Persistently High Interest Rates Dampen Investment Sentiment

• High interest rates cause a decline in Hong Kong's property market investment volume.
• Non-residential investment transaction volume falls by 37.5% from Q1 to Q2.
• End user demand dominates the office market, while hotel and retail investment markets remain muted.
• Savills predicts a 5% decrease in Grade A office prices, but a 0% to 5% increase in prime street shop prices.
• Niche segments like elderly homes, student housing and co-living products may offer stable incomes.

High interest rates impact property investment sentiment
High interest rates, with the 3-month HIBOR surging over 5% in mid-June, are considered one of the main reasons for the sluggish property investment sentiment. Additionally, the rapid increase in interest rates, which rose by 5 percentage points within 12 months, has caught many veteran investors off guard. The last two rate hikes (from 2004 to 2006 and from 2016 to 2018) saw interest rates increase by 4 and 2 percentage points respectively over a 2-year time span, thus having a much milder impact on market sentiment then.

Decline in non-residential investment transaction value
The real interest rate, represented by the 3-month HIBOR minus inflation, has had a significant negative impact on asset pricing during recent property cycles. This is illustrated by its strong correlation of -0.63 with Grade A office prices from 1997 to 2023. As the real interest rate turned positive in the past 12 months, asset prices came under increasing downward pressure, compounded by poor economic performance and fragile investment confidence. As a result, the value of non-residential investment transactions fell sharply, dropping by 37.5% from HK$12.0 billion in Q1 to HK$7.5 billion in Q2. Major transactions, such as en-bloc deals or those involving over 30% ownership, saw a decline in volume from HK$7.0 billion in Q1 to HK$0.6 billion in Q2.

Muted hotel and retail investment markets
High holding costs, banks' reluctance to lend in the commercial market, and negative yield carry in most sectors have deterred potential investors. As a result, the hotel and retail investment markets are currently muted, while the office market is dominated by end user demand. Rental yields stand at 2.5% to 3%, and interest rates are expected to remain high in the foreseeable future, potentially sidelining investment demand for office premises for another 12 to 18 months.

Asset Prices Under Pressure
The investment market looks set to endure another difficult six months at least with interest rates almost certain to remain high, experienced investors with sizable portfolios and relatively healthy loan-to-value ratios (LTVs) are being asked by banks to lower their loan amounts by cash repayment or selling down of their portfolios. This, along with declining office rents and slowing growth momentum in the retail and hotel segments, may put further pressure on asset prices. While more strata office floors and small retail shops will likely be purchased by end users, investment deals may only occur with a minimum 5% yield requirement, and more transactions are expected to be concluded at yield levels of around 7% to 8%.

As a result, Savills Price Forecast for 2H/2023 predicts a 5% decrease in Grade A office prices, but predicts a 0% to 5% increase in prime street shop prices.

Mr. Jack Tong, Director, Research & Consultancy of Savills commented, “With borrowing costs easily reaching 6% to 7%, investors are less interested in once attractive investment properties yielding 5%, and end users are more active in the market.”

Mr. Peter Yuen, Managing Director, Investment & Sales of Savills said, “Some niche segments with different concepts and operating models may prevail. Elderly homes, usually operated in retail podiums, may provide stable incomes due to an aging population and continuous government subsidies; student housing and co-living products, mainly coming from conversions of medium tariff hotels, may also become increasingly popular with the influx of overseas / Mainland talents and non-local students over the years to come.”