In Hong Kong’s commercial property market, ‘everyone has their fair share of pain’

In the second of a two-part series, Jiaxing Li, Aileen Chuang and Salina Li explore the effects of high interest rates and other factors on the city’s commercial real estate market.

In the heart of Causeway Bay, a bustling shopping district in Hong Kong that was once a more expensive retail destination than Fifth Avenue in Midtown Manhattan, a commercial building with shaky financing recently hit the market.

Cubus, a mixed-use building that houses tenants including sushi restaurants and hair salons, went up for sale last month. The owners of the 25-story building, including local real estate fund Phoenix Property Investors and an entity linked to Sa Sa retail chain chairman Simon Kwok, secured a loan from lenders led by Bank Sinopac but faced debt repayments on the decrease in rental income.

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As the due date approaches, the owners feel pressure to sell the building in order to repay the money. The public bidding process for the tower, which currently has more than a third of its floors vacant, began last month with an opening price of HK$1.4 billion (US$180 million) – up nearly 30% lower than its peak value of HK$2. billion.

Cubus is just one building in the city’s vast commercial real estate (CRE) market, which is currently in turmoil. A key pillar of the local economy that has propelled tycoons such as Li Ka-shing and Lee Shau-kee into the pantheon of the world’s uber-rich, the market has buckled under the crushing weight of China’s economic malaise, a shift in the consumption habits of Hong Kongers, an exodus of global firms fleeing geopolitical tensions and draconian Covid-19 controls, a supply glut and high interest rates that have just begun to fall.

The outpouring has spread far and wide, burning everyone from real estate moguls to savvy local investors as banks are shouted down over lending and left with a bag of bad debts – which are growing.

“It’s really a bearish market,” said Benjamin Chow, head of Asia real assets research at MSCI. “Everyone has their fair share of pain.”

Despite the U.S. Federal Reserve’s interest rate cut this month, experts say the market may not turn the corner immediately because underlying economic fundamentals remain too weak to lure large, quality tenants back. In addition, investor confidence remains uncertain.

The story continues

Cubus, a mixed-use building in Causeway Bay. Photo: Sun Yeung alt=Cubus, a mixed-use building in Causeway Bay. Photo: Sun Yeung>

Overall, Grade A office rents are down about 38% from their pre-Covid peak and are expected to fall 7 to 9% this year, according to Cushman and Wakefield. Property valuations have been dragged down – for office buildings they are 25% lower, according to MSCI – due to high vacancy rates and low rental income.

Pedestrians walk down Russell Street in Causeway Bay. Photo: Sun Yeung alt=Pedestrians walk down Russell Street in Causeway Bay. Photo: Sun Yeung>

The retail sector is in even worse shape, with valuations down about 40 percent from recent highs, according to MSCI. Mainland visitors – who once flocked and spent heavily in the city’s luxury retailers – have dwindled since China in 2017 cut an import tax that eliminated Hong Kong’s price advantage for luxury items, while the continent’s economic malaise has forced more shoppers to cut back. . And Hong Kongers have also become more discerning, looking for cheaper alternatives outside the city.

As rental income falls and valuations shrink, more landlords struggle to meet their debt obligations amid high rates, leading to an increase in distressed assets on the market. About three out of four property transactions this year were distressed sales, according to CBRE.

“It’s hard to use a number to quantify the (valuation) decline because the market is so big,” said Reeves Yan, head of capital markets at CBRE Hong Kong. “But if I have to say, it won’t be in terms of billions, it will be trillions.”

The difficulties in the commercial property market are now spilling over into the city’s financial system, which in June had HK$570 billion in sector debt, according to data from the Hong Kong Monetary Authority. Banks, long the willing financiers of the overleveraged real estate industry, have found themselves in a tough spot with more of their clients teetering on the edge of default.

“No one ever saw this coming,” said Foreky Wong, founding partner of Fortune Ark Restructuring. “The market was booming back then and these loans were very easy for the banks, but now practically nobody wants to provide financing for CRE.”

Some big players in the market have already seen their credit books deteriorate. HSBC, Hong Kong’s biggest lender, reported a total of US$3.2 billion in defaults on commercial real estate loans in the city in the first half of the year, a six-fold jump from the end of 2023 , according to him. interim report.

In addition, Hang Seng Bank said cash flow pressures for some commercial real estate borrowers have increased as interest rates have risen. This almost doubled the non-performing loan (NPL) ratio to 5.32% from six months ago and is the highest point in 30 years.

Banks are now in a precarious position because if they resort to loans, their customers will likely default, which could spread and metastasize into more serious problems. Instead, they prefer to work with borrowers to mitigate problems in the hope they don’t get worse, according to Sam Wong, an analyst at Jefferies. But that strategy leaves banks with limited room to operate if Hong Kong’s macroeconomic picture deteriorates further, he said.

“Commercial real estate risk will be difficult for banks to digest,” he said. “NPLs haven’t peaked for sure.”

When negotiations with troubled borrowers reach an impasse, banks find they need to be more aggressive in their enforcement actions against distressed properties. This has sparked a record wave of receivership sales in the city, according to Deloitte China’s national restructuring, turnaround and cost transformation leader Glen Ho.

“We’re getting more inquiries from clients with more expensive properties coming on the market,” said Ho, whose team now oversees about $10 billion worth of properties in receivership. “It’s a very troubled situation.”

But these types of divestitures can prove difficult, as lenders are reluctant to engage in fire sales, which represent a further drain on liquidity. The Cheung Kei Centre, a Grade A office building that was owned by Chinese tycoon Chen Hongtian, was forced into receivership by Hang Seng Bank early last year. It is still without a buyer.

Transaction volume for commercial property – including offices, retail space, industrial properties and hotels – amounted to approximately $20.5 billion in the first half of 2024. This was down 87% from the peak of the market in 2018, while which number of transactions is close to retreated to a level not seen since 2008, MSCI data showed.

“Nobody wants to buy down,” MSCI’s Chow said. “So as long as values ​​continue to fall, a lot of uncertainty is created and investors would probably be more likely to take a wait-and-see approach.”

Despite all the woes, Hong Kong’s commercial real estate market is unlikely to trigger a systemic crisis similar to what is plaguing China today. It is a much smaller and more mature market, and local developers are more conservative than their mainland counterparts – with less leverage and more liquidity.

“Yes, there are challenges, but we don’t expect to see a scale of defaults like on the mainland,” Ho said. Local companies that were tested by the Asian financial crisis of the late 1990s and the global turmoil of 2007 and 2008 are better prepared for market fluctuations and have relatively strong balance sheets, he added.

Despite the Fed’s half-point cut, rates are still high because commercial banks have moved only halfway to pass on cheaper funding costs to borrowers. But going forward, a lower interest rate environment will certainly ease the debt burden on highly leveraged firms and provide some funding relief.

“If the easing trend is sustained, it could reduce overall financing costs and make a significant difference in investment feasibility for commercial buildings,” Fortune Ark’s Wong said.

Plaza 2000 on Russell Street in Causeway Bay. Photo: Sun Yeung alt=Plaza 2000 on Russell Street in Causeway Bay. Photo: Sun Yeung>

But this limited relief does nothing to address the fundamental — and immediate — problems plaguing the market. Issues of tepid demand, oversupply and shaky confidence remain unresolved, jeopardizing the outlook for the sector. On Thursday, a record loss at one of the city’s biggest real estate conglomerates forced its CEO to step down so the company could undertake a series of asset sales to shore up its balance sheet.

“While a long-awaited rate cut cycle may provide some funding relief, we believe only stronger developers could benefit from improved market access,” said Tyran Kam, senior director of corporate ratings in Asia- Pacific at Fitch Ratings. He added that smaller firms have less access to finance, especially if property values ​​and rents are under significant pressure.

Some companies are taking advantage of the crisis. Luxury watchmaker Omega is expanding its footprint on Russell Street, paying $400,000 a month for new space, a discount of more than 70% from a peak in 2018.

Ultimately, Hong Kong’s commercial property market needs a stronger mainland economic recovery and increased business confidence to stabilize – and these scenarios have yet to emerge. Chow said.

“It’s a little early to call a bottom,” he said. “We’ll probably have to wait until sometime in 2025, but that’s still up in the air.”

“The current handover will be longer, deeper and more complicated than any cycle Hong Kong has ever gone through,” Deloitte’s Ho said. “Everybody is deleveraging to reduce the debt burden, and I don’t see any catalyst right now to reverse that trend.”

A Phoenix spokesman said the Cubus building was operating as usual, while a Kwok spokesman said it was a minority action and was following decisions made by the majority.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP Facebook and Twitter pages. Copyright © 2024 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2024. South China Morning Post Publishers Ltd. All rights reserved.