China / Hong Kong Industry Focus Hong Kong Property Sector DBS Group Research . Equity 16 Jan 2020 Decentralised offices defensive, Refer to important disclosures at the end of this report suburban malls steady HSI: 28,638 • Divergent office submarket performance with Island East to outperform Central • Suburban and community malls stay resilient ANALYST Jeff YAU CFA, +852 36684180 [email protected] despite the challenging retail scene Ian CHUI CFA, +852 36684174 [email protected] • Prefer Hang Lung Properties & Link REIT Jason LAM +852 36684179 [email protected] Divergent office submarket performance. Office sector has been peaking out amid softened leasing demand led by global Recommendation & valuation market uncertainty. Growing vacancy continues to weigh on office rents in Central. On the other hand, Island East sees Company T ick er Mk t Cap Price 12-m T P Recom continued steady leasing demand from multinational firms with HK$bn HK$ HK$ high occupancy. Overall, we project office rents to be 5-10% Property Investors lower in 2020 with Island East to outperform Central. Hang Lung Prop 101 HK 84 18.58 21.66 BUY Investment sales market has turned very quiet after the political HK Land @ HKL SP 13 5.64 6.64 BUY protests escalated. In late 2019, SHKP clinched the sizeable Hysan Dev 14 HK 31 29.85 32.35 HOLD commercial lot atop the West Kowloon High-speed Rail Swire Properties 1972 HK 151 25.75 29.25 BUY Wharf REIC 1997 HK 141 46.35 44.10 HOLD Terminus. To diversify the investment risks, SHKP disposed of 25% stake in office portion which, we estimate, would offer Commercial REITs initial rental yield of >4% upon completion. Champion REIT 2778 HK 29 5.01 5.47 HOLD Fortune REIT 778 HK 18 9.20 10.90 BUY Challenging retail scene. The fallout of the protests brought Link REIT 823 HK 171 81.70 96.60 BUY the retail market into severe downturn. Retail turnover rents Prosperity REIT 808 HK 5 3.05 3.53 BUY evaporated as a result of diving tenants’ sales, particularly at Sunlight REIT 435 HK 8 5.07 5.87 BUY shopping landmarks. This, coupled with rental relief offered to @US$ denominated affected tenants, should dampen the rental performance of retail landlords. Lease renewal negotiations between landlords *Closing prices at Jan 10, 2020 and tenants are on hold as more time is needed to assess the Source: Thomson Reuters, DBS Bank (Hong Kong) Limited (“DBS HK”), outlook of retail market. Lease restructuring is used to address Bloomberg Finance L.P. the prevailing challenges facing retail tenants. With challenging retail scene to continue in the near term, we forecast retail rents to fall 5-15% in 2020. Rents for street-front shops should see more downward pressure while community and suburban malls should fare better. Stock recommendation. Property investors are trading at 49% discount to our current NAV estimates on a weighted average basis, against the long-term average of 33%. Within the sector, we prefer Hang Lung Properties due to its improving retail mall performance in China. Swire Properties should be well placed to tap the steady office demand in Island East. Five commercial REITs we cover offer FY20 distribution yield of 4.1% on a weighted average basis. Link REIT and Fortune REIT are safe bets in the current volatile market given their earnings resilience. Ongoing unit repurchase lends support to Link REIT’s valuation. ed- JS/ sa-CS / AH Industry Focus Hong Kong Property Sector Office Office rental index - Central The office market reversed its uptrend in 2H19 due to the lingering US-China trade dispute and ongoing social unrest in Hong Kong. After rising marginally by 1.4% in 1H19, overall (index pt) office rents fell 4.8% in 2H19 led by Central, according to 300 Jones Lang LaSalle. Central 250 Leasing demand for office space in Central among Chinese 200 firms continued to be sluggish. Office landlords failed to fill 150 returning space from tenants relocating to other submarkets. 1Q19: 1.6% QoQ This resulted in continued net withdrawal of office space in 100 2Q19: -0.1% QoQ 3Q19: -3.8% QoQ Central since Oct-18. Office vacancy in Central climbed to 50 4Q19: -3.1% QoQ 3.5% in Nov-19, the highest in more than four years, from Jun-19’s 2.3% and Dec-18’s 1.8%. Moreover, vacancy has 0 been gathering momentum in 4Q19 with diminishing new Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 letting. With growing pressure from rising vacancies, Central Jan-20 landlords are adopting a flexible leasing strategy. Hence, office Central Rental Index leasing activities were dominated by renewals. According to Jones Lang Lasalle, Central office rents dropped 6.8% in 2H19 Source: Jones Lang Lasalle following 1.5% increase in 1H19. Office vacancy - Central With net take-up of office space plunging 62% to <1.1msf in 2019, the overall office vacancy rate rose to 5.9% in Nov-19, up from Jun-19’s 5.4% and Dec-18’s 4.2%. Leasing demand % was concentrated in decentralised areas as tenants continued 6.0 Nov-19: 3.5% to seek cost effective office accommodation. 5.0 Office vacancy - overall 4.0 3.0 % 2.0 9.0 1.0 8.0 Nov-19: 5.9% 7.0 0.0 6.0 5.0 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 4.0 Source: Jones Lang Lasalle 3.0 2.0 1.0 0.0 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Source: Jones Lang Lasalle Page 2 Industry Focus Hong Kong Property Sector Office vacancy – all submarkets Office vacancy – Kowloon East % % 30.0 14.0 Oct-19 Nov-19 12.912.8 13.0 12.0 Nov-19: 12.8% 11.0 25.0 10.0 9.0 8.0 7.0 5.8 5.9 20.0 6.0 4.2 5.0 3.3 3.5 4.0 3.5 3.9 4.0 3.0 2.8 15.0 3.0 2.0 1.0 10.0 0.0 5.0 Overall Central HK East HK 0.0 Tsimshatsui Bay Kowloon East Kowloon Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Wanchai/ Causeway Wanchai/ Source: Jones Lang Lasalle Source: Jones Lang Lasalle Among key submarkets, Island East posted modest growth of Office vacancy rose to 4.2% in Nov-19 from Jun-19’s 3.2% in 3.5% in 2019, with relatively low vacancy of 2.8% in Nov-19, Wan Chai/Causeway where office rents fell 3.6% in 2019, according to Jones Lang LaSalle. according to Jones Lang LaSalle. Kowloon East saw its office vacancy stable at 12.8% in Nov-19, with rents dropped Office rental change – all submarkets marginally in 2019. Office vacancy – Wan Chai/Causeway Bay % 4.0 3.0 % 2.0 6.0 1.0 5.0 0.0 Nov-19: 4.2% -1.0 4.0 -2.0 Overall Central -3.0 East HK Tsimshatsui 3.0 -4.0 Wanchai/ Kowloon East Kowloon -5.0 Bay Causeway 2.0 -6.0 1.0 0.0 Source: Jones Lang Lasalle Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Source: Jones Lang Lasalle Page 3 Industry Focus Hong Kong Property Sector As a result of subdued leasing demand, there was little taken up. We forecast that the office portion of Harbour East, improvement in commitment rates of newly built office if fully let, should generate annual rental income of c.HK$75m properties over the past six months. Occupancy at K11 Atelier p.a. King’s Road in Quarry Bay, and office space converted from Hampton Court at Harbour City stayed largely unchanged at Overall, we forecast that office rents to fall 5-10% in 2020. 50-60% while Quayside in Kwun Tong remains c.70% Island East where the leasing demand remains steady should committed. outperform. Vacancy in Central is expected to rise further amid . subdued leasing demand given uncertain market outlook. This K11 Atelier King’s Road should continue to overshadow the Central office market which should lag behind the other submarkets Harbour East Source: DBS HK Co-working space operators used to be a key source of office Source: DBS HK leasing demand. WeWork was a case in point. It continued to expand its business operations in Hong Kong and grabbed After Gaw Capital purchased 625 King’s Road in North Point more office space in areas close to CBD in 1H19.