In Q2/2011, Grade ‘A’ office rents continued to rise but move moderately by 4.4%, compared with 9.5% in the previous quarter. Leasing volume has shrunk quite significantly due to high rents, and global economic uncertainties, the stock market downturn and muted IPO responses have also slowed expansion and relocation plans of many multinationals.
Office Leasing
• In Q2/2011, Grade ‘A’ office rents continued to rise but move moderately by 4.4%, compared with 9.5% in the previous quarter. Leasing volume has shrunk quite significantly due to high rents, and global economic uncertainties, the stock market downturn and muted IPO responses have also slowed expansion and relocation plans of many multinationals.
• Grade ‘A’ office rents in Central reached an historical high with some notable deals transacted in prime buildings in Q2/2011. KKR, a private equity firm currently occupying a whole floor (13,000 sq ft) in AIA Central, pre-leased a whole floor (22,000 sq ft) in Cheung Kong Center for HK$149 per sq ft. Prime Grade AAA buildings approached the HK$200 per sq ft mark, while average rents in Central reached HK$122 per sq ft net effective, 7% higher than the previous peak. Extremely limited availability led landlords to pursue higher rents more aggressively and Grade ‘A’ office rents in Central increased by 5% in Q2/2011 as a result.
• Tenants from the insurance sector were again active in the Tsim Sha Tsui leasing market. Prudential expanded 63,000 sq ft in The Gateway portfolio in Tsim Sha Tsui, while a total of 72,000 sq ft in China Hong Kong City, Tower 3, was leased to AXA China Region Insurance. Availability in the area quickly diminished and vacancy rates in the area declined from 5.5% in March to 3.5% in May, with rents rising fastest, by 6.3%, in Q2.
• Well known retailers were also active in the leasing market reporting particularly strong retail sales in April and May and buoyant consumer confidence. Guess Asia committed to a whole floor in China Hong Kong City in Tsim Sha Tsui, while Hugo Boss HK Ltd renewed and expanded to 37,000 sq ft in Millennium City 6.
Office Sales
• Record prices continued to make headlines in the Central office sales market.
• Long-term investors were the main driver behind the latest price rally as they eyed rapid rental appreciation to compensate for sub-2% buy-in cap rates, and overall Grade ‘A’ office prices increased by 9% in Q2, compressing yields to 3.2%.
• As lump sum and average prices in core areas surged out of reach of the majority of investors, many have turned their attention to fringe areas such as Kowloon East and Wong Chuk Hang.
• Following their successful primary launches, both 133 Hoi Bun Road in Kowloon East and One Island South in Wong Chuk Hang attracted interest in the secondary market, with vendors selling at a 20–30% profit.
• Following in the footsteps of multinational companies, institutional funds also set their sights on decentralized offices with AEW purchasing 10 floors in Millennium City 3 (81,400 sq ft) for HK$510 million, riding on the maturing demand profile and higher rental affordability in the area.
Retail Sales and Leasing
• International retailers made the headlines with several famous fashion / leisure retailers, many of whom are new to Hong Kong, reported to have pre-leased prime spaces in street shops and shopping centre units in core retail areas.
• With retail sales of luxury items performing strongly (45% growth in the first four months of 2011, partially due to displacement effect of East Japan Earthquake in March) and Mainland tourists pouring in (20% growth from January to May, reaching 10.8 million arrivals) landlords of prime retail shops have increased asking rents to new highs, effectively squeezing out local retailers with lower rental affordability. Prime street shop rents rose by 8.3% in Q2.
• Landlords in core retail areas also held firm on rents given the strong leasing market and retail sales performance, and street shop prices rose by 11% in Q2 as a result. The current price levels have become increasingly unaffordable to many and only a handful of cash-rich and experienced investors are still active in the market.
• With limited availability in prime shops in core retail areas, investors turned their attention to fringe streets in core areas. As interest in these areas has increased, so too have prices. A street shop at 15 Canal Road West sold for HK$230 million at a mere 2.1% yield, while another shop at 1-5 Foo Ming Street sold for HK$97 million at 1.6% yield; both shops are on secondary streets in Causeway Bay.
Residential Sales and Leasing
• The latest round of government measures tightening mortgage ratios and further increasing land supply had more impact on the mass-to-medium sector than the luxury market, as Mainlanders and cash-rich buyers, the major demand groups in the luxury sector, are not reliant on mortgages.
• Sentiment was nevertheless affected with the luxury transaction volume in Q2 declining by 28% quarter on quarter to 243 (although still 22% higher year on year).
More headline deals were made in the townhouse segment – 3 Deepwater Bay Road sold for HK$888.8 million or an AV of HK$101,810 per sq ft, a record high for a townhouse in Hong Kong, surpassing the previous record of HK$96,362 per sq ft for House 10 at 10–18 Pollock’s Path (lump sum HK$800 million), and townhouse prices increased by 3% in Q2 as a result.
• Backed by a strong leasing market performance, which saw rents surging by 6.4% in Q2, luxury apartment prices increased by 7.8% over the same period, further compressing yields to 2.8%.
• Though leasing demand remained strong and the latest Hudson Report indicated 69% of companies intended to increase headcounts in Q3, some investment banks shed staff. Over-expansion in 2010 in anticipation of more IPO and asset management business in 2011 followed by an unexpectedly muted IPO market may have spurred these cost cutting measures.
Outlook
• While the office leasing market is slowing due to lack of large floorplate requirements, amount of backfill space in core Central as well as rental affordability issues, the fundamental supply / demand imbalance is unlikely to change in the near term, and we expect rents to continue to grow in H2/2011, albeit possibly at a slower pace.
• The office sales market is likely to continue to rise with more record prices achieved in Central, and offices in decentralized areas such as Kowloon East, Western Corridor and Island South attracting a more diverse base of clients due to their attractive pricing and future infrastructure developments.
• We may see more ‘displacement’ of local retailers by international retailers in both prime street shops and core shopping centres with their unrivalled rental affordability. In the sales market, difficulties in identifying stock in prime streets may lead to yield compression in secondary streets in core areas or even fringe areas such as Sheung Wan, Jordan and Kowloon City.
• While leasing demand remains strong and Hong Kong luxury home owners have a low debt burden and there is little speculative activity in the luxury sector, any external shocks such as cooling measures in China or a European sovereign debt crisis would cause us to downgrade our cautiously optimistic view of the luxury sector in the second half of the year.