The Future of Hong Kong’s Investment Climate (Magazine)
China has come under fire from countries, including the UK, US and Japan, over its controversial national security laws for Hong Kong. Concerns are rife that the laws could jeopardise the city’s special autonomy and freedoms. The new law has contributed to worsening US-China tensions with President Trump threatening sanctions against Chinese financial institutions as well as officials who contributed to undermining Hong Kong. China has also said it plans to restrict visas for Americans whom it deemed might have gone too far on matters related to the territory.
REIT AsiaPac talks to Dr. Daniel Feldmann, Director and Assistant Portfolio Manager, Global Listed Real Estate at Timbercreek Investment Management, which manages US$10 billion in assets, to get a grip on what is the current investment climate in Hong Kong amid these tensions and uncertainties.
Q: How are Hong Kong-based investors, in particular, American and Chinese institutions, reacting to the uncertainty surrounding these political tensions?
A: This is a rather difficult question to answer from a buy-side investment point of view. In terms of money flow, it can be assumed that overseas investors are underwriting a higher risk premium to Hong Kong, which results in higher required market returns and cash outflows. The South China Morning Post reported that Chinese investors had shown the strongest buying support through the Stock Connect program, acquiring US$35.7 billion of Hong Kong shares this year, the most since 2016. There are speculations that this strong southbound inflow is made to defend Hong Kong’s position as a financial centre.
Q: What is the effect on Hong Kong’s economy and invest-ability should the US decide to end Hong Kong’s special trade status, or should China rein in further on Hong Kong’s autonomy?
A: I would answer this question with a focus on the potential outcome for the investable universe in Hong Kong. I do believe that as a consequence of the tension between the US and China, Chinese controlled companies listed on US stock exchanges will potentially be looking into alternative listing opportunities. This potential shift should be beneficial for the Hong Kong banking sector and its domestic investment community.
Q: What is your view of the security law? Hypothetically, what could be an end-game scenario?
A: The Hong Kong economy is in an urgent need of an appropriate stimulus to revive its GDP and decrease the unemployment rate. Consequently, a stable business environment is inevitable. So far, the security law seems to have an effect on pressing the recommencement of further social unrest, while the political views of the public will most likely remain divided. It will be interesting to observe the outcome of the Hong Kong legislative election in early September 2020 in terms of the public’s view on the new legal framework. From an expat’s point of view, it would be disappointing if access to global media and social networks will be censored as a result of it.
Q: As a foreign company with business interests in Hong Kong, what are your plans?
A: I am a Swiss citizen working for a Canadian real estate asset manager. We will continue to have our local presence established in Hong Kong to cover South East Asia, Japan and Pacific without any plans for relocation for the time being.
Q: What is your near-term and long-term outlook for Hong Kong’s real estate market?
A: Hong Kong is experiencing one of its most severe financial crisis for a decade after a double whammy caused by social unrest and Covid-19. Tourism has slowed significantly since the second half of 2019. Now, strict travel restrictions because of Covid-19 have almost brought a complete stop to the domestic tourism sector.
Hotel operators and landlords are suffering from record-low RevPAR (revenue per room) with limited domestic demand. The retail sector is also facing pressure on higher vacancy rates. Meanwhile, landlords might be forced to offer reduced rent to incentivise retailers to retain their physical presence, particularly to keep footfall in shopping centres high. International retail brands will continuously re-assess their physical presence in Hong Kong, keeping in mind that there are more lucrative options in the mainland or other alternatives around the world with potentially better prospects.
Office tenants, impacted by the uncertain political environment, are currently in a wait-and-see situation before they commit to another lease period or decide to reduce space. Given the travel restrictions, demand from mainland China has cooled down significantly. Amid subdued demand, the office vacancy rate in Central has hit its six-year high. According to JLL, the overall office vacancy stood at 7.2% in April 2020, the highest since October 2009. The best fundamentals are currently seen in industrial, logistics and the data centre space. Most of the corporate real estate owners in Hong Kong are not in a forced seller-position, as leverage, in general, is low and pockets are deep. Although valuations for commercial real estate will consequently soften due to weaker fundamentals, bargain hunters who are hoping for a lucky asset deal will most likely be disappointed.
Global investors should, however, consider the large yield spread resulting from direct-to-indirect property investments. While cap rates of 3% are quoted for direct commercial property transactions, the listed real estate market offers discounts to NAV (net asset value) of up to 70% for developers. Hong Kong landlords currently trade at approximately 60% discount as sector average and discounts for Hong Kong REITs are from high teens to more than 70% with implied cap rates closer to 6%. This large yield gap should attract investors to switch into the listed real estate sector. Given highly attractive implied cap rates, the industry should see further privatisations of listed real estate corporations. Lastly, the most recent proposed amendment of the Hong Kong REIT code by SFC (Securities & Future Commission) should enable REIT managers to create further corporate value with enhanced flexibility.