Hong Kong’s Commercial Real Estate Market Navigating Through Challenges with Economic Headwinds and High Interest Rates

Global economy is muddling through clouds of uncertainty and ongoing high interest rates. The headwinds continued to impact the commercial real estate market with the investment sector hit hard the most, according to CBRE Hong Kong’s 2023 Q3 Market Review.

“Hong Kong’s commercial real estate market continued to navigate through global economic challenges and further interest rate hike during the quarter with a touch of resilience in some property sectors. Structural changes ensured overall market activity stayed at low levels but some sectors displayed improvements from the previous quarters. Office market activity has improved, thanks to the relocation and consolidation demand. Retail leasing sentiment remained healthy and demand from tourist-oriented trades continued to improve. Retail sector recovery also ensured a pick-up in logistics demand from retail-related companies. Nevertheless, further hike in interest rates continued to deepen negative returns, which have dragged down the investment market further,” said Marcos Chan, Executive Director, Head of Research, CBRE Hong Kong.

Review and Commentaries

Grade A Office

• Leasing volume in Q3 2023 increased by 32% q-o-q to 1.0 million sq. ft. which was broadly on par with Q1 2023. Leasing activity continued to be driven mainly by relocation and consolidation demand. 
• Net absorption turned positive in Q3 2023, registering 209,000 sq. ft. Greater Central and Hong Kong East registered noticeable declines in occupancy, but Kowloon East saw an increase in occupancy due partly to some forced relocation activities in Kowloon Bay. 
• The absence of new supply and overall positive net absorption ensured citywide vacancy edged down 0.2-ppt to 15.8%. Total vacant space remained high at 13.6 million sq. ft. 
• Limited demand and persistently high vacancy saw rents dropped a further 1.4% q-o-q, accelerating from the 0.5% drop in Q2 2023 and marking the 18th consecutive quarterly decline. Core Central rents experienced the sharpest fall, dropping by 1.4% q-o-q after staying largely flat in Q2 2023. Rents in Tsim Sha Tsui and Kowloon East logged marginal increases of 0.2% q-o-q and 0.3% q-o-q, respectively, as new leases were signed in selected buildings and landlords of other properties held off from implementing further rental reductions.
  

Ada Fung, Executive Director, Head of Advisory & Transaction Services – Office Services, CBRE Hong Kong: “Office leasing demand has picked up slightly from Q2 2023, with a noticeable level of activity found in Kowloon East where some buildings captured the demand from occupiers relocating out of KITEC for the site’s up and coming redevelopment plan. Yet the overall vacancy stabilized at approx. 16% despite the positive net absorption in the quarter. Cost saving was still the key objective, with some office occupiers strategically searching for fully-fitted office space to minimize CapEx during their moves. Public entities were relatively active with MTR and Hospital Authority backing some of the larger transactions during the quarter.”
 

Grade A Office	Q1 2023	Q2 2023	Q3 2023	Q1 2023*	Q2 2023*	Q3 2023*	2023F
	Net Absorption (Sq. ft.)			Rental Change (%)
Overall	102,200	-378,900	209,000	-1.7%	-0.5%	-1.4%	-0-5%
Greater Central	-112,000	-161,000	-76,900	-1.5%	-0.4%	-1.1%	-0-5%
Wanchai, Causeway Bay	-6,600	15,700	63,500	-1.9%	-0.2%	-0.5%	-0-5%
Hong Kong East	-55,900	-111,100	-76,500	-3.8%	-0.4%	-0.6%	-0-5%
Tsim Sha Tsui	48,600	-74,900	84,100	0.3%	-0.3%	0.2%	Flat
Kowloon East	152,400	-60,200	111,200	-1.6%	-2.0%	0.3%	-0-5%

(*) q-o-q

Grade A Office	End-Mar 2023	End-Jun 2023	End-Sep 2023	2022	2023F
	Vacancy (%)			New Supply (sq. ft.)
Overall	15.3%	15.7%	15.8%	4.2 mil.	2.8 mil.
Greater Central	9.3%	10.1%	10.4%	N.A.	N.A.
Wanchai, Causeway Bay	12.4%	12.3%	11.7%	N.A.	N.A.
Hong Kong East	13.6%	14.7%	15.4%	N.A.	N.A.
Tsim Sha Tsui	12.9%	13.6%	12.9%	N.A.	N.A.
Kowloon East	21.6%	21.9%	21.3%	N.A.	N.A.

Retail 

• The summer months saw a hike in tourist arrivals with 10.4 million visitors registered for the whole of Q3 2023, 23% more than the 8.4 million people arrived in Q2 2023. However, the thirty-day moving average tourist arrival figures have been on the drop since September, gradually normalizing after the school holidays.
• Overall retail market sentiment improved further in Q3 2023. Total retail sales continued to climb from a year earlier, growing 15.1% y-o-y in July and August combined. Year-on-year growth, however, continued to slow compared with the 17.5% and  24.1% y-o-y growths registered for Q2 2023 and Q1 2023, respectively.
• Overall leasing volume for high street shops reduced by 14.4% q-o-q to 368,000 sq. ft. in Q3 2023. Amongst the key retail trades, restaurants and cosmetics/pharmacies retailers were relatively more active, contributing 41% of the leasing volume during the quarter. 
• Healthy leasing demand helped vacancy edge down by 0.2-ppt to 11.4%. Causeway Bay vacancy dropped 2.6-ppt to 5.3%, the lowest vacancy rate of any submarket. Tsim Sha Tsui saw vacancy fall by 2.9-ppt, reaching 13.0%. Vacancy in Central rebounded by 3.9-ppt, pushing vacancy back up to 10.5% after maintaining single-digit figures since Q2 2021.
• Improved sentiment and vacancy saw high-street rental growth accelerated further by 2.4% q-o-q in Q3 2023, after growing 1.2% q-o-q and 1.9% q-o-q in Q1 2023 and Q2 2023, respectively.  

Lawrence Wan, Senior Director, Head of Advisory & Transaction Services – Retail, CBRE Hong Kong: “The retail leasing market continued to track well in Q3 2023, owing to improved inbound tourism which encouraged some retailers to look for expansion opportunities in the core shopping districts. However, residents’ enthusiasm for outbound travel during the school holidays also ensured slower business growth for retail outlets in neighborhood locations, balancing the overall picture. The upcoming Golden Week holidays and the government’s ‘Night Vibe’ initiative will see a noticeable boost in overall footfall and business growth, setting a good scene for retail and F&B businesses. Leasing momentum is expected to remain healthy in Q4 2023.”

High Street Shops in Core Districts	End-Mar 2023	End-Jun 2023	End-Sep 2023
	Vacancy (%)
Overall	13.4%	11.6%	11.4%
Central	6.6%	6.6%	10.5%
Causeway Bay	11.8%	7.9%	5.3%
Tsim Sha Tsui	17.4%	15.9%	13.9%
Mong Kok	15.4%	13.7%	13.7%

Retail	Q1 2023*	Q2 2023*	Q3 2023*	2023F	2022	2023F
	Rental change (%)				New Supply (sq. ft.)
High Street Shops	+1.2%	+1.9%	+2.4%	5-10%	N.A.	N.A.
Prime Shopping Malls	Flat	Flat	Flat	0-5%	0	3.2 mil.

Industrial  

• Aggregate trade continued to see negative growth although the situation improved slightly in June and July, falling 6.4% y-o-y in the two months combined after registering double-digit declines for four consecutive quarters. Container throughput dropped by 13.8% y-o-y but airfreight rebounded by 6.2% y-o-y over the same period. 
• Leasing momentum was stable with a more balanced contribution from various sectors. Retail-related demand included a luxury retailer consolidating to a 220,000 sq. ft. space at Goodman Westlink. Elsewhere, BYD took 100,000 sq. ft. in Hong Kong Spinners Industrial Buildings Phase 6 for its 4S centre.
• Warehouse vacancy jumped to 5.5% from 2.5% due to the completion of Cainiao Smart Gateway. Excluding new supply, same-basket vacancy dropped to 1.9%
• Low vacancy underpinned rental growth of 0.7% q-o-q, although this was contributed by just a few buildings. Growing future and shadow space is causing concern among landlords.
  

Samuel Lai, Executive Director, Head of Advisory & Transaction Services – Industrial & Logistics, CBRE Hong Kong: “With the trade sector remaining overall weak and that effective vacancy staying low, leasing momentum continued to be slow in Q3 2023. The pick-up in consumption market sentiment has started to see growing logistics demand from the retail sector, contributing 32% of the new leasing volume in Q3 2023. Fast diffusion of electric cars also saw some new motor brands actively looking for suitable space for their debuts and expansion plans in Hong Kong. Should economic recovery in mainland China accelerate to drive trade sector growth, the outlook of Hong Kong’s logistics sector should improve in the upcoming quarters. Low vacancy in traditional industrial areas might push logistics and warehouse operators to consider other available options in other outskirt districts in the coming seasons.”

Industrial & Logistics	Q1 2023*	Q2 2023*	Q3 2023*	2023F
	Rental Change (%)
Warehouse	+0.4%	Flat	+0.7%	Flat
Flatted Factories	+0.1%	+0.1%	-0.5%	N.A.
Industrial/Office	Flat	-0.7%	-0.7%	N.A.

(*) q-o-q

Industrial & Logistics	End-Mar 2023	End-Jun 2023	End-Sep 2023	2022	2023F
	Vacancy			New Supply (sq. ft.)
Warehouse	2.7%	2.5%	5.5%	1.6 mil.	4.3 mil.

Capital Markets

• Hong Kong’s major banks raised their Best Lending Rate by 12.5-bps in Q3 2023, following another 25-bps interest rate hike in the U.S. in July. The 1M-HIBOR rose to 5.4% in September from 4.9% in June 2023, the highest since September 2007.
• Despite a q-o-q improvement, overall investment market momentum remained low. Total commercial real estate investment volume (deals worth over HK$77 million) increased by 29% q-o-q to HK$6.9 billion in Q3 2023, marking the second consecutive quarter that investment volume failed to breach the HK$10 billion mark. While the total number of deals was on par with Q2 2023, the figure was just 51% of the past four quarter average.
• Redevelopment projects and end-user purchases accounted for the bulk of investment volume. Many deals involved strategic purchases, such as China Travel’s HK$898 million acquisition of De Fenwick Service Apartment. The property will be combined with an adjacent building for redevelopment. Elsewhere, China Merchants purchased a floor on Shun Tak Centre – China Merchants Tower for HK$778 million, expanding from an upper floor.
• Including these two deals and other acquisitions by individual investors, Chinese capital deployed HK$2.2 billion or 32% of total investment in Q3 2023, a figure on par with the previous quarter.

Reeves Yan, Executive Director, Head of Capital Markets, CBRE Hong Kong: “The commercial real estate investment market was comparatively quiet under the high interest rate environment which results in deeper negative returns. Professional investors were mostly on the side assessing various market trends while less yield-sensitive end-users were more active looking for discounted assets. While borrowing costs are expected to stay at high levels for longer, the investment market will likely remain overall quiet for the remainder of the year. Retail assets will remain on local investors’ radar as consumption market sentiment improves. Should the government will relax some of the restrictive measures on property demand in the upcoming Policy Address, overall investment market sentiment will likely see an improvement towards year-end.” 

Investment	Q1 2023	Q2 2023	Q3 2023
	Total Investment Volume (HK$ mil.)#
Overall#	13,432	5,311	6,870
Office	2,333	1,102	1,553
Retail	4,379	1,316	1,886
Industrial & related	948	798	438
Hotel & related	88	468	898
Miscellaneous	5,684	1,628	2,095

(#) property transactions >USD 10 mil (HK$78 mil), excl. govt and private land transactions.

Investment	Q1 2023*	Q2 2023*	Q3 2023*	2023F
	Capital Value Change (%)
Grade A Office (Stratified buildings only)	-0.1%	-1.9%	-5.5%	-5-10%
High Street Shops in Core Locations	+1.0%	+1.9%	+1.5%	0-5%
Warehouse	+0.4%	-3.0%	-2.2%	-5-10%

(*) q-o-q