Institutions have an opportunity to enter the Hong Kong market as developers sell off to raise liquidity, as  Michael Grimes finds

The remainder of 2008 and the first half of 2009 offers opportunities for direct investment in Hong Kong residential real estate as local developers sell off assets to gain liquidity for projects in mainland China, says a leading property consultant.
The opportunities to buy whole buildings will be very limited though, suggests Nicholas Brooke, chairman of Hong Kong-based Professional Property Services Ltd. Acquisition of strata title with the possibility of exit within 18 months may be the best option.
"I wouldn't be surprised to see some asset disposal over the next 12-18 months from developer to institution. Developers will be tempted to take advantage of the relative high price regime to exit at the top of the curve to investors hungry to get into Hong Kong," explains Brooke.
The reason for high potential in capital growth of residential stock is limited supply and strong demand, he continues.
"I believe we will see a bull run, with capital gains of 25-30% in the mass market and as high as 40% in the luxury sector."
The volatility of the Hong Kong market relates in part to the government's control of land sales. The release of land for new development varies annually and is used as an economic lever either to control prices or to deliver tax yield following economic downturns.
"One of the concerns was that the government would put a lot more land onto the market and use it as a signal to the market that it didn't want prices to increase any further. It hasn't done that. That's why I and others believe we're in a bull run. The supply is very tight," says Brooke.
"Around 19,000 units were sold last year and the additions to this year's application list are capable of adding around 15,000, so it's a topping up and nothing more. The message from the government is that 15,000 units a year are enough. It's probably not enough and I think demand is going to outstrip supply.
"Although Hong Kong is not a traditional institutional investors' market, it's a year to become a trader, buying strata title and perhaps exiting in 12 to 18 months' time. Investors could exit with substantial capital gains. That would then provide developers with cash not necessarily to reinvest in Hong Kong, but for their China initiatives. Many of them have increased their commitment to China in a very major way and will have to fund that commitment over the next three to five years," explains Brooke.
Hong Kong-listed developers have seen their capitalisation reduced after recent stock market volatility led to equity sell-offs and broker discounting, although net asset values remain generally strong.
"A lot of them are trading at 30-40% discount to NAV. Much of that has now been factored in," says Brooke. "The real catch up in the next 12-18 months is the measures China has introduced. The cumulative effect will be felt by the markets, and we're going to see some adjustment in values as a result.
"Essentially China has cut credit to the real estate industry, so anyone operating in that market has got to get money from elsewhere. That's why I think we will see developers selling assets here in Hong Kong and around the region. They will have to take equity into China to fund their ongoing development programmes. The credit pipeline has been cut off."
Rong Ren, CEO of Harvest Capital Partners in Hong Kong , says: "Those seeking debt in China for real estate development within China are certainly going to face more of a challenge this year. On the consumption side the supply of mortgages is tightening and consumers within China are also growing more cautious."
Despite the strong commitment of Hong Kong developers to real estate projects on the Chinese mainland and their need to maintain liquidity, they may still be able to get good prices for their Hong Kong assets. This is because of the likelihood of strong competition from foreign investors concerned about stagnation in the North American and European real estate markets, says Brooke.
This competition among inward investors to Hong Kong provides potential liquidity for those seeking a quick exit, but could push up PE ratios. Under those circumstances, entry and exit points on the value curve become critical.
"This is where an institution is going to have to change its mindset," says Brooke.
"The opportunity to buy whole buildings is very limited in Hong Kong. With owners seeing values rise, they will be even more reluctant to sell whole properties. An institution is going to have to become a trader, coming in and buying units as against a building."
Brooke thinks the less bullish market view on Hong Kong REITs is broadly correct, given that few of them hold much residential property.
"Very few Hong Kong REITs are residential. Because of the supply coming onto the office rental market we are seeing prices easing in the office sector, particularly in decentralised locations. The office holdings of Hong Kong REITs are mainly decentralised so I think office prices and yields are going to come off."
"Hong Kong and Singapore are the two Asia Pacific cities we would expect to be most affected by the credit crunch and global economic slowdown," says Megan Walters, regional director, research and business analytics group, Asia Pacific, for the global real estate adviser Cushman & Wakefield.
"Both have small open economies and according to our in house data bases, in both cities around 40% of office tenants in A-grade offices are allied to the banking and financial services sector. Nonetheless investment into the sector held up firmly in the last quarter of 2007."
Brooke says Hong Kong REITs still offer value opportunities for investors with a defensive posture.
"There was an awful lot of financial engineering that went on when Hong Kong REITs were launched. It enhanced the yield, but that has fallen away now. Most Hong Kong REITs are down to a basic property yield. I think there's a lot of latent potential in Link REIT. The management did inherit some social issues, given that the portfolio was made up of property previously owned by the Housing Authority, but as a REIT it is now a public entity. The management is going to have to respond to that challenge. I don't think at the moment that the potential of their commercial centres is being realised.
"Many of the projects injected into the Hong Kong REITs so far haven't been A-grade, but neither have they been of a sub-prime category. Any new securitising exercise is likely to involve B-grade plus or A-grade property so it certainly shouldn't have a negative effect on the REIT market."