Hong Kong Property:Office landlords set to attract more attention

What’s new: We have assessed the outlook for property stocks in light of the Hong Kong Government’s measures announced on 4 November, Donald Trump’s victory in the US presidential election, and our discussions with Hong Kong property companies on the outlook for various property segments at the Daiwa Investment Conference in Hong Kong last week. In our view, office landlords are poised to catch up with the sector in terms of relative performance, reinforcing our belief that this segment could play a leading role in the second leg of the rally in Hong Kong property stocks.

    What’s the impact: Developer stocks likely to take a breather. While the absolute valuation of property developers is still far from expensive, we note that they were a leading segment in the first leg of the rally in Hong Kong property stocks from July to September 2016 (average gain of over 30% from the year’s low point). We believe the latest government measures will result in a quieter market over the next few months, and have provided a trigger for more significant share-price retrenchment in the near term. While we advise investors to accumulate developers on this pullback, we expect their share prices to be range-bound in the near term and do not expect to see any breakthroughs in the next few weeks.

    We see office landlords poised to catch up, on the removal of concerns that office rents are at a cyclical peak. We note that office landlords lagged behind in the first leg of the rally due to the prevailing market view that current office rents are being held up mainly by unsustainable demand from China firms, with a correction likely sooner or later, as we have seen in the retail and residential sectors. We disagree with this view, and our confidence in the outlook for the Hong Kong office sector was reinforced by our discussions with various property companies last week. In any case, we believe the office rental market is on track, with most of the upcoming supply having secured or being close to securing anchor tenants. We see many positives for the sector in 4Q16 and beyond (see p2).

    What we recommend: We reaffirm our Positive stance on the Hong Kong Property Sector with a preference for office landlords. Our top picks are Swire Properties (1972 HK, HKD21.75, Buy [1]), Hongkong Land (HKL SP, USD6.30, Buy [1]), both sector laggards (see p2), in addition to Hysan (14 HK, HKD33.90, Buy [1]).

    How we differ: Unlike the consensus, we believe the office sector is a leading segment in the current cycle, having undergone a correction during 2011-14, similar to what the residential and retail sectors have experienced in recent years (where Central rents have fallen by over 20% but rents in decentralised areas have been holding up).