1) Time to reassess risk profile while the Federal Reserve begins unwinding stimulus
Almost a decade after the financial world plunged into its biggest crisis in generations, the US Federal Reserve has taken the landmark decision to start unwinding some of the stimulus it created to ward off a second Great Depression. The normalisation process would be gradual and predictable initially by just USD10 billion per month with a total balance sheet worth USD4.5 trillion. The US interest rates has left unchanged, at 1.25% to 1.5%. The Fed committee expects to raise borrowing costs one more time this year, followed by three increases in 2018. (Source: The Guardian, 20 September 2017)
The very loose monetary environment since the Global Financial Crisis (GFC) has contributed to the inflation of asset prices across the world. Hong Kong’s M2 supply has increased from HKD6.2 trillion (USD0.8 trillion) in 2008 to HKD13.5 trillion (USD1.7 trillion) in 2017. The very low interest rate has also supported a 330% increase in Hong Kong property prices since 2008. Now that the Fed has finally started the normalisation process and has indicated that interest rates will rise further, it is time to reassess the risk profile of real estate. However, the Fed’s balance sheet reduction process is likely to be very gradual in order to control any unexpected risks, and with inflationary pressures in the US very subdued, few observers expect interest rates to rise rapidly.
Hong Kong interest rates are effectively tied to US rates by the currency peg, and so will rise in tandem with US rates over the next few years. However, we maintain our view that Hong Kong will enjoy negative real interest rates until late 2018. This most obviously benefits residential properties. We expect that residential prices in Hong Kong will not see significant pressure until late 2018 or early 2019 when the monthly reduction by the Fed increases to perhaps USD50 billion per month and Hong Kong real interest rates turn convincingly positive again for the first time since the GFC.
We should add that the combination of persistent negative real interest rates and the recent strength of the Hong Kong stock market - up by about 50% from its low point last year - should support confidence among investment bank and asset manager occupiers in Central and Admiralty.
2) Top floor of The Center sold for a record price
Tai United Holdings Limited announced the disposal of the entire 79th floor of The Center, a Grade A office building in Central, for a total consideration of HKD738 million (USD94 million) to Profit Gate International Limited, which is suspected to be a subsidiary of a Chinese developer. Based on the gross floor area of 13,213 sq ft (1,228 sq m), the average price was about HKD55,854 (USD7,207) per sq ft. The unit rate of the transacted price was the record high for an office sale in Hong Kong. The building has only six transaction records over the past 16 years with Cheung Kong holding the majority of the ownership of the building. (Source: HKET and hkexnews, 22 September 2017)
The office prices in Central have been pushed up by the record sale of the Murray Road Carpark Site in Central which is designed for a premium grade office development. The growth has also been driven up by the strong investment sentiment in the market, with the total transaction volume and value for non-residential properties in the first eight months increasing 58% YOY and 66% YOY, respectively, and being the highest levels for the same period since 2014. Corporate investors have shown more interest in office properties despite very high prices, because the shortage of supply in the core areas helps ensure a positive capital value and rental outlook. We expect the office market to remain the core focus of investors in completed Hong Kong properties, although we also see opportunities in the retail sector, decentralised malls, old industrial buildings and hotels.
3) Stronger redevelopment potential maintains the popularity of industrial property investment
Konica Minolta Hong Kong has sold three properties for HKD388 million (USD50 million), including multiple floors in two industrial buildings, Eastern Centre in Quarry Bay and M.P. Industrial Centre in Chai Wan, which were sold for a total of HKD354 million (USD47 million) to a local company, Naval Empire Global Limited. Meanwhile, the company sold a residential unit in Beverly Hill to another local investor for HKD34 million (USD4.4 million). (Source: HKET, 25 September 2017)
Given that new commercial land is limited, developers have to seek industrial land for potential redevelopment. Looking forward to the fourth quarter, the government has already proposed revisiting the policy of revitalising industrial buildings. One idea is that the lower floors of old industrial buildings may be released for non-industrial use. This would be viewed favourably by the market, and so should boost prices of industrial properties.
According to the Rating and Valuation Department, the number of flatted factory transactions increased 124% YOY to 2,732 in the first seven months. Investment was also active in the en bloc industrial market, with the value of en bloc transactions totalling HKD7.1 billion (USD0.9 billion) in the first eight months, up 130% YOY. Despite the fact that the Planning Department estimated a 30 million sq ft (2.97 million sq m) deficit of industrial space by 2023, the government is considering setting a lower threshold for industrial property redevelopment and relaunching the revitalisation scheme for industrial buildings which will further reduce the total stock. The prices of industrial properties are set to rise thanks to the stronger redevelopment potential of industrial buildings. However, occupiers of industrial buildings will face stronger competition amid shrinking stock size and rising rents.