Is retail ownership too big-developer heavy? Should land sales encourage strata disposal? 20230808

When dining out, will you head for Ladies’ Market/Temple Street or Langham Place/MOKO? What about choosing between Tang Lung Street/Yiu Wah Street or Hysan Place/Time Square? The answers to these questions hint at the preferences in the shopping for the highly fragmented but competitive market on the one hand, and a curated but selective offering on the other. This phenomenon in Hong Kong’s retail landscape is the result of how the government approaches land sales in recent years: the creation of ever larger shopping complexes while premise choices for end users (i.e. retail operators) diminish.

This hypothesis appears to be corroborated when plotting the stock of retail Gross Floor Area (GFA) in the past 20 years and what market share is made up by the portfolios of the seven major developers (referred to later as the “major players”, including Sun Hung Kai, Henderson, Cheung Kong, Sino, New World, Hang Lung, and Swire): as shown in Chart 1, the major players’ weighting has been steadily rising year after year, except for 2006, when there was a large completion in the overall stock which lowered the ratio, and 2011, when Swire sold Cityplaza leading to a drop in the ratio:

Chart 1: Major players’ share of retail space has been steadily rising

The seven major players have seen their share of Hong Kong retail GFA from 23.8% in 2001 to 25.8% in 2022, and this rise has been accompanied by a meaningful increase in overall retail inventory (which grew by 26.5 million sq ft, or 27%, to 125.9 million sq ft).

Bigger land sites benefit large developers in land sales

Why can the major players acquire increasing shares of retail lands? Is it because there are fewer and fewer small property developers? Or is it because the rising complexity of retail property development is becoming so intimidating that even new large developers from the Mainland – who have been making waves in HK recently – opted to stay on the sidelines?

A look at the long-term trend of the size of land lots sold provides a possible explanation: from 1990 to 2022, the average floor area of pure commercial sites sold by the government has been progressively rising, doubling from 300,000 sq ft levels in 1991 to 600,000 sq ft in 2022 (see blue line and blue dotted line in Chart 2). On top of that, the highest average floor area of commercial sites sold was also reached in 2019, at 1.6 million square feet:

Chart 2: The expanding size of commercial land sold, coupled with rising property prices raises entry barrier to prohibitive levels

Meanwhile, as retail property prices climb, the capital investment required from developers escalates even faster (see red and red-dotted trend lines in the chart above), making it difficult for small developers to compete, thus allowing the major players to build their retail empires.

Moreover, even if we adjusted the red line by the Hang Seng Properties Index (HSNP) to factor in funding capabilities of listed developers, the same conclusion can be reached: the ever growing size of land parcels sold increasingly disqualifies even small listed companies, as the market cap adjusted development capital soars at a exponential rate (green line/green dotted line).

Well-known and old brands more likely own their premises

This trend of retail space increasingly concentrated in the hands of major players seem to be the result of years of government land sale practice. Even if this outcome is not official policy, the objective result is that small shops are excluded from owning their own premises. 

Imagine that land sale conditions stipulate that certain portions of retail sites must be sold as strata title, would that help create a community alive with innovative brands or specialty shops which do not have the pressure to maximise revenue in order just to pay their monthly rent? Assuming such shops need 1,000 sq ft of floor space each, and given that a 560,000 sq ft of floor space has been sold annually by the government (blue line in Chart 2) over the past 30 years, could we have helped at least 170,000 entrepreneurs realise their creative ambitions, and generate long-term wealth through the development of unique products and brands? Figure 1 and 2 are good examples of how rich and diverse (though not necessarily super profitable) brand fabric in Hong Kong’s commercial past may have indeed grown from the soils of pressure free premise ownership:

Figure 1: Century-old stores mostly own their premises outright

Figure 2: Other historic stores also rarely seen in major shopping malls

Source：https://www.hongkongd.com/hk-shops/

Mega mall proliferation breeds endless chain brands

The result of the increasing prevalence of large shopping malls alongside retail property ownership concentration not only makes it hard for small specialty stores to compete, but creates a retail scene dominated by well-known chain stores and an almost universally homogenous shopping experience. Let us quantify this issue with some charts:

Observation 1: The larger the average size of shops, the higher the degree of brand duplication in the shopping malls. Chart 3 correlates the distribution of brand overlap between seven pairs of shopping malls (all are leading Hong Kong malls in various categories: e.g. New Town Plaza in Shatin as a community mall, or Langham Place the destination malls group) and the average shop size; remarkably, the bigger the average shop floor area, the higher the overlap tenants between the pair of malls:

Chart 3: Brand duplications is closely correlated with the average floor area of shops within each mall pair

From another perspective, the highest duplication rates were found:

In the community malls group (44% for YOHO malls and Shatin New Town Plaza, Chart 4), probably due to these malls serving sizeable local populations with more homogeneous consumption patterns, they attract largely similar brands as tenants.

In the luxury shopping malls group (43% for International Finance Centre at Hong Kong Station and The Elements at Kowloon Station), again, serving high-end luxury clientele who buy largely similar brands such as Louis Vuitton and Gucci, limiting the variety of tenants these malls can choose from!

At the other extreme sits the group of highly strata titled malls (at a shocking 1% brand overlap, this group is paired between Sceneway Plaza in Lam Tin with a highly fragmented ownership profile and New Town Plaza, a single ownership mega mall); the former has had very dispersed ownership for a long time, and the stores inside have further been subdivided to tiny sizes (at average size of about 800 sq ft, it is 80% less than those of New Town Plaza coming in at 4,770 sq ft), no wonder Sceneway Plaza has very high footfalls, and has a very thriving vibe one finds in open bazaars:

Chart 4: Strata titled malls have more shops and more variety, leading to less repetitive shopping experience

In conclusion, whether we desire dispersed wealth among the populace (as small shop property owners) or strong autonomy of the retail outlets, or increasing choice and affordability for the shopping public, perhaps the government should give consideration to the economic and social benefits of strata title retail ownership after land sales, instead of just planning convenience and procedural expediency from a bureaucratic angle? 

Aside from these micro benefits, having greater economic resilience and diversity, as well as enlarging the middle class are potential further benefits of the government cutting up land sale lots and adding a mix of strata title into its sale mandates. The final added reputation bonus would be less perception that there is some sort of ‘land collusion’ game going on in the HK property market.

The author would like to thank Tang Chin Chung from The University of Hong Kong majoring in Surveying for assisting in data collection, analysis, and drafting of this article.

Is it time to buy HK retail property yet? 20210921

 

Stand news 20210917

In the past two years, the retail market has been decimated by first the domestic protests and then by the global lockdowns.

One of the prime victims of this combination of circumstances has been retail properties of Hong Kong, where rents have fallen some 14% from the 2019 peak, and is still down 8.9% even now (blue line in Chart 1). The drop in retail property prices were even more pronounced, down 17% peak to trough and now standing at 13% off the 2019 highs (red line in Chart 1).

Anecdotal reports of drops of 70-80% in prime street shop rents have also been common, indicating that formerly tourist hotspots have been far worse hit than the overall indices suggest.

Chart 1: Retail rents up 4x vs price surging 29x since 1984

Looking further back in time, however, both rents and prices have risen by multiples over recent decades, so the question remains – are these mere single-digit drops, which take us back to levels 7-8 years ago, enough of a correction for the current downturn?

 

Consumption drives rents, but interest rates hold sway of prices

To explain the rise in retail property prices, we plotted on the same chart the various components that contribute to prices: a) retail sales (very dark area, Chart 2); b) domestic consumption beyond pure retail (dark area); c) change in property yields (light area); and finally d) financing costs as represented by mortgage rates (very light area):

Chart 2: bulk of price increase driven by yield compression   Chart 3: PRC shoppers drove 03-12 run up in retail, which reversed big time after 2019

It is clear from Chart 2 that the bulk of the contribution to retail price increases were yield compression, 4.2x the magnitude contributed by domestic consumption, but yields did not follow mortgage rate’s falls which would otherwise have doubled again the net impact on retail property prices. To view the various value drivers in a logarithmic view (all exponentially rising value series are best viewed this way ), the yield compression component remains highly significant (see Chart 3).

What Chart 3 also makes clear is how retail sales as a top line driver was boosted by opening of the PRC independent travel market in 2003, which propelled retail sales to almost equal total domestic consumption by 2012. However, this factor fell away rapidly after the 2019 protests and then the lockdowns in 2020. The changed retail habits in the lockdown era also decimated retail and pushed a lot of shopping activity online, which explains the widening gap between consumption and retail in the chart.

Rental underperformance compensated by drastic yield compression

In Chart 2 above, the difference between price (red line) and the yield compression implied price (top of light area) must be explained by rental not keeping up with increases in top line consumption takes. This kind of makes sense, as not all domestic consumption activities take place in retail premises – eg services, as well as online sales, take place in office or industrial space, or increasingly nowadays, in data centres, which are calculated under office/industrial rents but not retail rents.

Another way to illustrate this divergence is shown below:

Chart 4: retail rent tracks retail sales, but not consumption

Here the rent index (purple line) tracks retail sales (blue line) very closely, proving that retail rent does indeed shadow retail specific activities and very little else – the fact they almost entirely overlap for almost all of the past three decades is impressive, and echoes our analysis above that rent has underperformed consumption (here represented by orange line) at large.

 

Retail property price – bit more rebound, then another leg down?

In our assessment, the current favourable tailwind of low interest rates and rental rebound from deep lockdown lows may peter out by late Q4 21 or early Q1 22, resulting in a topping out of retail property price growth by then:

Chart 5: Retail price likely to grow into end-21 before declining again as interest rates are likely to spike into 2023

Retail a safer bet than HK resi?

Despite possible bearish outcomes, retail property prices may still be in safer territory than HK residential for these reasons:

a) the lifting of lockdowns brings back PRC visitors, which will benefit foot traffic and retail rents more than residential rents;

b) the ability by PRC buyers to purchase HK flats has not evaporated as severely as retail spending in the past two years, thus will see less rebound post reopening;

c) HK’s high finance sector salaries that has sustained high residential rents may not see as much upside going forward (eg when interest rates rise and negatively impacting finance related incomes); and

d) residential yields are at historic lows and could expand even more than retail yields (blue area in Chart 6). These factors combine to provide more safety margin for retail property prices than residential prices, ie retail prices will likely outperform in the next year or two (red arrow in Chart 6):

Chart 6: Investing in retail properties seem to be a better decision than residential properties.

The ultra low yields in HK will be a big headwind to strong price appreciations ahead, especially in view of the lowest interest rates in all human history, coupled with a worldwide inflationary wave. Even so, retail property does not seem the worse amongst the various subsectors in HK property, given its recent corrections.

 

 

 

The author would like to thank Samson Leung of Hong Kong Baptist University and Jacky Chau of The Chinese University of Hong Kong for assisting in data collection, analysis, and drafting this article.