Once upon a time customers would line up, sometimes for hours, along the ritzy shop windows of Louis Vuitton and Dior, waiting eagerly behind velvet ropes. Now the luxury boutiques that line Hong Kong’s Russell Street are eerily deserted. The designer watches and jewellery that glisten in the windows go mostly unnoticed, despite the likes of Chanel slashing the prices of their signature handbags by nearly 25%.
Meanwhile, on a nearby street corner customers queue to enter a bustling open-air noodle shop to take their lunch. The scene highlights the odd dichotomy between the city’s high-end retailers and its everyday counterparts; luxury retail is in a slump but elsewhere, things are ticking along just fine. Is the luxury slowdown a sign of China’s coming fall, or something else altogether?
Over the last year luxury icons such as Gucci, LVMH and Coach have either closed stores or announced plans to reduce floor space, a result of a stunning decline in Hong Kong tourism. According to Hong Kong’s Census and Statistics department, in January Hong Kong’s retail sales fell 6.6%. In February, they plunged by 20.6%, the worst fall since the aftermath of the Asian Financial Crisis in 1999.
High-spending Chinese visitors are finding Hong Kong a far less attractive destination. Mainland tourist numbers are down by about a third on the prior year. New visa restrictions and negative sentiment caused by a series of high-profile anti-mainlander protests in Hong Kong are contributing to the drop, as well as growing competition from destinations like Japan, South Korea and Europe, which, with weakening currencies, are becoming more affordable.
With almost four in five of Hong Kong’s visitors originating in mainland China, this is a huge concern for high end retailers. But it is not necessarily a sign of a greater malaise in China itself.
According to figures released by the World Travel & Tourism Council, in 2015 Chinese tourists spent US$215bn outside mainland China, a 53% rise on 2014. Chinese shoppers now account for almost half of global luxury sales. They’re still spending money, but nowhere near as much in Hong Kong. Instead, they’re seeking a more ‘cultural experience’ abroad, which explains why mainland Chinese visitors to Japan, for example, have doubled in recent years.
We believe that the impact of this change on the APN Asian REIT Fund is limited. Mid-range shopping centres and necessity-based retail stores are still enjoying healthy growth, which is where the Fund has focused its investments.
Of course, a more robust retail environment would be nice but from an investment perspective, it’s not a necessity. The Fund’s main retail exposure in the Hong Kong market is via two real estate investment trusts.
Link REIT, the largest real estate investment trust in Asia, owns a large portfolio of retail and car park properties formerly owned by the HK Housing Authority. Its retail facilities are literally on the doorstep of nearly 40% of Hong Kong’s population and cater to the daily needs of the local communities in local public housing estates. These are not properties targeting the Chinese luxury shopper.
About half of Link REIT’s total leasable area is dedicated to food and beverage and supermarkets, the very definition of necessity based, non-discretionary retail spending. Link REIT reported 6% growth in tenant sales last year at a time when overall retail sales in Hong Kong fell nearly 4%.
It’s a similar story at Fortune REIT, which owns a portfolio of suburban retail properties. The trust’s most recent results showed increases in portfolio occupancy and double-digit growth in distributable income – a commendable performance amidst a soft overall retail environment.
The performance by these two REITs illustrates the benefits of the strategy we followed when launching the APN Asian REIT Fund in 2011. Our focus is on recurring income streams and more importantly, the sustainability of that income that the REITs can deliver to us and our investors. Investors do not necessarily need a booming Chinese tourism market in Hong Kong to benefit from overall Asian growth. The mass market retail in Hong Kong, focussing on the basic needs of the local population, has more in common with typical grocery anchored suburban shopping centres in Melbourne and Sydney than you might think.
Is there a revival in sight for the Hong Kong retail market? It depends. The Government is taking steps to boost the city’s beleaguered tourism sector, worth about 5% of GDP, waiving licence fees for local travel agents and hotels, expanding major events and moving up the value chain in the manner of Singapore’s tourism sector. But the world is a big place and more and more Chinese mainlanders want to explore it.
That spells trouble for the luxury brands in Hong Kong, which in the past have boasted that Hong Kong was comfortably their most profitable market. Now they’re pushing landlords to cut rents to lower costs to avoid more store closures. Still, Hong Kong’s proximity to the mainland cannot be under-estimated. The individual visitor scheme for mainlanders is only available for residents in 49 Tier 1 and 2 mainland cities. There has been some discussion of potentially expanding the scheme to the remaining 612 mainland cities, which certainly could substantially boost tourism numbers to Hong Kong, but such a move is unlikely to be made swiftly.
But for the APN Asian REIT Fund we believe the slowdown in Chinese visitors to Hong Kong is not critical. The Fund’s exposure to the Hong Kong retail market is selectively concentrated in the mass market, necessity-based segment. It may not be totally protected from the storm in luxury retail but it’s a pretty good place to hide.