Central offices might see decline in passing rents in 2015

For overall retail, it's likely in 2016.

Amid reporting season, it has been noted that a key theme revealed from this round of results is that landlords are starting to record negative reversions.

According to a research note from Barclays, as Hong Kong landlords typically carry a 3.5-year expiry portfolio and spot rent is now in its second or third year of slowdown, the base effect is setting in.

The question becomes, when will passing rents see the first decline, Barclays noted.

Arithmetically, if Barclays were to average spot rents for the past 3.5 years, this suggests that both Central offices and overall offices may start to see a decline in passing rents this year.

For overall retail, it may see this in 2016.

Here's more from Barclays:

In Central offices, passing rents should start to decline in 2015 assuming flat spot: The Central spot rent has come down 18% from the peak of 2Q11, and 1% from a year ago.

If we take the simple average of a rolling 3.5 years of spot rent as passing rent, passing rent reversed from a growth trend to a declining trend first in 3Q14. Assuming spot rents remain the same in 2015E; this would imply passing rents should start to decline on an annual basis in 2015 with a 4.3% y/y drop, on our calculations.

In overall offices, passing rents should start to decline in 2015 assuming a 2.5% spot decline: The overall office spot rent has come down 5% from the peak of 3Q11 and is flat from a year ago. Similarly, by taking the rolling 3.5 years of spot rent as passing rent, growth has slowed to 4.5% in 2014 from 8.3% in 2013.

As of 4Q14, passing rent still recorded 1.9% y/y growth. If we take our base case that overall offices should see a 2.5% drop in spot rent in 2015, this would imply that passing rent should start to see decline from 2Q15 onwards, although it would be only a small one of 0.3% drop for the full-year 2015, on our calculations.

In overall retail, passing rents may decline in 2016 if spot declines 10%y/y: Our case for retail is highly contingent in the magnitude of the coming slowdown. If we assume Hong Kong’s retail value is flat in 2015 and 2016, we find that passing rent growth should slow to only 0.4% in 2016.

If we were to assume a 10% decline in retail sales in both 2015 and 2016, then passing rents will record their first decline of -4.9% in 2016E.