HK commercial rents keep rising even as residential market cools

January 11, 2019 17:24
Hong Kong’s property market has matured to the stage where different segments of real estate can perform differently based on demand levels of that specific sector, an expert says. Photo: Reuters

Since its peak in August, transaction price of residential units in Hong Kong has fallen 5-10 percent on average. The Centa-City Leading Index ended 2018 at 174.49, representing a 7.5 percent slide  from the August peak of 188.64. This is perhaps close to the market clearing level, as we learned from our conversations with market participants that transactions can clear when sellers offer a 10 to 15 percent discount over peak pricing.

While transaction volume appeared to slow in the last several months, 2018 as a whole was a more active period than 2016. According to government data, there were 54,701 transactions in 2016, while the first 11 months of 2018 saw 55,187 transactions. Both 2016 and 2018 were weaker than 2017, which saw a record 61,591 deals. Given that transactions take months to complete, the effects of the recent sentiment may take a quarter or so to appear in the data. Thus, we probably will see some weaker transaction volume in early 2019. The volume performance after that will depend on whether sentiment picks up in the next several months.

Commercial rents, however, were still going up throughout the year. Using government’s rental index, office rentals in Central, North Point/Quarry Bay, Tsim Sha Tsui, and Kowloon Bay/Kwun Tong have all registered historically high rents in November 2018. On a year-over-year basis, Central rent has increased by 16.5 percent, North Point/Quarry Bay by 25 percent, Tsim Sha Tsui by 9.6 percent, and Kowloon Bay/Kwun Tong by 5.5 percent.

This highlights the fact that Hong Kong’s property market has matured to the stage where different segments of real estate can perform differently based on demand levels of that specific sector. Demand for office space, for example, depends on the continued expansion of economic activities. This is one reason why office performance held up while residential prices are seeing a pullback.

As Hong Kong's economy continued to grow, multinational companies and professional firms have found new spaces outside of the traditional central business district. In the last two years, for example, multiple banks and major law firms have moved to Island East (or roughly North Point/Quarry Bay in the government classification). This sustained the off-Central rental growth, a trend that we expect to continue in the foreseeable future.

One reason to consider a REIT portfolio as part of an investor’s long-term income portfolio is because of the diversification benefits it offers. This is especially true for investors who already own a residential unit (for self-use). All REITs in Hong Kong are primarily exposed to various commercial sectors, which can perform differently from residential units in the city. By allocating into a REIT portfolio, investors can potentially diversify their real estate exposure to beyond just residential without needing to manage the commercial assets on a day-to-day basis.

As relatively transparent vehicles backed by real estate assets, REITs also diversify away from pure equity. For example, in 2018 the Hang Seng REIT Index fell only by 2.9 percent, outperforming the main Hang Seng Index’s 13.6 percent fall. Since the Hang Seng family of indices are price indices, the outperformance of REITs on a total return basis will be another 100-200 basis points higher because of dividends.

The divergence of performance between REITs and equity is precisely due to the diversification benefits of REITs discussed in long-term studies, including that produced by my firm. We also note that a REIT portfolio diversified geographically, such as the Australia, Japan, Singapore and Hong Kong portfolio of a typical Asia Pacific REIT program, can create additional long-term performance. As geopolitical news flow, including the trade disputes between the US and China and the Brexit arrangement in the UK, continues to be volatile, a well-diversified portfolio will help investors even more today.

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Chief Investment Officer, Admiral Investment Ltd.