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Hong Kong property market sentiment remained cautious

Hong Kong's GDP registered a drop of 2.5% year-on-year in 4Q 2008, which was the first negative growth since 2Q 2003 when Hong Kong was in the midst of the threat posed by the SARS epidemic.  Meanwhile, the economic slowdown was also reflected in the negative growth of other indicators including exports and private consumption expenditure. 

In general, the overall investment sentiment in the marketplace remained cautious.  The yield spread between real estate investment yields and banks' lending rates continued to expand in 1Q 2009, reflecting that investors had factored in a thicker risk premium in their bids.  Despite the fact that the 3-month Hong Kong Interbank Offered Rates (HIBOR), which is commonly used as a benchmark for borrowing rates, fell by over 100 bps in 1Q 2009, real estate investment yields in the office and industrial property market in fact edged up more than 50 bps during the period.

Grade A Office
In 1Q 2009, most occupiers continued to put their expansion plans on hold, while the majority of existing tenants remained cost-conscious.  In addition to negotiations for lower rental rates, office decentralisation, consolidation of floor area requirements, downgrading to second-tier developments and a combination of the above were some of the most popular real estate options elected by tenants.  Meanwhile, more vendors with exposure to the key business districts on Hong Kong Island changed their leasing strategy to achieve a better occupancy rate at the expense of lower effective rentals.  As of February 2009, the average effective Grade A office rental slipped further by 15.7% quarter-on-quarter (QoQ) to HK$47.56 per sq ft per month.

Amid the overall contraction in leasing demand, the average vacancy rate in the market as a whole rose further from 7.1% in November 2008 to 7.4% in February 2009.  Individual sub-markets recorded rising vacancy rates, except Kowloon East, with its vacancy rate easing from 25.1% to 21.2% over the three months ended in February 2009.  Since the current rental difference between Kowloon East and the traditional business locations on Hong Kong Island in 1Q 2009 remained sufficiently wide to justify the case of relocation in financial terms, the district was favoured by a number of companies when they consider office decentralisation.

If the current trend attributing to lease restructures is to be maintained, the market will see further downward pressure.  Overall, the rental is expected to fall 25% over the next 12 months.  Individual sub-markets with higher vacancy levels are anticipated to see steeper rates of decline over the period.

Luxury Residential
Without genuine support from the occupational demand, the residential sales market remained uninspiring.  Property prices edged further down in 1Q 2009 as individual vendors were willing to offer deep cuts to their asking prices in order to entice prospective purchasers.  In general, the average transacted luxury residential price dropped 7.4% QoQ to HK$10,630 per sq ft in February 2009.  The benchmark transaction in the luxury market in 1Q 2009 was the sale of 27 apartments in Belgravia in South Side for a total consolidation of HK$982 million. 

In 1Q 2009, many multinational companies, including some engaged in the banking and finance sector, continued to restructure their workforce.  With plentiful supply of leasing stock and weakening occupational demand, residential rentals fell by 8.5% QoQ to HK$36.18 per sq ft per month as of February 2009.  Similarly, the serviced apartment market was affected by the substantial reduction of expatriate arrivals in Hong Kong as companies across all business sectors tightened their budgets. The average rentals of serviced apartments fell 3.4% QoQ to HK$47.41 per sq ft per month in February 2009.

Over the next 12 months, luxury residential rentals and prices are predicted to fall by 12% and 15% respectively.

Hong Kong, being one of the key ports for Mainland China, continued to suffer from the deterioration of the overall re-export trade performance during1Q 2009 as the demand for imports by the world's major economies contracted further.  Meanwhile, new leasing demand for industrial premises was rare.  Existing tenants also remained sensitive about their recurrent expenses and outgoings, while individual tenants have determined to cut down the cost either by downsizing or relocating to other inexpensive property alternatives.  In view of the sustained weak demand, vendors became more proactive in lowering their asking rentals by 7% – 8% during the first two months of 2009. 

In the warehousing sector, a number of logistics operators returned a portion of their space to their vendors amid the current difficult market conditions.  In order to retain tenants, individual landlords proactively offered favourable leasing terms, such as long leases with terms of up to six years, together with a cap on rental growth upon lease renewal.

Looking forward, industrial property rentals are expected to fall 15%-25% over the next 12 months in anticipation of further economic consolidation.

In 1Q 2009, the local consumption sentiment was affected due to falling stock market prices and deteriorating job market conditions, which the unemployment rate edged up from 3.4% in September 2008 to 5.0% in February 2009. 

In the investment market, the sales activity picked up from the exceptionally low level in 4Q 2008.  The number of major sales transactions of over HK$10 million increased 42% QoQ in 1Q 2009.  However, prospective investors remained cautious in view of the deepening global financial crisis and growing uncertainties in the market.

In the traditional shopping districts, the pace of correction in street-level shops' rentals tapered off from -6.1% QoQ in 4Q 2008 to -3.1%QoQ in 1Q 2009, representing the most resilient property sector in the period.   In fact, a number of local and international retailers would like to make use of the current market downturn as an opportunity to expand their outlets and increase their market share, with streets adjacent to first-tier streets in core shopping areas seeing strong demand.

Looking forward, visitors form Mainland China will remain one of the most important pillars supporting the Hong Kong retail market.  With the implementation of a new measure of Individual Visit Scheme, which is extended to cover about 2.2 million Shenzhen residents, starting from 1 April 2009, it will provide additional support to the local retail market and enable retail rentals to stage a soft landing over the medium term.  In general, retail rents in core shopping areas are expected to edge down by 7% over the next 12 months.