Concrete Analysis

Global economic uncertainty strengthens outlook for Hong Kong’s office market

While the Hong Kong stock market is highly geared to the slowdown in mainland China, the commercial property market in particular is less exposed

PUBLISHED : Tuesday, 15 March, 2016, 8:00pm
UPDATED : Tuesday, 15 March, 2016, 8:00pm

The outlook for continued US economic strength is less certain than in 2015. Doubts about the sustainability of US recovery increased late last year and were reflected in the decline in the US government 10-year Treasury bond yield from December’s average of 2.24 per cent to a low of 1.66 per cent on February 11, a move that would traditionally be interpreted as an indicator of increased recession risk.

Concerns that the economy was weakening again were partially dispelled in late February with the release of some robust data. These included a 1.7 per cent year-on-year increase in US inflation for January, the strongest growth rate since December 2012 and an upward revision in gross domestic product growth for the fourth quarter of 2015 from 0.7 per cent to 1 per cent.

These figures supported share indices and boosted the 10-year Treasury yield, which now stands at 1.88 per cent. However, the US economy still faces substantial challenges. These include the long slump in energy prices and the adverse impact on growth and corporate margins of weakening overseas demand and US dollar strength.

With positive and negative factors fairly balanced, the consensus opinion among economists now appears to be that there is an even chance that the Federal Reserve will raise interest rates in 2016, in line with its original projections, or that it will fail to do so.

Hong Kong office prices should remain high because too much capital is chasing too little stock

Outside the US, global economic prospects have clearly weakened so far in 2016. European central banks have been pushing interest rates into negative territory for some time in an effort to boost growth, while the Bank of Japan followed suit in late January.

However, deterioration in the global economic picture has been most evident in emerging markets. Chinese GDP growth fell to a 25-year low of 6.9 per cent in 2015 and is almost certain to be weaker this year. While growth in China remains solid, among other key emerging markets, South Africa is teetering on the brink of negative growth, and Russia and Brazil are in outright recession. Among the so-called BRICS countries, only India is performing well.

In short, interest rates in the US may not rise as far or as fast in 2016 as seemed probable a few months ago, while even if the US economy accelerates, many other countries will be heading in the opposite direction.

What does this imply for Hong Kong? Within Asia, a key difference between Hong Kong and most other markets is lower currency risk, thanks to the dollar peg system. For this reason, the city’s capital markets in general represent a relatively safe harbour for long-term investment. While the Hong Kong stock market is highly geared to the slowdown in mainland China, we believe the commercial property market in particular is less exposed.

Within commercial property, the office segment looks like the safest. We expect prices for en-bloc purchases to hold up well in 2016, supported by continued strong demand from large mainland companies for Hong Kong office buildings.

Financial firm China Everbright completed the most recent major deal by acquiring Dah Sing Financial Centre for HK$10 billion on February 25. This deal followed two large transactions in November 2015, in which Evergrande Real Estate paid HK$12.5 billion for Mass Mutual Tower in Wan Chai and China Life Insurance bought the One Harbour Gate West office tower and retail premises in Hung Hom for HK$5.85 billion.

Put simply, Hong Kong office prices should remain high because too much capital is chasing too little stock. Considering the alternative options such as bonds with low yields, minimal returns on cash or shares in companies with high mainland exposure, as an asset class Hong Kong office property looks attractive with rents likely to rise steadily looking forward.

Multinational companies and Chinese corporates are widely assessing the feasibility of purchasing for owner-occupation as a long-term strategic move that reduces risk and increases annual operating cash flows by removing the question of rental affordability.

From the perspective of mainland financial firms, one of the attractions of acquiring office blocks in Hong Kong is that it represents a simple form of offshore investment, which helps them diversify risk. In addition, mainland insurers have benefited from new regulations allowing them to invest in a broader range of assets, including foreign property.

En-bloc offices in Hong Kong available for sale are limited and offer good cash income streams that have been stable or, indeed, rising steadily. Colliers Research expects cap rates to stay roughly where they are, probably for most of this year, and only to start expanding if and when the US starts increasing rates sharply. With a limited supply of prime offices on Hong Kong Island in particular, Kowloon East should continue to evolve into an attractive and feasible location for office expansion needs and thus represents an attractive and feasible opportunity for cash investment.

Joanne Lee is senior manager of research and advisory at Colliers International