Company Update: Office reversionary growth stays in negative territory
- Leasing enquiries for Three Garden Road have improved but pace of transactions still slow
- Office reversionary growth for both Three Garden Road & Langham Office Tower to stay negative in FY23
- Tenant sales growth at Langham Place Mall outperformed the overall retail market
- Revised TP down to HK$3.09 due to higher interest rate outlook, maintain HOLD
Leasing enquiries for Three Garden Road has picked up following the full relaxation of travel restrictions in early 2023, mainly driven by financial institutions within Central. Yet, transactions have remained stagnant as tenants remain cost conscious amid global macro uncertainties and are more selective on the back of high vacancy rate and increased supply. Despite the departure of Invesco in 1Q23, occupancy at Three Garden Road was stable at c.83% (Dec-22: 82.7%) thanks to in-house expansion of an existing tenant. In FY23, about 12% of leases in term of gross rental area, are scheduled for renewal with another 28% up for rent review. Of these, >50% has been concluded. While spot rents have stabilized at >HK$80psf, rental reversion is expected to stay in negative territory due to high expiring rents of >HK$100psf.
About 42% of floor area at Langham Place Office Tower is scheduled for roll over in FY23. Thus far, Champion REIT has concluded >50% of these lease renewals. This should underpin its occupancy, which stood at 93.3% as of Dec-22, in the near term. The portion of space occupied by lifestyle tenants has remained stable at 71%. With the improved sentiment following the border reopening with China, spot rents at Langham Place Office have stabilized at >HK$40psf. Hence, we forecast a mild negative rental reversion for the property in FY23 given expiring rents at c.HK$46psf.
Tenant sales at Langham Place Mall has outperformed the general Hong Kong retail market, which registered 21% growth in 5M23. This was mainly driven by the robust sales growth from tourist-oriented trades, cosmetics in particular. This points to robust turnover rent growth in FY23. Coupled with the rental correction over the past few years, occupancy cost ratio has lowered to 19- 20%, on par with the level prior to the pandemic outbreak. Hence, rental reversions for 39% of leases to be renewed in FY23 is expected to resume positive growth. The mall remains fully let.
Champion REIT is trading at 6.0-5.4% distribution yield for FY23- 24. This translates into yield spreads of 2.3-1.7%, below its 10-year average of 3.5%. High vacancy rate and subdued leasing demand should continue to cap rental growth at Three Garden Road in the near term. Hence, this would weigh on the performance of the REIT’s largest property, which accounted for c.60% of its FY22 NPI. This, coupled with the negative rental reversions at Langham Place Office, should more than offset the earnings recovery from Langham Place Mall led by the revival of tourist spending. With earnings recovery still remote, we maintain our HOLD call with a DDM-based TP of HK$3.09.
