Date
23 August 2019
Office demand in Hong Kong is robust enough to not only absorb new supply but also bring in continued rental increases, says an industry watcher. Photo: Reuters
Office demand in Hong Kong is robust enough to not only absorb new supply but also bring in continued rental increases, says an industry watcher. Photo: Reuters

Rental trend remains supportive for Hong Kong REIT plays

Stock market sentiment picked up remarkably during the first quarter of 2019, with trading volumes in the equity, bond, and over-the-counter markets all recording heavy trading. According to our conversations with market participants, some institutional traders and private bankers have already reached their annual commission targets.

Given the strong sentiment, it is perhaps surprising that REITs and other defensive stocks have also done well. In Hong Kong, the Link REIT and Champion REIT have both recently reached historical high in terms of stock price, while other REITs such as Fortune and Hui Xian are also performing well. Outside of REITs, utility stocks have also done well.

We believe that there are both short and long-term reasons for the REIT performance. Over the short term, geopolitical risks continue to stay in investors’ mind. Even though China and the United States may be close to reaching an agreement over trade disputes, global trade has already been disrupted. Even in the best case scenario, it will take time for the trade networks and global supply chains to return to normal. This is best observed in the weakening Purchasing Managers’ Index around the region.

In addition, other geopolitical risks can still create uncertainty. For example, even though the United States and North Korea held a summit in Vietnam, the meeting between the two leaders did not produce an agreement. This is an example of a geopolitical event that can ripple through the market, and thus, investors are allocating at least some capital to more defensive sectors.

However, Hong Kong’s domestic economy is resilient in the face of the geopolitical winds. Tourist arrivals in January, for example, have increased 27.2 percent year over year, with tourists from Mainland China up 34.8 percent in number. This is a marked difference from the situation in 2015 and 2016, and this trend should continue to support the hotel and retail sectors. This is one reason behind the recent strong performance of retailer and retail landlord stocks.

Over the longer term, however, interest rate movements are perhaps the strongest trigger for the recent performance of REITs. After the Federal Reserve has taken a more dovish stance, the market has moderated its expectation for further rate increases. As of this writing, the market is only pricing in a 10 percent probability of rate increases before the end of the year. A halt in USD interest rate increase should mean a much slower interest rate increase in Hong Kong, and current cap rates should stay at around current levels, even though they seem low when compared to long term historical trends.

Rents, however, have maintained an upward trend. According to the latest numbers from Jones Lang Lasalle, Hong Kong Central office rents have edged up another 1 percent in the fourth quarter of 2018, bringing the full year increase to 8 percent. This is further evidence that office demand in Hong Kong is robust enough to not only absorb the new supply in other office nodes in the city such as Island East and Kowloon East, but also continue to bring rental increases in Central. A stable cap rate coupled with still-increasing rent should translate to further price increases for commercial properties in Hong Kong.

Overall, we believe that Hong Kong’s economy is showing more resilience than what many had feared amid the China-US trade dispute. Continued geopolitical news flow may send in periodic shocks. Nonetheless, the stock market has so far rallied behind the economic resilience, a trend that we expect to continue in the short term.

– Contact us at [email protected]

RC

Chief Investment Officer, Admiral Investment Ltd.

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