Difficult times call for difficult measures. Even as retail sales are falling in Hong Kong, the city's major landlords will spend more to attract footfall. S&P Global Ratings thinks the investments will be manageable for rated landlords and should pay off.

Revamps are needed because the profile of shoppers is changing. Hong Kong is still not drawing the level of mainland Chinese visitors it did prior to the pandemic. Given the pie is not growing, major landlords need to attract footfall from rival shopping areas and online retail.

So far, this is working. The vacancy rates of for rated retail landlords are less than 5%. This compares with more than 20% for some of the traditional high street properties, including Granville Road in Tsim Sha Tsui, Kowloon or Jaffe Road on Hong Kong Island.

Tough Conditions For Hong Kong's Retail Sales

We anticipate that Hong Kong's retail sales will be under pressure this year, after declining 6% year-on-year for the first five months. The weakness will span both ordinary and luxury spending. Even supermarket sales are a bit cautious (see chart 1).

In our view, this malaise won't be lifted overnight.

Hong Kong residents are increasingly heading overseas.   Overseas travel has fully recovered after several years of severe restrictions on mobility. As of end-June 2024, outbound travel by Hong Kong residents exceeded 2018 levels on an annualized basis.

Tourist arrivals haven't recovered.  At the end of last year they were only 52% of 2018 levels. Moreover, the spending power of same-day tourists from mainland China has dropped sharply. On a per-capita basis, it's 40% lower than the 2018 level.

The ratio of Hong Kong resident outbound travel to visitors arrival to Hong Kong is currently 2.3x; this ratio was 1.4x in 2018 (see chart 2).

Chart 1

Chart 2

An unfavorable wealth effect.  A faltering property market--with prices down a quarter the since peak in 2021--hurts consumption. We expect Hong Kong's home prices to decline a further 5% to 10% in 2024.

More online shopping.   This retail trend has been steadily growing in recent years. Online sales represented 8.7% of the city's total retail sales in May 2024, exceeding the average of 8.1% during 2020-2022.

Chart 3

The Tourist-Zone High Streets Will Be Hit The Hardest

Weak patronage and spending is most apparent in the tourist-zones. We expect the shopping malls operated by rated property companies will continue to gain market share from high street and individual strata-title retail properties.

This is because high street and strata-title property lack the flexibility to attract foot traffic through operational improvements such as enhancing assets, reshuffling tenant mixes, and offering loyalty programs or free parking etc.

Malls that are solely owned by one operator have more control over the offerings, amenities and the capital to invest in refurbishments and renovations that meet changing shopping habits.

Sun Hung Kai Properties has shifted its tenant mix while maintaining occupancy at 95%.  It has accelerated marketing; for instance, with a campaign to introduce mainland Chinese brands to domestic shoppers and international brands for visitors from across the border. It introduced a pet friendly area in its YOHO Mall. New Town Plaza recently reconfigured the mall's rooftop as a dinosaur-themed outdoor playground. Since its opening in October 2023, this 35,000-square-foot park has boosted the mall's traffic and customer base, according to the company.

Link Real Estate Investment Trust, Hong Kong's largest mass-market retail landlord, will focus a touch more on food and beverage to improve performance.  Some 29% of tenants are in this segment, up from 27.6% a year ago. The trust has managed tenant sales growth of 0.4% in the fiscal year that ended in March, even as sales for supermarkets declined 5.1%. This is partly because food and beverage sales expanded 4.6% over the period.

Hongkong Land Holdings will upgrade its Landmark luxury retail malls in Central.  This will include widening floor areas for key tenants--all international fashion houses that collectively will invest US$600 million in the US$1 billion project. Hongkong Land will fund the remainder. We think such initiatives will continue to pay off. The vacancy rates of rated landlords have stayed below 5%. Whereas high street property in core areas reached vacancy rates of 12.8% in the first quarter of 2024 (see table 1).

Chart 4

Rated landlords' rental rates are also outperforming. Link REIT and Hongkong Land's average monthly rent per square feet declined by 5% and 13% respectively from their peak in 2018, whereas high street rents were 70% below 2018 level, according to real estate consultancy JLL.

Rated Landlords Can Absorb Our Base Case And Downside Scenario

We expect rental reversions for retail-space leases will range from flat to a 5% decline in 2024. This is manageable for the rated landlords. They can also manage a 10% negative rental reversion, based on stress tests we conducted.

Our assumptions in brief:

We forecast adjusted EBITDA will increase 1%-5% this year for rated landlords.  Drivers are company-specific but include new completion of investment properties, and recognition of development projects. A diversified property portfolio of rated landlords will support a stable financial profile. However, there are downside risks to performance across all property types. Our base case also includes a forecast of a 5% to 10% decline in home prices (see "Hong Kong's Easing Property Policy Isn't A Quick Fix For Developers," March 6, 2024) and 5% decline in grade-A office rents (see "Capping The Cap Rates: How Hong Kong Office Landlords Are Managing," Feb. 26, 2024) in 2024. Hong Kong retail rental typically accounts for 13%-55% of their total revenue (see table 2).

In a modest downside scenario, EBITDA could decline by 0.4 to 1.6 percentage points from our base case.  This assumes 10% negative rental reversions, or more than double our base-case range of flat to negative 5%, maintaining our base-case assumptions for home price and office rentals for Hong Kong.

Upgrades will remain a driver of capex.   As one example, we recently increased our capex estimates for Hongkong Land after the company announced a revamp of its luxury Landmark mall. The upgrade will cost the company US$400 million and also disrupt rental flows over the three-year life of the project. Link REIT plans to spend HK$640 million enhancing assets over the coming few years, after spending HK$230 million (about US$82 million) for such projects in 2023.

Even so, leverage for rated players will likely remain stable. These capital outlays will be spread out and account for 5%-10% of their annual rental income, based on our estimates.

Table 2

Can Landlords Afford The Capex In These Softer Times?

Yes, we think they can. In our view, it would be costlier, in the long run, if landlords did not adjust to changing consumer spending habits and market trends. We think the recent and planned upgrades and retail marketing should help the major retail landlords generate stable rental income and hone their competitive positions. This will help them attract "flight to quality" tenants as well as a bigger share of local footfall.

Table 3

Writer: Cathy Holcombe

Digital design: Evy Cheung

Related Research

• Bulletin: Hongkong Land Can Afford Bill For Landmark Upgrade Project, June 28 2024
• Hong Kong Retail Property: Can The Resilience Last?, March 26 2024
• Hong Kong's Easing Property Policy Isn't A Quick Fix For DevelopersMarch 6, 2024
• Capping The Cap Rates: How Hong Kong Office Landlords Are Managing, Feb. 26, 2024