These days for Hong Kong property firms, one out of three subsectors showing improvement isn't bad. Office rents are declining on weak occupancy levels. Home prices continue to ebb. Hong Kong's retail property market, however, has shown some recent strength in leasing rates.

S&P Global Ratings is not hugely confident that this resilience will last. The Hong Kong economy is going through a structural change with low volumes of capital market activity, a shift in the visitors coming to the city to low-spending day-trippers, and a diversion of residents to Shenzhen for spending on essentials.

The current pockets of vigor in retail sites are meaningful for Hong Kong's property firms. Most rated firms have at least some retail space, likely integrated into offices or residential complexes. Indeed, Hong Kong retail accounts for about one-fifth of the income of our rated property companies.

We assume that rental income from the retail portfolios of rated property companies in Hong Kong will rise an average of 5% this year. The sustainability of positive rental reversions of retail landlords will vary, based on their market positioning. The credit impact of such trends will likewise vary.

Luxury and tourist-focused retail properties are showing vigor. This is partly because of the return of shoppers from mainland China to Hong Kong.

Yet, the picture is mixed. Nonluxury spending is softening. The segment accounts for most of Hong Kong's retail market, and half of some Hong Kong landlords' rental income. Such sales in the city have been recently declining, we assume because of a trend for Hongkongers to shop for essentials in the neighboring mainland Chinese city of Shenzhen.

Moreover, even for the mainland Chinese shoppers that have been returning to Hong Kong, most of these are in and out in single day, spending moderately. It is not yet a full return to large numbers of mainland Chinese buying high-margin items such as jewelry and designer handbags in Hong Kong boutiques, as was the norm of the early 2010s.

Lease Rates Indicate Resilience For Rated Landlords

Hong Kong's retail sales grew 19% in 2023, to HK$487 billion. By the second half of 2023, such sales had recovered to around 84% of pre-COVID (2018) levels. The figures exclude fuel and vehicle sales, but include restaurant receipts.

Chart 1

According to government data, average retail rent increased 4% in 2023. That puts rates just 10% below the pre-pandemic peak in February 2019.

For major retail landlords, rental income from their Hong Kong retail portfolio grew at an average of 7% in 2023. Occupancy remains high at 95%-99% across the firms we rate.

Parties that negotiate lease renewals typically reference rents of one to three years ago. We believe this positions retail landlords for rent increases as leases are renewed in 2024.

Chart 2

Nonluxury Spending Is Pulling Down Total Retail Sales

Sales of luxury goods will likely continue to be resilient in 2024, driven by the recovery in tourism, mainly from mainland China. Inbound tourist arrivals were less than two-thirds of 2018 levels as of the second half of last year. This leaves room for growth, in our view.

For instance, Hongkong Land Co. Ltd. (A/Stable/--), which operates a luxury mall portfolio in the city's upmarket Central district, said its retail sales had returned to pre-COVID levels by the end of 2023.

Harbour City in Tsim Sha Tsui--a tourist hotspot--saw luxury tenants such as Gucci and Celine expand their floor space, as well as new flagship stores for De Beers, Fendi, and Van Cleef & Arpels. Wharf Real Estate Investment Co. Ltd. (nonrated) operates Harbour City in Tsim Sha Tsui.

Note, however, that nonluxury spending accounts for 80%-85% of retail receipts in Hong Kong, and this segment is in decline. Supermarket sales fell 9% in January 2024, year on year, while other nonluxury spending slipped 2% in the same period. The declines pulled down Hong Kong's overall retail sales growth to just 0.9% at the start of the year.

Anecdotally, Dah Chong Hong, a supermarket chain operator, announced this month the closure of its 28 stores in Hong Kong.

Why? In our view, this reflects weaker domestic consumption as Hong Kong residents increasingly travel overseas. In 2023, the outbound travel of Hong Kong residents climbed to 78% of 2018 levels.

While it is hard to precisely measure this trend, newspapers have widely reported on a tendency for Hongkongers to buy essentials in the neighboring mainland Chinese city of Shenzhen. This includes groceries and other nonluxury items, displacing sales of those goods from Hong Kong, we assume.

Chart 3

CK Hutchison Holdings Ltd. (A/Stable/--) highlighted the weak performance of its supermarket chain, ParknShop, in fiscal 2023; the chain is one of the largest in Hong Kong. The firm attributed the underperformance to subdued consumer spending and cross-border shopping in mainland China.

The divergence in retail performance is well reflected in the results of a single operator: Swire Properties Ltd. (nonrated). The landlord recorded 44% sales growth in 2023 at its upmarket Pacific Place shopping mall. Sales at its tourist-focused Citygate Outlets--which is close to the airport--rose 43% in the same period. Meanwhile, receipts for its nonluxury, locally focused Cityplaza were up just 6% in the same timeframe.

Link Real Estate Investment Trust (A/Stable/--) is Hong Kong's largest mass-market retail landlord. Accordingly, among rated entities, its shops face more competition from across the border. As such, we project a modest (2%-2.5%) income rise for Link REIT's Hong Kong retail mall portfolio in fiscal 2024 and 2025 (ending March 31).

Indeed, things could be much worse for Link REIT given its market positioning. However, it has a big advantage of placing its malls directly next to housing estates and transport hubs. It has also been enhancing its sites, and such factors have helped it shake off weakness.

The upside will be capped.   While the inflow of mainland Chinese to Hong Kong is boosting luxury sales, the outflow of Hongkong travelers to mainland China offsets much of these gains. Moreover, the spending power of same-day tourists from mainland China has dropped sharply. On a per-capita basis, it's 40% lower than the 2018 level.

Economic growth in Hong Kong and mainland China has been slowing, moderating demand for high-end luxury items.

Some of these shoppers are now going to the mainland Chinese island of Hainan, which offers duty-free options. This makes it competitive with Hong Kong, a duty-free zone. Finally, Hong Kong's attraction as a shopping center has been slipping somewhat due to the strengthening of the Hong Kong dollar versus the renminbi.

Hongkongers' outbound travel in 2023 was more than double the inflows to the territory. We believe this trend could continue to depress spending on nonluxury spending in Hong Kong, and may limit significant growth in overall retail.

Chart 4

One big X-factor in this calculation lies in potential relaxations of visa rules on inbound tourists coming from mainland China to Hong Kong. Such visitors comprised 79% of Hong Kong tourists arrivals in 2023. Any easing would be favorable for the city's retail sales, and retail landlords. The relaxations could include introducing multiple visits in the visas used by mainland Chinese, and an expansion of mainland cities eligible for such visas.

Currently, residents of 51 cities in mainland China can visit Hong Kong once or twice with each visa. Shenzhen citizens can come to Hong Kong once a week, if they have a visa.

Rated Hong Kong Retail Landlords Have Different Exposures

Hong Kong retail could act as a stabilizer for rental growth. Rated asset owners have differing portfolios in terms of the exposure to Hong Kong retail within their business, as well as the target markets to which their malls cater.

Table 1

We believe luxury and tourist-focused malls will benefit the most from current trends.

Operators of neighborhood malls and local malls can raise competitiveness by improving the customer experience at their properties, increasing the use of loyalty programs, and by refining tenant mix.

For instance, New Town Plaza, a sizeable neighborhood mall operated by Sun Hung Kai Properties Ltd. (A+/Stable/--) recently reconfigured the mall's rooftop as a dinosaur-themed outdoor playground. Since its opening in October 2023, the 35,000-square-foot park has boosted the mall's traffic and customer base, according to the company.

Recovery Is Not Forever

Hong Kong's rated property players are facing extraordinary pressures: high interest rates, excess supply, and potentially poor sentiment spilling over from mainland China's property downturn. Our consistent messaging on the entities, however, is that they have the means to manage the strains within rating buffers.

A key strength of Hong Kong property firms is diversification. All the rated players have exposure to Hong Kong retail, and some have particular exposure to the rebounding tourism and luxury segments.

The current retail upturn will act as a stabilizer for these entities, in our view, largely building on the return of visitors from mainland China to Hong Kong.

We wonder, however, if a full return of Hong Kong's retail property market might require something deeper and more durable. For example, a restoration of Hong Kong's role as a global IPO hub, revitalizing the investment banking sector, or a ratcheting down of geopolitical tensions, which often ensnare Hong Kong.

The recent uptick in retail sales comes off the low base of the pandemic era. The city continues to have its share of vacant storefronts in retail districts, which would have been unheard of a decade ago. So resilience today for shop sales and rents, but we reserve our bets that this will continue in the years to come.

Appendix

Table 2

Writer: Jasper Moiseiwitsch

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