Office 68.4% 67.1% 65.5% 65.9% 61.2% 61.7% 64.3% 66.0% 73.0% 76.0% 75.7% 75.2% 76.1% 75.9% 76.7% 76.1% 74.7% 73.8% 75.1% 75.9% 76.2% - Retail 31.6% 32.9% 34.5% 34.1% 38.8% 38.3% 35.7% 34.0% 27.0% 24.0% 24.3% 24.8% 23.9% 24.1% 23.0% 23.5% 24.8% 25.7% 24.5% 23.7% 23.5% - Serviced apartments/ ------0.3% 0.4% 0.5% 0.4% 0.4% 0.4% 0.4% residential Source: Daiwa estimates

- 137 - Financials / Hong Kong 1972 HK 22 May 2014

 C.Swire Properties: gross rental income from China (HKDm) 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E Taikoo Hui, Guangzhou - Office - - - - 33 194 270 303 332 357 390 435 491 559 - Retail - - - - 266 686 793 825 911 986 1,056 1,122 1,208 1,347 - Serviced apartments/ residential ------6 7 10 12 14 14 15 16 - Hui Fang retail podium - 19 19 19 24 24 28 31 33 35 38 40 43 46 - 19 19 19 322 903 1,097 1,166 1,286 1,391 1,498 1,612 1,757 1,968 Taikoo Li Sanlitun and INDIGO, Beijing - Office (One INDIGO) ------70 73 79 85 90 97 106 115 - Retail (Taikoo Li Sanlitun) - 163 239 325 457 469 526 600 638 676 714 752 805 933 - Retail (INDIGO) - - - - - 47 144 152 153 161 168 176 188 226 - Serviced apartments/ residential ------163 239 325 457 516 740 824 871 921 972 1,026 1,099 1,274 Daci Temple, Chengdu - Office ------9 11 12 12 12 12 12 - Retail ------41 130 137 226 292 350 419 - Serviced apartments/ residential ------9 22 23 24 26 ------50 141 158 259 327 386 457 Dazhongli, Shanghai - Office ------16 37 43 45 48 - Retail ------78 185 196 233 271 - Serviced apartments/ residential ------94 222 238 278 319 Dalian port project, Dalian - Office ------Retail ------232 465 484 - Serviced apartments/ residential ------232465484 Total - 181 258 344 779 1,419 1,837 2,040 2,297 2,564 2,951 3,434 3,985 4,502

Taikoo Hui Guangzhou - 19 19 19 322 903 1,097 1,166 1,286 1,391 1,498 1,612 1,757 1,968 Taikoo Li Sanlitun, Beijing - 163 239 325 457 469 526 600 638 676 714 752 805 933 INDIGO, Beijing - - - - - 47 214 224 232 245 258 274 294 341 Daci Temple, Chengdu ------50 141 158 259 327 386 457 Dazhongli, Shanghai ------94 222 238 278 319 Taikoo Hui, Dalian ------232 465 484 Total - 181 258 344 779 1,419 1,837 1,990 2,156 2,312 2,470 2,637 2,856 3,242 Source: Daiwa estimates

 Swire Properties' profits from property sales Year of GFA Attri.GFA No. of 2014E 2015E 2016E Projects Name Stake (%) Location completion (sq ft) (sq ft) car parks (HKDm) (HKDm) (HKDm) Hong Kong 2A Seymour Road AZURA 87.5% Mid-level 2012 13,164 11,519 41 - 89 89 63 Seymour Road ARGENTA 100% Mid-level 2013 46,155 46,155 17 148 480 - 148 Argyle Street Dunbar Place 50% Homantin 2013 88,555 44,278 57 266 177 - Sai Wan Terrace Mount Parker Residences 80% Island East 2014 151,954 121,563 68 766 328 - Phase 1, 33 Seymour Road AREZZO 100% Mid-level 2014 165,792 165,792 - - 909 1,246 160 South Lantau Road TBD 100% Cheung Sha, Lantau 2015 64,407 64,407 - - - 232 2 Castle Road (formerly Phase 2, TBD 100% Mid-level 2016 195,533 195,533 43 - -- 33 Seymour Road) 725,560 649,246 226 Miami/ Fort Lauderdale 900 Brickell Key ASIA 100% Miami 2008 5,359 5,359 4 - - - River Court River Court 75% Fort Lauderdale 2006 12,586 9,440 38 - - - South Brickell Key TBD 100% Miami TBD 421,800 421,800 395 - - - Development site, Fort Lauderdale TBD 75% Fort Lauderdale TBD 787,414 590,561 1050 - - - Brickell City Centre Phase 1 TBD 100% Miami 2015 1,114,000 1,114,000 1025 - - 712 Brickell City Centre Phase 2 TBD 100% Miami TBD 450,000 450,000 440 - - - 2,791,159 2,591,159 2,952 China One Pinnacle 50% 1,156,895 578,447 320 - - Property sales profit 1,500 1,983 2,280 Source: Company, Daiwa estimates

- 138 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: gross rental income breakdown by usage (HKDm) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E HONG KONG Hong Kong office - Consolidated gross rental 2,251 2,261 2,155 1,920 1,574 1,647 2,118 2,700 3,521 4,009 4,121 4,433 4,798 5,098 5,394 5,728 5,948 6,222 7,193 8,287 9,343 - Share of gross rental from 96 99 90 82 70 78 94 110 128 148 155 163 187 189 282 296 313 331 352 375 404 associates/jces 2,347 2,360 2,245 2,002 1,644 1,725 2,213 2,810 3,649 4,157 4,277 4,596 4,985 5,287 5,676 6,024 6,261 6,554 7,546 8,662 9,747 Hong Kong retail - Consolidated gross rental 1,989 2,144 2,170 2,123 2,218 2,315 2,420 2,710 2,782 2,899 3,114 3,022 2,496 2,614 2,664 2,803 2,986 3,188 3,443 3,750 4,105 - Share of gross rental from 7 12 12 11 12 18 19 26 28 28 31 67 76 89 96 105 115 181 227 263 290 associates/jces 1,996 2,156 2,181 2,134 2,230 2,333 2,440 2,736 2,810 2,926 3,145 3,089 2,572 2,703 2,761 2,908 3,101 3,369 3,670 4,012 4,395 Hong Kong serviced apartments/residential - Consolidated gross rental 372 348 285 236 187 207 262 261 291 267 296 310 332 319 344 360 373 386 403 423 445 - Share of gross rental from ------associates/jces 372 348 285 236 187 207 262 261 291 267 296 310 332 319 344 360 373 386 403 423 445

Hong Kong office 2,347 2,360 2,245 2,002 1,644 1,725 2,213 2,810 3,649 4,157 4,277 4,596 4,985 5,287 5,676 6,024 6,261 6,554 7,546 8,662 9,747 Hong Kong retail 1,996 2,156 2,181 2,134 2,230 2,333 2,440 2,736 2,810 2,926 3,145 3,089 2,572 2,703 2,761 2,908 3,101 3,369 3,670 4,012 4,395 Hong Kong serviced 372 348 285 236 187 207 262 261 291 267 296 310 332 319 344 360 373 386 403 423 445 apartments/residential 4,716 4,863 4,711 4,372 4,061 4,264 4,915 5,807 6,750 7,350 7,717 7,995 7,889 8,309 8,781 9,292 9,735 10,309 11,619 13,097 14,587 % breakdown Hong Kong office 49.8% 48.5% 47.7% 45.8% 40.5% 40.4% 45.0% 48.4% 54.1% 56.6% 55.4% 57.5% 63.2% 63.6% 64.6% 64.8% 64.3% 63.6% 64.9% 66.1% 66.8% Hong Kong retail 42.3% 44.3% 46.3% 48.8% 54.9% 54.7% 49.6% 47.1% 41.6% 39.8% 40.7% 38.6% 32.6% 32.5% 31.4% 31.3% 31.9% 32.7% 31.6% 30.6% 30.1% Hong Kong serviced 7.9% 7.1% 6.0% 5.4% 4.6% 4.8% 5.3% 4.5% 4.3% 3.6% 3.8% 3.9% 4.2% 3.8% 3.9% 3.9% 3.8% 3.7% 3.5% 3.2% 3.0% apartments/residential CHINA China office - Consolidated gross rental ------33 194 270 303 332 357 390 435 491 559 - Share of gross rental from ------70 82 90 113 139 151 162 175 associates/jces ------33 194 340 385 421 470 529 587 653 734 China retail - Consolidated gross rental ------181 258 344 747 1,179 1,347 1,455 1,582 1,698 1,807 2,146 2,521 2,810 - Share of gross rental from ------47 144 193 284 375 579 664 771 916 associates/jces ------181 258 344 747 1,226 1,490 1,648 1,866 2,073 2,387 2,810 3,292 3,726 China serviced apartments/residential - Consolidated gross rental ------6 7 10 12 14 14 15 16 - Share of gross rental from ------9 22 23 24 26 associates/jces ------6 7 10 21 36 37 40 43

China office ------33 194 340 385 421 470 529 587 653 734 China retail ------181 258 344 747 1,226 1,490 1,648 1,866 2,073 2,387 2,810 3,292 3,726 China serviced ------6 7 10 21 36 37 40 43 apartments/residential ------181 258 344 779 1,419 1,837 2,040 2,297 2,564 2,951 3,434 3,985 4,502 % breakdown China office ------4.2% 13.6% 18.5% 18.9% 18.3% 18.3% 17.9% 17.1% 16.4% 16.3% China retail ------100% 100% 100% 95.8% 86.4% 81.1% 80.8% 81.2% 80.9% 80.9% 81.8% 82.6% 82.8% China serviced ------0.3% 0.3% 0.4% 0.8% 1.2% 1.1% 1.0% 1.0% apartments/residential Source: Daiwa estimates

- 139 - Financials / Hong Kong 1972 HK 22 May 2014

 Swire Properties: gross rental income breakdown by usage (cont’d) (HKDm) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E MIAMI Miami office - Consolidated gross rental ------51 96 96 240 392 413 - Share of gross rental from ------associates/jces ------51 96 96 240 392 413 Miami retail - Consolidated gross rental ------189 359 359 378 425 472 - Share of gross rental from ------associates/jces ------189 359 359 378 425 472 Miami serviced apartments/residential - Consolidated gross rental ------24 45 45 48 54 59 - Share of gross rental from ------associates/jces ------24 45 45 48 54 59

Miami office ------51 96 96 240 392 413 Miami retail ------189 359 359 378 425 472 Miami serviced ------24 45 45 48 54 59 apartments/residential ------263 501 501 666 871 944 % breakdown Miami office ------19.2% 19.2% 19.2% 36.0% 45.0% 43.7% Miami retail ------71.8% 71.8% 71.8% 56.8% 48.9% 50.0% Miami serviced ------9.1% 9.1% 9.1% 7.2% 6.2% 6.3% apartments/residential TOTAL Total office 2,347 2,360 2,245 2,002 1,644 1,725 2,213 2,810 3,649 4,157 4,277 4,628 5,179 5,628 6,061 6,495 6,827 7,179 8,372 9,707 10,893 Total retail 1,996 2,156 2,181 2,134 2,230 2,333 2,440 2,736 2,991 3,184 3,488 3,836 3,798 4,193 4,409 4,963 5,533 6,115 6,859 7,730 8,593 Total serviced 372 348 285 236 187 207 262 261 291 267 296 310 332 325 351 394 440 468 488 516 547 apartments/residential 4,716 4,863 4,711 4,372 4,061 4,264 4,915 5,807 6,931 7,608 8,061 8,774 9,308 10,145 10,821 11,852 12,800 13,761 15,719 17,953 20,033 % breakdown Total office 49.8% 48.5% 47.7% 45.8% 40.5% 40.4% 45.0% 48.4% 52.6% 54.6% 53.1% 52.7% 55.6% 55.5% 56.0% 54.8% 53.3% 52.2% 53.3% 54.1% 54.4% Total retail 42.3% 44.3% 46.3% 48.8% 54.9% 54.7% 49.6% 47.1% 43.2% 41.9% 43.3% 43.7% 40.8% 41.3% 40.7% 41.9% 43.2% 44.4% 43.6% 43.1% 42.9% Total serviced 7.9% 7.1% 6.0% 5.4% 4.6% 4.8% 5.3% 4.5% 4.2% 3.5% 3.7% 3.5% 3.6% 3.2% 3.2% 3.3% 3.4% 3.4% 3.1% 2.9% 2.7% apartments/residential Source: Daiwa estimates

- 140 - Financials / Hong Kong 1972 HK 22 May 2014

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Hiroaki KATO (852) 2532 4121 [email protected] Chang H LEE (82) 2 787 9177 [email protected] Regional Research Head Head of Korea Research; Strategy; Banking John HETHERINGTON (852) 2773 8787 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Deputy Head of Asia Pacific Research Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Rohan DALZIELL (852) 2848 4938 [email protected] Shipbuilding; Steel Regional Head of Product Management Jun Yong BANG (82) 2 787 9168 [email protected] Kevin LAI (852) 2848 4926 [email protected] Tyres; Chemicals Deputy Head of Regional Economics; Macro Economics (Regional) Mike OH (82) 2 787 9179 [email protected] Christie CHIEN (852) 2848 4482 [email protected] Capital Goods (Construction and Machinery) Macro Economics (Taiwan) Sang Hee PARK (82) 2 787 9165 [email protected] Jonas KAN (852) 2848 4439 [email protected] Consumer/Retail Head of Hong Kong Research; Head of Hong Kong and China Property Thomas Y KWON (82) 2 787 9181 [email protected] Jerry YANG (852) 2773 8842 [email protected] Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game Banking (Taiwan); Insurance (Taiwan and China) Leon QI (852) 2532 4381 [email protected] TAIWAN Banking (Hong Kong, China); Broker (China) Mark CHANG (886) 2 8758 6245 [email protected] Winston CAO (852) 2848 4469 [email protected] Head of Taiwan Research Capital Goods – Machinery (China) Steven TSENG (886) 2 8758 6252 [email protected] Alison LAW (852) 2532 4308 [email protected] IT/Technology Hardware (PC Hardware) Head of Regional Consumer; Consumer (Hong Kong/China); Gaming and Leisure Christine WANG (886) 2 8758 6249 [email protected] (Hong Kong, China) IT/Technology Hardware (Automation); Cement; Consumer Jamie SOO (852) 2773 8529 [email protected] Kylie HUANG (886) 2 8758 6248 [email protected] Consumer (Hong Kong/China) IT/Technology Hardware (Handsets and Components) Anson CHAN (852) 2532 4350 [email protected] Consumer (Hong Kong/China) INDIA Eric CHEN (852) 2773 8702 [email protected] Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) Head of India Research; Strategy; Banking/Finance Lynn CHENG (852) 2773 8822 [email protected] Saurabh MEHTA (91) 22 6622 1009 [email protected] IT/Electronics (Semiconductor) Capital Goods; Utilities Felix LAM (852) 2532 4341 [email protected] Head of Materials (Hong Kong, China); Cement and Building Materials (China, SINGAPORE Taiwan); Property (China) Adrian LOH (65) 6499 6548 [email protected] Dennis IP (852) 2848 4068 [email protected] Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and Power; Utilities; Renewables and Environment (Hong Kong/China) China); Capital Goods (Singapore) John CHOI (852) 2773 8730 [email protected] Benjamin LIM (65) 6321 3086 [email protected] Regional Head of Small/Mid Cap; Small/Mid Cap (Regional); Internet (China) Oil and Gas (ASEAN and China); Capital Goods (Singapore) Jackson YU (852) 2848 4976 [email protected] Angeline LOH (65) 6499 6570 [email protected] Small/Mid Cap (Regional) Banking/Finance, Consumer/Retail Joey CHEN (852) 2848 4483 [email protected] David LUM (65) 6329 2102 [email protected] Steel (China) Property and REITs Kelvin LAU (852) 2848 4467 [email protected] Evon TAN (65) 6499 6546 [email protected] Head of Transportation (Hong Kong, China); Transportation (Regional) Property and REITs Jibo MA (852) 2848 4489 [email protected] Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of Custom Products Group; Custom Products Group Head of ASEAN & India Telecommunications; Telecommunications (China, ASEAN & Thomas HO (852) 2773 8716 [email protected] India) Custom Products Group Jame OSMAN (65) 6321 3092 [email protected] Telecom (ASEAN & India); Pharmaceuticals and Healthcare (Singapore)

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Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

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DAIWA INSTITUTE OF RESEARCH LTD HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603 MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

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Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Capital Markets Co. Ltd., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person.

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Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, The subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Blackgold International Holdings Ltd (BGG AU); Tosei Corporation (8923 JP); Modern Land (China) Co. Ltd (1107 HK); China Everbright Bank Company Limited (6818 HK); econtext Asia Ltd (1390 HK); Lotte Shopping Co (023530 KS). *Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.

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United Kingdom This research report is produced by Daiwa Capital Markets Europe Limited and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and/or its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and/or its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

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This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory . Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

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Bahrain This research material is issued/compiled by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113 This material is provided as a reference for making investment decisions and is not intended to be a solicitation for investment. Investment decisions should be made at your own discretion and risk. Accordingly, no representation or warranty, express or implied, is made as to and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, Content herein is based on information available at the time the research material was prepared and may be amended or otherwise changed in the future without notice. All information is intended for the private use of the person to whom it is provided without any liability whatsoever on the part of Daiwa Capital Markets Europe Limited, Bahrain Branch, any associated company or the employees thereof. If you are in doubt about the suitability of the product or the research material itself, please consult your own financial adviser. Daiwa Capital Markets Europe Limited, Bahrain Branch retains all rights related to the content of this material, which may not be redistributed or otherwise transmitted without prior consent.

United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (telephone 212-612-7000).

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Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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