Industry / Real Estate

Retail Real Estate (China)

Group Research / October 23, 2019

Photo Credit - AFP

Overall Outlook

1) Rental rates edged up in 2Q19. Retail sales grew 8.2% y-o-y in 1H19, while commodity retail sales from 5,000 key retail enterprises (a proxy for offline sales) slowed to 2.5%. As opposed to this reading, retail malls in major cities saw improving occupancy rates with rental rates edging up. E-retailers continued to show demand for offline expansion. Meanwhile, coffee/tea and cosmetic/skincare retailers kept adding new outlets. Retail malls in tier 1 cities actively adjusted their brand mix, resulting in a 0.1% q-o-q increase in average ground floor rents, primarily led by Shanghai. Average ground floor rents rose by 0.2% q-o-q in major tier 2 cities, led by Nanjing and Hangzhou. Average occupancy for the key tier 1 and 2 cities improved by 0.3ppt to 6.3%.

2) Government’s tax cut to support domestic consumption, in order to alleviate external uncertainties. Consumer confidence index hit highs after the government cut personal income tax rates and introduced additional deductions for expenditures on education, elderly care, rental housing, etc. On the other hand, value-added tax (VAT) has been cut by 3ppts for manufacturers starting from April. As a result, retailers are cutting selling prices accordingly for general merchandise. Several luxury brands have also followed suit. Over the longer term, China is expected to see rising affluent population with >7% CAGR growth in the number of middle-class households. In terms of cities, Shenzhen, Guangzhou and Hangzhou saw the highest population growth over the past several years, while Wuhan, Hangzhou and Nanjing saw the strongest growth in disposable income.

3) Oversupply persists, but polarised performance. Commercial gross floor area (GFA) of new starts has slowed down in major cities since 2015/2016. Chongqing is likely to see higher oversupply risks in 2019/2020. While oversupply concern persists, landlords’ operating capability varies, leading to polarised performance. Major listed China landlords continued to grow their retail sales and rental income at a double-digit rate in 1H19. On the other hand, e-commerce is less of a threat to mall landlords as e-retailers have limited room to increase the e-commerce penetration rate in China while major e-retailers are expanding their offline exposure.

4) Still room for rent upside in well-managed malls. Tenants’ occupancy costs in retail malls operated by major China landlords were 13-14% in 2018, which are relatively low as compared to the international figure of 15-20%. This provides room for landlords to optimise brand/tenant mix to enhance rental income. In addition, rental rates in Shanghai and Beijing are still lower than those of regional gateway cities such as Hong Kong, Tokyo and Singapore.

5) En-bloc transactions retained strong momentum, largely driven by foreign investors. While retail malls are not the most preferred assets, foreign investors and experienced operators are seeing repositioning potential for existing malls, while domestic private equity investors are looking at redevelopment opportunities (conversion into office). In May 2019, the JV between Sino-Ocean Capital and BHG Long Hills Capital acquired Anzhen Hualian Department Store and plans to redevelop it from a community mall into a commercial complex project.

Near-term outlook

Demand remains decent in major cities. Major retail malls in top-tiered cities adjusted their brand mix to maximise rental income in 2Q19. Cosmetic/skincare retailers continued to expand retail space in tier 1 cities. Online kitchen and fitness apps also opened brick–and-mortar stores in Beijing and Shanghai. F&B players such as international brands and coffee/tea retailers are adding more outlets in tier 1 cities. In tier 2 cities, e-retailers and new retailers for fresh produce remains active in leasing retail space. Several international trendy brands entered well-managed malls in tier 2 cities, such as Xi’an Joy City, Xiamen Mixc and Chongqing Mixc. Key Opinion Leader stores (KOL, 意見領袖店 or 網紅店) also sped up expansion in tier 2 cities. 

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