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Hong Kong Real Estate 24 March 2017 Hong Kong Property Sector Beginning of the end or end of the beginning? How “creative destruction” could take Hong Kong property and its companies to the next level See important disclosures, including any required research certifications, beginning on page 190 Hong Kong Property Sector: 24 March 2017 Table of contents Overview: Can Hong Kong make it once again? Q1 And, if it does, what are the implications for its 5 property companies? Q2 Are Hong Kong property prices too high? 17 Can prices be sustained or is the upcycle coming to Q3 25 an end? Will US interest-rate normalisation spell the beginning Q4 59 of the end for Hong Kong property? What could drive Hong Kong property to the next Q5 83 level? Will Hong Kong property companies be able to ride Q6 113 on the opportunities that arise in the years ahead? Company section 145 Please also see: Hong Kong Property Sector: Hong Kong Property Sector: The Hong Kong Property Toolkit It’s time to be more greedy than First impressions can be deceiving: fearful another look at the contrarian case Autumn 2013 25 May 2016 1 July 2016 Jonas Kan, CFA (852) 2848 4439 Jonas Kan, CFA (852) 2848 4439 Jonas Kan, CFA (852) 2848 4439 ([email protected]) ([email protected]) ([email protected]) 2 Hong Kong Property Sector: 24 March 2017 Beginning of the end? Or end of the beginning? Jonas Kan, CFA (852) 2848 4439 “Now is not the end. It is not even the beginning of the end. But it is, perhaps, the end [email protected] of the beginning.” - 1942, Winston Churchill We believe the Hong Kong Property Sector, which has long been an anomaly in global property, has now reached a critical point in its development. As a regional-scale property market of 7m people, this is a fairly mature market by most measures. But, if it can make the leap into being a genuinely metropolitan market akin to London or NewYork, we think the Hong Kong property market could have many more years of development ahead of it. And as a result of this next leg of development, the market could eventually reach a scale far larger than it is today. Much depends on whether market participants discover and then execute well new drivers that can take the market to the next level. In our view, what economist and political scientist Joseph Schumpeter called the force of “creative destruction” is alive and kicking in Hong Kong. Indeed, we believe the free-market system has been signalling many of the issues facing the market for some time now, and market participants have begun responding to these signals. In a sense, therefore, the market has been preparing to make the step up. We believe the Hong Kong Office Sector is ready to accommodate new entrants while existing players expand. Meanwhile, in the retail and residential sectors, the excesses that had built up look to have been largely wiped out. Importantly, our read is that there are several potential drivers of “creative destruction” in the making, not least of which is the ongoing financial-sector liberalisation in China and Hong Kong’s unique position in bridging the institutional gap between China and the rest of the world. In our view, the Hong Kong property companies are nicely placed – they would be fine if the market simply holds up and would be presented with significant opportunities if the market makes a breakthrough. In sum, we consider the Hong Kong property stocks to be a safe and attractive way to play this potential leap in Hong Kong property and the companies’ own continuing modernisation. This reinforces our stated view: if the Hong Kong property companies take their opportunities to continue modernising, they could conceivably come to be seen as a force to be reckoned with in global property, which could in turn unlock USD100bn or more of investment value in their shares. Jonas Kan, CFA, Head of Hong Kong and China Property This report draws on information and insights gleaned from industry experts who have spoken at Daiwa’s Hong Kong Corporate Summit, an event held each January since 2011. The author duly acknowledges these experts’ valuable contributions. 3 Hong Kong Property Sector: 24 March 2017 4 Hong Kong Property Sector: 24 March 2017 Question 1 Overview: Can Hong Kong make it once again? And, if it does, what are the implications for its property companies? 5 Hong Kong Property Sector: 24 March 2017 Q1: Overview: Can Hong Kong make it once again? And, if it does, what are the implications for its property companies? “It was the best of times; it was the worst of times. It was the age of wisdom, it was the age of foolishness… it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us…” - A Tale of Two Cities, Charles Dickens “Profit is the payment you get when you take advantage of change….. As a matter of fact, a capitalist economy is not and cannot be stationary. Nor is it merely expanding in a steady manner. It is incessantly being revolutionised from within by new enterprise, ie, by the intrusion of new commodities or new methods of production or new commercial opportunities into the industrial structure as it exists at any moment.” - Joseph A Schumpeter Hong Kong property appears to be at another transition point Making a major directional call on a major property market is never easy. This is especially the case for Hong Kong, as its property market is in many respects an anomaly in global property, in our view (see our September 2013 publication, the Hong Kong Property Toolkit). Still, we have argued that the forces driving the development of the Hong Kong property market aren’t so different from those that have driven the development of metropolitan markets such as London and New York. Historically, this is a market that is used to facing contradictory forces. As it stands, the market is caught in the middle of several global currents, not least of which are US interest-rate normalisation, the possibility of a change in Sino-US relations, the potential for a new economic and political landscape in Europe, and the changes brought about by China’s attempt to transform its economy from one led by fixed asset investment and rapid monetary expansion into one led by growth in private consumption. We should say from the outset that this is not an attempt to belittle the challenges facing the Hong Kong property market. Indeed, if the abovementioned issues do not play out as we expect, it is reasonable to expect the Hong Kong property market to be rocked. The market in some respects resembled a sampan sailing in the Pacific Ocean, albeit one tied to 2 super tankers – it is part of the US in a monetary sense, and of China in an economic sense. And, of course, these super tankers don’t always sail in the same direction. 6 Hong Kong Property Sector: 24 March 2017 The Hong Kong property market: stages of development Stages of Hong Kong as a city Period Manifestations in the property market A manufacturing and trading centre 1970s-1980s Office and retail property stock reach a scale similar to emerging cities in the world Very small portion of the population living in Class C (>69.9 sq m) or above units due to the peculiarities of the local land supply and socio-economic situation A medium-sized city in Asia which is strong in commercial services, 1990s-now Stock of office and retail properties reaches a scale similar to that serving as the commercial gateway to China, the capital formation of major medium-sized cities in the world centre for major Chinese enterprises and a major hub for outbound The proportion of people living in Class C or above units rises Chinese consumers notably but is still low by international standards A major service economy in Asia which is attempting to go higher Now -2020? Sustained expansion in the stock of office and retail properties, and deeper in the value chain, serving as a city that can help build driven by new districts being transformed into retail/ office usage closer ties between China and the rest of the world. An important and land being used in other purposes before being converted component of China's attempts to reform and liberalise its financial into office/ retail use system; the co-ordination centre for PRC enterprises trying to go The proportion of people living in Class C or above units does not overseas and overseas companies trying to go to China and Asia; increase that much, however, due to the special circumstances as well as a retail hub for consumers in China and Asia that have prevailed in Hong Kong since 4Q97 Another round of companies and retailers coming to Hong Kong, many of which are in the mid-tier segments -- larger in volume than the top-tier ones but with lower rent-paying capacity than the top-tier ones Can it gradually emerge as a world-class metropolitan city, 2020-2030? A notable expansion in the stock of office and retail properties, becoming an important offshore component in all aspects of China’s reaching a scale approaching about half or more of the level of financial architecture; playing an important role in serving PRC New York/ London today enterprises going overseas and overseas corporations coming to Number of people who can live in Class C or above units China and Asia, as well as a trend-setting city and retail hub for depends critically on developments in the land market in the consumers in Asia and China? coming years, especially the pace of development of new towns and farmland conversion Source: Daiwa Can the forces of “creative destruction” be unleashed again? For decades, the Hong Kong sampan has been sailing in turbulent waters.
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