Hong Kong’s office property market has seen a sharp recent slowdown and is unlikely to recover for many months thanks to the combination of political unrest, Covid-19 and well-capitalised building owners being reluctant to sell at a loss, argue real estate investors.

Flows into the city’s office market in the first quarter of 2020 totalled $93 million, just 7% of the $1.3 billion inflows in the same period last year, according to data provider Real Capital Analytics. Total inflows last year were $7.5 billion, half the $14.8 billion in 2018.

“It will be the new normal to see these low transaction volumes,” said Allan Lee, managing director of Hong Kong-based real estate investment firm Pamfleet.

Allan Lee, Pamfleet

With no pressure to sell, owners are able to ride out price falls. “Nobody is making a loss, there is no distress: leverage is low and interest rates are low,” he said. His firm has not done a transaction in Hong Kong since it sold a centrally located office building in 2018.  

Lee said that low levels of borrowing by owners of Hong Kong offices meant that despite falling rents they had large cushion to absorb losses before they were forced to sell. “Valuations are falling at a very slow pace,” he added.

Capital values for grade A offices have fallen between 15% and 20% since their peak in spring 2019, thanks to a fall in rents, which are down roughly 15% over the period, said Marcos Chan, Hong Kong head of research at property broker CBRE. He expected capital values and rents to hit troughs at the end of the year and remain stable in 2021. Government data showed Hong Kong home prices fell 5.3% between their peak in May 2019 and April 2020.

“The price falls reflect the rental change, and there are not many distressed assets for sale,” added Chan. “Decision-making has been slow. There are expectation gaps between vendors and potential buyers.”

Pamfleet’s Lee said the pain was being felt across most sectors. “We find hard to pinpoint a sector where yields look attractive. The big problem is demand: office, retail, hospitality, industrial – all have been affected by the [US-China] trade war, the protests, Covid-19, the new security law and additional US-China tension,” he said.

In May the Chinese government unveiled plans for the new national security law to be imposed on Hong Kong that is widely expected to curtail the city’s freedoms. It was introduced officially on Wednesday (July 1).

FAMILY BOLT HOLES 

The fact that Hong Kong's office sector has a high proportion of local owners – especially high-net-worth individuals – has further reduced the flow of prospective deals, said Louise Kavanagh, head of Nuveen Real Estate’s Asia Pacific Cities Strategy in Hong Kong.

“We haven’t seen any wholesale selling of those prime assets because those [Hong Kong] families still want to keep their bolt holes in the market,” she added. “It is very hard to buy a controlling interest in key office buildings in [the centre].

“Investors looking for meaningful discounts may be hampered by limited stock availability. Hong Kong owners and developers have low levels of leverage and access to low margin debt.”

Christina Gaw, Gaw Capital

The behaviour of local investors would continue to hold the key to the Hong Kong market meaning little chance of future discounts, Kavanagh said. “I think domestic capital will continue to dominate the landscape. Mainland Chinese capital remains restricted by capital controls and overseas investors having travel restrictions to contend with, in addition to geopolitical considerations.”
Others agree that assets are unlikely to become available at decent prices.

“There is not much distress in the market right now as QE [quantitative easing] is occurring globally. Owners are not in panic mode, while buyers are looking for bargains in the current uncertain environment,” said Christina Gaw, head of capital markets at Gaw Capital, a Hong Kong-based real estate private equity firm.

She flagged the challenges for global investors to conduct proper due diligence on assets as a result of travel restrictions – that too has contributed to lower transaction volume. 

So which assets are worth considering?

Lee said Pamfleet was focusing on small-scale residential opportunities, notably buying and developing small parcels of land – typically between 3,000 and 5,000 square feet – over two to three years before selling them. This is purely a capital play rather than a yield investment, although he declined to say what such a plot might cost. Owners in this section of the market are more likely to be under stress, lacking income or the means to raise capital to develop the land, Lee added.

Despite the current headwinds, the long-term prospects of Hong Kong real estate remain strong given its historical resilience, accommodative monetary policy imported from the US (given Hong Kong’s US dollar peg) and emerging rebound in the Chinese economy, said Stuart Mercier, head of China at Brookfield Asset Management.

“There will be near-term challenges faced by sectors reliant on tourism, particularly retail and hospitality," he said. "However this, too, should ease with time”.