Landlords must offer class in today's market
Poor conditions are set to continue to prevail in Hong Kong's already depressed office market, says Asia Equity.
The brokerage has come out with a doom and gloom report on the sector just as the real estate players have been predicting a bottoming out of the sector and a possible rebound. For the investor, working out which stocks in the sector are going to get hit hardest in the coming round of capital value declines is important.
The correlation between the share performance of investment property companies and capital values, according to Asia Equity, in the past is 0.91, where 1 is perfect correlation. The correlation with rentals is 0.8.
Asia Equity reports office rentals are down 35 per cent over 18 months and capital values are down by a similar amount, according to data from the brokerage and Jones Lang Wootton.
Record new supply and new strata title supply are the key fundamental agents acting on the sector.
Demand is expected to remain lacklustre as the domestic economy wallows.
Demand from across the board has yet to show any signs of turning into the tidal wave that is needed to fill all the empty space coming on to the market between now and the year 2000.
The brokerage is not predicting a mega-crash and conditions are not going to get so bad people in the sector are going to go bust.
What the tougher conditions ahead do mean is there is going to be a growing diversity in the relative performance of players in the sector and their buildings.
More important than ever will be the three L's and Q.
What will count more than ever in the next two to three years in governing the capital value and rental performance of a building will be location, location, location and quality.
Vanilla office space in the next few years is going to get hammered by market forces. Office space in good to prime locations, with good facilities and good management, will be more resilient to the continued downward pressure on capital values and rentals ahead. Even location might not save a building from serious capital value erosion and rental decline.
Management with a reputation for maintaining their buildings in good nick will do better than groups with a mediocre legacy in this respect.
For instance, the Lippo Centre in Admiralty might not do so well as Pacific Place Towers I and II in terms of capital value and rentals in the next four years.
The investment property portfolio at Wharf might be better located than that of Amoy Properties, for instance. Given the importance of the new transport hubs in Kowloon, the group's office complex at Gateway I and II is well placed to benefit from customer demand in this area.
What Asia Equity appears to be saying is the rules of the game are not changed. The days in the past, especially from 1991 to 1993, when it appeared anything coming to market would float, are gone. Market conditions are set to become more competitive. Only those firms with the right geographic disposition of office property holdings and with good quality management stand any chance of coming through with mild bruising.
According to Asia Equity, market conditions are going to go back in time. They will more closely correlate what was happening in the office property market after 1984, when there was a property and banking collapse in Hong Kong, than in the asset inflation days leading up to the end of 1993.