BMI View: Hong Kong, as a global financial hub and a gateway to mainland China, has one of the most dynamic commercial real estate markets in the world. Rental rates, particularly for retail, are among the highest in the world, and the market has traditionally been characterised by strong demand and, due to its small size, limited supply. With the market vulnerable to the impact of an economic slowdown in China, the medium-term outlook is one of stability in rental rates.
Hong Kong is a Special Administrative Region (SAR) of the People's Republic of China. It is governed under the principle of 'one country, two systems', which means that it retains many institutions, for example its common law legal system, that date back to its time as a British colony. All this gives a level of predictability to the business environment, although tensions with Beijing over the level of democracy allowed in Hong Kong do arise from time to time, as witnessed in the protests in the latter part of 2014.
Hong Kong's economy is closely linked to that of China, leaving the SAR particularly exposed to any potential slowdown in the mainland. The main risk to our outlook for the commercial real estate sector is thus a sharper-than-expected slowdown in China. However, other risks are the impact of rate rises in the US, any renewed crisis in the eurozone and, closer to home, any downturn in consumer confidence resulting from a fall in residential real estate prices.
The office market is currently characterised by moderate supply and demand. However, as a global financial hub, Hong Kong's office real estate market is highly developed, and we do expect demand to continue to meet the space available, with particular interest from international and mainland Chinese firms. Demand for premium space in the central business district will be the key driver of the office market, although we are also noting a trend of increasing development in more suburban areas.
Hong Kong's retail market is one of the most developed in the world, and rents are among the highest in the world. The retail market is supported by high consumer spending by Hong Kong residents, as well as the large number of tourists, and barriers to entry are low, leading to much international retailer activity in the market. We see key opportunities in shopping mall space, particularly at the luxury end of the market.
The industrial real estate market in Hong Kong is characterised by low supply and moderate demand. With only a limited pipeline of new developments, investor caution will be offset by supply issues over the medium term. In the longer term the government is seeking to improve the quality of Hong Kong's industrial real estate through renovation. Opportunities in industrial real estate are mainly in the areas of logistics and warehousing, supported by the strength of the territory's retail market, including online retail.
In our Commercial Real Estate Risk/Reward Index for Asia Pacific, we give Hong Kong a score of 66.7 out of 100. It is in fourth place in our table of 14, behind South Korea, China and Australia. Hong Kong's score is boosted by a high score of 91.7 out of 100 for country rewards, given its mature economy and status as a global financial hub. However, it is let down by a score of only 52.5 for industry rewards, as a result of the territory's small geographic size and developed nature, which limit opportunities for investment and new development.
Key BMI Forecasts
We see no change in office rental rates between 2014 and 2016. At the top end, rents will be some USD168 per square metre (sq m) per month, and USD38 at the bottom end.
Retail rental rates are exceptionally high, at some USD625 per sq m per month at the top, and USD88 at the bottom. We forecast no change in 2015 or 2016.
Likewise, we forecast no change in industrial rental rates. Although significantly lower than their retail and office counterparts, they are higher than most of the rest of Asia. Rents will remain at USD13-35%.
The recent pro-democracy protests in Hong Kong have caused jitters in the stock market. We continue to expect that the protests will be resolved peacefully, although there is certain unpredictability in the outcome and at the least, short-term investor confidence could be dented.
The pipeline of new supply is small, particularly in the industrial sub-sector. Transactional activity also remains very limited.
Hong Kong's Securities and Futures Commission is considering partially reversing an existing rule preventing REITs from engaging in property development and redevelopment. The changes are expected to allow REITs to invest up to 10% of their gross asset value in such activity, a move that is forecast to open up HKD34bn (USD4.4bn) for property development and rebuilding.