2018 Spotlight on Hong Kong

It is not easy to source deals in Hong Kong’s expensive and competitive property market, but private equity players are finding value in one of Asia’s busiest cities, writes Mark Cooper

Local developers, REITs, Chinese players and private buyers dominate the Hong Kong property investment market, but a small group of local and international private equity players have built up a successful track record and remain active in the city.

Home-grown real estate private equity firms include Gaw Capital Partners, PAG Asia, CLSA Capital Partners’ Fudo Capital, Pamfleet and Phoenix Property Investors, all of which have invested in their home city as well as the wider region. International firms that have invested in Hong Kong include AEW Capital Management, Infrared Capital Partners, Baring Private Equity Asia, Blackstone Group, BlackRock, Morgan Stanley and Angelo Gordon.

Managers tend not to raise funds solely for Hong Kong, but the city is almost always included in Greater China and Asia-Pacific mandates.

Strong domestic competition

Rising asset prices and competition from local investors in particular have made life difficult for private equity investors. A fund manager’s concerns about a fund’s internal rate of returns can be brushed aside by the local player investing long-term capital. For example, the largest single asset deal in real estate history took place last November, when a consortium of local private investors bought office tower The Center from CK Asset Holding for HK$40.2 billion ($5.5 billion; €4.4 billion). A Chinese company was originally slated to take a 55 percent stake but after it dropped out, two of the six Hong Kong private investors stepped in. Few private equity funds could move huge quantities of capital so swiftly and decisively.

This means private equity companies have been operating in niche sectors and districts and seeking out unloved or undermanaged assets.

Neighborhood retail a big deal

The biggest private equity deal of the past 12 months was the Gaw Capital-led acquisition of a HK$23 billion ($2.9 billion) portfolio of neighborhood shopping centers from Link REIT, the largest real estate investment trust in Asia-Pacific. The deal, which also involved Goldman Sachs’ private equity group and China’s Great Wall Asset Management, gave the Gaw-led consortium ownership of 2.2 million square feet of retail space in 17 malls. The deal was priced off a tight yield of 2.9 percent and Gaw will look to improve portfolio income.

Other private equity firms, including KKR and Blackstone Group, are understood to have looked at the portfolio, a rare opportunity to acquire a diverse group of malls with asset management potential. The neighborhood retail segment is not exactly niche, but as the malls are all located on public housing estates, the new owners will have to play a careful public relations game; Link REIT has received flak for removing smaller retailers from its malls in the past. Gaw Capital chairman Goodwin Gaw said earlier this year that the consortium would take a long-term view of the portfolio.

In January this year, Chelsfield made the first acquisition for its Asia value-add fund, also targeting the neighborhood retail sector in Hong Kong. The UK firm bought Provident Square, a 210,000 square feet neighborhood shopping mall on Hong Kong island in a joint venture with Pamfleet and two local partners for $257 million. Chelsfield plans asset improvement and re-leasing work.

Weakest links

High street luxury retail has been Hong Kong’s weakest sector for the past three years, with sharp falls in rent and asset values. JLL’s rental and capital value index for the sector fell more than 40 percent between the fourth quarter of 2013 and the first quarter of 2018. However, rental falls have been slowing and Chelsfield took the opportunity to buy four units on Queen’s Road Central, in the heart of the city’s business and shopping district, from Hermes for HK$670 million. It is understood the French luxury brand had previously attempted to sell the units in 2016 for more than twice the price Chelsfield paid. JLL predicts rents and values will at least flatten out this year, so more investors may try to buy for the recovery.

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Number of Hong Kong-based funds in market

$3.07bn

Capital targeted by Hong Kong-based funds in market

Hong Kong is the most expensive office market in the world, according to CBRE, with overall prime occupancy costs of $307 per square feet, well ahead of London’s West End, in second place on $253 per square feet. High and rising prices plus huge lot sizes mean private equity buyers are pushed to outlying areas. For example, PAG Asia bought a 50 percent stake in an office building in Cheung Sha Wan, North-West Kowloon, which is expected to develop as an office area due to falling vacancy in the main East Kowloon office district and record prices on Hong Kong Island.

Think niche

Niche sectors favored by private equity firms include self-storage – Infrared invested $50 million in Red Box self-storage in May – and co-living. Both Gaw and Pamfleet have both invested in co-living projects in Hong Kong.

JLL predicts that values and rents in the office and industrial sectors will rise this year, as will residential prices, with retail rents and values being flat at worst, suggesting no easy opportunities going forward. Private equity investors are therefore more likely to be active in niche districts and sectors.