1)  Hong Kong raises base rate by 25 basis points to 1 percent with further increases expected in 2017

The Hong Kong Monetary Authority, the city’s de facto central bank, raised the base rate by 25 basis points to 1 percent, following an overnight move of the same magnitude by the US Fed. Further interest rate increases by the Fed are expected in 2017, which will affect Hong Kong’s equity market and property developers, and is likely to bolster the local currency in relation to the yuan. Commercial banks in the city have the flexibility to choose if they want to immediately match the increase. (Source: SCMP, 15 December, 2016)

Valuation View
After Hong Kong Monetary Authority raised the base rate by 25 basis points to 1 percent, the real interest rate in Hong Kong stands at minus 1.5 percent given the underlying CPI inflation rate of 2.1 percent and the three-month Hong Kong Interbank Offered Rate (Hibor) of 0.6 percent.  It is believed that a 25 basis point increase in the base rate will only have a psychological impact on the real estate market.  Home owners are only required to pay an extra HKD124 per month for every HKD1 million mortgage loan at a 25-year term for every 25 basis point rise in interest rates.

Property buyers will continue to favour mortgage products with lock-in rates that lower the risk of further interest-rate increases. The current mild interest rate hike has been expected and is likely not to have a significant impact on the Hong Kong property market unless a considerable rise in the market interest rates is seen in the coming year.

Research View
The timing for Hong Kong to return to positive real interest rates will have important implications. The near-200 percent surge in Hong Kong residential prices between end-2008 and their peak in 2015 almost exactly coincides with the period over which Hong Kong has enjoyed negative real interest rates. We would argue that Hong Kong has benefited from the loosest monetary conditions in Asia for most of that time.

The chance of a substantial downward correction in Hong Kong’s residential property prices over the medium term remains significant. Apart from stretched affordability, the potential for interest rate increases following the lead of the US - most probably from December onwards - and an ample pipeline of new apartment supply represent important threats to the recovery in market sentiment that had become apparent before the changes in stamp duty.

We do not expect Hong Kong to return to positive real interest rates before early 2018, and more probably H2 2018. However, residential property prices should start to reflect this return six to nine months before it happens. The strength of the increase in prices driven by negative real interest rates suggests that there is ample scope for prices to fall as the process is reversed.

2)  Kai Tak site sets new record to support future property price

Chinese conglomerate HNA Holding Group has outbid 20 rivals to win its second residential site in Kai Tak for a record HKD13,600 per sq ft, with a bid of HKD5.41 billion, 24 percent to 38 percent higher than the market expectation of HKD2.98 billion to HKD4.38 billion (HKD7,500 to HKD11,000 per sq ft).  The industry expects HNA to offer the units built on the site for around HKD22,000 per sq ft in order to generate a reasonable profit. In September, apartments at the One Kai Tak development, built by China Overseas Land & Investment, were transacting for HKD18,500 to HKD20,000 per sq ft. (Source: SCMP, 20 December, 2016).

Agency View
While residential sales prices have continued to increase after the new stamp duty measures, the immediate impact has been the shrinking of transactions volume. However, we have seen increasing numbers of luxury transactions purchased by wealthy individuals who are classified as “first time buyer” and are exempt from the new stamp duty.

Research View
We re-affirm our view that the new stamp duty will have an immediate impact on shrinking transaction volume, but only a mild impact on dropping residential price. Given the latest interest hike and the expected new supply, private mass home prices will stay flat in the short term as the majority of owners are not desperate to sell, while developers will offer more incentives such as mortgage financing and discounts on stamp duty for primary home buyers. However, we believe that prices will decline gradually over the coming 12 months with the majority of investors staying away from the local property market. Based on previous rounds of stamp duty increases, we believe the mass market and luxury market prices will decrease by 5 percent and 8 percent for the next 12 months respectively.

3)  Luxury brands downsizing continues as Hong Kong’s retail slump bites

Prada, the Italian luxury fashion brand, follows Ralph Lauren and Burberry in scaling back as the flow of free-spending mainland visitors decreases. Prada will close its boutique at the Peninsula hotel shopping centre on 31 December in the latest sign that the retail slump is hurting high-end brands. With fewer wealthy mainland Chinese shoppers visiting the city, analysts warn more luxury stores could fold after expanding too rapidly in the past decade.  Premium lifestyle brand Ralph Lauren quietly closed its 20,000 sq ft store in the Causeway Bay shopping hub overnight earlier this month, and British fashion house Burberry is to cut the size of its biggest Hong Kong flagship store in Pacific Place by 50 percent within the next financial year. Retail sales of luxury items in the city such as jewellery, watches and clocks, and valuable gifts slumped 19.7 percent in the first 10 months of the year. (Source: SCMP, 15 December, 2016)

Agency view  
While the retail market continues to be stagnant in Hong Kong due to a drop of tourist’s arrivals (thereby weakening purchase volumes and sales values) we are excited to see the potential sales performance in the coming Christmas and New Year peak season.  The relatively small decline in total sales value in October YOY, allow us to be more confident that the retail performance in November and December may also be similar and hold through to the beginning 2017.     

We see the growing demand and popularity of trendy luxury than traditional luxury. International luxury brands that are new to the market or existing luxury brands that do not have multiple flagship stores in HK are able to sustain in the current market condition with a healthy P&L.  We may see further closure of traditional luxury brands on first tier high streets in 2017.  Usually these brands have aggressively opened too many flagships with high lump sum rental value in the past.  On the other hand, luxury brands would not prefer to leave their key performance shops / grade A mall locations as they don’t want to run the risk of not being able to get back in when the retail market picks up.

Research view  
Hong Kong's total retail sales have been suffering since mainland tourist arrivals in Hong Kong started weakening in 2014. Consequently, the retail landscape has shifted from expenditure by tourists to expenditure by local residents. The share of local consumption in total retail sales has increased from 58 percent in 2014 to 67 percent in H1 2016; this is the same proportion as in 2012.  We expect that prime street rents will continue to slide by single digits through 2017 as luxury brands are replaced by new shopping and F&B concepts catering for local consumers.