China / Hong Kong Industry Focus Hong Kong Property Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 10 Jul 2019 Seeking safe haven in uncertain times HSI: 28,543 • Steady office take-up in Island East while office demand continues to soften in Central ANALYST Jeff YAU CFA, +852 36684180 [email protected] • Challenging retail scene, resilient suburban malls Ian CHUI CFA, +852 36684174 [email protected] Jason LAM +852 36684179 [email protected] • We like office landlords more than retail counterparts and prefer Swire Properties (1972.HK). Fortune REIT (778.HK) and Sunlight REIT (435.HK) are our preferred REITs Recommendation & valuation Company T ick er Mk t Cap Price 12-m T P Recom From Central to Island East. The Central office market is HK$bn HK$ HK$ expected to peak out soon as demand especially from China- Property Investors based corporates continues to soften. With improved Hang Lung Prop 101 HK 84 18.58 20.35 BUY transportation links following the opening of Central-Wan Chai HK Land @ HKL SP 15 6.44 7.93 BUY Bypass, Island East continues to benefit from steady leasing Hysan Dev 14 HK 42 40.35 43.80 HOLD demand led by tenant decentralisation and should outperform Swire Properties 1972 HK 185 31.55 36.90 BUY the broader market which is projected to record flat rental Wharf REIC 1997 HK 167 55.05 54.45 HOLD REITs & Business Trust growth in 2019. Property funds and private equity dominate Champion REIT 2778 HK 38 6.51 6.99 BUY the investment sales market. The upcoming tender of the Fortune REIT 778 HK 21 10.74 11.80 BUY mega-sized West Kowloon Terminus commercial site will be in Link REIT 823 HK 203 96.00 96.80 HOLD the spotlight. Prosperity REIT 808 HK 5 3.41 3.86 BUY Sunlight REIT 435 HK 10 5.99 6.56 BUY Challenging retail scene, resilient suburban malls. Inbound Source: Bloomberg Finance L.P., DBS Bank (Hong Kong) Limited (“DBS HK”) tourism growth did not translate into increased tourist consumption. Local shoppers have become cautious on @US$ denominated spending given rising global economic uncertainties. The Based on 28 Jun 2019 closing political protests, if prolonged, could weigh on consumer spending especially luxury goods and big-ticket items. While retail reversionary growth remains marginally positive, turnover rents could potentially fall, and be a drag on retail rental income. Suburban malls are faring better as their tenants largely serve the daily needs of nearby residents and therefore their businesses are more stable. Stock recommendations. Property investors are trading at 42% discount to our current NAV estimates on a weighted average basis. Within the sector, we like office landlords more than retail counterparts. We continue to prefer Swire Properties which benefits from sustained demand from office decentralisation. Wharf REIC and Hysan Development are HOLDs given the challenging retail scene in the near term. The commercial REITs we cover are trading at prospective distribution yield of 3.6% on a weighted average basis. Benign interest rate environment should provide the runway for further unit price appreciation. We like Fortune REIT and Sunlight REIT for their steady growth with further rental upside from asset enhancement initiatives. ed-JS/ sa-CS / AH Industry Focus Hong Kong Property Sector Office In Central, demand for office space among China-based corporates has further softened from 2H18. According to Jones Fading office demand in core areas. According to Jones Lang Lang LaSalle, office vacancy in Central edged up to 2.3% in Lasalle, the overall market registered a net withdrawal of May-19 from Dec-18’s 1.8%. 217,500 square feet (sf) in 1Q19, the first since 2Q17. This was reflected as an increase in office vacancy as a result of fading Office vacancy - Central office demand in core areas. Coupled with the completion of One Hennessy in Wan Chai and NEO in Kwun Tong, the overall vacancy rate in Hong Kong continued to rise to 4.9% in May- % 19 from Dec-18’s 4.2%, according to Jones Lang LaSalle. The 6.0 leasing market in Hong Kong East held up better within all sub- May-19: 2.3% markets, largely led by the ongoing decentralisation trend. 5.0 Office vacancy - overall 4.0 3.0 % 2.0 9.0 8.0 May-19: 4.9% 1.0 7.0 0.0 6.0 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 5.0 Jul-18 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 3.0 Source: Jones Lang Lasalle 2.0 1.0 Office decentralisation is showing no signs of abating, and this 0.0 is supporting the leasing market. Given the substantial rental gap between CBD and decentralised areas, cost-conscious Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 multinational firms continue to relocate their business operations to decentralised locations. Significant rental savings Source: Jones Lang Lasalle can be realised from office relocation. Office vacancy – all submarkets Island East’s transport connectivity has greatly improved following the commissioning of Central-Wan Chai Bypass in 3Q18. The Bypass has shortened the travelling time between % Central and North Point to 5 minutes from 15-20 minutes. 13.0 Apr-19 May-19 12.112.2 With remarkable improvement in transportation accessibility, 12.0 11.0 Island East should become increasingly popular as an office 10.0 9.0 destination among cost conscious multinational corporates. 8.0 The Securities and Futures Commission (SFC) has confirmed to 7.0 6.0 4.8 4.9 relocate from Cheung Kong Center in Central to One Island 5.0 3.4 2.9 3.1 4.0 2.2 2.3 East in Quarry Bay where rents are c.60- 70% lower. The 3.0 1.8 1.5 1.9 2.0 regulatory authority will occupy 195,000sf of office space 1.0 0.0 vacated by JP Morgan, who is moving to the newly built The Quayside in Kwun Tong, a 60/40 joint venture between Link Overall REIT and Nan Fung Group. Overall, the vacancy at Island East Central HK East HK has further improved to 1.5% in May-19 from 1.7% in Dec-18. Tsimshatsui Bay Kowloon East Kowloon Wanchai/ Causeway Wanchai/ Source: Jones Lang Lasalle Page 2 Industry Focus Hong Kong Property Sector Office vacancy – Island East Henderson Land (12.HK) is offering 218 Electric Road in North Point for pre-leasing. Redeveloped from Newton Hong Kong, this office tower provides GFA of 144,000sf upon scheduled completion in 3Q19. It is in close proximity to AIA Tower and % 5.0 18 King Wah Road. Based on an average monthly rent of May-19: 1.5% 4.5 HK$50psf (on lettable area basis), we estimate that this office property, if fully let, would produce rental income of 4.0 c.HK$80m p.a. 3.5 3.0 218 Electric Road 2.5 2.0 1.5 1.0 0.5 0.0 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 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 New World Development (17.HK) is developing an office project in Quarry Bay known as K11 Atelier King’s Road. Internal fit out work is now being carried out. The company retains this property for long-term investment upon scheduled project completion in 2H19. Situated next to Quarry Bay MTR Station, this office development provides total GFA of 487,500sf. Coupled with highly improved transportation links from the Central-Wan Chai Bypass, this property should attract strong leasing demand. L’Occitane has leased 1.5 floors Source: DBS HK (25,500sf) at this office tower, relocating from Times Square in Causeway Bay. This makes this France-based personal care retail brand the first tenant at this office development. The WeWork is grabbing more office space. WeWork has further reported monthly rent is HK$50psf, c.30% lower than that for expanded its footprint in Hong Kong with a focus on areas Times Square. Overall, K11 Atelier King’s Road is c.40% pre- close to the CBD. It has leased office space of 80,000sf at committed. If fully let, this new office tower should generate Hysan Place and Lee Garden One, both held by Hysan rental income of >HK$250m p.a. Development (14.HK). It has also agreed to take up 150,000sf of office space at Gateway in Tsim Sha Tsui, which has been K11 Atelier King’s Road converted from Hampton Court. Reportedly, WeWork has inked an agreement with Swire Properties (1972.HK) to become the sole tenant of Generali Tower in Wan Chai (near Three Pacific Place) and will occupy 100,000 sf of office space at newly built H Code in Central. In Kwun Tong, WeWork committed two floors at The Quayside but scrapped the expansion plan at Two Harbour Square. Eaton Club (owned by Great Eagle) has taken up an additional floor at Three Garden Road for in-house expansion.