As at the end of the first quarter of 2021, Hong Kong had witnessed four waves of COVID-19 outbreaks. The economy saw its worse performance on record. Although the residential market remained resilient, the commercial property market was hard hit. Compared with the office and retail markets, the industrial property market has been relatively stable. The COVID pandemic has changed market fundamentals. Instead of believing the market will return to the previous normal after COVID, we see six potential new normals in the Hong Kong commercial real estate market.
1. Recentralisation of office tenants
2. New retail landscape in Central
3. Modern logistics taking over
4. Expected return of sizable transaction of commercial
5. Stronger buying appetite for data centre sites
6. Not enough consideration of ESG elements by HK investors for real estate
Recentralisation of office tenants
Grade-A office rents in Central have been dropping since March 2019. The downward trend was exacerbated by COVID-19 since the beginning of 2020, leading to a cumulative drop of 29.8% as at the end of Q1 2021. Since the current trough in the Central office market was not started by a financial crisis, it could have a shorter recovery period.
As there has been so much talk about “decentralisation” for two years, it is worth exploring the possibility and timeline for “recentralisation” since office rents in Central are almost on par with those in the post-GFC level.
With the Chinese mainland economy set to significantly rebound in 2021 and the COVID situation is under control, Chinese mainland companies are expected to continue to take up Central office space and potentially kick off a recentralisation trend.
New retail landscape in Central
The COVID-19 pandemic has entirely changed the retail landscape in Central, especially on the prime streets in the Queen’s Road Central area. Since the start of the COVID-19 outbreak, retail shops in the so-called prime street area in Queen’s Road Central have been replaced by non-luxury retailers.
Upon completion, the Harbourfront Site 3 development could provide some 1.1 million sq ft of premium retail space. As the first large-scale commercial mixed-use development in Central after IFC and considering the close physical connection between Harbourfront Site 3, IFC and Landmark, the three retail developments will form the latest premium retail cluster, with a total size of about 2.4 million sq ft.
The COVID-19 crisis has accelerated the transformation of the traditional prime retail streets in Central. The repositioning of Queen’s Road Central and the emergence of Harbourfront Site 3 will alter the retail landscape by moving most of the luxury retail activity to the north edge of Central in the next four to five years.
Modern logistics taking over
Modern logistics, unlike traditional logistics, is seen as the physical integration of materials handling, production, storage and transportation, and also includes higher-level non-physical and commercial business functions. Modern logistics buildings have higher requirements for building specifications. This has made it a technical challenge to convert older general industrial buildings into modern logistics buildings.
There is currently about 2.3 million sqm of modern logistics space in Hong Kong. With the COVID situation driving demand from the wider application of e-commerce, total demand for modern logistics space could be up to 3.1 million sqm by 2025, so another 0.8 million sqm will be needed to fill the supply gap in the next four to five years.
Expected return of sizable transaction of commercial
The impact of the COVID-19 pandemic has been seen across all segments of the commercial real estate market over the past year. Many investors froze their plans and adopted a wait-and-see attitude. In terms of property type, industrial property was the only sector that weathered the market downturn.
With investors regaining confidence in the market outlook, transaction activity began to recover. In 2H 2020, the volume of major commercial property transactions was three times that in 1H 2020. With the rollout of vaccination programme and the declining number of COVID cases, overall business performance has continued to improve. Many investors have started to revisit potential opportunities to acquire bargain assets, with a preference for Hong Kong’s Grade-A office space.
Industrial property sales momentum is also expected to grow steadily in the post-COVID era, thanks to the government’s implementation of standard rates pilot scheme for industrial redevelopment.
Stronger buying appetite for data centre sites
In recent years, data centres in Hong Kong have been seen as good investments with tremendous growth potential, thus attracting investors to enter the market targeting great investment returns. Hong Kong is an attractive location for data centres because of its advanced telecommunications infrastructure, reliable power supply at reasonable cost, limited climate risks, and strong demand from local companies for cloud services.
Purchase sentiment for data centre sites remained robust during the COVID outbreak with major transactions being completed. COVID has highlighted the importance of data centres. With the market in Hong Kong maturing, buying appetite of any site available will only become stronger.
Not enough consideration of ESG elements by HK investors for real estate
In recent years, people worldwide have expanded the use of environmental, social and governance (ESG) criteria in every respect, from their daily life to business operations and formulating an investment strategy.
In the real estate sector, there is a stronger focus on the ESG elements because of their close ties with financial and cost-saving incentives. In Hong Kong, developers are paying more attention than ever to ESG elements, from internal policies and governance to project planning, and from green financing to leasing, operations and facilities management.
Regardless of huge potential benefits over the long term, Hong Kong investors have not found sufficient incentives in ESG-focused property investments and are lagging behind other parts of the world in attempting to understand ESG-focused property investment.
Martin Wong, Director and Head of Research & Consultancy, Greater China says, “The new normal has demonstrated that the Hong Kong commercial property market is evolving. The focus has switched towards certain emerging sectors and investors are actively seeking first-move advantages after COVID. Having proved their resiliency in combating bad times, these new trends are expected to last longer in the business cycle following an economic recovery. Rather than focusing on the financial side of the assets, the ESG initiative is likely to add more consideration criteria for investors and lower risks in the long term.”