Hong Kong Property Sector
SECTOR REVIEW
From dusk to dawn
■ With the sharp rebound in stocks since December, we believe it is not
time to chase the entire sector now. There is still about 20% downside
for the property market in 1H09. Stock prices tend to lead the physical
market by about four months and we believe the best time to revisit the
whole sector will be toward the end of 1Q09. In the meantime, the
sector is likely to be range bound on news flow. The upcoming
launches of the Cullinan and Lake Silver by SHKP and Sino
Land/MTRC, respectively, are expected to be key sector catalysts.
■ By assessing a checklist of seven factors (loan-to-deposit ratio,
corporate gearing, mortgage rate, income growth, wealth impact,
housing supply and demographic changes), we conclude that the
property market is considerably stronger now than during the last down
cycle – as highlighted below, the lower the score of each factor, the
better. The key differentiating factors are the low level of leverage in the
system and limited supply for the next few years.
■ Office rents are staying firm for the time being, but we expect more
downside in 2009 when vacancy rates could start to climb. For retail
rents, we would not be surprised to see mass and prime shopping mall
rents fall by 20% and 15%, respectively, in 2009 as private
consumption shrinks.
■ We continue to stick with the sector leaders. Our top picks among the
developers are Cheung Kong and Sun Hung Kai Properties. Among the
landlords, Great Eagle has limited rental reversion pressure in 2009,
while Wharf and Swire also remain top picks because of their
decentralised office and prime shopping mall exposure.

From dusk to dawn
Cheap but not distressed anymore
From their recent trough discounts of 51% and 53% for the developers and investors,
respectively, property stocks have rebounded on average by about 34-41%. With the
sector currently trading at 32% and 39% discounts to NAV for the developers and
investors, respectively, valuations remain cheap but not distressed anymore. While we are
still expecting 20% further downside in the residential market, mostly concentrating in
1H09, and given the sector tends to lead the physical market by about four months, we
believe the best time to start considering bottom fishing is only at the end of 1Q09.
In the meantime, we would continue to stick with the sector leaders. Our top picks among
the developers are Cheung Kong and Sun Hung Kai Properties. Among the landlords, due
to the potential negative take-up in the market, we expect more downside for the office
market, especially in Central in 2009, despite rents remaining firm for the time being.
However, in terms of earnings volatility, the landlords should still be cushioned by the
rental reversion cycle. Great Eagle should have limited reversion pressure in 2009. Wharf
and Swire also remain top picks because of their decentralised office and prime shopping
mall exposure.
Dissimilarity to the last bust
We were expecting property prices to fall by 41% from the peak in 2008. Given that prices
have already fallen by 23%, we believe the remaining downside for the property market is
about 20%. We have gone through a checklist of seven key parameters – loan-to-deposit
ratio, corporate gearing, mortgage rate, income growth, wealth impact, housing supply and
demographic changes. We conclude that on a scale of 1 to 10 (from best to worst), in all
key aspects except for income growth, the Hong Kong current property market is much
more sound than during the last peak in 1997. The main attributing factors supporting the
property market are the lowered overall leverage of the economy, i.e., loan-to-deposit ratio
and corporate gearing, stronger income growth, higher wealth effect from the stock market
and much lower housing supply. While the higher wealth effect from the previous run in
the stock and property markets is dissipating, lower overall leverage and the limited supply
of housing over the next two to three years are not likely to change, thus, providing strong
support to the property market.
Office downside in 2009
Despite the resilience of Central office rents so far, we expect them to decline by about
35% in 2009. Based on the 3Q08 headline effective rent of HK$115/sq ft, as reported by
Jones Lang LaSalle, and assuming rents remained flat in 4Q08, we expect the level to
drop to about HK$75/sq ft. This assumes that the financial industry will continue to
contract in 2009. There is certainly upside risk to this. For example, if China’s economy
were to revive in 2H09 and the prospects for the equity market improve, a potential
increase in the IPO pipeline could rejuvenate demand for office space from the financial
services sector.
Retail rents under pressure
We would not be surprised to see retail rents at mass and prime shopping malls fall by
20% and 15%, respectively, in 2009. Our view of a slightly smaller fall in retail rent for the
prime shopping malls is based on: 1) increasing polarisation between prime and non-prime
shopping malls during a downturn and 2) support from mainland tourist spending in Hong
Kong on the potential opening up of more geographical coverage from the expansion of
China’s individual visitor scheme.