Still no light in sight
- Office market downcycle to persist with ongoing demand and supply imbalance
- Rents to head south amidst all-time high vacancy, while reversionary growth to remain negative
- End-users seeking to buy office space capitalising on softer prices
- We like Swire Properties which offers consistent long-term earnings and dividend growth without stretching its balance sheet
Office market downturn to persist with ongoing demand and supply imbalance. Corporates remain cost conscious on business expansion amid global economic uncertainties and lackluster financial market performance. New leasing demand is limited while relocation activities are driven by corporate downsizing and office consolidation. Office rents fell 5.9% in 2023 after dropping 26% since 2020. This was led by Island East where vacancy surged to 13.5%in Dec-23 with a slowdown in office decentralisation demand. Central market has become increasingly polarised with continued “flight to quality” trend. Pre-leasing of soon-to-be-completed new office buildings is progressing slowly. Office vacancy is set to rise further from 12.8% in Dec-23. This should exert pressure on office rents which are projected to fall another 5% in 2024.
End-users seeking to buy office space, taking advantage of the currently softer prices. Despite the gloomy market outlook, en bloc office transactions have started to emerge. End users are looking to buy office space to take advantage of softer prices. The Securities & Future Commissions is a case in point. This regulatory body acquired twelve office floors at One Island East with an implied rental yield of 3.3%. We expect more office deals, mainly from end-users, to materialise. Investor demand remains subdued due to negative carry and ongoing rental corrections.
Stock recommendation. Hongkong Land and Swire Properties have delivered stronger office rental performance than their office peers. Both stocks trade at discounts of 71-72% to their respective current NAV estimates, c.2SD below their 10-year mean. Concerns over office market prospects are likely priced in at such low valuations. We have BUY ratings on both stocks on compelling valuations. Swire Properties is making good progress in its HK$100bn investment plan without stretching balance sheet, which should underpin long-term core earnings and dividend growth. We are keeping an eye on any potential fine-tuning of corporate strategy of Hongkong Land after the new Chief Executive joins the company in Apr-24.