Coronavirus takes a heavy toll on the world’s most expensive office market – Hong Kong’s Central district

In global real estate markets, the retail and hospitality sectors are the biggest casualties of the unprecedented turmoil caused by Covid-19. An internal survey of real estate adviser Savills’ research heads in 24 countries, conducted at the end of last month, found that the sharpest falls in investment activity this year have been in the hotel and retail sectors.

The two sectors are also bearing the brunt of the virus-induced damage in occupier markets. A sharp fall in demand in the hotel sector was reported by 95 per cent of countries surveyed, compared with nearly 74 per cent reporting a steep drop in demand for retail space.

Nowhere are the problems of the retail and hospitality industries more acute than in Hong Kong, which fell into recession in the third quarter of last year for the first time in a decade.

Long before the epidemic took hold, the two sectors were reeling from the devastation wrought by last year’s mass anti-government protests, which scared off tourists (particularly mainland visitors which make up 80 per cent of annual arrivals and are traditionally the biggest spenders) and caused hotel occupancy rates to plummet. Hong Kong retail sales have been contracting at a double-digit pace since last July, data from Bloomberg show.

Yet, the succession of shocks suffered by the territory – China’s sharp slowdown, the trade war, the political crisis and now the fallout from Covid-19 – have also exacted a heavy toll on the office market.

In the fourth quarter of last year, leasing activity had already fallen 67 per cent quarter on quarter, resulting in the lowest quarterly volume since the second quarter of 2014, CBRE noted in a report published in January. Demand from mainland companies and co-working operators was “practically non-existent”.

Can Hong Kong’s free-falling real estate market avoid the cliff?

Since then, the fundamentals of Hong Kong’s office market have deteriorated more sharply. In February, rents in the Central district – which dropped by more than 6 per cent in the second half of last year, mainly because of the collapse in demand from mainland occupiers – fell 3.2 per cent month on month, the steepest monthly decline since the 2008 financial crisis, data from JLL shows.

Indeed, not only is the disruption caused by Covid-19 exacerbating the vulnerabilities of Hong Kong’s office market, earlier sources of resilience are being compromised. While some of the long-term drivers of the market – the most important one being mature decentralised office districts whose rents offer the steepest discounts to core districts among the world’s major office markets – remain intact, the outlook for the occupier and investment markets has never been more uncertain.

Three key assumptions about Hong Kong’s office market, contained in research reports by the big agents published as recently as January, look a lot less convincing today.

The worst peacetime recession since the Great Depression will severely crimp demand for office space the world over. The prospects for a pickup in leasing activity in Hong Kong in the second half of this year, forecast by CBRE in January, are even bleaker than they were at the start of 2020.

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Core submarkets, in particular Central, the world’s most expensive office district, are more vulnerable given their significantly higher occupancy costs and the persistent lack of demand from mainland companies.

As reported by the Post last week, Central’s reliance on demand from mainland occupiers puts it at a disadvantage relative to Singapore’s office market, which is less dependent on take-up by Chinese firms. JLL’s earlier prediction of a 15-20 per cent decline in rents in Central this year now looks somewhat optimistic.

While the decentralisation trend was expected to become more pronounced as Hong Kong’s economy contracted, the severe fallout from the spread of Covid-19 has made tenants more cautious about making decisions regarding their real estate requirements. Tellingly, Hong Kong East, the main beneficiary of demand from occupiers in core districts relocating to cheaper submarkets, suffered a decline in rents last quarter.

In a report published earlier this month, Savills noted that “the capital expenditure incurred in a move can be substantial (HK$600 to HK$1,000 per sq ft net), and has become an overriding concern in the current uncertain economic environment”.

Investment funds eye fire sales as Hong Kong real estate distress mounts

While the relative resilience of the office sector makes it the preferred asset class for property investors, extremely loose financial conditions globally – now even more accommodative due to the unprecedented liquidity support by the big central banks – are helping underpin capital values, making the sector less appealing to bargain hunters.

This is particularly evident in Hong Kong, where office landlords, most of whom are in a strong position financially, have been more willing to cut rents to maintain occupancy levels than sell assets at steep discounts. In a report published earlier this month, Colliers noted that there is a gap between bid and ask prices of 20-25 per cent for some office assets, stymieing transaction activity and preventing the city’s office market from repricing properly.

The retail and hotel sectors may have been hit the hardest by the succession of shocks over the past two years, but Hong Kong’s office market is facing its own crisis.

Nicholas Spiro is a partner at Lauressa Advisory