HONG KONG LANDLORDS：Rental growth still key amid rate hikes

for hong kong landlords BNP PARIBASPatrick C Wong 29 JULY 2015 SECTOR REPORT HONG KONG LANDLORDS Rental growth still key amid rate hikes  Strong Central grade-A office rentals on track to achieve 15% growth in 2015-16 Latest data from JLL show that grade-A office rents in Central rose 7% h-h in 1H15 and outperformed other sub-markets in HK. Following the sharp decline in the vacancy rate in Central, from 3.7% to 1.7%, in 1H15, we expect vacancies in Central to remain low and support 15% y-y growth in spot rents in 2015-16. Current available options for office decentralisation from Central are also limited, as the overall vacancy rate for HK offices dropped from 4.1% to 3.5% during 1H15 and is now close to its lowest level of the past 27 years.  Potential Central office rental growth to offset impact of cap-rate expansion on office landlords In view of rising concerns of US interest rate hikes from 2H15, we expect investors to be more sensitive on cap rate expansions, which would reduce book values of landlords. We think the cap rates adopted in the latest book values of landlords under our coverage (3.3-4.75%) are prudent, when compared with current cap rates of 3.1-3.2% for grade-A offices according to JLL. Our sensitivity analysis found that spot rental growth of 15% would offset the impact of a 60bp cap rate increase for Central offices of Hongkong Land (HKL SP) in maintaining its book value.  Reiterate BUY on Hongkong Land, Swire Properties and Wharf We roll over our NAV estimates to FY16. Hongkong Land remains our top pick in the sector, as we believe Central office rental growth should continue to outperform other sub-markets in 2H15-2016. Despite concerns of declining luxury retail sales and rentals of high-street shops, retail rents of prime shopping malls in HK remained solid in 1H15. After the recent share price correction, we think the current valuation of Wharf (4 HK) at 12.9x P/E and 0.48x P/BV in FY15E, at a 49% discount to FY16E NAV of HKD97 is undemanding and therefore maintain our BUY. BNPP recommendations Note: Priced at close of business 29/07/2015. Share prices and TPs are in listing currency. Sources: FactSet; BNP Paribas estimates Our research is available on Thomson One, Bloomberg, TheMarkets.com, FactSet and on http://eqresearch.bnpparibas.com/index. Please contact your salesperson for authorisation. Please see the important notice on the back page. PREPARED AND PUBLISHED BY NON-US BROKER-DEALER(S): BNP PARIBAS SECURITIES (ASIA) LTD . THIS MATERIAL HAS BEEN APPROVED FOR U.S DISTRIBUTION. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES CAN BE FOUND AT APPENDIX ON PAGE 25 Patrick C Wong Wee Liat Lee patrick.c.wong@asia.bnpparibas.com weeliat.lee@asia.bnpparibas.com +852 2825 1825 +852 2825 1105 CompanyBBG codeRatingShare priceTarget priceUpside/downsideHongkong LandHKL SPBuy7.6510.96+43.3%Swire Properties1972 HKBuy24.8532.60+31.2%Hysan Development14 HKBuy32.3040.70+26.0%Wharf Holdings4 HKBuy49.6063.10+27.2%Champion REIT2778 HKBuy4.355.21+19.8%Hang Lung Properties101 HKBuy22.0024.40+10.9% HONG KONG LANDLORDS Patrick C Wong 2 BNP PARIBAS 29 JULY 2015 Investment thesis Latest data from JLL show that grade-A office rents in Central rose 7% h-h in 1H15 and outperformed other sub-markets in HK. Following the sharp decline in the vacancy rate in Central, from 3.7% to 1.7%, in 1H15, we expect vacancies in Central to remain low and support 15% y-y growth in spot rents in 2015-16. Historically, spot rents in Central have grown at more than 5% q-q during periods when vacancies dropped to 2.5% or less, given the improved bargaining power of landlords. Current available options for office decentralisation from Central are also limited, as the overall vacancy rate for HK offices dropped from 4.1% to 3.5% during 1H15 and is now close to its lowest level of the past 27 years. We think the cap rates adopted in the latest book values of landlords under our coverage (3.3-4.75%) are prudent, when compared with current cap rates of 3.1-3.2% for grade-A offices according to JLL. Our sensitivity analysis found that spot rental growth of 15% would offset the impact of a 60bp cap rate increase for Central offices of Hongkong Land (HKL SP) in maintaining its book value. Despite concerns of declining luxury retail sales and rentals of high-street shops, retail rents of prime shopping malls in HK remained solid in 1H15. After the recent share price correction, we think the current valuation of Wharf (4 HK) at 12.9x P/E and 0.48x P/BV in FY15E, at a 49% discount to FY16E NAV of HKD97 is undemanding and therefore maintain our BUY. Catalyst 1 Positive leasing updates of Central grade-A office space;2 Positive update on monthly rental and vacancy data for the Central grade-A office market; 3 Potential turnaround of retail sales numbers in HK. Risk to our call 1 Faster-than-expected US interest rate hikes, raising cap rates for investment properties; 2 A hard-landing of the Chinese economy