From residential to commercial
The next leg up
We upgrade our NAV estimates for property companies by 13-49%. The upgrades are due
to: 1) raising our outlook for commercial properties (office and retail) in 2010;
2) compression in cap rates; 3) raising our 2009 property price assumption from -5% to
+21%; and 4) rolling over our NAV estimates from FY09 to FY10. While we believe the
upside for property stocks (due to further strengthening in residential) has probably been
discounted, the next driver for property stocks is likely to be commercial property,
especially the office sector, which is saw an improvement in take-up, with office rents
expected to start rising towards the end of the year. We upgrade Hysan, Hong Kong Land
and Swire Pacific to OUTPERFORM from Neutral. For developers, we upgrade SHKP and
Henderson to OUTPERFORM from Neutral. We downgrade MTRC to NEUTRAL from
Outperform due to its rich valuation.
Office demand turning around
We believe the significant financial market improvement in the past two quarters in Hong
Kong is leading to a rejuvenation in demand for office space in Central. Office rents in
Central fell by about 35% for the first two quarters in 2009, in line with our full-year
forecast of a 35% decline. However, we started to see sequential improvement in office
rents in 2Q, with the decline narrowing from 21% in 1Q09 to 14% in 2Q09. Also, we have
seen a sharp turnaround in negative take-up in 2Q09. We believe with demand starting to
expand again, we may see flattish rental performance for 2H09, while office rents are likely
to increase by 20% in 2010.
Retail rents lag HSI
Hong Kong retail sales were down a further 6% YoY in May 2009. We believe it will
recover to positive territory quickly, driven by the strong positive wealth effect from the
property and stock markets. Historically, Hong Kong retail sales value growth has lagged
the performance of the stock market by about two months with a 62% correlation. With the
Hong Kong stock market continuing to perform well, it will be a major positive driver for
local consumption. We are projecting retail rents to increase by 10% in 2010.
Cap rate compression
Central office yield has fallen sharply in 2Q09, while Hong Kong’s 1Q09 GDP growth was
-7.8%. Over the past 22 years, rental yields have ceased to fall only when the momentum
of the economic improvement has peaked. Currently, Hong Kong’s economy is at a trough
and we believe it is still further away from the peak in economic momentum. As we expect
the situation to continue improving, we believe rental yield will compress further from
current levels. We are revising down our cap rate assumptions for office and retail to 5.5%
and 5.0%, from 6.6% and 6.0%, respectively.
Residential – period of consolidation
We were previously expecting residential prices to fall 5% in 2009. However, we were
proved wrong since our last report, Spring is over, published on 15 May 2009. The chain
reaction from a sustainable increase in domestic liquidity for Hong Kong is that the local
employment picture also started to improve on the back of the positive wealth effect. Given
the strong liquidity in Hong Kong, we revise up our full-year property price forecast to
+21%, from -5%. We expect prices to stay flat from current levels.