Hong Kong Property Sector

Hong Kong Real Estate 24 March 2017
Hong Kong Property Sector
Beginning of the end or end of the beginning? How creative destruction could take
Hong Kong property and its companies to the next level
See important disclosures, including any required research certifications, beginning on page 190
Hong Kong Property Sector: 24 March 2017
Table of contents
Overview: Can Hong Kong make it once again?

Q1 And, if it does, what are the implications for its 5
property companies?
Q2 Are Hong Kong property prices too high? 17
Can prices be sustained or is the upcycle coming to

Q3 25
an end?
Will US interest-rate normalisation spell the beginning
Q4 59
of the end for Hong Kong property?
What could drive Hong Kong property to the next
Q5 83
level?
Will Hong Kong property companies be able to ride
Q6 113
on the opportunities that arise in the years ahead?
Company section 145
Please also see:

Hong Kong Property Sector: Hong Kong Property Sector:
The Hong Kong Property Toolkit Its time to be more greedy than First impressions can be deceiving:
fearful another look at the contrarian case
Autumn 2013 25 May 2016 1 July 2016
Jonas Kan, CFA (852) 2848 4439 Jonas Kan, CFA (852) 2848 4439 Jonas Kan, CFA (852) 2848 4439
(jonas.kan@hk.daiwacm.com) (jonas.kan@hk.daiwacm.com) (jonas.kan@hk.daiwacm.com)
2
Beginning of the end? Or end of the beginning?

Jonas Kan, CFA
(852) 2848 4439 Now is not the end. It is not even the beginning of the end. But it is, perhaps, the end
jonas.kan@hk.daiwacm.com
of the beginning.
- 1942, Winston Churchill
We believe the Hong Kong Property Sector, which has long been an anomaly in global
property, has now reached a critical point in its development.
As a regional-scale property market of 7m people, this is a fairly mature market by most

measures. But, if it can make the leap into being a genuinely metropolitan market akin
to London or NewYork, we think the Hong Kong property market could have many
more years of development ahead of it. And as a result of this next leg of development,
the market could eventually reach a scale far larger than it is today.
Much depends on whether market participants discover and then execute well new
drivers that can take the market to the next level. In our view, what economist and
political scientist Joseph Schumpeter called the force of creative destruction is alive
and kicking in Hong Kong. Indeed, we believe the free-market system has been
signalling many of the issues facing the market for some time now, and market
participants have begun responding to these signals. In a sense, therefore, the market
has been preparing to make the step up.
We believe the Hong Kong Office Sector is ready to accommodate new entrants while
existing players expand. Meanwhile, in the retail and residential sectors, the excesses
that had built up look to have been largely wiped out. Importantly, our read is that there
are several potential drivers of creative destruction in the making, not least of which is
the ongoing financial-sector liberalisation in China and Hong Kongs unique position in
bridging the institutional gap between China and the rest of the world.
In our view, the Hong Kong property companies are nicely placed they would be fine
if the market simply holds up and would be presented with significant opportunities if
the market makes a breakthrough. In sum, we consider the Hong Kong property stocks
to be a safe and attractive way to play this potential leap in Hong Kong property and
the companies own continuing modernisation. This reinforces our stated view: if the
Hong Kong property companies take their opportunities to continue modernising, they
could conceivably come to be seen as a force to be reckoned with in global property,
which could in turn unlock USD100bn or more of investment value in their shares.
Jonas Kan, CFA, Head of Hong Kong and China Property
This report draws on information and insights gleaned from industry experts who have spoken at Daiwas
Hong Kong Corporate Summit, an event held each January since 2011. The author duly acknowledges
these experts valuable contributions.
3
4
Question 1
Overview: Can Hong Kong make it
once again? And, if it does, what are
the implications for its property
companies?
5
Q1: Overview: Can Hong Kong make it once again? And, if it does,
what are the implications for its property companies?
It was the best of times; it was the worst of times. It was the age of wisdom, it was the age of foolishness it was
the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us
- A Tale of Two Cities, Charles Dickens
Profit is the payment you get when you take advantage of change.. As a matter of fact, a capitalist economy is
not and cannot be stationary. Nor is it merely expanding in a steady manner. It is incessantly being revolutionised
from within by new enterprise, ie, by the intrusion of new commodities or new methods of production or new
commercial opportunities into the industrial structure as it exists at any moment.
- Joseph A Schumpeter
Hong Kong property appears to be at another transition point

Making a major directional call on a major property market is never easy. This is especially the case for Hong Kong,
as its property market is in many respects an anomaly in global property, in our view (see our September 2013
publication, the Hong Kong Property Toolkit). Still, we have argued that the forces driving the development of the
Hong Kong property market arent so different from those that have driven the development of metropolitan
markets such as London and New York.
Historically, this is a market that is used to facing contradictory forces. As it stands, the market is caught in the
middle of several global currents, not least of which are US interest-rate normalisation, the possibility of a change
in Sino-US relations, the potential for a new economic and political landscape in Europe, and the changes brought
about by Chinas attempt to transform its economy from one led by fixed asset investment and rapid monetary
expansion into one led by growth in private consumption.
We should say from the outset that this is not an attempt to belittle the challenges facing the Hong Kong property
market. Indeed, if the abovementioned issues do not play out as we expect, it is reasonable to expect the Hong
Kong property market to be rocked. The market in some respects resembled a sampan sailing in the Pacific Ocean,
albeit one tied to 2 super tankers it is part of the US in a monetary sense, and of China in an economic sense.
And, of course, these super tankers dont always sail in the same direction.
6
The Hong Kong property market: stages of development

Stages of Hong Kong as a city Period Manifestations in the property market
A manufacturing and trading centre 1970s-1980s Office and retail property stock reach a scale similar to emerging
cities in the world
Very small portion of the population living in Class C (>69.9 sq m)
or above units due to the peculiarities of the local land supply and
socio-economic situation
A medium-sized city in Asia which is strong in commercial services, 1990s-now Stock of office and retail properties reaches a scale similar to that
serving as the commercial gateway to China, the capital formation of major medium-sized cities in the world
centre for major Chinese enterprises and a major hub for outbound The proportion of people living in Class C or above units rises
Chinese consumers notably but is still low by international standards
A major service economy in Asia which is attempting to go higher Now -2020? Sustained expansion in the stock of office and retail properties,
and deeper in the value chain, serving as a city that can help build driven by new districts being transformed into retail/ office usage
closer ties between China and the rest of the world. An important and land being used in other purposes before being converted
component of China's attempts to reform and liberalise its financial into office/ retail use
system; the co-ordination centre for PRC enterprises trying to go The proportion of people living in Class C or above units does not
overseas and overseas companies trying to go to China and Asia; increase that much, however, due to the special circumstances
as well as a retail hub for consumers in China and Asia that have prevailed in Hong Kong since 4Q97
Another round of companies and retailers coming to Hong Kong,
many of which are in the mid-tier segments -- larger in volume
than the top-tier ones but with lower rent-paying capacity than the
top-tier ones
Can it gradually emerge as a world-class metropolitan city, 2020-2030? A notable expansion in the stock of office and retail properties,
becoming an important offshore component in all aspects of Chinas reaching a scale approaching about half or more of the level of
financial architecture; playing an important role in serving PRC New York/ London today
enterprises going overseas and overseas corporations coming to Number of people who can live in Class C or above units
China and Asia, as well as a trend-setting city and retail hub for depends critically on developments in the land market in the
consumers in Asia and China? coming years, especially the pace of development of new towns
and farmland conversion
Source: Daiwa
Can the forces of creative destruction be unleashed again?

For decades, the Hong Kong sampan has been sailing in turbulent waters. It has seen storms, typhoons and even
hurricanes, and yet somehow it has managed to survive and thrive, contrary to most expectations at the time.
In hindsight, these challenges and crises might have been blessings in disguise, as they forced the citys economic
participants whether regulators, banks, developers or home-owners to reinvent themselves, explore new
opportunities, and move further up the value chain. The combined effect of these efforts is what Joseph
Schumpeter termed creative destruction.
In our opinion, creative destruction is central to the path the Hong Kong property market has taken and how it
could well evolve in the years to come.
Over the years, Hong Kong has continued to evolve as a city, starting out as a fishing village, becoming a port and
then a manufacturing centre, and then turning itself into a commercial hub. More recently, it has changed
complexion once again by becoming an international financial centre. These repeated chameleon-like
transformations distinguish Hong Kong from many other cities around the world, in our opinion.
Whether Hong Kongs fortitude is mainly attributable to luck, the power of the invisible hand, or a combination of
other supportive factors is beyond the scope of this report. But we believe Hong Kongs proven resilience,
responsiveness and adaptability argue for the city to be given the benefit of the doubt when assessing its prospects
in the face of ongoing and future challenges.
7
The challenges Hong Kong has faced and the creative destruction it has seen
Stages Period Main challenges Creative destruction achieved
A manufacturing and 1970s-1980s How long Hong Kong can remain a Hong Kong manufacturers transform Southern China into
trading centre manufacturing and trading centre? an extension of their manufacturing base
Other sectors in Hong Kong evolve into servicing a much-
expanded manufacturing and trading base
A medium-sized city in 1990s-now A slowdown in the growth momentum of Hong Kong has established itself as the capital formation
Asia China's export and manufacturing sector centre of PRC enterprises and a luxury retail hub for
outbound PRC consumers.
A major service Now -2020? Need to find roles other than just the capital Can Hong Kong serve China in other ways with regard to
economy in Asia formation centre of PRC enterprises and a its financial reform and liberalisation?
luxury retail hub for outbound PRC
consumers
Need to build sufficient transport as well as Can Hong Kong play a role in the deployment of the
social, cultural and economic connections financial assets of PRC people and institutions?
with China and the rest of the world to
accommodate such a leap
Need a larger stock of property assets in all Can Hong Kong play a bigger role in PRC corporations
segments (but especially mid-tier ones) to going overseas and overseas corporations going to China
accommodate such a leap, through new and Asia?
supply and upgrading of existing property Can Hong Kong become a retail hub for consumers in Asia
assets and China in retail segments other than just luxury?
Potentially emerging as 2020-2030? Need a larger stock of property assets in all Can Hong Kong become an important centre in the
world-class segments (but especially mid-tier ones) to offshore component of China's financial sector, which shall
metropolitan city in accommodate a potential quantum leap in the extend well beyond equities to include commodities,
Asia? scale of its property market, through new currency, fixed income, etc.
supply and upgrading of existing property Can Hong Kong provide indispensable services for PRC
assets corporations going overseas and overseas companies
going to China and Asia?
Can Hong Kong evolve into the major trend-setting city for
consumers in Asia and China?
Can Hong Kong establish new and productive roles for the
city?
Source: Daiwa
8
In terms of financial resources, the situation today looks better than at

any stage in the past
Beyond the citys track record, we think there are concrete reasons to give the local property market the benefit of
the doubt. Chief among these reasons are the financial resources that the major market participants have access
to. It is beyond dispute that the aggregate balance sheets of Hong Kongs households, corporate sector and the
government are a force to be reckoned with. At the same time, there is considerable wealth and financial resources
in the hands of at least some individuals and corporates in the territory.
Financial resources of the major market participants

1. The 10 largest property companies in Hong Kong
Total book NAV > USD200bn
Cash on hand > USD12bn
Net debt < USD30bn
Net gearing ratio < 10%
Annual gross rental > USD12bn
2. Private households
Bank deposit > USD1tn
Value of residential properties owned > USD0.8tn
Mortgage loan outstanding < 0.13tn
Home equity > USD0.6tn
3. Government
Fiscal Reserve > USD110bn
Budget surplus in 2017 > USD12bn
Source: Company reports, Daiwa
Another point is that market participants in Hong Kong have been unusually prudent in the face of the unusually
low interest-rate environment of recent years. This time around, the monetary authorities in Hong Kong and likely
Singapore as well seem determined to pre-empt the emergence of asset bubbles, to the point they have imposed
unprecedented and arguably draconian administrative measures to make leveraging up more difficult than ever
(see Chapter 4 for more details).
As such, however large the challenges that Hong Kong is facing, one cannot say that the participants are
unprepared or lack the resources to cope with adverse changes in the environment. As pointed out by Savills,
typically, a property cycle tends to end when faced with 4 of the factors tabled below. Heading into the second
quarter of 2017, it does not seem these potential triggers of an end to the cycle apply to the Hong Kong property
market currently.
Typical triggers for the ending of a property cycle

Likely to happen to Hong Kong in the next few years?
Yes Maybe No
Oversupply
Over-leverage
Banking crisis
Global Financial Crisis
Major economic recession
Major social and political crisis
Source: Savills, Daiwa
Does the Hong Kong property market need a challenge to drive it

forward?
Looking at the way the Hong Kong property market has evolved over the past few decades, one could say that,
paradoxically, it is better for the market to face challenges than to operate in a highly supportive environment.
There is an old Chinese saying that crisis and opportunity go hand in hand. In other words, it is fear and the need
to survive that compel Hong Kong property market participants to continue to improve and innovate, which
eventually takes the local economy to the next level of the value chain.
Seen in this light, we believe the challenges faced by the various segments of the Hong Kong property market in
recent years have been blessings in disguise. For example, had the surge in spending by visitors from the
Mainland continued unabated, there was a risk that Hong Kongs major retail districts would end up being uniformly
monotonous, overcrowded with watch and jewellery shops, as well as luxury brands.
9
Can Hong Kong take advantage of the change and move forward as a
city?
Has Hong Kong exhausted all of its growth opportunities, or are there still factors that can take it to the next level?
Just as with other factors in the free-market process, the answer to this question might be perceptible only after
the facts, as Alan Greenspan put it. Joseph Schumpeter argued that profit is the payment you get when you take
advantage of change. In any free capitalist economy, there will always be sectors that are facing challenges and
other sectors that are in decline. Those market participants that see the opportunities of tomorrow are necessarily
in the minority but they stand to reap good rewards as their visions become realities.
Our view is that, as a small and open economy, Hong Kong is used to facing change, and that these changes may
well accelerate in the coming years, not least because of the global factors now at play. More specifically, we
believe there is at least one major agent of change in the coming years that will directly affect Hong Kong: Chinas
changing role on the global arena.
Is China set to enter the world stage?

In the Inaugural Speech at the World Economic Forum, held in Davos in January 2017, President Xi Jinping made
the following remarks:
There was a time when China also had doubts about economic globalisation, and was not sure
whether it should join the World Trade Organization (WTO). But we came to the conclusion that
integration into the global economy is a historical trend. To grow its economy, China must have the
courage to swim in the vast ocean of the global market. If one is always afraid of bracing the storm
and exploring the new world, he will sooner or later get drowned in the ocean. Therefore, China took a
brave step to embrace the global market. We have had our fair share of choking in the water and
encountered whirlpools and choppy waves, but we have learned how to swim in this process. It has
proved to be a right strategic choice.

He went on:
Pursuing protectionism is like locking oneself in a dark room. While wind and rain may be kept outside,
that dark room will also block light and airChinas development is an opportunity for the world; China
has not only benefited from economic globalisation but also contributed to itChina will keep its door
wide open and not close it. An open door allows both other countries to access the Chinese market
and China itself to integrate with the world. And we hope that other countries will also keep their door
open to Chinese investors and keep the playing field level for us.
10
Can Chinas financial architecture be readily connected to the rest

of the world?
It remains to be seen whether China is as committed to integrating with the global economic order as President Xis
words imply. However, we believe the tremendous expansion in the size of Chinas economy and financial assets
over the past few decades means that its financial architecture cannot stay unchanged forever.
Indeed, we believe that China needs to establish a modern financial architecture, one commensurate with the size
and scale of its economy and financial assets today. Chinas financial architecture was first established to meet its
own needs and priorities, and its evolution has likewise been largely dictated by domestic considerations. But the
scale of the economy is such that we believe it cannot remain entirely isolated from the rest of the world for much
longer.
In this light, we contend that Chinas financial architecture needs to be connected with the rest of the world one way
or another. By the same token, it is hard to imagine Chinas financial system, in its present form and structure, fully
embracing global forces and norms because it is in many respects the product of a command economy.
The institutional gap between China and the rest of the world
Indeed, our view is that China is arguably the worlds first example of a command economy trying to transform into
a semi-command, semi-market-driven one an economy that is still a command economy at heart, but one that
features, and is subject to, productive market forces operating rigorously within it. There is simply no precedent for
this kind of transition.
At the same time, as much as China wants to modernise and become integrated with the global economic order,
we believe it is not prepared to give up altogether some of the legacies of the command economy, including
national security, social stability, and the supremacy of the states power.
The result: there exists a significant institutional gap between Chinas system and the rest of the world.
In the realms of trade and manufacturing, these institutional differences may not present large barriers to doing
business. But, as one moves deeper into other sectors, large and fundamental differences emerge between
Chinas way and the global way. Finance is one of the most complex sectors in any economy.
In this context, we believe there would be significant economic value in a city (or cities) or system (or systems) that
can effectively bridge the institutional gap between China and the rest of the world. And among the cities or
systems that could take on this role, it is reasonable to argue that Hong Kong has sufficient credentials to at least
be a candidate.
The institutional gap between China and the rest of the world and how
Hong Kong could help in bridging the gap
Source: Daiwa
11
Hong Kong has made some steps in the right direction already
In our opinion, market forces are increasingly calling for China to establish an offshore financial centre that would
more closely connect Chinas financial architecture with that of the rest of the world. Indeed, we view Shenzhens
Qinghai financial district and CNY liberalisation as steps in this direction. To the extent that Chinas financial
architecture is going to have an offshore dimension, we believe Hong Kong is well placed to get a share of the pie.
Our base case is that China cannot rely forever mainly on its banking sector to finance its economy, and that the
countrys capital market will have to expand considerably, though it will likely remain largely domestic. However,
even if the offshore component of Chinas financial architecture accounts for only 5% of the overall China capital
market, there should be more than enough impetus to drive sustained growth in the talent and capital heading to
Hong Kong. In turn, this growth should create significant opportunities for a city of Hong Kongs size. (Also see the
joint Daiwa-CBRE sector report of 25 May, 2015: The Mutual Market: a new helping help for office landlords).
The evolving role of Hong Kong in serving Chinas financial sector
Source: HKEx
Chief among the moves Hong Kong has made to bridge the gap is the launch in 2015 of the Shanghai-Hong Kong
Stock Connect scheme. While many observers focus on utilisation of the Stock Connect quota as a barometer of
the schemes success or failure, we believe the schemes significance extends far beyond this measure.
For us, the bigger picture is that Stock Connect represents a game-changing step in the institutional structures of
Hong Kong and China. As a result of the scheme, the rest of the world does not have to find ways to work through
Chinas system; it can use the Hong Kong route to do largely the same thing, as endorsed by regulators from both
sides.
At the same time, Mainland Chinese entities do not seem to have learnt their way around the system used
throughout the Western world. Instead, they can carry on doing things their way, as long as their activities
ultimately go through a single Mainland entity that can work with its Hong Kong counterpart. Having been extended
to Shenzhen at end-2016, the scheme could well be further broadened to include asset classes such as bonds,
ETFs and commodities. Indeed, the Mutual Market concept, first proposed back in 2015, continues to evolve.
12
The HKEx Strategic Plan 2016-18
Source: HKEx
Lets take things a step further and ask whether the institutional gap between China and the rest of the world
extends beyond the world of finance. We contend that such gaps do indeed exist in nearly all sectors, which should
present Hong Kong with further opportunities to take on the role of a kind of super-connector a more
sophisticated and value-enhancing role than that of a simple middle man.
Our view is that amid all the challenges Hong Kong will have to face, there will also be many new opportunities to
take and roles to play for the city. It is the vision, foresight, creativity and determination of market participants that
will determine whether the city makes the most of these possibilities.
As a metropolitan city, Hong Kong still has considerable room to grow

Population of Hong Kong versus other major international cities
(m)
40
35
30
25
20
15
10
5
0
Hong Kong
So Paulo
Tokyo
Seoul
Karachi
Guangzhou
Jakarta
Delhi
Beijing
Manila
New York City
Shanghai
Mexico City
Source: Wikipedia
13
Population of Hong Kong versus cities in China

('000 persons)
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
Yinchuan
Luoyang
Lanzhou
Xining
Jinan
Wuxi
Changzhou
Haikou
Hefei
Zibo
Chengdu
Beijing
Ganzhou
Hong Kong
Nanning
Kunming
Suzhou
Zhengzhou
Xuzhou
Xiamen
Zhongshan
Hohhot
Zhuhai
Shanghai
Hangzhou
Xian
Nanjing
Changsha
Shantou
Nanchang
Guilin
Jiujiang
Guiyang
Tianjin
Harbin
Wuhan
Wenzhou
Ningbo
Yantai
Lianyungang
Sanya
Guangzhou
Shijiazhuang
Chongqing
Qingdao
Dongguan
Nantong
Dalian
Huizhou
Taiyuan
Fuzhou
Foshan
Shenzhen
Shenyang
Bengbu
Zhenjiang
Source: CEIC, Wikipedia, Daiwa
Whatever the case, Hong Kongs population of 7m is small relative to major cities in China and the rest of the world.
Given the size of Chinas population, the number of Chinese living overseas, and the relative ease with which
expatriates can find jobs and live in Hong Kong, we think the city could see a sustained inflow of capital and talent
for many years, provided it can find new roles to play and has the office, retail and housing space needed to attract
and retain them.
Over the past few decades, many of the worlds major cities have become large and more populated. Yet Hong
Kong remains moderately sized in terms of its population and geographical spread. Indeed, the citys urban area is
within a 30-minute car drive for most people, while driving the length of Hong Kong could be done within an hour.
Therefore, there is still considerable scope for Hong Kong to expand in the years to come. In which case, where do
the citys property companies fit in?
The Hong Kong property companies look well-positioned to play any

leap in Hong Kong property
One only needs to assume that the Hong Kong property market will be able to make a modest step forward to
conclude that the citys property companies are in a very safe and favourable position a situation few property
companies in the world have ever faced.
For as long as the Hong Kong property market doesn't collapse (which we see as a very unlikely scenario), we
think the citys property companies will offer investors secure asset backing and recurrent income, which could
translate into rising dividend yields. And if the market succeeds in making a leap forward, then the property
companies should get a good slice of the rise in the economic value of Hong Kongs property assets just by holding
onto what they already own.
It is important to note that the Hong Kong property companies are actively managed and, in many respects,
steadily improving as far as managing the property business is concerned. Although Hong Kong property stocks
are not priced as premier stocks in global property, we are not convinced they are really inferior to the global
names in the execution of property projects and management of property assets.
Compared with some global property companies, what Hong Kong property companies may be seen as lacking is
the organisational structures and systems, and the checks and balances needed for professionals to manage large
portfolios of property assets across large geographical areas. But when it comes to the management of individual
assets, the Hong Kong players do not seem to us to trail the global players.
Indeed, one could argue that mixed development will be an important business model for major cities, in which
case the Hong Kong players are perhaps more experienced than even the top names in global property.
Indeed, within the corporate world, the Hong Kong property companies seem to command much more respect than
their stock valuations might imply they are seen by their global peers as players to be reckoned with as far as
property expertise is concerned.
Further, we see a big disconnect between how the stock market views the Hong Kong property companies and
how they are seen by their property-industry peers, the banks and the bond market (and how their assets are
priced in the physical market).
14
The billion-dollar question: whos right? The stock market or the physical
and all other markets?
In other words, it seems that in all markets other than the stock market, the Hong Kong property companies are
seen as reputable and respected players. Which market has the right perspective? And if the stock market is in fact
misguided, what would make it change its view?
We contend that if the Hong Kong property market can move forward, and the Hong Kong property companies can
take their opportunities to modernise, then the Hong Kong property players could become more recognised names
in global property and eventually perhaps even premier names in the industry.
Alongside this view, we note that China could likewise emerge as a sizeable and important market in global
property. While this scenario seems remote from an equity-market perspective, we believe it is already the case as
far as the physical market is concerned.
Since Hong Kong is probably the most advanced of the Chinese cities in terms of property development and
metropolitanisation, we see ample room for Hong Kong players to put their expertise and experience to use in
major cities in China.
In fact, they have been doing so for more than two decades. But only recently have they joined the ranks of the
largest players in commercial property in Chinas major cities. Collectively, the Hong Kong players are now among
the largest players in prime commercial property in Shanghai, and they own some of the most prime commercial
property assets in cities such as Beijing, Shenzhen and Guangzhou, Chengdu, and Chongqing.
By extension, we believe the Hong Kong players could become major players in prime commercial property in
many major cities in China, though the equity market does not look to be pricing in such a possibility.
All of which brings us to our central argument: the Hong Kong property companies have good exposure to the
upside potential in Hong Kong property and yet investing in them does not entail that much risk. As long as they
can continue to improve, modernise and become more professional, we think they could go on to be seen as
premier names in global property something the equity markets have yet to recognise, in our view.
As highlighted in our Special Reports of May and July 2016, if the Hong Kong property companies continue to
modernise, they should remain on track to unlock USD100bn or more of investment value in their shares to global
investors. Such a sizable sum should not be ignored.
USD100bn in investment value waiting to be unlocked

(USDbn)
400
Potential investment
30 0 value to be unlocked
200
100
0
Estimat ed market va lu e of the p rop ert y and o ther assets owned by Total market ca p of the listed real estate securitie s in HK
HK's liste d real estat e comp anies
Source: Daiwa estimates
In the following sections, we ask and try to answer another 5 inter-linked questions:
1) Are Hong Kong property prices now too high to be sustained?
2) Is the upcycle beginning to end?
3) Will US interest-rate normalisation trigger an end to the Hong Kong property cycle?
4) Are there factors that could take Hong Kong property to the next level?
5) Are Hong Kong property stocks an attractive way to play the potential leap in Hong Kong property?
15
16
Question 2
Are Hong Kong property prices too
high?
17
Q2: Are Hong Kong property prices too high?

Prices are incentives, signals and predictions...We must look at the price system as such a mechanism for
communicating information if we want to understand its real function.
- Frederich August Hayek
For good or ill, a forgiving capitalist process is driving wealth creation.. In the end, it is clear that all economic
progress rests on competitionThe incentives associated with a competitive market are critical in determining the
degree to which our endowments of natural resources and human skills are turned into wealth.
- Alan Greenspan
Hong Kong: an anomaly in global property

That Hong Kong property prices are some of the highest in the world is beyond dispute. In physics and investment,
of course, there is well-known mantra: what goes up must come down. It is reasonable therefore for observers to
question whether Hong Kong property prices have reached a level that is too high to be sustained.
Bearing in mind that prices for some property assets in Hong Kong are already comparable to or even higher than
those of New York and London, it seems sensible at first blush to conclude that Hong Kong property prices are now
too high to be sustained.
We can see the logic and acknowledge that the argument looks compelling. But, on this basis, Hong Kong property
prices have looked absurdly high for many years. Not much has changed over many decades, though the
situation has become pronounced in recent years.
Common sense dictates that there must be some reasons why Hong Kong property prices have continued to rise
and defy all expectations for such a long period.
We argue that Hong Kong is an anomaly in global property an anomaly created by a combination of
circumstances rarely if ever found in other property markets in the world. We consider Hong Kong property to be a
phenomenon created by a decades-long cumulative undersupply of land on a barren little island which has evolved
from a fishing village of little import into an international financial centre.
Hong Kong in 1841
Source: Daiwa, Google
Hong Kong today
Source: Daiwa, Google
18
This is a city with an area of just 1,100 sq km; most of its economic activity is concentrated in 130 sq km (Hong
Kong plus Kowloon), if not less than 40 sq km (the size of flat land in the Hong Kong Island). Yet it is connected
with the two largest economies in the world -- one in a monetary sense, the other in terms of its real economy.
Hong Kong: land area vs. major international cities

(sq km)
2,500
2,000
1,500
1,000
500
0
Tokyo Central London New York City HK Island + HK Island Manhattan Kowloon
Kowloon
Source: Wikipedia
Hong Kong property: a market with depth and sophistication

In common with many seemingly absurd but persistent phenomenons, the issue of Hong Kong property prices is
more complex that it may first appear. Yes, in certain cross-sections of the market, prices do look absurdly high.
However, the bigger picture requires a more nuanced analysis, in our view.
First, the question of what is the current level of Hong Kong property prices is not as straightforward to answer as
it might first appear. That Hong Kongs most expensive property assets be they office, retail or residential rank
among the highest in the world is not in dispute. But there are two other aspects that must be taken into account.
One is the total market value of Hong Kong property assets. Unit price are only one part of the puzzle. The other
key component is volume. In the stock market, it is not uncommon for high-growth small-cap companies to trade at
much higher PER multiples than established blue chips. This should not be viewed as mis-pricing, since the market
expects the small-cap companies to deliver stronger earnings growth than the blue chips.
Hence, while the per share value of the small caps earnings seems expensive, the small caps total market cap is
notably smaller than those of blue chips, and we believe that the total market cap rather than PER is the more
appropriate yardstick.
In this light and in line with Hayeks insight related to the function of price as a market signal we view the high
PER commanded by the small cap as the markets way of saying that demand for this companys shares is large
relative to the number of its shares that are available for trading. As and when this company issues more shares,
its total market value will likely increase and its relative PER is likely to converge more closely with those of blue
chips.
We believe a similar perspective is useful when analysing Hong Kong property prices. It is true that the unit price of
some property assets in Hong Kong is even higher than in London or New York. But the total market value of each
property asset class in Hong Kong relative to those of other major global metropolitan cities tells a different story.
We know the geographical size of Hong Kong is small compared with London and New York. And across each
major property asset class, the total stock (in terms of total GFA) in Hong Kong is appreciably lower than in New
York, London or Tokyo.
19
Grade-A office stock in Hong Kong versus international peers

(m sqm)
25
20
15
10
0
Tokyo (Central 5 Wards) New York (Manhattan) London (Central) Hong Kong Shanghai
Source: DTZ , Daiwa
Note that if city As total physical property stock is only 20% that of City B, then even if the average unit price of all
the property assets in City A is double that of City B, the total market value of the property assets in City A would
still be 60% lower than in City B.
Indeed, the high ASP for City A could be a function of the insufficient availability of physical property assets and, as
such, it could be the markets way of saying that the level of property asset stock in City A is not big enough. As
and when the physical stock of property assets increases, then prices in City A should gradually converge with
those of City B while the gap in the total market value of the two cities property assets would narrow.
The range of office rents in Hong Kong is probably the widest in Asia,
and possibly in the world
Apart from this market-cap consideration, it is also worth looking at whether the samples used in these surveys are
genuinely representative of whole property segments. After all, just because some property assets carry some of
the worlds highest prices does not necessarily mean that the Hong Kong property sector as a whole is similarly
expensive.
Take the office segment as an example. If a company wants to secure new space in the top-five office buildings in
Hong Kong, it will probably have to pay more than USD20/sq ft (net lettable basis) among the worlds most
expensive rentals in the office segment. However, the Hong Kong office market is comprised of more than 300
office buildings, not all of which are as expensive.
The range of achieved rents in major office districts in Hong Kong (3Q16)
(HKD/sq ft/mth)
180
160 High
140
120 Average
100
80
Low
60
40
20
0
Central Admiralty & Wanchai & Greater Tsim HK East Kowloon New Territories Kowloon East Wong Chuk
Sheung Wan Causeway Bay Sha Tsui Others Hang
Source: CBRE Research
20
The range of prices and rents of various property asset classes in Hong Kong
(HKD/sq ft, based on GFA) Capital value (HKD/sq ft, based on GFA) Rental value
300,000
600,000 300
3,000
200,000 200
100x 200x
100,000 100
10x
14x 12x
9x
0 0
Residential Office Retail Residential Office Retail
Source: Daiwa forecasts
Once we go beyond the 5 major office buildings in Central, rental levels are notably lower, at around USD10-15/sq
ft. Moreover, if a company is prepared to move to a building outside the top 20 in Central, or set up in Wanchai or
Causeway Bay (less than 15 minutes from Central by car), it can find quality buildings in the USD8-10/sq ft range
not so different from the level in other major international cities. Indeed, just a few minutes walk from IFC in Central,
prices for space in old office buildings are 60% less, at USD8/sq ft or even less.
Distribution of Grade-A office space in Hong Kong

(m sq ft)
90
77m sq ft
80
70
60
50
40
28m sq ft
30
20 16m sq ft
10
0
Grade A Grade B Grade C
Hong Kong Island Kowloon (Incl. New Kowloon) New Territories
Source: CEIC
On the other hand, if a company is prepared to move to Kowloon East, which is just 30 minutes travel time from
Central, it could find many office buildings with specs comparable to or better than those in Central, at rents of
USD3-5/sq ft. That is not so far-fetched a notion: travelling from one end of Manhattan to the other takes more than
30 minutes, and the same could be said of going from the Bank area in London to the West End. And, if the
company is prepared to accept being located in Kwai Chung, Cheung Sha Wan or Wong Chuk Hang, it could find
space for rents as low as USD2-3/sq ft.
In other words, while some office buildings in Hong Kong are among the worlds most expensive, these only
account for a small portion of Hong Kongs office stock. Tenants do have much cheaper alternatives. Some office
tenants in Hong Kong pay very high rents for their office space not because they dont have a choice, but because
they have chosen to do so.
Over the past 10 years or so, the Hong Kong office market has seen large-scale relocation and a reconfiguration of
the office-space requirements of financial institutions and multinationals. Many firms have moved out of Central. Still,
the vacancy rate in Central is below 2% and rents are close to record highs. Hence, some companies have chosen to
pay premium rents, perhaps because of the nature of their business (where operating profit per employee rises
substantially in good times, or where image is a big factor in the business) or other strategic considerations.
In a sense then, the achieved rents of the most prime office buildings in Hong Kong may simply reflect the
expected economic or commercial value that can be derived from such a space.
The range of retail rents in Hong Kong is even wider

Much the same can be said of Hong Kong retail property. Indeed, the range of retail rents in Hong Kong is even
wider than in the office segment. While the range between top-end and bottom-end office space is about 10x
(USD2-20/sq ft), the range in retail goes from USD2/sq ft to more than USD250/sq ft per month.
21
The range of achieved retail rents in Hong Kong

(HKD/sq ft, based on GFA)
800
2,100
700
2,000
1,900
600
500
400
300
200
100
0
Shopping Arcade
CK
Swire
MTRC
Harbour City
HK Land
New World
Champion REIT
Landmark
Henderson
High st shop in major
Pacific Place
Sino Land
SHKP
Hysan
HLP
Sunlight REIT
Fortune REIT
Chinese Estates
Metro City Phase 1

High st shop in
Wharf
Link REIT
Sheung Shui
Russell St
st in CWB/TST
Source: Companies, Daiwa estimates
Generally speaking, retail rents in a city can be seen as a reflection of tenants expectations about the sales
productivity of the retail property asset. Provided that free-market forces are allowed to play out, the rent charged
by a retail landlord cannot over time deviate much from the long-term sustainable occupancy cost of the retailer.
Of course, advertising and strategic considerations can play a role in a retailers decision of where to rent space.
But if the tenants business cannot justify the rent, the situation will not last long. We acknowledge that the
emergence of on-line sales has added another dimension to the rent that a retail property asset can command, but
we do not think this factor would materially affect our argument.
Hence, the nature of retail properties is that the rent always tends to adjust to business realities. Indeed, high-street
stores in Hong Kong, whose rentals surged during boom times, have fallen by as much as 60% from the peak in
2014. Rents in malls have not fallen by as much, and some have continued to rise, albeit more slowly.
In evaluating retail rents, we believe it is important to compare the rental level with the productivity of the space.
While some retail properties in Hong Kong command high absolute rentals by global standards, some of these
properties can deliver the productivity levels needed to make paying such rents commercially viable.
In the US retail property sector, about USD300/sq ft seems to be the benchmark for mass-market malls, and
USD500/sq ft for top-end malls. From this perspective, though the absolute level of rents for many retail property
assets in Hong Kong is high, the rents look altogether more acceptable when these assets sales productivity is taken
into account. Indeed, some retail property assets in Hong Kong have sales productivity of USD2,000/sq ft or more.
In other words, while the absolute rental level of some retail properties in Hong Kong is high in a global context,
there are retail properties in Hong Kong where the rental level can be backed up by the sales productivity of the
underlying assets. Our understanding is that the current occupancy cost of most major malls in Hong Kong is still in
the 11-20% range.
Moreover, just as with the office segment, while rents for some high-street shops in Hong Kong are very high, there
are retail spaces in Hong Kong with much lower rental levels. And, in another echo of the office segment, many
companies have in recent years opened stores in the New Territories or other districts that they likely would not
have considered just 10 years ago.
Retail property tenants in Hong Kong are likewise not without choices. Some retailers pay the rent they are paying
because they are willing to do so.
The price range for residential properties is probably the widest

The Hong Kong residential property sector has similar characteristics. Indeed, the price range in residential
property assets in Hong Kong is probably the widest of all the segments.
The following exhibit features Hong Kong government data related to different classes of housing in various
districts. Overall, the unit price range is 15x, from HKD3.5m (Class A unit in New Territories) to HKD52m (Class E
unit in HK Island). However, the government figures refer to the average price in each category. If we look instead
at market transactions, there are a few units in Hong Kong with price tags of more than HKD500m (the highest so
far is HKD2bn) whereas the lowest went for around HKD2.5m, implying a top-to-bottom range of around 200 times .
22
Structure of residential stock in Hong Kong in terms of unit size and price
Private housing stocks (No. of units) - end-2015 Class A Class B Class C Class D Class E Total
HK Island 105,998 137,159 38,791 27,007 15,952 324,907
Kowloon 127,339 166,228 41,226 17,607 2,922 355,322
New Territories 122,632 256,677 60,283 18,756 6,877 465,225
Total 355,969 560,064 140,300 63,370 25,751 1,145,454
Private housing price (HKD/sq ft) - December 2016 Class A Class B Class C Class D Class E
HK Island 13,399 13,808 15,611 19,742 24,858
Kowloon 10,914 11,218 14,461 17,234 17,830
New Territories 10,223 9,065 9,548 9,107 7,923
Private housing price (HKDm/unit) - December 2016 Class A Class B Class C Class D Class E
HK Island 4.8 9.1 15.9 30.7 53.5
Kowloon 3.9 7.4 14.7 26.8 38.4
New Territories 3.7 6.0 9.7 14.2 17.1
Source: CEIC, Daiwa
Back in 2010, the number of smaller ticket-sized residential property assets in Hong Kong was still quite sizeable,
with some 0.35m units (about 30% of the territorys total private housing stock) priced at around HKD2.7m
(USD346,000) or below, according to the governments Property Review.
Structure of residential stock in Hong Kong in unit size and price (2010)
Private housing stocks (No. of units) - end-2010 Class A Class B Class C Class D Class E Total
HK Island 105,804 136,979 38,635 26,217 15,575 323,210
Kowloon 126,231 164,230 39,951 16,441 2,695 349,548
New Territories 119,844 237,230 51,335 15,863 5,879 430,151
Total 351,879 538,439 129,921 58,521 24,149 1,102,909
Private housing price (HKD/sq ft) - December 2010 Class A Class B Class C Class D Class E
HK Island 7,660 8,657 10,991 15,329 18,661
Kowloon 5,572 6,921 11,716 12,777 15,307
New Territories 4,868 4,706 5,849 6,550 7,080
Private housing price (HKDm/unit) - December 2010 Class A Class B Class C Class D Class E
HK Island 2.7 5.7 11.2 23.8 40.2
Kowloon 2.0 4.6 11.9 19.9 33.0
New Territories 1.7 3.1 5.9 10.2 15.2
Source: CEIC, Daiwa
Six years ago, the cost of getting onto the property ladder for private residential housing in Hong Kong was not so
high. Granted, these were old and small units, but the ticket size wasnt prohibitive and prospective buyers were
not entirely without choices.
However, over the past 6 years, the number of small ticket-sized units has decreased rapidly, such that the
minimum entry point for private residential units in Hong Kong has substantially increased.
Hong Kong: changes in prices for different types of units

Class A Class B Class C Class D Class E
Change in price (Nov 2010* - Aug 2015***)
HK Island 82.1% 61.5% 49.9% 21.9% 29.1%
Kowloon 105.8% 65.7% 16.7% 8.3% 15.1%
New Territories 115.1% 96.4% 67.2% 47.2% 11.1%
Average 101.0% 74.5% 44.6% 25.8% 18.4%
Change in price (Feb 2013** - Aug 2015)

HK Island 18.2% 16.3% 11.6% 4.2% -0.1%
Kowloon 32.2% 15.4% -0.8% -8.1% 14.6%
New Territories 37.8% 29.3% 24.6% 44.3% 8.3%
Average 29.4% 20.3% 11.8% 13.5% 7.6%
Change in price (Aug 2015 - Dec 2016)

HK Island -5.3% -1.6% -11.8% 6.6% 12.3%
Kowloon -6.8% -0.2% 1.1% 31.8% -2.1%
New Territories -1.3% -2.4% -5.3% -10.4% -11.7%
Average -4.4% -1.4% -5.3% 9.3% -0.5%
Source: CEIC, Daiwa
Note: *Nov 2010: the government introduced its first measures for the residential property sector
**Feb 2013: the government introduced its most severe measures for the residential property sector
***Aug 2015: the most recent peak in residential property prices in Hong Kong
23
We think this suggests that there is ample bottom-up demand from end-users in Hong Kong. In property, it is
useful to examine both top-down and bottom-up forces. When the bottom-up forces are strong, the fundamentals of
the real-estate market tend not to be too bad.
Our point is that, while Hong Kong property prices are high, there is sufficient depth in the market, especially in the
office sector and probably retail as well, such that there are much cheaper alternatives for tenants.
Hence, property prices in Hong Kong are determined by competitive forces in a free market, and there exists a
price structure -- or what we call a price contour that signals this is a relatively mature and sophisticated market.
This price contour together with free competition among different districts should help to restrain prices and rents in
certain areas, preventing them from going too far beyond commercial realities.
Indeed, tenants in Hong Kong (whether office or retail) have actively engaged in exploring alternative, cheaper
locations. For example, in the office sector, we have seen decentralised offices perform well over the past 10 years,
while many areas formerly regarded as fringe areas have gone on to become established office areas.
Similarly, in retail, we have seen the rise of suburban malls such as New Town Plaza and Tuen Mun Town Plaza,
and many of these malls feature tenants one would not have expected to find there just a decade ago. By and large,
most retail tenants in Hong Kong have accepted the idea of opening stores in the New Territories, a development
that we believe will help to restrain retail rents in the core areas.
A similar trend is at play in the residential market, though government measures may have lessened its impact.
Still, we have seen the emergence of some new residential districts.
One of the major factors in the development of the Hong Kong residential property market in recent years has been
the rise of West Kowloon as a luxury residential location. In the 2000s, Olympian Station looked like a new area
and the area next to it Tai Kok Tsui was not regarded as a high-end location. Fast forward to the present time
and Olympian Station has established itself as a mid-/high-end residential location. Similarly, Hung Hom and To
Kwa Wan look to have become higher-end locations than before.
Meanwhile, in the New Territories, Tseung Kwan O has gone from being a market for home-starters to a mid-range
or mid-to-high end residential area. Similarly, Yoho Town in Yuen Long and Century Gateway in Tuen Mun now
command prices comparable to tier 2 estates in the urban areas something that would have been hard to imagine
10 years ago.
Had the government not imposed measures to restrain demand, and had it speeded up land conversion (the main
source of land in Hong Kong before the 1997 handover to China; the inadequate housing supply of recent years
owes much to the relatively slow conversion of land since then), the migration to the New Territories would have
been still more pronounced. Hence, we think more people would have left the city centre and headed for the New
Territories, effectively trading commute times for more living space and better living environments, just as people in
New York City and London have been doing for decades.
In sum, we highlight that competitive market forces exist to help determine both the absolute and relative prices of
different districts in Hong Kong. In assessing any property market, we believe that the presence and strength of this
trickling down (in the sense that rising prices and demand for some higher-end districts result in growing demand
for alternative areas) is an important indicator of the extent of demand. This force looks to have been at play, with
some vigour, in Hong Kong.
Looking at the price structure of the Hong Kong property market in its entirety, we conclude there is considerable
depth and sophistication to the market, and the very high prices commanded by certain segments are a result of
natural and competitive market forces, rather than the result of exuberance or regulations.
In the next section, we dive deeper into the issue and ask: 1) whether Hong Kong property prices have reached a
level that is too high to sustain, effectively pricing the city out of the market, and 2) is the upcycle beginning to end?
24
Question 3
Can prices be sustained or is the
upcycle coming to an end?
25
Q3: Can prices be sustained or is the upcycle coming to an end?

Market economies are driven by what Professor Joseph Schumpeter, a number of decades ago, called Creative
Destruction. By this he meant newer ways of doing things, newer products, and novel engineering and
architectural insights that induce the continuous obsolescence and retirement of factories and equipment and a
reshuffling of workers to new and different activities. Market economies in that sense are continuously renewing
themselves. Innovation, risk-taking, and competition are the driving forces that propel standards of living
progressively higher
- Alan Greenspan
Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.
- Sir John Templeton
With the absolute price level of prime property assets in Hong Kong being high by international standards and the
property upcycle (which started in 2H03) having run now for some 13 years, it is reasonable to question whether
Hong Kong property prices have become too high to be sustained, and whether its property upcycle is now
approaching an end.
We concur with Schumpeter that many things in a capitalist market economy need to be understood as an
evolutionary process; in this section, we analyse this question by delving into how Hong Kong property has evolved,
how the major market participants have responded to the prevailing property prices in Hong Kong, and whether
Hong Kong property prices are sufficiently backed by economic and commercial fundamentals.
Our conclusion is that the Hong Kong property market is not evolving into its final phase. On the contrary, we
believe price signals in the free market have been providing direction for the evolution of the physical market
landscape prompting market participants to find ways to cope with the high property prices, and thereby creating a
property market with more breadth and depth.
We summarise our views in the following analysis on the evolutionary trajectory of the Hong Kong property market
as a whole, which is followed by a deeper analysis of the 3 major segments that comprise Hong Kong property:
office, retail and residential.
One of the most consolidated property markets in the world?

In our September 2013 Hong Kong Property Toolkit, we put forward the view that Hong Kong property is a global
anomaly in many respects, in particular the extent to which it is dominated by a handful of major players in all key
property segments. Indeed, we noted that Hong Kong is arguably one of the most consolidated property markets in
the world, with a few major property players dominating the sector, be it the residential, office or retail segment.
By and large, this situation is mainly a result of competitive market forces. Over the past few decades, Hong Kong
has encountered some of the most turbulent periods ever seen in global property. As a result of these severe
property downturns, many of Hong Kongs original property companies were forced to either exit the market or
heavily downsize (Hong Kong had well over 100 property companies back in the 1960s), paving the way for a few
big property companies to dominate the market.
Downturns in Hong Kong property in the past

Downturns Triggers Length
1960s Banking crisis 2 years
1967 Riots 2 years
1973 Oil crisis 2 years
1981 Sovereignty crisis 3 years
1997 Asia financial turmoil 6 years
Source: Daiwa
What this means is that the Hong Kong property market is now essentially driven by a handful of major property
players, each of which have well over 40 years of experience in the industry and have survived many ordeals in the
26
industry in the past, and yet are still run by more or less the same group of people. Such depth of experience and
level of dominance and continuity of the major players is unusual in global property, in our view. Importantly, we
think the path the Hong Kong players have taken has left behind some cultural traits that are also unusual in terms
of the global property scene.
It appears to us that in many property markets in the world, some property companies are essentially playing on
interest-rate cycles and making returns through the clever use of leverage and the capital-raising function provided
by the capital markets. Some seem to have the objective of maximising their returns within certain defined time
frames and as a result, elements of when to exit and how to exit may have been on the minds of some players from
the very outset.
However, this is not the case in Hong Kong. By the standard of global peers, the Hong Kong players are unusually
long-term in their thinking, which may leave some to wonder whether their business model is essentially one of
building wealth and accumulating trophy assets for posterity.
Whatever the case, the Hong Kong players look highly prudent in terms of financial leverage by global industry
standards. As of today, 2 of the major property companies in Hong Kong are in net cash positions and virtually all
have a net gearing ratio of below 15% an unusual feat for an industry known to be very capital-intensive and
seen by some as essentially an industry about using leverage.
In our view, one legacy of such cultural traits is that the major players in Hong Kong all seem to have paid a lot of
attention to managing the risk dimension of the business. They have tended to focus mainly on the long-term
viability of their businesses as well as what is going to work in the very long term, rather than maximising
opportunities provided by short-term circumstances, such as the interest-rate cycle, credit cycle, etc.
As such, it does not appear to us that the Hong Kong players have been operating under the assumption that the
high property prices in Hong Kong are going to keep on rising or remain at current levels ad infinitum. Looking back,
it appears that many treated the price rises as more like a bonus or windfall, and prefer to preserve such windfalls
for posterity rather than using them to leverage up to the limit to maximise their returns.
Have the Hong Kong players ever been driven by euphoria or

exuberance? It appears not
In our opinion, the cultural traits discussed above have led the property companies in Hong Kong to take a long-
term view of their property businesses. As such, instead of counting on high property values to leverage up to the
limit (and then face the consequences when the cycle eventually turns), the Hong Kong players have adopted a
patient and long-term view as a way of generating attractive and sustainable returns.
In this connection, note that many Hong Kong property companies have tried different routes in order to achieve
sustained earnings growth over the long term, and many have tried not to focus merely on Hong Kong property and
certainly not invested based on the assumption that the Hong Kong property market would continue to boom.
In hindsight, Hopewell (54 HK, not rated) might be considered one of the first examples of a Hong Kong property
company trying to diversify away from Hong Kong property, in that it has used its profits from Hong Kong property
to invest heavily in infrastructure projects in Asia and China. New World Development (17 HK, not rated) is another
property company that has tried to diversify, investing in overseas hotels back in the 1980s and then diversifying
into infrastructure, China property, telecom and others.
Meanwhile, Hongkong Land (HKL SP, USD7.24, Buy [1]) invested in Trafalgar House in London back in the early
1990s and then used property profits from Hong Kong to invest in Singapore and other countries in Asia.
Arguably, even large players like Cheung Kong (1113 HK, HKD53.0, Buy [1]) have not been that focused on Hong
Kong property. In retrospect, we would contend that the company has used Hong Kong property profits to finance
the transformation of Hutchison Whampoa into a global conglomerate (Cheung Kong underwrote the 2 rights
issues for Hutchison Whampoa in the early 1990s), and all along, it has not focused that much on building
commercial properties in Hong Kong for long-term investment.
In short, regardless of how well or otherwise Hong Kong property prices have done, there has never really been
any exuberance among the major players about the Hong Kong property sector. This background is important, in
27
our view, because there has probably never been excessive optimism in the market, and the investments made by
Hong Kong property companies in Hong Kong, by and large, have been rational and prudent commercial decisions
based on the prevailing environment at the time.
Are the Hong Kong players essentially guided by market forces to

cope with the high real estate prices in the territory?
In this light, one may say that many of the investments made by Hong Kong property companies over the past few
decades were rational commercial responses to the prevailing market signals. To the extent that the free market
can often generate a self-correcting response over time, one may argue that many of the investments and
responses made by Hong Kong property companies over the past few decades can be seen as attempts to tame or
rationalise the high real estate prices in Hong Kong.
In retrospect, we think projects like Pacific Place, and the transformation of Island East and Kowloon East, can be
seen as attempts made by the long-term-oriented market participants to cope with the situation of high office rents
in Central. Indeed, you could argue that they represent common sense solutions proposed by the private property
companies to address or rationalise the phenomenon of high rents in Central.
In any case, our observation is that the Hong Kong property companies, by and large, were not too carried away by
the property market boom of 2004-15. Instead of taking up leverage to make the most from the boom, they decided
to capitalise on it by building alternatives.
In our view, the Hong Kong property market and its major participants have not been unresponsive to the high
rents and prices in Hong Kong. Rather, some have pro-actively adapted and responded to the situation. In this light,
Hong Kong real estate could be seen as a market where the players constantly try to come to terms with the high
prices. In our opinion, the Hong Kong players could be considered experienced, prudent and rational players which
invest in Hong Kong property when the economics make commercial sense in the long run.
While Hong Kong property prices are undoubtedly high, they are high for a reason, in our view, and we do not think
the market has been complacent about it, and made investments based on the assumption that such prices and
rents will continue to rise ad infinitum.
On the contrary, many major property companies have made investments which, if proven to be workable, should
help restrain property prices, as much of what they did was about providing supply and cheaper alternatives to the
market to profit from the high prices/ rents.
As we see it, the Hong Kong property market is more dynamic and multi-faceted than it may first appear. And we
take the dynamism and depth exhibited by it as signs of a relatively mature and sophisticated property market.
In what follows, we examine the 3 major segments of Hong Kong property office, retail, and residential in
greater detail to substantiate our view that the Hong Kong property market is mature, sophisticated and dynamic
and not in a situation where its prices have become too high to be sustained. Rather, we believe it is sophisticated
and could be on the verge of taking a leap forward.
Office: the leading segment in this cycle?

Opinions on the Hong Kong office market are divided. While some see it as having reached a cyclical peak, we see
it as the leading segment in Hong Kong property in this cycle, and indeed the first sector to come out of the
adjustment.
To recap, our read is that the Hong Kong property market has been moving along the path of a metropolitan
property market, with phase one being characterised by an across-the-board rise in prices for top-end Hong Kong
property assets to amongst the highest in the world. This would sooner or later meet with natural resistance from
market participants, and we believe the office sector was the first to face this issue (starting with Central Grade A
office rents in 2010). However, the Hong Kong office sector had more or less emerged from such an adjustment by
2014 in the sense that by then it had wiped out many of the excesses created in the previous boom.
28
Current position of the 3 property segments in Hong Kong*
Source: Daiwa
*More details on the metropolitanisation process can be found on page 72
In the office sector, there is no ready and generally accepted yardstick, like occupancy cost in the retail property
sector, to assess whether the aggregate affordability for office space in Hong Kong is strong or not. However, we
believe profit tax paid in Hong Kong can be an important and reliable indicator to gauge this metric. We see
aggregate profit tax paid as a conservative and reliable indicator for the aggregate profits of the corporate sector, in
that presumably, no company would overstate its profitability and tax liability.
Importantly, based on this indicator, the current affordability for office space in Hong Kong looks healthy. As shown
in the following table, profit tax paid in Hong Kong reached a record high in 2015 which suggests that while some
companies or industries are facing difficulties, there are others that have found new opportunities, and at the
aggregate level, the situation does not look bad.
Hong Kong: corporate profit tax paid

(HKDm)
160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
1994/95
1995/96
1996/97
1997/98
1998/99
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
2011/12
2012/13
2013/14
2014/15
2015/16
Source: HKSAR Government
Meanwhile, we cross-checked our findings by rebasing the governments office rental index and found that
corporate profits in Hong Kong in recent years have been rising faster than office rents. Between 1994 and 2015,
corporate profit tax paid in Hong Kong rose by about 3x to HKD138bn, while for the Grade A office rents, it was up
a mere 2% over this period office rents fell by as much as 70% from 3Q97-2Q03.
Overall, the picture seems to suggest that while office rents in Hong Kong have been rising, they have been
backed by an increase in corporate profits and employment in Hong Kong. This is before we take into account the
office relocation opportunities in the sector, which is an effective way to manage office rental costs in Hong Kong,
because if rent is the main factor affecting the profitability of a business, companies can always relocate to other
less-expensive districts to address the issue.
29
Changes in office rents vs. corporate profits tax and number of employed persons
(Rebased)
350
300
250
200
150
100
50
0
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Office Rental Index (Overall) Corporate profits tax paid Employed persons
Source: CEIC, Daiwa
Moreover, on the corporate profit tax indicator, we see 2 other points worth noting:
1. Hong Kong still follows the British colonys territory principle that income generated outside Hong Kong is not
subject to Hong Kong tax. For example, the tax paid by Cheung Kong Infrastructure (1038 HK, HKD61.75,
Outperform [2]) is much lower than the statutory rate, simply because many of its businesses are outside Hong
Kong and hence the profits generated are not subject to Hong Kong tax. For corporations with businesses
across the region or across the globe, there are tax advantages associated with being located in Hong Kong,
and as such the profit tax they pay in Hong Kong is likely to be an understatement of their true profitability.
CKI: profit tax and effective tax rate

(HKDm)
1,000 25%
800 20%
600 15%
400 10%
200 5%
0 0%
(200) -5%
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Profits tax Effective tax rate

Source: Bloomberg
2. Even for profits reported as derived from Hong Kong, the effective tax rate paid by many businesses in
Hong Kong is often lower than the statutory rate. Our read on the tax structure in Hong Kong is that it is
dominated by the top players, and the Hong Kong Government has never had to worry about a budget
deficit except during the 1998-2003 period. Meanwhile, there exists a large number of smaller companies
in Hong Kong. As such, the reported profitability of many companies in Hong Kong is likely to be
understated, especially for the smaller businesses which receive a large part of their revenue in cash.
Number of overseas companies with regional headquarters in Hong Kong

(No. of companies)
1,600
1,400
1,200
1,000
800
600
400
200
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
From the perspective of corporate profits, we believe the current situation in Hong Kong is probably healthy and a
lot better than many perceive in the market.
30
Has the office sector already solved the main factor constraining its
leap into becoming a metropolitan office property market?
On a deeper level, the reason we think Hong Kongs office sector is healthy is that it has been the most advanced
among the 3 key property segments in Hong Kong in terms of addressing one main issue constraining the
development of the Hong Kong property sector: the lack of availability of land and relatively moderate size of the
mid-tier segment of the market.
As noted before, we see Hong Kong property as a phenomenon created by a decades-long cumulative
undersupply of land. The undersupply of land, in turn, has resulted in a lot of upward pressure on the property
sector being manifested in the price dimension, while in many other cities, such pressure would have been largely
absorbed by volume expansion (in the sense of geographical expansion of the city.)
In retrospect, Hong Kong may be said to have considerable luck in that it has overcome this issue by constantly re-
inventing itself through engaging in higher value-added economic activities to justify and support the higher prices.
That said, we think luck may have been just one part of the story. We contend that such high prices might well be
one of the secrets behind Hong Kong property prices for it might well be precisely the high property prices in
Hong Kong that have ignited a survival instinct in the economic participants in the territory to adapt and innovate,
thereby unleashing the Creative Destruction forces in the economy. In this light, one may wonder whether it is the
constant re-invention of Hong Kong which has led to the rise in prices or vice versa; or whether these 2 issues
have a circular relationship.
Canning Fok, managing director of CK Hutchison, which is the parent company of AS Watson, one of the largest
retailing groups in Hong Kong and the world, once remarked that AS Watson could have done even better in Hong
Kong had it been able to more rapidly figure out how to manage the issue of Hong Kong property prices. In Mr.
Foks opinion, the way to cope with Hong Kong property prices is not to wait for them to correct, because this is
hard to forecast and difficult upon which to base a business plan. Rather, he believes the way to cope with Hong
Kongs real estate prices is to take them as a fact of life, change your product mix/target groups/ positioning so that
such real estate cost make commercial sense, and then execute a revised business plan.
Such remarks have been echoed by Rod Eddington when he was the managing director of Cathay Pacific back in
the 1990s. At that time, Cathay Pacific was urging the government to find ways to cope with Hong Kongs inflation
as the airlines business model (Hong Kong-based operating costs but foreign-currency-based revenue) made it
vulnerable to the high inflation in Hong Kong at the time. However, while highlighting the problems brought about
by inflation in Hong Kong, Mr. Eddington commented that for all the problems it brought, Hong Kongs inflation
could have a one-sided benefit, which lay in forcing the economic participants to adapt, improve and innovate. He
believed the high cost of living in Hong Kong might have been one reason behind Hong Kong transforming itself
from a fishing village to a financial centre.
Does the Hong Kong property sector constantly evolve to cope with
the high prices?
We contend that the Hong Kong property sector is one where free market forces have been constantly responding
and adapting to the situation of high property prices in the territory. In the face of high property prices, some
companies have succeeded in moving up the economic value chain, and some newcomers from outside Hong
Kong have entered the market which has helped keep the expensive segment of the Hong Kong property market
occupied and remain just as expensive.
In the meantime, those companies/retailers/individuals that have not been able to move up may well have moved
on to other segments and taken up less expensive space; and through such a process, the depth of the market has
increased while the size of the market has expanded.
In our view, Hong Kong is already on its way to becoming a metropolitan city and we believe the future of its
property market lies in it becoming a larger, deeper and more sophisticated metropolitan property market. In this
light, we think key for the territorys property market will be whether it can offer more space to attract and
accommodate more new demand for office, retail and residential space, which would then drive a sustained
expansion in the scale of its property market, eventually bringing it closer to the situation of New York and London.
31
This brings us to one of our main arguments: that the future of Hong Kong property does not lie in continuous
expansion at the top end. Hong Kong benefits from having a big contingent of wealthy people, high-margin firms
and retailers and this has driven its property prices to levels as high as anywhere in the world. In our view, there
are pros and cons to this situation, with the cons being that Hong Kong property prices could have made it very
difficult for newcomers to enter the market or to take the risk of experimenting with new ideas.
On the plus side, it places Hong Kong well to potentially become a major hub for all these high-margin businesses
and activities. However, we believe such positioning does entail risk in the long term, in that if the situation just
goes on and on, Hong Kong property prices could eventually be pushed to levels that would be out of reach of all
but a few high-margin companies and wealthy people. However, we believe the number of wealthy individuals as
well as high-margin retailers or corporations is limited and should be seen as an exception rather than the norm.
As such, a city cannot have an infinite amount of these high-end occupiers and our view is that, ideally, a strong
and sustainable top-end segment needs to be supported by a large and vibrant mid-range segment, or else the
industry could become vulnerable to volatility in those high-margin sectors.
In this light, we believe Hong Kong needs more space, especially mid-tier space, to accommodate the arrival of
more new players in all its 3 key property segments (retailers for retail, new businesses for office, and
entrepreneurs and professionals for residential) from China and the rest of the world, which we think is essential to
build a stronger mid-tier base for the Hong Kong property market, and cushion it from the cyclicality and volatility at
the top end.
Hong Kong saw an influx of high-end players during the 2004-10 period which pushed up prices in Hong Kong to
among the worlds highest for basically all segments. However, if this had continued, the Hong Kong property
market would have become homogenous and vulnerable, consisting only of luxury units, investment banks as well
as watch and jewellery and luxury brands, which would create serious problems if any of them encountered a
downturn.
As such, we see the influx of high-end players from 2004-10 as a path to a niche luxury market rather than a
vibrant and self-sustaining metropolitan property market wherein we think Hong Kong propertys future lies.
In our opinion, a strong property market can do well in all segments; and to us, this is what defines a truly vibrant
and metropolitan market so that it becomes a magnet to attract all types of property users. A vibrant metropolitan
market generates sustained demand for property space and eventually leads to the scale of a property market
becoming much larger.
In our opinion, the office segment is the healthiest segment in the Hong Kong property sector because we believe it
is the most advanced among the 3 segments in terms of creating the required space to pave the way for the Hong
Kong property market to make a leap forward in the direction of what we would see as a metropolitan property
market.
The emergence of Kowloon East as an office hub goes a long way to

addressing issues in the Hong Kong office sector
In our opinion, both strategically and structurally, the emergence of Kowloon East as a recognised office hub is
important for the Hong Kong office sector because it provides this segment with abundant quality space at
reasonable rents by global standards. In our opinion, the path Kowloon East has taken is a vivid illustration of how
free market forces can work to address the challenges in the Hong Kong property sector.
When the Kowloon East Grade A office space first came on the market in the late 2000s, it was a source of
concern for many. These new offices had high building specifications and yet they were offering net effective rents
as low as below HKD10/sq ft, and some expected a glut to accumulate resulting in a major drag on office rents in
Hong Kong overall.
32
Kowloon East: a new generation CBD for Hong Kong
However, the situation turned out to be far better than prevailing expectations. To recap, we think a big obstacle in
the evolution of the Hong Kong property market has been psychological by nature, stemming from the mindset and
perceptions that Hong Kong property has not been evolving as fast as the pace of development of Hong Kong as a
city. So, in terms of office space, many see moving across the harbour as a cop-out; in retail, some see going to
the New Territories or the Link REIT malls as downgrading; and many home buyers are reluctant to move outside
of the urban areas.
However, to become a truly metropolitan property market, the participants need to shed their perception and
presumption that Hong Kong would forever remain a 30-minute city in terms of commuting time. In other words, we
believe people need to break through such a psychological barrier in order for Hong Kong to make a leap forward
as a metropolitan property market.
In our view, the Hong Kong office sectors development over the past 13 years shows that, by and large, natural
market forces have already resulted in psychological barriers being broken through to some extent (we concede
that the governments talk about Kowloon East being a CBD2 have helped the areas evolution, though our
observation is that the initial transformation of Kowloon East was driven mainly by market forces).
We believe 2008 was the watershed year for Hong Kong office property a year that saw the psychological barrier
of moving across the harbour be broken, symbolised by 3 investment banks deciding to move from Central to
International Commerce Centre (ICC) in West Kowloon. And we believe this breakthrough came about by natural
market forces rather than any government plans. Basically, Central rents rose 3-fold from 2004-08, forcing many
companies to take a hard look at the economics of the business. Finally, in 2008, the hard numbers won and some
forward-looking companies overcame the psychological barrier and saw relocation as part of their normal and
rational business planning rather than any downgrading.
Subsequently, various industries such as accounting, shipping, insurance, sales and marketing gradually accepted
Kowloon East, leading to rents in the area tripling from the bottom in 2009 to about HKD30/sq ft in 2012.
However, while Kowloon East rents tripled over a short period of time, we see this area providing a healthy and
important supplement to the Hong Kong office market, given that a rental option for USD3-5/sq ft (the current rent
level at Kowloon East) is a reasonable level for MNCs and a lot of companies.
For companies seeking to separate their middle/ back office operations, or wanting to expand but finding Central to
be too expensive, or those coming to Hong Kong for the first time, or wanting to own their offices, Kowloon East
provides an option that other areas in Hong Kong could not provide. Moreover, Kowloon Easts emergence as a
decentralised office area has also prompted other districts like Wong Chuk Hang, Cheung Sha Wan, and Kwai
Chung etc. to upgrade to provide space in each rental category.
33
Stock in every segment to accommodate demand and changing

economics
Shown in the following section is our analysis of the Grade A office stock in Hong Kong, which we conclude has a
healthy structure, with sizeable stock at every rental level.
Essentially, we see Kowloon East as the sub-market which provides rental options at USD3-5/sq ft, while the
emerging markets in Wong Chuk Hang, Cheung Sha Wan, and Kwai Chung provide rental options at USD2-4/sq ft.
At the same time, the 4 established office districts (Wanchai, Causeway Bay, Island East and Tsimshatsui) provide
rental options at USD5-10/sq ft, while Central has become a hub focusing on companies that can afford unit rents
at USD10/sq ft and above.
As such, Hong Kongs Grade A office market has become a sector where there are office options for USD2-20/sq ft
or more, giving corporations the choice of office space that can fit the economics of their businesses, and one
where each segment stops the rents in other segments going too far beyond business reality.
As such, we define a healthy market structure as one where for every segment of office rents, there is space
available, meaning that nearly all kinds of businesses can find office space that suits the economics of their
business. Meanwhile, corporations can also adapt their office requirements in accordance with the changes in the
economics of the business. This kind of market structure is conducive to the emergence of a large, dynamic,
vibrant and self-sustaining office market, in our view.
If 2009-13 was a period when Kowloon East struggled to establish itself as an upcoming office hub in Hong Kong,
our read is that the next few years will be a period when areas like Wong Chuk Hang, Kwai Chung, Cheung Sha
Wan evolve to complement Kowloon East and provide rental options in the USD2-4/sq ft range.
As things stand today, we think what the Hong Kong office market lacks is space for business parks, but we do not
see that as a major handicap for the Hong Kong office market. We have some doubts as to whether Hong Kong
needs to accommodate business parks, given that such space would be better provided by nearby Shenzhen,
where there is plenty such space available in the city already.
Hence, as long as Hong Kong can find a way to integrate with Shenzhen, Hong Kongs lack of business parks
would not be an issue. Indeed, given that the office stock in Shenzhen (including business parks) is so large, at
well over 50m sq ft GFA on our estimates, it could provide a strong hinterland for the Hong Kong Grade A office
market if Hong Kong could find a way to integrate with Shenzhen.
In conclusion, our view is that the current structure of the Hong Kong office sector has helped provide good checks
and balances for the sector, essentially ensuring that companies are located at where they want to be and paying
rent they are paying because they choose to and can afford it.
34
Rents in Central are high for a reason, and likely to remain so

Of course, rents in Central are high and few places in the world have ever commanded rents at over USD15/sq ft.
However, we believe it would be somewhat simplistic and risky to jump to the conclusion that Hong Kong property
prices have become too high to be sustained.
Daiwa's definition of the 5 layers of the Hong Kong office market

Current size Size by 2020E
Districts (m sq ft) (m sq ft)
I Greater Central
Core Central 15.7 15.9
Admiralty and its Wanchai South extension 6.3 6.3
Sheung Wan 4.4 4.4
26.4 26.6
II The 4 established core office areas
Wanchai 7.8 8.1
Causeway Bay 4.0 4.6
Island East 9.0 11.9
Tsimshatsui* 10.1 10.5
West Kowloon* 2.0 2.0
32.9 37.0
III Kowloon East
Kowloon East 13.6 20.2
IV Tsimshatsui East, Hunghom, Mongkok 7.2 7.8
V. Rest of Hong Kong

Cheung Sha Wan and Kwai Chung 3.6 3.9
Wong Chuk Hang - 1.0
New Territories 1.3 2.1
4.9 7.0
Total 85.0 98.6
Source: Daiwa
Note: *we see Tsimshatsui and West Kowloon as one district
In our view, unit rent makes up just part of a businesss costs. In most cases, staff costs account for a much larger
portion of a companys operating costs. Moreover, in a free market which does provide credible choices, rent often
reflects anticipated productivity rather than determining competitiveness.
Of course, the space needs to be able to deliver such anticipated productivity to sustain such rents, but having
someone willing to pay a high rent, provided that the corporation concerned is a sensible and rational entity, is
often a positive rather than negative sign.
Moreover, we believe that the total prime Grade A office stock in Hong Kong is not too large yet. Presently, Hong
Kong has about 121m sq ft of office stock. This is not small for a mid-tier office property market but it is still notably
smaller than that for major metropolitan office markets in the world such as New York, London, Tokyo, etc.
Office stock in Hong Kong vs. other tier-1 office markets

(m sq ft)
500
400
300
200
100
0
Manhattan, NY London Sydney Hong Kong Singapore Beijing Shanghai
CBD Decentralised districts
Source: Knight Frank
35
Distribution of Grade-A office stock in Hong Kong vs. other major office markets
100%
80%
60%
40%
20%
0%
Manhattan, NY London Sydney Hong Kong Singapore Beijing Shanghai
CBD Decentralised districts
Of course, USD15/sq ft plus is high but this doesnt mean that such rents are unaffordable. In retail, the benchmark
we use to analyse affordability is operating profit per sq ft, and for office its operating profit per office based
employee. In our opinion, there are some businesses where operating profit per office based employee can be very
high and rise exponentially in good times.
A case in point is the asset management business, which is a trade that may not employ many people but one that
can have significant operating leverage. Indeed, there is a saying in property circles that, for some asset management
companies in London, they see it as a must that their office is located in Londons West End and they do not really
care that much about the per sq ft rent for it is conceivable that some of them could be recording EBITDA in the tens
of millions or even hundreds of millions of USD, while their required office space is well under 10,000 sq ft.
We think this situation is plausible. For, theoretically, there is no limit to the amount of financial assets an asset
management company employing just 10-20 people can handle. It could be just about USD50m for now, but even if
assets under management (AUM) rise to USD5bn or even USD50bn, the company may not necessarily need a lot
more people. And whether they have a prestigious address can count a lot in terms of whether they can expand or
retain their AUM.
So an office address does matter significantly to some businesses and we have found that different industries rent
payment capability can vary significantly. Generally speaking, front offices for companies in finance, consultancy,
asset management or large conglomerates can afford very high rents because their total rent bill related to housing
the top management or front-line staff can amount to only a small portion of the total profits or operating costs of
that business.
In this light, in assessing whether Central has priced itself out of the market, the key is whether Hong Kong has the
kind of industries that can afford very high unit rents and what the size of such industries is relative to the existing
stock plus new supply in the foreseeable future.
In this connection, we think Hong Kong has not scored badly. While Central rents are high, the total stock of office
space in Central (including Admiralty) is around 22m sq ft NFA which is not too large and in fact a scale that is
much smaller than Manhattan, Londons West End or Tokyos Marunouchi.
Moreover, not all buildings in Central are very expensive and we estimate there are only around 10-20 major
buildings in this area that command rents of over USD15/sq ft. As such, one may say that the high rents paid for
some office buildings in Hong Kong reflect the scarcity of office space versus the demand.
This is before we take into consideration other dimensions such as information access, deal-making opportunities,
regular and close contacts with the community, which are very valuable in some businesses.
Indeed, if one is to take a 10-minute walk from IFC Two to the China Club during lunch time in Central, it is not
uncommon to bump into a number of business contacts along the way; and this level of interaction is not so easily
found in other districts in the world. Note that information access, timing and speed are everything in some
businesses, and one deal in the finance industry can well involve a billion dollars or more. In other words, we
believe there are sound commercial reasons why some businesses would want to at least maintain a presence in
Central despite the areas high unit rents. This is before we take into consideration the importance of factors such
as prestige and perception, which are important aspects for certain businesses. As such, the rents in Central
arguably just reflect the value the district can deliver for some businesses.
36
As things stand today, Central-Admiralty together have about 22m sq ft NFA which we do not see as too large by
global standards. CBRE recently undertook a comprehensive study on the occupied floor areas of banking and
finance as well as various major sectors in Hong Kong. Given that banking/finance is the largest industry for
Central offices, we believe this study throws light on the typical rental cost of a banking and financial firm in Hong
Kong.
Based on CBREs study, we found that there are about 5,000 office occupiers in the banking and finance industry
with the average office size being about 3,000-4000/sq ft. Based on HKD100/sq ft, this translates into USD40,000-
50,000/ month in rent, which is not too large in absolute terms, on our estimates.
Distribution of office footprint range (banking & finance sector)

(No. of firms) (No. of firms)
1,400 35
1,200 30
1,000 25
800 20
600 15
400 10
200 5
0 0
0 - 5k 5k - 10 k 10k - 30 k 30k - 50 k 50k - 100k 100k - 200k 200k - 300k 300k - 500k 500k +
Size range (sq ft)
Firms < 30k sq ft footprint (LHS) Firms > 30k sq ft footprint (RHS)
Moreover, a closer study suggests that most of the occupiers in banking and finance do not rent more than 100,000
sq ft of space; based on the study by CBRE, only about 20% (1,000) of the 5,000 tenants in banking and finance
rent 100,000 sq ft or more. We estimate that well over 1,000 of them rent less than 5,000 sq ft of space and believe
many rent 2,000 sq ft or less. For companies renting about 2,000 sq ft of office space, at HKD100/sq ft, the
absolute monthly rental cost is about USD25,000, which is just about the price of 2 business class tickets to New
York, and we do not consider it to be too large.
Has the Central office market addressed the issue of high rents?
Not to deny however that there are also many other companies or businesses that do not need to stay in Central.
Admittedly, high unit rents in Central is a challenge the Hong Kong office market has to face, but our read is that
free market forces have been in place to address the issue for probably a decade by now.
Indeed, we observe that many companies have decided to leave Central over the past decade. While some would
see this as a threat and a dangerous sign for Central, we would think decentralisation is a healthy force in the office
market in that it provides healthy checks and balances to the Central market and would help ensure that Central
needs to delivers value for its tenants in order that it can command the high rents it does.
In any case, we do note that, over the past decade, there has been a significant re-distribution of space in Hong
Kong whereas many companies that do not rent a lot of area or put great emphasis on image have come to occupy
Central, while those that do not want to pay Central rents have either left or moved their middle or back offices
further away.
In retrospect, 2000-13 was arguably the testing period for Central, when many companies decided to move out,
creating abundant vacant space, particularly in Citibank Plaza (now 3 Garden Road), which saw the highest
vacancy rate for a building in Central during this period. However, it has turned out that Central vacancies have not
since exceeded 5% and rents have held up. Moreover, the vacancy rate has come down and rents have continued
to rise. Meanwhile, we are also seeing new companies moving into Central, filling much of the space vacated by
the European and US corporations.
37
Footprint growth of Mainland China companies in Greater Central
Japan
Others 4% 2014
7% HK
3% 25%
8% 2008
China 12% 26%
19% By
occupied
space
22%
29% EU
22%
US
23%

*Note: based on 25 key Grade-A office buildings in Central, Admiralty, Sheung Wan
In our opinion, the number of Chinese corporations that have yet to come to Hong Kong and Central is still sizeable,
especially in relation to the amount of space available in Central. We expect many current Central tenants to move
out of the area, but for their vacant space to be taken up by Chinese and other corporations which can afford the
high unit rents. We expect the average tenant size in Central to continue to decline and many more buildings to
become self-owned, but see high unit rents in Central as here to stay.
Chinese financial firms absorbing space vacated by Western occupiers
Source: CBRE
Both centralisation and decentralisation; becoming a larger and richer

office market?
We note that the stock of decentralised office space in Hong Kong has risen significantly over the past 2 decades,
by about 20m sq ft, according to CBRE. In the past, the stock of Hong Kong offices had tilted more towards Central,
reflecting that many industries wanted to be near Central. However, we believe that psychological barrier
associated with moving across the harbour has now been broken through and expect the structure of the Hong
Kong office market to evolve towards that for most other property markets in the world.
38
A growing pool of decentralised office stock.
We also do not dispute that not that many corporations have a business nature (in terms of profit/employee) that
can afford the unit rent level in Central. Hence, if the total office space in Central were to double tomorrow, we
would be concerned as to whether the Central market could command its existing level of rent.
However, we think, over the years, many large corporations in Hong Kong have adapted to the situation of high
office rents in Hong Kong through trying to own their office space as far as possible. In fact, the major banks in
Hong Kong, such as HSBC, Hang Seng Bank, Bank of China, China Construction Bank, Agricultural Bank of China,
Bank of East Asia, as well as all the largest business groups (such as Jardine Matheson, Swire Pacific, Cheung
Kong Group, SHK Properties Group, Henderson Group, New World Group, Hang Lung Group, Wheelock, etc.)
have all owned their office premises in Central.
As such, those companies which have to lease office space are the late-comers and those that do not yet have a
scale of business that justifies owning their offices. In general, we do not expect to see a major increase in new
supply in the Central area in the foreseeable future the Murray Road car park redevelopment project will add just
around 2% to the existing Grade A office stock in Central and we do not see its impact being large.
Hence, if the Central office market stays as one comprising 10-20 major buildings, we believe Central could well
sustain its current rental level if Hong Kong continues to develop and progress as an international financial centre
and the offshore financial centre for China. Note that despite all the companies that have left Central over the past
decade and all the well-known difficulties facing the investment banking industry, still the current vacancy rate in
Central is below 2%.
In all, we expect the trend of decentralisation to continue and believe there will continue to be companies leaving
Central, to go to Wanchai, Causeway Bay, Island East, Kowloon East or even Wong Chuk Hang.
However, we see this as healthy natural market forces at work. In our view, it is a healthy sign to have each of the
office districts compete for tenants, allowing tenants to have a large range of choices. At the same time, tenants can
also adapt by splitting offices, relocating, etc. Note also that with the continuous expansion in the scale of non-Central
office space, the proportion of office occupiers paying Central rents of USD15/sq ft plus is becoming ever smaller.
Overall, we see the Hong Kong office market evolving into a structure which is healthy and conducive to new
comers arriving. Note that Central has been expanding, with the current boundary being Three Pacific Place; and in
future, the area might continue to move eastward and ultimately merge with Hysans portfolio in Southern
Causeway Bay to create a much larger Greater Central office hub.
The scale of the Hong Kong office market is still smaller than New York and London and other major centres. As
the stock and decentralised Grade A office stock rises, we expect the median office rent in Hong Kong to
gradually converge more with other international cities.
39
Is office showing the way for the end-game of Hong Kong property?
As such, we believe the high unit rents in Central is a transitional and temporary issue. As and when the scale of
the Hong Kong office market further expands, the median rent and prices for Grade A offices in Hong Kong would
likely gradually converge with levels in other major metropolitan cities.
We envisage that the Hong Kong office sector will be composed of 4 major segments over time (Greater Central,
the 4 established office core areas; Kowloon East and the rest of the market), with each serving particular types of
companies and each offering its own range of rental options for office occupiers, and each providing a kind of
checks and balances for the 3 other segments.
Daiwas definition of the 5 layers of the HK office market by relative positioning

Major office markets Areas Remarks
I. Greater Central: Central, Admiralty, Pacific Place's Wanchai Central is the core, but will expand and integrate into neighbourhood
extension, Sheung Wan areas that offer different and complementary office options
II. Four established core office areas: Wanchai, Causeway Bay, Tsimshatsui & Offering alternatives to corporations that may not be finance-centric;
West Kowloon, Island East Causeway Bay and Tsimshatsui could offer special appeal to retail and
fashion-related corporations. We also expect to see some finance
companies starting to accept non-Central locations.
III. Kowloon East: Kowloon Bay, Kwun Tong and Kai Tak Offering alternative office options to corporations in addition to the four
redevelopment established core office areas
Could meet the owner-occupation demand from premier corporations
IV. Tsimshatsui East, Hunghom, Tsimshatsui East, Hunghom, Mongkok Offering additional and likely cheaper alternatives to corporations.
Mongkok Supplementing Tsimshatsui as an office location.
V. New satellite office areas: Wong Chuk Hang, Kwai Chung & Tsuen Could satisfy some of the ownership demand for offices. Do not have
Wan; Cheung Sha Wan, Tuen Mun, Shatin, sufficient critical mass in their own right, but could satisfy the niche
Sheung Shui etc. demands of specific industries
Source: Daiwa
In our opinion, such a 4-tier structure would provide office options for a broad range of companies and be
conducive to the sustainable growth of the Hong Kong office sector. So, instead of seeing Hong Kong prices
reaching an unsustainable level, we believe Hong Kong property can be seen as a case where market forces have
been working on ways to address such risk, and it has been evolving to accommodate, or even nullify, such risks.
In our view, it has now more or less come out of the adjustment phase and is awaiting more demand to emerge. In
this light, we believe Hong Kongs Grade A office sector is now at the verge of entering a new stage and will show
the way for other property segments.
Retail: can Hong Kong move beyond a luxury hub?

Admittedly, retail rents in Hong Kong are high. But as with office rents, we see high retail rents in Hong Kong as
simply a reflection of the underlying economic reality and real-estate fundamentals of the market.
Shown in the following table is the growth in retail sales and retail space in Hong Kong since 2003. It is clear from
the chart that while retail sales in Hong Kong saw 10 golden years from 2004-14 which resulted in a 158% rise in
retail sales in the territory, retail space expanded by only about 16% over the period.
Hong Kong: growth in retail sales and retail space since 2003
(rebased)
350
300
250
200
150
100
50
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Retail sales Stock of retail space
Source: CEIC, Daiwa
40
As such, average sales productivity in Hong Kong surged. Moreover, of note is that in retail property in Hong Kong,
there is a structural trend for retail sales to be skewed towards the strongest (in the sense of highest sales
productivity) retail districts and retail property assets. Against this background, we see the surge in rents in Hong
Kong from 2004-14 as merely a reflection of the rise in expectations for the sales productivity of the retail space
concerned.
Dividing retail sales by retail space as at March 2016 in Hong Kong gives us average retail sales of USD400/sq ft,
which is high by global standards as a general benchmark, in the US, sales of USD500/sq ft would qualify a mall
as being high-end, while USD300/sq ft in sales denotes a mass-market mall.
As such, the average sales productivity of retail property assets in Hong Kong is high to start with; however we
think this is understandable given that Hong Kong has high population density, small living spaces, low tax rates
and a culture of people leaving their small places of residence to shop, eat and meet friends, etc.
Note also that the sales productivity of strong malls can be much higher than the average, given the structural trend
in retail for shoppers to gravitate towards the strongest malls.
Take Harbour City as an example. This malls sales productivity is among the highest in the world, and is
exceptionally high even when compared with the most productive malls in the Western world. In the US or Europe,
USD1bn in annual retail sales would render a mall among the most productive, yet Harbour City achieved retail
sales of over USD4bn in 2014 and 2015 and USD3.6bn in 2016. Moreover, over the past few years, Harbour Citys
sales per sq ft has remained at a jaw-dropping level of over USD3,000/sq ft.
Harbour City: achieved sales per sq ft

(USD/sq ft)
5,000 25%
4,000 20%
3,000 15%
2,000 Industry benchmark for high- 10%

end malls in North America
1,000 5%
0 0%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Annual tenants' sales psf (LHS) Blended avg. occupancy cost* (RHS)
Source: Wharf, Daiwa estimates

Note: *after adjusting for management fee and miscellaneous charges which have been included in reported gross revenue from rental
Achieved tenant sales in Harbour City and Times Square vs overall retail sales
in Hong Kong
Harbour City Times Square HK overall
(HKDbn) (YoY) (HKDbn) (YoY) (HKDbn) (YoY)
2013 1Q 8.5 14.9% 2.3 -4.2% 129.3 13.9%
2Q 7.5 11.9% 2.0 0.0% 123.6 16.1%
3Q 8.1 8.0% 2.2 0.0% 114.5 7.5%
4Q 9.8 6.5% 2.9 7.4% 127.1 6.8%
FY 33.8 9.7% 9.4 1.1% 494.4 11.0%
2014 1Q 9.1 7.1% 2.8 21.7% 134.6 4.2%
2Q 7.7 2.7% 2.4 20.0% 115.0 -7.0%
3Q 8.6 6.2% 2.5 13.6% 116.3 1.6%
4Q 9.6 -2.0% 2.8 -3.4% 127.3 0.2%
FY 35.0 3.4% 10.5 11.1% 493.2 -0.2%
2015 1Q 8.6 -5.5% 2.6 -7.1% 131.6 -2.3%
2Q 7.0 -9.1% 2.1 -12.5% 114.0 -0.9%
1H 15.6 -7.1% 4.7 -9.6% 245.6 -1.6%
2H 15.1 -17.0% 4.4 -17.0% 229.6 -5.8%
FY 30.7 -12.1% 9.1 -12.8% 475.2 -3.7%
2016 1Q 7.0 -18.9% 2 -20.0% 115.2 -12.5%
2Q 6.3 -9.6% 2 -10.3% 104.6 -8.3%
1H 13.3 -14.7% 3.9 -15.7% 219.7 -10.5%
2H 14.4 -4.6% 4.2 -4.5% 216.9 -5.5%
FY 27.7 -9.7% 8.1 -11.0% 436.6 -8.1%
Source: Wharf, CEIC, Daiwa
41
All told, we believe retail rents in Hong Kong are high for a reason, and are supported by the sales productivity of
retail space in the territory. For as we have pointed out, retail property is the property segment where we are least
concerned about rents or prices forming a bubble, as long as there is free competition and leases remain flexible in
that they are not excessively long.
If retailers are unable to remain profitable, they can always close the shop, and we believe such a scenario is a
powerful mechanism restraining rents from rising too high. In our opinion, retail rents generally reflect anticipated
productivity rather than determining the competitiveness of the retail property assets concerned.
Plunge in rents on high street and high-profile closures of stores need

to be put into context
In assessing retail rents in Hong Kong, it is worth noting that in theory, there is no absolute limit on the level of
achieved rent, for it all depends on the sales productivity or operating profit per sq ft of the retail space concerned.
Moreover, the sales and operating per sq ft generated by some trades can be many times more than that
generated by others.
Hence, in boom times, it is not inconceivable that some retail landlords can raise rents by a huge multiple. This has
been the case in Hong Kong when, during certain periods of time, some luxury watch and jewellery retailers have
been prepared to pay almost any price to secure a presence in the most prime streets in Hong Kong. If their
average ticket size amounts to multi-millions of dollars and the retailer only rents 1,000 sq ft of space, then the
economics work.
Therefore, if a 1,000 sq ft shop could sell 3 luxury watches or pieces of jewellery in a day (each costing
HKD500,000 on average), then it could record sales of about HKD45m a month. Assuming an average gross
margin of 10%, the gross profit of the shop could be HKD4.5m a month. For a shop with this level of sales
productivity, it is arguable that a rent of even HKD4,000/sq ft (the highest Hong Kong has seen is about
HKD3,000/sq ft) would still be affordable for the retailer, as this would only translate into about HKD4m per month,
implying an occupancy cost of about 9%.
Similarly, we note that the gross margin on luxury handbags and other goods can be as high as 40% or more. As
such, if a 3,000 sq ft shop can sell to just 4 customers per day for an average ticket size of HKD100,000, then its
monthly sales could reach HKD12m, while its gross profit could be as high as HKD4.8m per month. For a shop with
such sales productivity, then it is arguable that even HKD4,000/sq ft is still affordable, as it would translate into only
HKD1.2m a month, implying an occupancy cost of 10%.
While the scramble for retail space in Hong Kong during the recent boom time seemed absurd to many, if Hong
Kong retailers can sustain the high levels of retail sales seen in 2009-13, then we could argue that the level of rent
paid by some new-comers would not be impossible to sustain. In as much as when wealthy customers abound,
retailers need to ensure that they are well-placed to capture these customers. As such, a retailer that has a
presence in the most prominent streets in Causeway Bay or Tsimshatsui is very likely to see such big spenders
end up shopping in one of their stores.
Of course, the aforementioned average ticket size is an anomaly and therefore cannot be realistically assumed to
last for long. It is uncommon in global retailing that Hong Kong saw so many such wealthy customers and this kind
of spending pattern from 2009-13.
However, once Chinas government started to crack down on corruption and related activities, such kinds of
atypical customers quickly disappeared from the market. As a result, both retailers and landlords had to
significantly slash their sales expectations, as the average spending of an average customer fell to only a fraction
of those big spenders who once existed during 2009-13. As a result, rents in high street shops have collapsed and
have gone down by as much as 60% or more in some cases since 2013.
42
The adjustment in prime street rents

(1Q03 = 100) Savills prime street shop rental index
450
400
350 Pre-GFC
300
250
200
150
100
50
0
1Q03
3Q03
1Q04
3Q04
1Q05
3Q05
1Q06
3Q06
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
1Q12
3Q12
1Q13
3Q13
1Q14
3Q14
1Q15
3Q15
1Q16
3Q16
Source: Savills
That said, we believe the high street shop segment is a special one and should be seen in the context that it
accounts for a very small amount of the retail space in Hong Kong, although it always attracts prominent headlines.
Structure of retail stock in Hong Kong

Major high streets in Five major retail properties
Causeway Bay and in the urban areas* 2.2%
Tsimshatsui 0.2%
Rest of the sector 97.6%
Source: Hong Kong Property Review, Companies, Daiwa

Note: *Harbour City, Times Square, Sogo HK, IFC, Pacific Place mall
In our opinion, retail rents in Hong Kong have mainly reflected the economic reality prevailing at that time. In
common with many retail booms, new retailers have been attracted to Hong Kong, and with the prime space having
already been locked in by those early entrants, many retailers have found that they have no choice but to bid up
the rents in the established areas, and relocate to some new and less proven retail districts and streets, such as
Queens Road Central, Pedder Street, etc.
Against such a backdrop, it is not difficult to understand that when the big-ticket spending no longer comes to Hong
Kong, some retailers would have to adjust their expectations and close down their operations. In our opinion, such
a move represents the natural clearing process in a free market, and investors should not be overly concerned.
Moreover, note that many of the retail space that has been vacated by watch and jewellery retailers has been taken
up by sports and other trades (such as cosmetics). We see this development as a sign that there are still retailers
waiting to enter the Hong Kong retail market pending rents starting to reflect the prevailing economic reality.
Hong Kong retail property is dominated by a few players; malls look

most resilient
On the other hand, we think it is also important to take into account the structure of Hong Kongs retail property
sector.
Like the office sector, Hong Kong does not have many landlords. Indeed, in Asia, retail property management is a
relatively new concept. Most property companies in Asia are asset owners, and there are not many asset
managers. Indeed, we believe many of them see the business mainly from the perspective of a residential
developer, which tends to make the bulk of its profits from property sales, while the retail portion is seen as a bonus
business the space for which they aim to fully lease.
43
As such, few players in Hong Kong have in the past been willing to invest much time and effort in managing their
assets, a situation we generally see in Mainland China now. Against this background, its probably not surprising
that, in Hong Kong, retail management expertise tends to lie mainly with the old companies like Hongkong Land,
Swire Properties, and Wharf, which have rich endowments of property assets and a tradition of managing the
assets to get the most out of them over time.
In hindsight, SHK Properties was probably one of the first local players to become serious about the business. Our
observation is that such a change in mindset probably started in the 1980s when the company managed the New
Town Plaza and other retail properties, which it decided to keep as they were probably too large to sell anyway.
However, time has proved that if retail property assets are managed well, they can be a gold mine. Link REITs
developments are proof that there are many ways to manage retail property assets well so that they generate large
and sustainable economic benefits to the landlord over an extended period of time.
Our read is that retail landlords in Hong Kong tend to adopt a long-term view of the business, as they have become
increasingly aware of the importance of taking a long-term view on running such a business.
We think such a view has significant importance in assessing Hong Kongs retail property market. By and large, we
do not think Hong Kongs mall owners were carried away by the retail boom of 2004-14. Indeed, we believe they
were prudent and long-term oriented in their response to the boom.
Note that a few major retail landlords in Hong Kong own and control most of the territorys prime retail property
assets, and as with their office assets, these retail landlords have over 4 decades experience in the industry and
tend to take a long-term view on the business.
Looking at the occupancy costs of various major malls in Hong Kong, it appears that the Hong Kong retail landlords
were not too carried away by the retail market boom, as most are still in the 11-20% range.
Admittedly, some malls such as Pacific Place, went down the over-luxury path, replacing many mass-market retail
outlets with luxury goods stores. However, in general, even for urban area malls, the extent to which they tended
towards over-luxury (ie, having more than enough luxury tenants) was not too excessive in the grand scheme of
things. Pacific Place made a concerted effort to fine-tune its tenant mix about a year ago (through bringing in a
larger variety of trades and F&B outlets) which we believe has led to a revitalisation of the mall.
At the same time, while Hysan Places pre-leasing was done in the heyday of Hong Kong retail property, in around
2011, the company did not fill up its mall with luxury watch and jewellery shops which could pay the highest per sq
ft rent. Instead, it focused on bringing in more new comers to the Causeway Bay area which we see as a sign that
many Hong Kong property companies are focusing more on the long-term and sustainability of the business.
Meanwhile, we believe the retail landlords in Hong Kong have seized the opportunity created by the retail market
boom to revitalise their suburban malls. While SHK Properties and Link have been the most active in such
endeavours, others like Henderson Land, Sino Land or even the Cheung Kong Group (done mainly through
Fortune REIT) have been investing in revitalising their suburban malls and are starting to see results.
In our view, such moves have been welcomed by retailers, and we believe the transformation of the Hong Kong
retail property landscape is now under way and is worth investors attention.
Retailers have not yet lost faith in Hong Kong retail

Meanwhile, however high retail rents in Hong Kong have become and however over-luxury Hong Kong retail
property market has become, our read is that the retail brands and luxury brands have not lost faith in this market,
at least not yet.
This is in sharp contrast to their strategy in some lower tier cities in China where some brands have decided to
downsize the number of stores in major cities or even withdraw from some lower tier ones.
Note that amidst all the concerns about downsizing by retail brands and that luxury retail spending has been weak
in Hong Kong for several years already, no major luxury brands have decided to exit the Hong Kong market.
44
Major events in retail property and different interpretations

Events Popular interpretation in Alternative interpretation and supplementary remarks
the media
Abercrombie & Fitch (A&F) has An international retailers A&Fs 25,600sq ft is a large space and we do not see Central as an established
decided to close its flagship store on sign of desperation about retail district in Hong Kong. We have reservations as to whether A&F's decision to
Pedder Street Central by July 2017 the dire situation of Hong pay HKD7m a month for the space back in 2011 was a sound commercial decision
despite having to incur a break-lease Kongs luxury retail market and think the termination of the lease could be seen as part of the natural clearing
cost of HKD125m (its 9-year lease is process in a free market. It remains to be seen whether the space will be vacant or
not scheduled to expire until 2020). whether another retailer takes up the lease. Generally, when the tide turns, it is
usually those second and third tier property assets that are hit the hardest.
Forever 21 has decided to close its International retailers are Forever 21 is not exiting Hong Kong. It has just opened a 19,000sq ft store in
51,188sq ft flagship store in Capitol retreating from Hong Kong Mongkok and 51,188sq ft is probably a size that is too large for the company,
Centre, Causeway Bay. especially given the rental rate it paid (according to media reports, it paid HKD13.8m
per month or HKD270/sf [gross]). Note also that the store has been re-let to
Victoria's Secret (at HKD7m per month, based on media reports) before Forever 21's
contract expires in August 2017. We see tenant changes and rental adjustments as
part of the natural market clearing process and see HKD7m per month as still a
sizeable amount, indicating that there are still international retailers willing to commit
significant investment to penetrate the Hong Kong retail market. Victoria's Secret
currently operates 12 stores in China.
Coach has closed its flagship store in A sign of the collapse of Coach is not exiting HK it still has 17 stores in the territory. It is questionable as to
HK luxury spending in Hong whether Coach's decision to pay the rent it did in 2012 (10x the level 12 years ago)
Kong was a sound commercial decision. In any case, the space was taken up by Adidas
before Coach's lease expired in 2017 (please refer to our 25 May sector report Its
time to be more greedy than fearful for more details).
Hermes has offered to sell its Even Hermes is bearish Hermes is not exiting or downsizing. It has leased 9,000sq ft across the road in
flagship store for HKD1.5bn about Hong Kong luxury Prince's Building which is about 1,500sq ft larger than its flagship store was in terms
retail of GFA. Hermes bought its shop for HKD190m back in 2002 and it seems to us that
this was just a sensible capital allocation to lock in substantial investment gains
while having a larger store in a better building (please refer to our 25 May sector
report Its time to be more greedy than fearful for more details).
Source: CEIC, Daiwa
While some brands have closed some of their stores, notable examples being Coach, Forever 21 and Abercrombie
& Fitch, they have not closed down their entire retail operations in Hong Kong. Rather we see their moves as an
attempt to fine-tune their strategy for the Hong Kong market and believe this is something every retailer does
constantly.
For all the medias reports of gloom and doom in the retail sector, we think it is notable that not one luxury brand
has decided to exit the Hong Kong retail market, or given up their most prime retail space in Hong Kong.
At the same time, the luxury brands are adapting to the changing retail market environment by adjusting their
number of stores, store sizes, product mix, etc., to make their Hong Kong operations viable.
In our view, the era of opening many large flagship stores may now be over. However, we believe many luxury
brands are still keen to have major flagship stores, although now most would probably only have one or two such
stores for the entire Hong Kong market.
Meanwhile, we note that many luxury brands have been fine-tuning their product lines. Instead of having only the
traditional luxury lines, some seem to be developing new lines such as light luxury or contemporary luxury or
kids lines, etc.
At the same time, many appear to have adopted a global pricing policy which would make products in Hong Kong
less affected by a strong USD over time, in that retail prices for its outlets outside Hong Kong would be marked up
to similar prices over time. While a strengthening USD would certainly affect the relative attractiveness of products
in Hong Kong, if retailers adhere to a global pricing strategy, such an impact would be one-off and temporary. As
and when subsequent batches of merchandise arrive, their pricing would become currency neutral. We believe a
number of retailers have been moving towards adopting such a practice.
In our view, some in the market may not realise that retailers have considerable power over deciding their sales mix
in different jurisdictions. For example, deciding what products are to be sold in which cities and at what quantity
and prices.
Our observation is that a number of brands are moving more toward global pricing, which would nullify the impact
of currency factors on Hong Kong retail sales over time. We believe global brands have also been gradually
adjusting their pricing in China so that now for many luxury brands, the gap between their prices in China and Hong
Kong is much narrower than before for many brands, their prices are broadly the same in China and Hong Kong,
with the only difference being put down to the CNY/ HKD exchange rate.
45
We see these as signs that retailers still regard the Greater China market as important and have been seeking the
right strategy to penetrate the Hong Kong China market.
In our view, Chinese consumers are probably the main deciding factor for which brand will be successful over the
next decade. While Hong Kong may no longer hold the monopoly over Chinese visitors, we think it is hard to
conceive that Hong Kong would not remain one of the important markets for Chinese consumers.
Our read is that retailers have not lost faith in Hong Kong. They, like the landlords and consumers, are adapting to
the post-anti-corruption era of Chinese consumers, as big-spenders disappear from the market. The major brands
have also supported suburban malls such that now, only a handful of brands do not have a presence in the New
Territories, while back in the mid 2000s, few international brands had outlets in the New Territories.
Does retail provide a glimpse into Hong Kongs overall property

market?
So where is the Hong Kong property market headed?
While we see the office market as the healthiest among the 3 property segments, in that it has more or less
overcome the issue of availability of space at reasonable rent levels, the importance of the retail property sector
should not be underestimated. In our view, retail is the most advanced of the 3 segments in terms of reflecting the
proper situation of the Hong Kong property market.
In retrospect, we contend that retail was the strongest of all 3 property segments in Hong Kong until 2014, and that
this sector probably most vividly illustrates what Hong Kong property has been undergoing and where it is heading.
Essentially, we believe the Hong Kong retail property market has been undergoing a transformational change since
2H03. Before Chinas introduction of an individual visitor scheme (IVS) for its citizens, the Hong Kong retail
property market was essentially a market for 7m people, as its catchment area was limited to the territorys 7m
population plus tourists.
However, since 2H03, there has been a paradigm shift in the Hong Kong retail property market, which has seen it
move from a 7m people retail market into a strategic retail hub that holds one key to penetrate Chinese consumers,
where potential consumers number the tens of millions.
With Hong Kong no longer holding the monopoly over Chinese tourists, whether its retail property market can
become one that serves several hundred million people has yet to be seen. That said, however we cut it, the scale
and catchment area of Hong Kong will remain significantly larger than it was when it encompassed just 7m people.
In other words, we are seeing a quantum leap in the scale and importance of the Hong Kong retail property market.
46
Stages of development of the Hong Kong retail property market

Period Nature How global retailers see Hong Kong Actions by market participants
Pre-2004 A local market for mainly 7m people A small market from a global perspective No investment in building new malls
during the recession years.
2004-09 A market that can offer access to the first A small market but could be important for Many retailers become very active in
generation of outbound consumers from penetrating the much bigger market securing prime retail space
China behind it
2009-14 A market with almost a monopoly over A key strategic retail market for The watch and jewellery retailers rush to
outbound consumers from China successfully penetrating Chinese pay almost any rent to secure prominent
consumers over time space in a few prominent streets
Must secure a presence almost at all cost The mall operators put more emphasis on
the luxury dimension and Chinese
consumers, but generally do not go too far
Many international retailers begin to
accept suburban malls and become active
in opening stores in the New Territories
where rents are notably lower than those
in urban areas
2014-16 A market that has gone "over-luxury" and Still a strategically important market but Rents for high-street shops plunge but the
no longer has a monopoly over outbound has been too good for too long. situation for malls looks much better
consumers from China.
Need to right size their presence in the Some retailers (such as those from sports,
city; and search for the right scale and F&B, etc.) take up the space left behind by
strategy to achieve sustained profits the watch and jewellery brands.
Still offers better sales productivity than
many markets but managing the real
estate cost is not easy
2017 Still an important market for outbound More and more international retailers see More and more mid-end retailers come
consumers from China; and still could be it as an important market where they need and the HK retail market begins to see
at least one of the trend-setting cities for to have a presence if they are to do well in critical mass and starts to attract more
consumers in China or Asia China over time. shoppers from China and other parts of
the world.
2020? An important retail market in Greater An important retail market, with the Retailers and landlords change to
China and Asia, being a hub for luxury potential to become the trend-setting city compete more in terms of convenience,
retail as well as many other retail for consumers in China and Asia reliability, service quality, variety of choice,
segments. etc.
More and more shoppers and retailers
come to HK, turning its retail market into
an important hub in global retail.
Source: Daiwa
Along these lines, we think the change in some international retailers view about the Hong Kong retail property
market is important to note. Before 2009, not many large global retailers had a major presence in Hong Kong, and
negotiations between these retailers and Hong Kong retail landlords often broke down.
We believe perception was an issue. The large global retailers (such as some of those from the US) did not see
Hong Kong as an important and relevant market. After all, being a large and even No.1 brand in a retail market with
just 7m people was of little consequence to their global businesses, and so when they tried to negotiate with Hong
Kong landlords, the US side would often start by asking for concessions and incentives to justify them moving to
Hong Kong.
However, major retail property assets in Hong Kong dont have to worry about occupancy and the culture in the
Hong Kong retail property sector is not about giving incentives. As such, negotiations between Hong Kong
landlords and large global retailers seldom came to much in the past.
However, after 2009, some large international retailers seemed to change the way they viewed Hong Kong. Instead
of seeing Hong Kong as a market with just 7m people, they began to see it as a strategically important market
where they needed to have a major presence in order to become major players in the China market over time.
In short, the IVS brought critical mass to the Hong Kong retail property market, and the question now is how
international retailers see Hong Kong in the longer term.
In retrospect, the luxury retailers in the world certainly view Hong Kong as an important luxury hub. Indeed, the
Hong Kong retail property sector became over-luxury during the boom years, in some ways, not unlike what was
seen in the Central office market during 2H03-2009. The office sector might have become too investment bank-
centric during those years, which had the effect of driving up rents to levels which crowded out many other, and
possibly more important and lasting, trades.
47
In hindsight, it was probably a blessing in disguise for the Hong Kong retail property sector that the go-luxury trend
tapered off after 2013, because such trend was driven by an abnormal retail spending pattern which could not be
sustained for too long.
Hence, if such a trend were to have continued for a few more years, there could have been a real risk of Hong
Kong turning into a dull and monotonous retail market, comprising mainly watch and jewellery, and luxury fashion
brands in the most prime retail areas, and seeing Hong Kong become a market serving the wealthy and a small
group of arguably unreal consumers.
In this light, the pain that the Hong Kong retail property sector has been through over the past few years may be
seen as being necessary to bring the sector back on track.
Note that during 2012-14, while Central office rents fell notably, rents in decentralised areas held up; and then by
2014, rents in both Central and decentralised areas picked up. We think it is not inconceivable that a similar
situation could happen in retail property.
In short, Hong Kong became a luxury hub for retail during the 2009-14 period. Like investment-banks expansion of
office space, it went too far and too fast and the sector started paying the price from 2014 onwards.
Can Hong Kong retail go beyond being just a luxury hub?

In our opinion, investors view about Hong Kong retail depends on their view about the longer-term prospects of
Hong Kong as a retail hub. Is it an over-luxury retail market whose best days are behind it, and will it take years just
to unwind the excesses created in the past 2 years? Or is it a market that can resume its vigour after it has become
less of a luxury market.
There are valid arguments on both sides. In our view, the scale of the Hong Kong retail property market is still
moderate relative to the worlds largest retail hubs, such as Londons West End, or Tokyos Ginza and Shinjuku. As
we see it, the scale of all 3 retail hubs in Hong Kong is not that large by global standards in terms of both
geographical size and total tenant sales. On our estimates, the total annual retail sales in Londons West End and
Shinjuku exceed USD15bn, while Tsimshatsui probably sees sales in the region of USD5-7bn, and Causeway Bay
USD4-6bn.
At the same time, a walk in the Tsimshatsui and Causeway Bay area would probably tell that their scale is notably
smaller versus Londons West End or Shinjuku in Tokyo. That said, Hong Kong already has among the largest
concentration of luxury brands in any city.
Tourist vs. domestic retail spending in Hong Kong

(HKDm)
600,000 30%
500,000 20%
400,000
10%
300,000
0%
200,000
100,000 -10%
0 -20%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Tourist speding domestic spending Retail sales value YoY chg
Source: CEIC, Daiwa
48
Hong Kong overall retail sales (annual)

(HKDbn) (share of total)
600 30%
500 25%
400 20%
300 15%
200 10%
100 5%
0 0%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Jewellery, Watches, Clocks & Valuable Gifts Total others Share of Jewellery, Watches, Clocks & Valuable Gifts (RHS)
Source: CEIC, Daiwa
Hong Kong retail sales of luxury goods (annual)

(HKDbn) (YoY)
140 60%
120
40%
100
80 20%
60 0%
40
-20%
20
0 -40%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Jewellery, Watches, Clocks & Valuable Gifts YoY change (RHS)
Source: CEIC, Daiwa
In our opinion, it is not possible to have a large-scale retail hub driven only by luxury brands, given that there are
not a lot more than 20 global luxury brands, and therefore a limit to how much space they can occupy.
Moreover, for luxury malls or luxury retail districts, the key is ticket size and customer loyalty. These malls and
districts do not need much traffic indeed, some of the wealthy likely prefer to shop away from the crowds. Hence,
globally, it is a challenge for property managers to make pure luxury malls work well, albeit there are a few places
where luxury malls are successful. However, how to create a luxury mall which is seen as welcoming and having
strong footfall as well as a vibrant shopping atmosphere is a challenging task.
There may be a few retail property assets in the world that succeed solely on luxury brands, but they are usually
malls or streets; for an entire retail district or retail market to be driven purely by luxury retail is hard to conceive, in
our view.
In our opinion, a strong and vibrant retail hub cannot be dependent on just luxury brands. It needs to have a large
variety of products, be able to attract a broad spectrum of retailers and shoppers, and need to have retail property
space that can accommodate a large variety of shoppers and retailers.
For the office market, our benchmark is a rental option ranging from USD2-20/sq ft, and for retail, we think strong
retail hubs need to accommodate per ticket spending ranging from USD2 to USD200,000.
How does Hong Kong score on these counts?
49
Scale of retail property assets can be larger but need to compete in

variety and efficiency: mid-range retailers could hold the key
Our view is that Hong Kong does not score badly in terms of offering variety to customers at least not yet. While
the Hong Kong retail property market has gone over-luxury, we think the problem lies mainly in some major high
streets which do not account for a large portion of Hong Kongs total retail space.
By and large, we think the retail landlords in Hong Kong have handled the retail boom sensibly and rationally. While
we believe they have introduced too many luxury brands to their malls, it has not been to the point of undermining the
long-term viability of their malls and frightening off the tenants (in general, occupancy costs in major retail properties in
Hong Kong look still defendable) and we see the difficulties faced by the retail sector as a solvable problem.
In our opinion, the Hong Kong retail property sector still offers choices to retailers and the sales productivity of
some retail space in Hong Kong remains high by global standards. We also think Hong Kong has a fair amount of
shoppers who have spending power, and are eager to try new concepts and ideas and are receptive to global
fashion trends, which are among the preferred shopper qualities for retailers.
Savills prime street shop rental indices

2013 2014 2015 3Q16
(YoY chg) (YoY chg) (YoY chg) (YTD)
Central -4.2% -13.5% -30.3% -17.8%
Causeway Bay -10.3% -10.6% -35.5% -13.9%
Tsimshatsui 4.2% -4.4% -29.0% -12.8%
Mong Kok 0.7% -6.4% -26.6% -8.9%
Overall -2.2% -8.5% -30.4% -13.4%
Source: CEIC, Daiwa
Savills major shopping centre rental indices

2014 2015 3Q16
(YoY chg) (YoY chg) (YTD)
Hong Kong Island 5.2% -4.8% -0.1%
Kowloon 7.5% 8.6% 7.4%
New Territories 6.0% 4.1% 4.2%
Overall 6.3% 3.0% 4.1%
Source: CEIC, Daiwa
Moreover, we believe Hong Kong maintains its strategic role as an important market for outbound Chinese tourists
and potentially, one of the trend-setting cities for Chinese consumers.
At the same time, like the situation for Kowloon East office space, we think the rise of suburban malls has opened
up a new dimension for the Hong Kong retail property sector.
In our view, the past 10 years has seen a period of transformation for suburban malls in Hong Kong, during which
time many have been upgraded and seen a greater variety of retailers and merchandise introduced. In our opinion,
while retailers would always bargain on an absolute rental level, they are actually happy to pay a much higher rent
as long as the sales productivity of the malls justifies a higher rent.
In retailing, novelty, variety, choice, excitement, services and reliability are attributes shoppers like. As such, we
believe major retail hubs do not compete only on the basis of price and rent. Rather, they compete on scale, as
well as the variety of products, services, quality offered.
For all the challenges the Hong Kong retail property sector is facing, we believe it is too early to assume Hong
Kongs retail sector has already had its heyday, and is set to decline. After all, Hong Kongs transport infrastructure
remains among the best in the world, and there are still wealthy and high income groups in Hong Kong, while
Chinese consumers have not abandoned Hong Kong.
Meanwhile, Hong Kongs population density is high and sales productivity in the city is high by international
standards, while Hong Kong consumers are receptive to new ideas and concepts than in many other world cities.
In retrospect, the Hong Kong retail property market veered towards being too over-luxury during the 2011-13 period.
However, our view is that Hong Kong still has qualities that will attract upcoming brands, which in turn would
expand, enrich and enlarge the retail property pie in Hong Kong.
50
Do mid-range retailers hold the key?

In our view, the key issue for Hong Kongs retail market is whether it can re-invent itself after having been over-
luxury. While only time will tell, we believe we have been seeing free market forces addressing that issue for some
time.
In our opinion, the retail scene in Hong Kong has become too focused on super luxury brands; but this issue is now
being addressed, and we believe mid-end retailers hold the key to the future of Hong Kong retail property.
In an ideal world, new and mid-end retailers would continue to come to Hong Kong and the city would compete on
efficiency and amount of offerings. As and when more retailers enter the market, Hong Kong would have a breadth
and variety of choice, matched by few other cities.
In our opinion, Hong Kong has the credentials and potential to be a hub for mid-end consumers and the key lies
with attracting more consumers to the city.
F&B is one area where Hong Kong has the potential to excel internationally, in our view, and as such, we expect
many more modern F&B brands to come to Hong Kong over the next few years. When it comes to dining, Hong
Kong probably offers more choices than many cities in the world as there is large variety of cuisines on both Asian
and Western food. In this light, we believe Hong Kongs future as a retail hub depends on the city going beyond
being a retail hub for just luxury goods to include F&B and as many other trades as possible. Note that a retail hub
has many dimensions: F&B, sports, entertainment, cosmetics, fashion, clothing, leather, childrens wear, etc.
In our opinion, the future of Hong Kong retail lies in the city being able to offer more variety and the most trendy
and fashionable merchandise in more and more of these trades. This would make Hong Kong a retail hub for
luxury as well as many of these trades.
A large retail hub must succeed in the mid-market segments, because once we step out of the luxury world, the
number of brands multiplies. While there are probably only about 20 global luxury brands, there are thousands of
mid-tier brands across a wide variety of trades like clothing, accessories, sports, etc. Moreover, in between the mid-
end and luxury brands, there is a segment where the ticket sizes involved are not as high as traditional luxury, yet
the volume sales are much larger, eg, designer brands, and segments for the young and upcoming ones.
Hong Kong: retail sales breakdown

Retail sales (HKDbn) YoY change (HKDbn) YoY change (%)
Ex-Jewellery, Jewellery, Jewellery, Ex-Jewellery, Jewellery,
Watches, Watches, Ex-Jewellery, Watches, Watches, Watches,
Clocks & Clocks & Watches, Clocks Clocks & Clocks & Clocks &
Valuable Gifts Valuable Gifts Total & Valuable Gifts Valuable Gifts Total Valuable Gifts Valuable Gifts Total
2000 164.0 22.7 186.7
2001 163.2 21.2 184.4 (0.8) (1.5) (2.3) -0.5% -6.8% -1.2%
2002 156.5 20.3 176.9 (6.7) (0.9) (7.5) -4.1% -4.1% -4.1%
2003 153.1 19.7 172.9 (3.4) (0.6) (4.0) -2.2% -2.9% -2.3%
2004 167.3 24.3 191.5 14.1 4.5 18.7 9.2% 23.0% 10.8%
2005 178.1 26.3 204.4 10.8 2.0 12.8 6.5% 8.3% 6.7%
2006 188.7 30.3 219.0 10.6 4.0 14.6 6.0% 15.2% 7.2%
2007 209.3 37.7 247.0 20.6 7.4 28.0 10.9% 24.5% 12.8%
2008 230.5 42.7 273.1 21.2 5.0 26.1 10.1% 13.2% 10.6%
2009 229.9 44.8 274.7 (0.5) 2.1 1.6 -0.2% 5.0% 0.6%
2010 264.0 61.0 325.0 34.1 16.2 50.2 14.8% 36.1% 18.3%
2011 316.4 89.4 405.7 52.4 28.4 80.8 19.8% 46.6% 24.9%
2012 349.3 96.2 445.5 32.9 6.9 39.8 10.4% 7.7% 9.8%
2013 376.1 118.3 494.4 26.9 22.1 49.0 7.7% 22.9% 11.0%
2014 391.1 102.1 493.2 15.0 (16.2) (1.2) 4.0% -13.7% -0.2%
2015 388.9 86.2 475.2 (2.2) (15.9) (18.1) -0.6% -15.6% -3.7%
2016 365.3 71.4 436.6 (23.7) (14.9) (38.5) -6.1% -17.2% -8.1%
Source: CEIC, Daiwa
In other words, a retail hub is like an ecosystem. It needs a luxury segment for the margin, but to make it vibrant
and sustaining, it needs to have a wide variety of goods and cover a broad spectrum of brands and customers.
Note that scale and critical mass matter a lot for retail hubs, just like financial centres. Hence, strong retail hubs that
have critical mass tend to feed on themselves, ie, self-generating forces to propel them to gain market share and
are resilient to challenges.
51
In short, we think the future of Hong Kongs retail property sector lies in it becoming a hub for luxury goods as well
as many other trades, and that as a retail hub, Hong Kong needs to compete in terms of variety of choice,
efficiency of shopping, product reliability, service quality of professionals in the retail industry, etc. As we see it,
there is still considerable room for Hong Kong to improve in this area, and we see Hong Kongs retail and retail
property industry adapting to correct itself from the past orientation towards over-luxury.
As and when the progress and improvement made by the industry reaches critical mass, we would expect retail
sales growth momentum in Hong Kong to improve, while the transport infrastructure breakthrough, in terms of
linking up Hong Kong with southern China and the High-speed Rail network in China, we expect to see in the next
1-2 years would certainly help.
Residential: backed by the wealth in Hong Kong

Admittedly, unit prices of residential properties in Hong Kong are high. But like office and retail, we think the
phenomenon is more a reflection of economic reality and is backed by the wealth in Hong Kong.
Again, we suggest looking at the market in its totality. However high residential property prices are in Hong Kong,
the total market value of Hong Kong residential property assets is not out of kilter with the wealth in the city, and
the relative size of the 3 key asset markets in Hong Kong.
Shown below is the relative size of the 3 main asset classes in Hong Kong and how it has evolved over the years.
Note that in 1997, their sizes were quite similar. Since then, the relative size of residential property assets has
shrunk even though its performance has been probably the strongest since 2H03.
Hong Kong: relative sizes of the 3 main asset classes

(HKDtn)
45
40
35
30
25
20
15
10
5
0
Dec 10
Dec 90
Dec 91
Dec 92
Dec 93
Dec 94
Dec 95
Dec 96
Dec 97
Dec 98
Dec 99
Dec 00
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Dec 11
Dec 12
Dec 13
Dec 14
Dec 15
Dec 16
Stock- market cap Total bank deposits Mkt cap of private residential pty mkt
Source: Midland, CEIC, Daiwa
Note that Hong Kong has total bank deposits of about HKD10tn and our understanding is that not many real estate
markets have bank deposits larger than the market value of its residential properties; Hong Kong covers it by
almost 2x.
However high prices of Hong Kong residential properties are, there is a significant amount of wealth in Hong Kong
that has not yet been deployed into this asset class.
Hence, while residential property prices in Hong Kong are undoubtedly high, the total market value of the private
residential property assets in Hong Kong, at about HKD6.5tn we estimate, does not appear too large relative to the
2 other major asset classes in Hong Kong bank deposits (HKD10tn) and equities (over HKD25tn). Indeed, the
growth in value of Hong Kongs private residential properties has actually lagged the growth of bank deposits in the
city, not to mention equities.
52
Residential property prices not yet out of kilter with the wealth
structure in Hong Kong
Note that based on the figures from the Governments Property Review, the number of units in Hong Kong worth
above USD1m was still less than 200,000 at the end of 2015, while Hong Kong has 1.1m private residential units
and some 2.4m households.
In terms of number of units exceeding USD1m, we believe it is still much smaller than that in London and New York
where the number of larger-sized units is notably larger than that of Hong Kong, in our view.
Moreover, the current distribution of residential units in Hong Kong (in terms of value and size) does not look out of
kilter with the income and wealth structure of the city. Shown further on are the stock levels of different types of
units in Hong Kong and how they compare with the number of different socio groups in Hong Kong.
We do not dispute that Hong Kong residential property prices are high, and look unsustainable, but it is arguable
that the picture more or less mirrors the wealth and income structure of the city, in the sense that the absolute
number of units in each price range does not appear too large relative to the number of people with the wealth and
income to afford them.
But note that the above analysis is based on the assumption that each person only owns one unit. This, however,
is not the case, as it is typical for the wealthy in Hong Kong to own more than one unit. The government estimates
that over 350,000 residential units in Hong Kong are not owner-occupied, while over 60% of the residential units in
the city are mortgage-free.
As such, it appears that residential units in Hong Kong have become an instrument to store wealth, and players
here have come to see it that way. So, in a way, the situation in the Hong Kong residential property market is that
the wealthy bought the units ahead of those who only have income. It is arguably a game where those with balance
sheet and wealth bought units and wait for those who only have income to catch up.
53
The structure of the residential property sector

In our view, the structure of the residential property sector throws light on its development over the past few
decades. We note that many home-owners have owned their assets for over 4 decades.
While residential property prices are high, these prices are only paid by new and marginal buyers. For units in
Taikoo Shing which now cost HKD10m plus, many existing owners would only have paid about HK0.5m or less,
while on The Peak, many units which would now go for well over HKD100m, would only have been originally
bought around HKD1m or less.
In other words, the current high level of prices in Hong Kong precludes many newcomers from buying residential
property assets in Hong Kong. However, for those who already own units, the price they paid is generally a lot less
than the prevailing price, and the debt they carry, if any, is based on the price they have paid rather than the
prevailing price of their unit(s). This situation means that if existing home owners are not keen to sell, prices could
hold at such high levels for some time.
Hong Kong: home equity

(HKDbn)
The size of home equity in Hong Kong has
9,000
increased significantly since mid-2003
8,000
7,000
6,000
5,000
4,000
3,000
2,000
Home equity
1,000
0
Dec 13
Dec 90
Dec 91
Dec 92
Dec 93
Dec 94
Dec 95
Dec 96
Dec 97
Dec 98
Dec 99
Dec 00
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Dec 10
Dec 11
Dec 12
Dec 14
Dec 15
Dec 16
Market cap of the private residential-property market Total residential-property loans
In short, there has been a substantial rise in home equity in Hong Kong over the past few decades. Importantly, we
see 4Q97-2Q03 as an important period to understand the industry now. This 6-year downturn removed many
marginal owners and resulted in a significant surge in home equity for many existing home owners.
While low interest rates theoretically encourage marginal and undercapitalised buyers, it has turned out that the
Asian central banks especially those in Hong Kong and Singapore pre-empted the asset bubble and
suppressed people from leveraging up since 2011.
Survival of the wealthiest?

Hence, our read is that the governments cooling measures have made it increasingly difficult for upgraders to
enter the market. These measures have also raised the threshold for people to qualify as buyers. But for the
market as a whole, such government policies have had some unintended consequences.
First, the people who can afford to buy are increasingly the wealthy and they can afford to hold on to their
properties for some time. While the government measures have resulted in the pool of potential buyers of
residential properties becoming smaller, there is still a decent number of wealthy people in Hong Kong, probably
more than 100,000, a sufficient critical mass, and this socio group could just keep on buying property.
Second, those wanting to upgrade their properties would now take longer to do so, and while some may give up,
there are others who would pursue their ambition, and this would ensure the market had buyers if prices fell.
Third, the measures have resulted in a growing reluctance among home-owners to sell, as many would not be able
to buy back into the market. Such circumstances have led to a fall in supply on the secondary market, and we think
this is one of the main reasons secondary market transaction volume has declined consistently in recent years. In a
situation where most home-owners are unwilling to sell, most buyers would then have to go to the primary market;
and with a much smaller volume of transactions than before would be enough to exert upward pressure on overall
property prices.
54
While we do not think the current situation is healthy, it is difficult to see prices falling much over the next 1-2 years,
barring any shocks that are worse than those seen over the past few years.
Indeed, looking back, each time of crisis or government intervention in Hong Kong has merely resulted in units
being passed from the less capitalised buyers to those who are more well-capitalised and have stronger holding
power.
In our opinion, under the current situation, it has become increasingly difficult to find new buyers, except first-home
owners buying small units and the very wealthy purchasing luxury units. The longer-term outlook for the sector
would depend on whether the wealthy are willing to put money into Hong Kong property. We do not expect the
habits of the wealthy to easily change. Moreover, mortgages can be repaid rapidly under the current low interest-
rate environment, so we believe the market has considerable ability to sustain the current high property prices.
An unhealthy equilibrium, but an equilibrium nonetheless

Many developers are now building smaller and smaller units, using floor size as a means to adapt to affordability.
While this strategy may have undesirable social consequences, we cannot deny that it is not a sound commercial
move.
Note that government forecasts only count number of units, and nowadays 3 new units may equal just 1 unit in the
past in terms of total GFA. The government has been working hard to increase the land supply, but we expect
supply to only rise from an exceptionally low level to a more normal level, and think the situation is far from being in
over-supply. In our view, the market has been adapting to smaller units and the consequences could be a trade-off
in the quality of living in Hong Kong and social discontent. But as a market, Hong Kongs ability to withstand
challenges and crises is strong.
Residential property completions, take-up and vacancy in Hong Kong

(No. of units) (%)
40,000 8
35,000 7
30,000 6
25,000 5
20,000 4
15,000 3
10,000 2
5,000 1
0 0
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016E
2017E
2018E
2019E
2020E
Net supply Take-up Vacancy rate

Source: CEIC, Daiwa forecasts
Indeed, the problem could well lie with the government, which, albeit with good intentions, may have taken on too
big a role in the property process. Before 1997, about two-thirds of the land supply in Hong Kong came from lease
modification. But the pace of the lease modification process has become much slower and difficult over the past 20
years. However, there is ample farmland in the New Territories. In theory, this farmland could be converted into
middle class housing in the price range of USD0.5m-1m, which we think Hong Kongs middle class could accept.
Then, it would just be a case of overcoming the psychological barrier of living in the New Territories. Note that
Hong Kong is still a small city, where it only takes about 40 minutes to drive from Central to the China border in the
New Territories.
As and when more new units are built in the New Territories, more people will be faced with the decision to either
continue living in a shoebox unit in the urban area, or move to the New Territories and accept the longer commute
(anything from 45 minutes to an hour by public transport) but live in a 2-3 bedroom unit. By global standards, a 1-
hour commute is common, and we do not see why the same shouldnt be the case in Hong Kong.
Our overall view on the Hong Kong residential property sector is that it is in urgent need of a larger mid-tier
segment, like Kowloon East in the office sector and suburban malls in the retail sector. As and when a larger
amount of mid-tier units become available, we would expect to see many end-users trading commuting time for
more space and a superior living environment, similar to what has happened in London, New York and Tokyo over
the years. As more mid-tier units in the New Territories are built, the median size of residential units in Hong Kong
55
would likely move more towards 600-700sq ft (from below 500 sq ft currently) while the total market value and
number of private units in Hong Kong would expand notably.
Ironically, the land for the mid-tier segment has always been there, as several developers have accumulated a
substantial amount of farmland over the past 2-3 decades, waiting for the opportunity to monetise it. In this light,
once the government comes out with an open and equitable mechanism for converting such farmland into
residential use, one of the main obstacles for the development of the Hong Kong residential property sector would
be removed.
In the meantime, before such a mechanism for converting farmland is established, many end-users will have to
accept small units, some under 300sq ft, with the extreme cases being less than 200sq ft in size, which on the face
of it, is a disturbing phenomenon from a social perspective. However, from a purely commercial perspective, it
simply represents a rational commercial response to the various government measures that have been
implemented.
Hence, on the whole, while the Hong Kong residential property sector looks unhealthy, the current price contour is
likely to be sustainable and should show considerable resilience against headwinds, in our view.
Another perspective to assess the sustainability of prices

In our view, property prices in Hong Kong be they office, retail or residential cover a wide spectrum and there
are fundamental reasons the prices and rents in each segment of property assets are what they are.
In China and many developing markets, we believe chaotic describes the price contour in some of the cities in
those markets. However, the price contour for Hong Kong property assets exhibit a rational pattern and structure,
in our view, and we think that in Hong Kong, prices and rents of different districts provide a kind of checks and
balances.
More importantly, we expect all property segments in Hong Kong to expand their geographical boundaries over
time, and new and cheaper districts to be constantly added to the existing landscape. Such a situation would also
restrain prices from becoming entirely out of touch with economic fundamentals, on top of confirming that there is
underlying genuine demand in the market. At the same time, the market participants seem to be active and rational
in terms of spotting mis-pricing and taking investment action to capitalise on what they see as mis-pricing as well as
relatively overvalued/undervalued situations.
In this light, competitive market forces exist to restrain prices in the Hong Kong Property Sector and the market
participants do take action to provide alternatives to the expensive property assets in Hong Kong.
As such, it appears to us that the prevailing prices of the 3 major kinds of property assets in Hong Kong as well
as the variations of them across districts by and large, just reflect prevailing market expectations and are the
result of rational bargaining and negotiations between buyers and sellers; or between landlords and tenants, all of
which look informed about the market situation and alternatives.
Accordingly, we do not see a high risk of Hong Kong property prices having reached levels at which they are no
longer competitive. Whether it is office, retail or residential, new-comers still seem willing to come to Hong Kong
despite the high prices, and it appears that, so far few of them have decided to exit. We see this as another
indication that the market participants can accept prevailing prices and that there are choices in Hong Kong, such
that each type of user of the properties can find assets where the prices or rents can fit well with the economics of
their businesses and their own level of wealth.
In addition, we have also analysed the sustainability of the prices and rents of all 3 property segments in Hong
Kong at an aggregate level. Our conclusion is that the aggregate retail rent paid in Hong Kong is not out of touch
with the aggregate sales productivity of the retail space in Hong Kong, while the aggregate office rents paid in
Hong Kong are also not out of touch with the aggregate profits made by the companies operating in Hong Kong. At
the same time, the total value of residential property assets in Hong Kong does not look out of touch with the total
wealth of the people living in Hong Kong (see p70-71 for details).
56
As such, while there would always be people/retailers/corporations which cannot accept prevailing prices and rents
this is the nature of the capitalist process the situation seems to be that for every player that finds the prevailing
prices or rents unacceptable, there are more than one who can still accept them. And there are still new-comers
seeking to come to Hong Kong.
Indeed, our read is that it has been successive waves of companies/tenants/buyers coming to Hong Kong that has
pushed prices up to the next level. If the worlds most wealthy individuals, as well as most profitable corporations
and retailers, continue to come to Hong Kong, it is hard to say whether Hong Kong property prices have reached
levels that cannot possibly go even higher.
Can top-end property prices in Hong Kong possibly rise further?

Our estimate on the maximum level of retail rental is based on sales per sq ft. If a 2,000sq ft retail space can sell
more than 20 pieces of million dollar jewellery a day, then it is arguable that even HKD10,000/sq ft (over 3x what
Hong Kong achieved at the peak) or HKD20m per month is not inconceivable.
Similarly, for an asset management company with AUM of over USD30bn, it is conceivable that its profit could be in
the region of hundreds of millions of HKD and it might only need an office space of 5,000 sq ft or even less. For a
company like this, paying HKD1,000/sq ft per month (over 5x of the peak level ever achieved in Hong Kong so far)
or HKD5m per month is not unaffordable.
By the same token, for an individual whose net worth is over USD10bn, spending 10%, or USD1bn (over 3x of the
highest unit price of residential unit ever achieved in Hong Kong) to buy his/her dream house is not inconceivable.
Seen in this light, theoretically there is almost no limit to the maximum price that can possibly be commanded by a
single property asset which has become like an antique. What we can do, however, is assess the size of the
property assets in a city which command antique-like prices, and assess how possible it is that there would be
enough individuals/companies/retailers with the wealth/profit/sales to take them up.
From this perspective, we cannot rule out the chance that Hong Kong might still see transactions that keep
breaking what already look like incredible levels.
On the residential front, The Peak and Island South currently have less than 2,000 detached houses. In this light, if
the number of billionaires who desire owning one or more than one unit in Hong Kong exceed 2,000, then we
would already be in a situation where the available stock in the city would not be able to satisfy all the demand.
We estimate that the number of billionaires in Hong Kong is probably over 2,000 already and the number of
billionaires in Shenzhen alone may not be less than 2,000. This is before we take into account the wealthy people
from Shanghai, Beijing and other Chinese cities who probably already own billions of dollars of property assets in
China and are ready to swap some of their China property assets into properties in the international markets.
As such, we believe that the super-luxury residential units in Hong Kong will continue to command scarcity value.
In our opinion, one way to assess the reasonableness of the unit price of a residential property is to: 1) first
assess how it ranks among the existing stock of residential units in the city, and 2) assess its price relative to the
wealth of the person who ranks similarly in terms of wealth living in that city.
th
This is to say, for a unit that ranks around 100 among all the existing residential units in that city, when we assess
the sustainability of its unit price, we can look at the level of wealth of an individual who ranks about 100th among
the wealthy living in the city. Assuming that the more wealthy in the city do not want to own more than one unit and
that there are no wealthy people from outside coming to buy his/her dream house in the city (both are big IF), it
would be a concern if this individual could not possibly afford to buy it.
th
However, we do not think this is the case in Hong Kong yet. We suspect that the individual who ranks 100 in Hong
Kong in terms of wealth probably has a net worth of over HKD10bn, and if we use 10% of their net worth as
benchmark, the amount he/she can spend on his/her dream house would be HKD1bn. And HKD1bn would rank
nd
about 2 for residential units ever transacted in Hong Kong, and we believe this sum would be enough to buy a
unit which ranks within the top-50 in the entire private residential unit pool in Hong Kong and probably higher.
57
Similarly, Russell Street in Causeway Bay and Canton Road in Tsimshatsui are both very short when compared
with Fifth Avenue, Bond Street or Avenue des Champs Elysees, as the total number of shops in these 2 streets in
Hong Kong would add up to no more than 50 stores, on our estimates. For a retail property segment which consists
of less than 50 stores, our view is that we cannot say that peak rent achieved in Causeway Bay in the past cannot
possibly be broken again some years down the road.
On the whole, we estimate that the top-5 retail property assets in Hong Kong Harbour City, Times Square, IFC
Mall, Sogo HK and Pacific Place mall would add up to still under 5m sq ft of GFA or less than 3% of the entire
retail property space in Hong Kong. As such, we expect the major retail landlords to remain in a strong position in
terms of negotiating base rents.
Along the same lines, we estimate that there are now about 5,000 companies operating in Central (including
Admiralty) which has about 22m sq ft (NFA) of office space, of which over 4m sq ft is self-owned, on our estimates.
We expect the average tenant size in Central to continue to decline and companies to continue to relocate from
Central to other districts. Assuming an average size of 5,000 sq ft for a new tenant, we estimate that 50-100 of
them a year would be enough to back-fill the space that would be vacated in Central, and we see 50-100 as
possible figures.
Our read is that, this time around, the landlords in Central would set their leasing strategies based on their
perceived strength of new demand for office space in Central. When the demand looks strong, they would be more
aggressive when renewing leases with existing tenants. However, when the demand did not look as favourable,
they would be more flexible and accommodating when renewing leases.
Based on the above, our view is that while prices of the very top-end segment of the Hong Kong property sector
are high, we believe Hong Kong is not in a situation where its property prices and rents are so high that they cannot
be sustained. Indeed, we believe they can still show considerable resilience against the impact of adverse factors,
an issue to which we turn in the next section.
58
Question 4
Will US interest-rate normalisation
spell the beginning of the end for
Hong Kong property?
59
Q4: Will US interest-rate normalisation spell the beginning of the end

for Hong Kong property?
The Chinese use two brush strokes to write the word crisis. One brush stroke stands for danger; the other for
opportunity. In a crisis, be aware of the danger but recognise the opportunity.
- John F. Kennedy
The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty
actually is the friend of buyer of long-term values.
- Warren Buffett
When a virus gets into a body, what is its impact? There are 2 key parameters to answering this question: 1) how
strong is the virus? and 2) how strong is the body? But note that everything is relative. If the body is weak, then
even a weak virus would be enough to have a significant adverse impact on the body. Conversely, if the bodys
immune system is strong, then it is conceivable that even a strong virus may do that much harm.
We believe this analogy is useful when assessing the impact of rate hikes and other headwinds facing the Hong
Kong property market.
Is a rate hike unanticipated and are participants unprepared?

Whatever the case, we believe the economic participants are not unaware of nor unprepared for this risk factor.
We believe the episode from 4Q97-2Q03 is important to put the current cycle into context. One consequence of
that episode was that many market participants became aware of the consequences of over-leverage debt was a
big burden during those 6 years of deflation which saw property prices fall by as much as 70% from peak to trough.
Residential property prices in Hong Kong since 1979

*Feb 2017:
10,000 HKD8,549/sq ft
8,000
Mega upcycle Mega downcycle
6,000
4,000
2,000
0
Dec-80
Dec-84
Dec-79
Dec-81
Dec-82
Dec-83
Dec-85
Dec-86
Dec-87
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Source: Midland, Daiwa

Note: *provisional figure
Those over the age of 30 in Hong Kong probably still have memories of that depressive period, and our read is that
the major participants in the Hong Kong residential property market are still people who are over 30.
Indeed, probably because of the legacy left by that period, our observation is that since 911 when the US lowered
interest rates, the media has been claiming that US interest rates would rise sooner or later. As a result, we do not
think the economic participants have been using low interest rates to leverage up; instead, many seem to have
opted for using low interest rates to pay down debt faster.
The Hong Kong residential property market has seen a good amount of turbulence over the past few decades, and
it appears that many have learnt from this experience and are now not so inclined to use leverage. Not that
leverage would be allowed by the regulators. This time round, Asian central banks especially those in Singapore
and Hong Kong seem determined to pre-empt the occurrence of any asset bubble and have employed draconian
measures to prevent excessive use of leverage.
60
Government regulations in Hong Kong to pre-empt excessive leverage

Special stamp duty and buyers stamp duty
Before Feb 2013 Since Feb 2013
Special Stamp Duty (SSD)
Length of the SSD period 2 years 3 years
Resale within 6 months 15% 20%
Resale in 6-12 months 10% 15%
Resale in 12-24 months 5% 10%
Resale in 24-36 months nil 10%
Buyers Stamp Duty (BSD)

- HK permanent residents nil nil
- Purchases using company nil 15%
- People working/living in HK but without permanent-resident status nil 15%
- Foreign buyers not living or working in HK nil 15%
Double stamp duty (DSD)

Double stamp duty (DSD)
Double stamp duty (DSD) (effective 5 Nov 2016, for
Property value Basic stamp duty (effective 23 Feb 2013) residential properties only)
< HKD2m HKD100 1.50% }
HKD2m - 3m 1.50% 3.00% }
HKD3m - 4m 2.25% 4.50% } 15%
HKD4m - 6m 3.00% 6.00% }
HKD6m- 20m 3.75% 7.50% }
> HKD20m 4.25% 8.50% }
Note: 1) DSD applies to all residential and non-residential properties purchased either by individuals or companies
2) DSD does not apply to Hong Kong permanent residents (HKPR) who do not already own any other residential property in Hong Kong at the time of
acquisition
3) A HKPR who acquires a residential property A while seeking to dispose of another one B (his /her only other residential property) will be subject to
the new rate as usual in the first instance, but may seek a refund of the stamp duty paid in excess of that computed under the old rates upon proof
that property B has been disposed of within 6 months from completing the transaction of property A
Maximum loan-to-valuation rates on residential mortgages in Hong Kong

Date <HKD7m HKD7-8m HKD8-10m HKD10-12m HKD12-20m >HKD20m
Before Oct 2009 70% 70% 70% 70% 70% 70%
Oct 2009 onward 70% 70% 70% 70% 70% 60%
Aug 2010 onward 70% 70% 70% 70% 60% 60%
Nov 2010 onward 70% 70% 60% 60% 50% 50%
Jun 2011 onward 70% 60% 60% 50% 50% 50%
Sep 2012 onward 70% 60% 60% 50% 50% 50%
Feb 2013 onward 70% 60% 60% 50% 50% 50%
Feb 2015 onward 60% 60% 60% 50% 50% 50%
Source: HKMA, Hong Kong Economic Times, Daiwa
Mortgage loans guidelines

First property Subsequent properties
With HK income Without HK income With HK income Without HK income
Self-occupy units
<HKD7m 60% 50% 60% 40%
HKD7-8m 60% (cap at HKD5m) 50% (cap at HKD5m) 60% (cap at HKD5m) 50% (cap at HKD3m)
HKD8-10m 60% (cap at HKD5m) 50% (cap at HKD5m) 60% (cap at HKD5m) 50% (cap at HKD3m)
HKD10-12m 50% 40% 50% 30%
HKD12-20m 50% 40% 50% 30%
>HKD20m 50% 40% 50% 30%
Units not for self-occupation 50% 40% 50% 30%
Net-worth based mortgages 40% 40% 30% 30%
Source: HKMA, Hong Kong Economic Times, Daiwa
In any case, Hong Kong did have experience in coping with US rate hikes before, from February 1994 to February
1995, June 1999 to May 2000, and June 2004 to June 2006 are among some of the examples in the past 3
decades, with the length ranging from 12-24 months and the magnitude ranging from 150bp to 400bp. Meanwhile,
the consensus has been expecting the next move in US interest rates to be a rise since about early 2014. The US
Fed Funds Rate did start rising in December 2015 and so far it does not seem to have had a major adverse impact
on the physical market.
61
Fed Funds Rate hikes vs Hong Kong property prices

Rate hike period Fed Funds Rate Midland property price
(%) (HKD/sq ft, GFA)
Start 4-Feb-94 3.25% 3,837
End 1-Feb-95 6.00% 3,882
Change +275bp 1%
Start 30-Jun-99 5.00% 3,538
End 16-May-00 6.50% 3,232
Change +150bp -9%
Start 30-Jun-04 1.25% 2,792
End 29-Jun-06 5.25% 3,157
Change +400bp 13%
Start 16-Dec-15 0.50% 8,331
Latest 1.00% 8,549
Change +50bp 3%
Source: Bloomberg, Midland, Daiwa
In retrospect, during the 2005-06 period when US rate hikes were seen as a major theme in the market, Hong
Kong residential property prices were flat. And for the whole rate cycle during this episode, which lasted for 24
months from June 2004 to June 2006 (involving 16 times and 400bp cumulative hikes in rates), Hong Kong
residential property prices actually rose by 13%. Hence, from a historical perspective, rate hikes may not
necessarily bring down property prices, and we think this is conceivable especially if the developers have been
anticipating and preparing for such risks.
Importantly, our read is that this round of rate hikes has been anticipated for some time. Our observation is that talk
about rate hikes has resonated in the market for over a decade; ever since 1H14, the market has been expecting
the US to introduce tapering, with the next move in interest rates being up. Since then, the market has anticipated
several rounds of interest-rate rises, and as such, we believe rate hike expectations have been ingrained in the
system for some time. If the past is anything to go by, rate hikes did not have a definite adverse impact on Hong
Kong residential property prices.
Fed Funds Rate vs Hong Kong property prices

(%) (HKD/sq ft, GFA)
25 10,000
20 8,000
15 6,000
10 4,000
5 2,000
0 0
Dec-87
Dec-79
Dec-80
Dec-81
Dec-82
Dec-83
Dec-84
Dec-85
Dec-86
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Fed Funds Rate Midland property price (LHS)

Source: Bloomberg, Midland, Daiwa
Has the residential property market become over-leveraged?

While low interest rates are conducive to excessive borrowing, it appears that this has not been the case in Hong
Kong, probably because the economic participants in the city be it the regulators, the banks, the developers or
the home-owners are aware of the undesirable consequences that excessive borrowing can create. As such, the
response in the Hong Kong physical market is very different from what we would normally expect to see in most
other markets.
Of note is that the latest era of low interest rates was preceded by arguably the worst economic recession Hong
Kong has seen, which lasted for 6 years, and during this period those who were highly leveraged were heavily
affected.
Hence, instead of leveraging up to take advantage of the current cheap money, it appears that the Hong Kong
markets initial reaction to the onset of low interest rates in the aftermath of 911 was to opt to use the low interest
rates to pay down debt faster. As a consequence, from 2000-06, total outstanding mortgage loans in Hong Kong
were stagnant despite some HKD150-307bn in annual residential property sales (primary plus secondary) during
the period.
62
While total outstanding mortgage loans in Hong Kong did start to rise from 2007 onwards, the magnitude was
modest after taking into account the amount of annual residential property transactions and the value of the
underlying residential property assets we estimate that the net increase in mortgage loans averaged only about
10-15% of the transacted value of residential properties during this period.
Although some commentators have used the mortgage loan/GDP ratio to argue that there has been an excessive
build-up of leverage in Hong Kong, our view is that referencing this chart is misguided. We think it is more
appropriate to compare the size of the mortgage loans outstanding to the value of the underlying assets and not to
GDP.
Mortgage loans outstanding vs. GDP

(HKDbn)
3,000
2,500
2,000
1,500
1,000
500
0
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Mortgage loan outstanding GDP
Source: CEIC
To elaborate, we believe the structure of the Hong Kong economy is an anomaly relative to global peers, given that
the size of its asset market is much larger than its GDP. Note that in Hong Kong, the residential property market
alone is over 2x Hong Kongs GDP, and the multiple rises to 4x if we include other property asset classes. If we
include bank deposits and equities, then the multiple rises to over 18x which may be the highest in the world
Hong Kong has probably long overtaken Switzerland as the economy with the largest asset market relative to its
GDP.
And we think this peculiar characteristic of the Hong Kong economy is symptomatic of some important changes
that have been taking place in the Hong Kong economy and society, and would likely be a situation that will stay, if
not further accelerate in the years ahead (more in the next section).
As such, we think the chart above merely reflects that the size of Hong Kongs residential property market is large
relative to its GDP, and this has been a situation that has persisted for a long time and become increasingly
pronounced in recent years.
Does this mean that Hong Kong has been taking up excessive leverage relative to the income generation capability
of its economic participants for a long time? This is theoretically possible, but does not seem consistent with many
other indicators we have observed.
Indeed, we think this conundrum opens up the question: is Hong Kongs GDP representative enough of the income
generation capability of the economic participants in Hong Kong? We have some reservations about this, as we
think it is quite clear that the income and wealth of people living in Hong Kong are not limited to the economic
activities taking place within the geographical boundary of the city of Hong Kong.
In as early as the 80s, the manufacturing companies in Hong Kong already derive the bulk of their earnings from
goods produced by their plants across the border. And there are clearly quite many people in Hong Kong working
in China and that the Hong Kong companies and individuals have sizeable investment s in China, London, as well
as many parts of the world.
With Hong Kong continues to evolve along the lines of the co-ordination centre for economic and investment
activities in Greater China, Asia or even the entire world for people and corporations in Hong Kong, we think it is
reasonable to expect that the proportion of the citys net income from abroad are more likely to rise than decline.
63
The problem, however, lies in that there is no systematic and reliable way to track Hong Kongs net income from
abroad. Our view is that it is possible that Hong Kongs GDP figures could have underestimated the income of the
entire Hong Kong citizens as a whole.
At this stage, we highlight in the following table after breaking down and analysing how mortgage loans outstanding
in Hong Kong have evolved since 1996, the first year when such data became available.
Changes in mortgage loan outstanding in Hong Kong

(HKDbn) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Transaction value in
- primary market 72 113 120 84 73 68 75 79 101 91 52 114 68 113 128 131 132 92 177 162 188
- secondary market 320 564 155 136 111 91 79 71 174 216 177 318 276 313 433 312 323 208 254 255 242
Total 392 677 275 220 183 160 153 150 275 307 230 432 344 426 561 443 455 300 431 418 430
New loans drawn 163 256 112 119 116 107 99 79 134 143 115 174 185 199 324 228 192 159 214 244 217
New loans approved 182 274 126 142 137 122 108 85 156 157 141 214 224 311 414 270 257 196 279 285 299
Change in total mortgage loan o/s 58 95 34 19 43 7 5 (11) 6 5 (4) 28 30 53 99 61 67 36 80 89 45
Total mortgage loan brought forward 273 330 425 459 478 522 529 534 522 528 533 529 558 588 641 740 801 868 905 985 1,074
Total mortgage loan carried forward 330 425 459 478 522 529 534 522 528 533 529 558 588 641 740 801 868 905 985 1,074 1,119
Implied total downpayment + loan repayment 334 582 241 201 140 153 148 161 269 302 234 404 315 373 461 382 388 264 351 329 385
Source: CEIC, Midland, Land Registry, Daiwa
One implication of such an analysis is that for the residential property market as a whole, the extent of leverage in
Hong Kong is modest, and it could well be among the lowest leveraged residential property market in the world.
While annual residential property transacted value ranged from HKD150bn to HKD677bn from 1996-2006, the net
increase in mortgage loans outstanding was at most HKD99bn, and was negative in 2003 and 2006 and more or
less flat for 4 years (2001, 2002, 2004 and 2005).
Why? We think the first reason was that buyers in Hong Kong often put down significant downpayments when
purchasing flats. While residential property prices in Hong Kong are high, and the average transacted unit price in
Hong Kong was HKD10.2m for the primary market and HKD6.5m for the secondary market in 2016, the average
value of new mortgage loans in Hong Kong was only about HKD3m, reflecting that the banks have been stringent
in lending in recent years and that a large part of the volume are units for home starters.
Hong Kong: average size of new mortgage loans made

(HKDm)
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Dec-11
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Source: Daiwa
Besides, we think these figures also reflect that many buyers do not need to borrow a large amount of finance
because either: 1) they are wealthy and mainly using residential properties to park their wealth, or 2) they are
funding their new purchase(s) from the proceeds obtained from selling an existing unit(s). In any case, the above
figures are consistent with the figures from the HKMA which showed that the average LTV in Hong Kong was about
50% in 2016.
64
Hong Kong: LTV ratio for new loans approved

(%)
75
70
65
60
55
50
45
40
Dec-04
Dec-00
Dec-01
Dec-02
Dec-03
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Source: CEIC
Hong Kong: average size of new mortgage loans made

(HKDm)
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Dec-11
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Source: Daiwa
On the other hand, another reason for the low level of leverage in Hong Kong is that in a low interest-rate
environment, most of the monthly mortgages would go to pay down the principal, resulting in much faster
repayment of existing mortgage loans (discussed in greater detail in the later part of this section).
In any case, the result of this low leverage was that there has been a significant build-up in equity in the whole
system, as shown in the graph below. At the end of 2016, the total mortgage loan outstanding in all financial
institutions in Hong Kong was HKD1.1tn, according to the HKMA.
Hong Kong: home equity

(HKDbn)
The size of home equity in Hong Kong has
9,000
increased significantly since mid-2003
8,000
7,000
6,000
5,000
4,000
3,000
2,000
Home equity
1,000
0
Dec 13
Dec 90
Dec 91
Dec 92
Dec 93
Dec 94
Dec 95
Dec 96
Dec 97
Dec 98
Dec 99
Dec 00
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Dec 10
Dec 11
Dec 12
Dec 14
Dec 15
Dec 16
Market cap of the private residential-property market Total residential-property loans
However, we estimate that the market value of the 1.2m private residential units in Hong Kong was HKD6.7tn,
meaning that for the system as a whole, outstanding mortgage loans represent less than 20% of the value of the
underlying assets, which is probably one of the lowest in the world. Meanwhile, the Hong Kong Government has
also estimated that over 60% of residential units are mortgage-free.
Of course, we cannot rule out that some individuals could have significantly over-leveraged. However, for the
residential property market as a whole, it appears that Hong Kong should be far from the point of having excessive
leverage.
65
Shown below is the sensitivity of monthly mortgage payments to changes in interest rates. Note that based on a
mortgage loan size of HKD3m (the average size of a mortgage loan in Hong Kong), each 25bp rise in mortgage
rate would only result in about a HKD368 rise in monthly mortgage payments. Even if the increase in mortgage rate
is 300bp, the increase in monthly mortgage is still HKD4,822, which is not a particularly large amount.
Hong Kong: sensitivity of mortgage payment to changes in mortgage rate

Loan size (HKD)
1m 2m 3m 5m 10m
Monthly repayment at current mortgage rate
1.80% 4,239 8,477 12,716 21,193 42,385
Incremental monthly payment
+25bps 123 246 368 614 1,228
+50bps 248 495 743 1,238 2,476
+75bps 375 749 1,124 1,873 3,746
+100bps 504 1,007 1,511 2,518 5,036
+125bps 635 1,269 1,904 3,173 6,346
+150bps 768 1,535 2,303 3,838 7,677
+175bps 903 1,806 2,708 4,514 9,028
+200bps 1,040 2,080 3,119 5,199 10,398
+225bps 1,179 2,358 3,537 5,894 11,788
+250bps 1,320 2,640 3,959 6,599 13,198
+275bps 1,463 2,925 4,388 7,313 14,626
+300bps 1,607 3,215 4,822 8,037 16,074
Source: Daiwa
Note: Assuming current mortgage rate of 2.0%, and mortgage term of 25 years
Meanwhile, based on a conventional affordability ratio analysis, it looks as if the current affordability ratio, while not
low, is not yet extremely high in relation on an historical basis.
Hong Kong: affordability ratio (on median household income)

(%)
120
100
80
49.4
60
40
20
0
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Source: CEIC, Daiwa
Hong Kong: affordability ratio (on median household income for top 50% of
households)
(%)
70
60
50
40 26.9
30
20
10
0
Jan-04
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Source: CEIC, Daiwa
Since February 2013, the HKMA has imposed a 300bp stress point stress test requirement for the approval of new
mortgage loans. This means that, even if the rate while the mortgage loan the buyer served is 2%, the loan is
approved on the basis that the mortgage rate is 5%.
66
Effectively, the government measures seem to have made it difficult for most people to leverage up. As such, while
exceptionally low interest rates are conducive to excessive borrowings, government administrative measures seem
to have pre-empted this scenario through making it difficult to borrow. As a consequence, the market as a whole
looks very under-borrowed relative to the prevailing interest rates. Such a scenario has protected the banking
system though what has been sacrificed could be the quality of living of the majority of the population.
Mortgage rates in Hong Kong and the stress test requirement

(%)
14
12
10
8 Average: 6.1%
6
4
300bp*
2
0
Jan-85
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Source: CEIC, HKMA, Daiwa
Note: *rates where banks approval of mortgage loans were based on since Feb 2013 (HKMA required a 300bp stress rest since then)
Individual cases would vary but the market as a whole seems to have
considerable ability to hold up
Another angle from which to examine on the affordability issue is the cost of servicing existing mortgage loans and
how that compares with the income-generation capability of the people of Hong Kong. We estimate that the
monthly mortgage payment required to serve a HKD1.1tn outstanding mortgage loan in Hong Kong is about
HKD5bn while the total payroll in Hong Kong is over HKD60bn (based on the 3.8m employed workers in Hong
Kong, before taking into account the 0.4m owners and self-employed persons).
Meanwhile, we also estimate that the various types of Hong Kong assets (excluding equities) generate over
HKD200bn in monthly cash flow for Hong Kong asset owners, while the listed companies generated over HKD80bn
in annual dividends to their shareholders. What this means is that for the Hong Kong market as a whole, the ability
to serve existing mortgage loans is strong and the equity portion is large. This scenario implies that for every
person who faces financial difficulties because of rate hikes, there are probably 4 or 5 who can weather the impact.
As such, as long as the wealthy are still willing to park their wealth in Hong Kong residential properties, the
consequence of any market panic could well be mainly that of a re-distribution of the ownership of assets while the
market as a whole would remain resilient.
Survival of the wealthiest?

For the market as a whole, Hong Kong is far from having excessive leverage, and the size of home equity is
substantial, meaning that the holding power of some owners of residential units is very strong.
Meanwhile, although the living environment of many people in Hong Kong could be considered substandard, the
overall distribution of units in Hong Kong broadly matches the distribution of income and wealth in the city. In this
sense, one could say that the strange phenomenon we observe in the Hong Kong private residential property
sector (such as most people living in rather small and old units; high unit price, etc.) may merely reflect the
underlying distribution of income and wealth in Hong Kong.
67
Structure of Hong Kong housing stock Sources of demand for different types of units
Total 2,321,698 units at end-2015 (No. of households)
(No. of units) 1,400,000 1,295,600
1,400,000 1,310,033
1,200,000
963,700
1,200,000 1,000,000
1,000,000 800,000
782,244
800,000 600,000
600,000 400,000 246,500 >100,000*
400,000 200,000
140,300
200,000 63,370 25,751 0
0 Below HKD20,000 HKD20,000-80,000 >HKD80,000 Wealthy individuals^
Public-rental HOS, PSPS, Class C Class D Class E (Monthly household income)
flats Class A&B
Source: CEIC Source: CEIC, Daiwa estimates
Note: E - Private domestic units: more than 160 sq m Note: *Daiwa estimates
D - Private domestic units: 100-159.9 sq m ^people who own assets or businesses who do not have reported salaries but have wealth
C - Private domestic units: 70-99.9 sq m (according to government statistics, there are about 200,000 self-employed persons in
B - Private domestic units: 40-69.9 sq m Hong)
A - Private domestic units: less than 39.9 sq m
HOS, PSPS, etc - Home Ownership Scheme, Private-Sector Participation Scheme, Urban
Improvement, Flat For Sale and Sandwich Class Housing Scheme
Note that the analysis above does not take into account that the wealthy in Hong Kong typically do not own just one
unit. Based on the governments estimate, there are about 350,000 private residential units in Hong Kong which
are not owner-occupied. As such, the Hong Kong residential property market could well be a reflection of a
situation where the wealthy own most of the better and larger units and are waiting for those who only have income
to gradually earn enough to buy those units from them.
In this light, we could say that the top 100,000 residential units in Hong Kong are expensive because the top
100,000 people in Hong Kong are wealthy and many of these people bought their units a long time ago when the
prices were only a fraction of the prices today. Against this background, it is not difficult to understand why the
selling pressure in the Hong Kong residential property market has remained low.
That said, there is no doubt that getting on to the housing ladder in Hong Kong has become increasingly difficult
and the government measures have likely had a significant suppressive effect on residential property demand,
especially upgrading activities. This seems ironic because we think the main housing problem in Hong Kong is that
most units are small and old. While the government measures are intended to help home buyers, it appears that
the unintended consequences of these measures is that they have actually made it more difficult for normal and
legitimate upgraders to move into newer and larger flats.
Ironically, what the government measures mean is that the threshold for entering the wealthy class in Hong Kong is
getting higher and higher. However, for those who are already in this group, the government measures might have
helped them, in that there are now fewer competitors in the market. In this light, the government measures, for all
the good intentions, may have actually resulted in a worsening of the wealth gap between the wealthy and lower-
income people in Hong Kong.
Indeed, our observation is that, arguably, a process of survival of the wealthiest seems to have been working in
Hong Kong in recent years; and the impact of each new round of government measures seems to be mainly that of
resulting in units being passed from the less well-off to the more well-capitalised players.
So, the consequences of the various cooling measures in the past seem to have been that units have been passed
into the hands of people who are more well-off and well-capitalised. But with more and more of the potential sellers
having already sold, and more and more units having fallen into the hands of the wealthy, the markets ability to
withstand an external shock may well be on the rise.
Another point to note is that while the prices of residential units in Hong Kong are high, the total market value of
residential properties in Hong Kong is still moderate relative to other major asset classes in Hong Kong. Note that
there are 3 main asset classes in Hong Kong (bank deposits, residential properties and equities) but since 1997,
the relative share of residential properties in Hong Kong has come off significantly.
Hence, however high the price of residential properties in Hong Kong, the total market value of residential property
assets in Hong Kong do not appear too large relative to the size of the 2 other asset classes in Hong Kong. This means
that, in theory, there is still a lot of capital that could move from the 2 other asset classes into residential property.
68
Hong Kong: relative sizes of the 3 main asset classes

(HKDtn)
25
20
15
10
Dec 04
Dec 08
Dec 90
Dec 91
Dec 92
Dec 93
Dec 94
Dec 95
Dec 96
Dec 97
Dec 98
Dec 99
Dec 00
Dec 01
Dec 02
Dec 03
Dec 05
Dec 06
Dec 07
Dec 09
Dec 10
Dec 11
Dec 12
Dec 13
Dec 14
Dec 15
Dec 16
Stock- market cap Total bank deposits Mkt cap of private residential pty mkt
Annual primary market sales in terms of volume Annual primary market sales in terms of value
(no. of units) (HKDm)
35,000 Primary market transaction volume 200,000 Primary market transactions value
180,000
30,000
160,000
25,000 140,000
1996-2016 avg = 1996-2016 avg =
20,000 18,508 120,000 106,384
100,000
15,000 80,000
10,000 60,000
40,000
5,000
20,000
0 0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Land Registry, Midland, Daiwa Source: Land Registry, Midland, Daiwa
Annual secondary market sales in terms Annual secondary market sales in terms of value
of volume
(no. of units) (HKDm)
160,000 Secondary market transaction volume 600,000 Secondary market transaction value
140,000
500,000
120,000
400,000
100,000 1996-2016 avg =
1996-2016 avg =
80,000 73,196 300,000
239,425
60,000
200,000
40,000
100,000
20,000
0 0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Land Registry, Midland, Daiwa Source: Land Registry, Midland, Daiwa
Based on the above analysis, we expect the residential property market to show considerable resilience against the
impact of rate hikes and other external factors as long as the wealthy class in Hong Kong remain comfortable about
parking their wealth in Hong Kong assets.
In this connection, we think it is worth noting that long-term owners of Hong Kong property assets have made a
large fortune and we estimate that the equity in Hong Kongs property market is currently well over HKD5tn, or over
2x Hong Kongs GDP.
Of course, past performance is no guarantee for the future; nevertheless, its hard not to notice that Hong Kong
property has done better than most people ever expected for multi-decades.
Our observation is that a large part of the wealth in Hong Kong comes from owning Hong Kong assets early, and
hence many of the wealthy in the city are people who have owned Hong Kong assets for a long time.
69
We estimate that of Hong Kongs 7.1m population, around 100,000 (1.5%) are wealthy and control the bulk of the
wealth in the city. We estimate that the private wealth related to Hong Kong assets (excluding private businesses)
is about HKD14tn. Assuming that 80% of such wealth is owned by 100,000 people, then the average NAV of these
100,000 people is about HKD140m, on our estimates. We believe many of the people in this group have lived in
Hong Kong for many years, have bought Hong Kong assets many years ago, and tend to be generally quite
conservative in terms of financing.
Hong Kong: asset market and private wealth

Size Unit price Owned by Amount of
(m sq ft) (HKD/sq ft) Est debt NAV non-listed & private wealth
/ (m units) (HKDbn) / (HKDm) (HKDbn) (HKDbn) local entities (HKDbn)
HK private residential 1.1 6,510 5.7 1,119 5,391 95% 6,185
HK office 121 972 8,000 20% 778 50% 389
HK retail 118 1,775 15,000 20% 1,420 50% 710
HK Industrial 181 454 2,500 10% 408 90% 367
HOS units 0.32 1,134 3.5 30% 794 100% 794
Urban taxi 15,000 98 6.5 20% 78 100% 78
New Territories taxi 10,000 15 1.5 20% 12 100% 12
Minibus 10,000 80 8 20% 64 100% 64
Bank deposit na 11,727 na - 11,727 80% 9,382
22,765 20,672 17,981
HK stock market 26,820 10% 2,682
49,585 20,663
% of HK's private wealth shared by the top 100,000 people 80%

Amount of HK's private wealth shared by the top 100,000 people 16,530
Average private wealth of HK's top 100,000 people (HKDm) 165
In our view, 100,000 is not a small number, and represents considerable capacity to buy out assets sold by
desperate sellers and less strongly capitalised players. This is also before we take into account the buying power
from the wealthy in the mainland and other countries.
As such, as long as this group of people remains comfortable about parking their wealth in Hong Kong and is on
the look out to buy when there are distressed sellers, this would provide considerable resilience to the market, as
developments over the past few years have illustrated.
The office market is also resilient to rate hikes

We believe the office market is also resilient to interest-rate hikes. Based on the governments reported corporate
profit tax of HKD138bn in 2015, we estimate that the amount of pre-tax profits in the Hong Kong corporate sector is
likely to exceed HKD1tn.
Estimated aggregate profits of the Hong Kong corporate sector

Effective tax rate (%)
10% 11% 12% 13% 14% 15% 16.5%
Total aggregate pre-tax profit of HK's corporate sector (HKDbn) 1,380 1,255 1,150 1,062 986 920 836
Corporate profit tax paid in 2015 (HKDbn) (138) (138) (138) (138) (138) (138) (138)
Aggregate net profits of the HK corporate sector 1,242 1,117 1,012 924 848 782 698
Net profit margin (%) 12% 12% 12% 12% 12% 12% 12%
Estimated revenue of the HK corporate sector (HKDbn) 7,696

Meanwhile, based on the governments property review and the disclosure of Hong Kong listed property companies,
we estimate that the total rental bill of all the companies in Hong Kong (we estimate to be about 15,000 of them) is
about HKD56bn, assuming that some 20% of the companies own their office premises and the average office rent
in Hong Kong being HKD50/sq ft per month.
Relative to the pre-tax profit of the Hong Kong corporate sector (HKD138bn in 2015), we do not think the total
office rental bill of the entire Hong Kong corporate sector is too excessive. This would mean that for every company
that cannot afford the office rent, there is likely to be several others that can afford to take up more space,
especially given that many of them are currently renting less than 3,000sq ft (for the smaller tenants) and below
50,000 sq ft (for the larger tenants).
70
Estimated gross office rental bill in HK vs estimated aggregate corporate profits

Total office stock in HK (m sq ft) 121 121 121 121 121 121 121
% of office spaces that are owner-occupied 5% 10% 15% 20% 25% 25% 25%
Total stock of offices for leasing (m sq ft) 114 108 102 96 90 90 90
Total office stock in HK which is not owner-occupied (sq ft) 96 96 96 96 96 96 96 96 96 96 96

Average rent (HKD/sq ft) 20 30 40 50 60 70 80 90 100 110 120
Total rental bill in a year (HKDm) 23 35 46 58 69 81 92 104 115 127 138
Estimated aggregate corporate profits in HK in 2015 (HKDbn) 924 924 924 924 924 924 924 924 924 924 924
This is before we take into account the savings on operating costs a firm can get through moving to areas where
rents are closer to USD2/sq ft than USD20/sq ft.
Also worth noting is that Hong Kong has not seen much new office supply over the past 10 years, and hence a
number of firms in Hong Kong have probably been in the city for some time, some for over 40 years. This implies
that many could have culminated some retained profits and have seen how Hong Kong has recovered from
previous crises.
In the event of a major external shock (created by interest rate trend or other factors), we believe the office market
could turn quiet. However, since the current vacancy rate in the overall Hong Kong office market is still low and with
the major office landlords in Hong Kong being well-capitalised, we would not expect major panic to spread among the
landlords.
We think if the situation of high rents continues and worsens, we could see more companies moving to low rental
areas which could result in a rise in vacancies in some districts, but there would likely not be a significant
deterioration in vacancy level in the office market as a whole.
Note that we have not taken into account potential new companies from China and overseas, which would see
cyclical downturns as an opportunity to secure a presence in the Hong Kong market, and whose prospects
probably would not be totally dependent on the situation of the domestic Hong Kong economy.
Overall, we would expect the Hong Kong office market to demonstrate considerable resilience against US interest
rate normalisation and other potential external shocks.
Retail property also likely to be resilient to rate hikes

Based on data from listed companies and government data, we estimate that the total rental bill of retail tenants in
Hong Kong is about HKD67bn. Given Hong Kong saw total retail sales of HKD480bn in 2016 (before online
shopping) , the implied occupancy cost is about 15%, which we do not consider excessive, given that the ability of
some trades (such as banks) to afford retail space may not be constrained by sales value, while some retailers do
own their own retail premises. Meanwhile, given the very large range in retail rents in Hong Kong, we believe
retailers can always relocate or close their stores.
Again, in the case of a major external shock, we would expect to see a major re-distribution of the tenant profile (like
what happened in high street shops in the past few years, with sports, F&B, etc., replacing watch and jewellery tenants).
Once again, we think the low vacancy rate, lack of new space availability in recent years, as well as the retail
landlords balance sheets and experience, should help ensure that, on the whole, the market has a considerable
cushion against external shocks.
Estimated average occupancy cost in the Hong Kong retail sector

Total retail property stock in HK (m sq ft) 118 118 118 118 118 118 118
% of office spaces that are owner-occupied 5% 10% 15% 20% 25% 30% 35%
Total stock of retail space for leasing (m sq ft) 111 105 99 94 88 82 76
Total retail stock in HK which is not owner-occupied (sq ft) 94 94 94 94 94 94 94 94 94 94 94

Average rent (HKD/sq ft) 30 40 50 60 70 80 90 100 110 120 130
Total rental bill in a year (HKDm) 34 45 56 67 79 90 101 112 124 135 146
Total retail sales in Hong Kong (HKDbn) 437 437 437 437 437 437 437 437 437 437 437
Implied average occupancy cost in the entire HK retail sector 7.7% 10.3% 12.9% 15.4% 18.0% 20.6% 23.1% 25.7% 28.3% 30.8% 33.4%
71
Cap rates unlikely to be affected much by rate hikes

On the other hand, it also appears that the Hong Kong commercial property sector also may not be significantly
affected by rate hikes. For one thing, the existing HKMA rules have capped the LTV for commercial properties at
40%. Moreover, the demand and supply dynamics for commercial properties are not affected directly by interest
rates.
Of course, in theory, changes in interest rates can affect the cap. rates for valuing commercial properties. However,
again this appears to be a risk that the market has been prepared for and our read is that many market participants
have already been building in a cushion against rate hikes.
Shown below are the cap. rates of the various major properties of Sunlight REIT. It shows that when US interest
rates were coming down, valuers did not lower the cap rates for valuing commercial properties accordingly.
As such, when US interest rates normalise, whether valuers must use higher cap rates is not clear. Our read is that
there is still a considerable cushion in the cap rate assumptions of many valuers, especially given that, in the
physical market, there appears to be pressure for cap rates to come down in many major cities in the world.
Cap rate of the properties owned by Sunlight REIT

(%) 4.62
5 4.50 4.50 4.80
4.50 4.50 4.50 4.50 4.50 4.50
4.50 4.80
4.40 4.40 4.40 4.40
4 4.40 4.40 4.40
4.21
4.50 4.00 3.85
4.20 3.85 3.85 3.85 3.85
3 4.47
3.81 4.20
2.07
2
1.30 1.37 1.63
1.13 1.19
1 0.68 1.02
0.36 0.26 0.38 0.38 0.39
0 0.57
Sep-06 (IPO Jun-07 Jun-09 Jun-11 Jun-13 Jun-14 Jun-15 Jun-16 Dec-16
valuation)
Sunlight Tower (office portion) Sheung Shui Centre Shopping Arcade
Metro City Phase I 3M HIBOR
5YR Exchange Fund Notes
Source: Company, Bloomberg
Is the market driven by low interest rates and Chinas economy?

Of course, this also opens up the deeper question of: is Hong Kong property driven merely by low interest rates or
is there a deeper layer of forces driving it?
In our May 2016 sector report, Its time to be more greedy than fearful, we argued that the most important factor
driving this property upcycle in Hong Kong is the metropolitanisation process the city has been undergoing
interest rates and the China economy only reinforce this process.
However, just as the Hong Kong property market has not taken a full ride up when both factors were moving in a
favourable direction, so when these 2 tidal waves turn, Hong Kongs property market also may not have a
complete dip.
72
Daiwas 5 phases of the metropolitanisation process

Features Hallmarks Property market implications Manifestations in HK property
Phase 1 Scramble for the most prime assets People or companies or retailers are A surge in capital and rental values for the most Central office in 2005-10; high street
willing to pay a premium to secure prime assets. retail rents in prime districts in 2004-13;
access to the most prime assets, luxury residential in 2004-13.
especially high-margin corporates and
retailers as well as wealthy individuals.
Phase 2 Markets begin to respond Market resistance begins to emerge Some districts are transformed and new districts HK office in 2009-14; residential entering
and create substitutes among other market participants could emerge to balance the surge in capital and into this phase since 2013; and retail
especially when the growth momentum rental value of the most prime assets. since 2014.
of the leading segments begins to lose
steam.
East Kowloon and the upgrading of the 4 other core
areas (Wanchai, Causeway Bay, TST and Island
East) can be seen as the office market's response
to phase 1.
If market forces are allowed to operate freely, a lot The result was that the market adapted
of land in the New Territories would be converted through developers changing to build a
into middle class housing, which could resemble lot more small units, and the primary
the Kowloon East equivalent in residential. market significantly eating into the
However, this has not been allowed to happen. market share of the secondary.
Instead, the government has responded by
implementing severe administrative measures to
suppress demand.
Suburban malls in the New Territories as well as
horizontal and vertical expansion of the prime retail
districts as well as landlords' renewed focus on
locals and mid-end brands can be seen as the retail
sector's response to phase 1.
Phase 3 Back to a more balanced growth path The market rests on a more solid and Becoming a property market which is much more HK office is just starting to enter into this
balanced foundation, with the top, mature and has a lot more depth and phase.
middle and low-end segments all sophistication. We would say that London is
having their own growth drivers and probably the closest example; while New York and
each major district having their own Tokyo are much more advanced than HK in this
characteristics as well as demand and respect.
supply dynamics.
Phase 4 The city continues to expand in size and depth Each major segment and district tries to The market is vibrant, dynamic and energetic, with London, New York and Tokyo are
grow and expand. Some will grow, many districts continuing to change and evolve, probably in this phase.
others may undergo a cyclical and new districts emerging. The city's size also
adjustment. But on the whole, the continues to expand.
market rests on a much more solid
foundation, and the city continues to
expand in size and depth if talent and
capital continue to come.
Phase 5 The city begins to go downhill The virtuous cycle in the development The development of a city could well be a multi-
of the property market reverses and decades process and one may not say that
unwinds, with talent and capital leaving London, New York and Tokyo have reached their
the city. maximum potential.
Source: Daiwa
Is there going to be a complete reversal in the US interest-rate cycle or

a normalisation of it?
On the other hand, we think it is also worth pondering whether there will be a complete reversal of US interest rates
or are they just going to normalise?
Shown below is the long-term interest rate in the US. It is worth noting that now the rate is at a historically low level,
and even if the rate were to rise by 200-300bp, it would still be in the low interest rate zone. That is to say, one key
variable would be whether now is the normalisation of interest rates from an exceptionally low level to a higher but
still low interest-rate environment, or a complete reversal of the interest-rate cycle.
73
US Federal Funds Rate (1979-now)

(%)
25
Volcker Greenspan Bernanke Yellen
20
15
10
0
Dec-87
Dec-16
Dec-79
Dec-80
Dec-81
Dec-82
Dec-83
Dec-84
Dec-85
Dec-86
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Source: Bloomberg, Daiwa
Admittedly, historically, fending off inflation has been one main objective of the Fed. In the days of Paul Volker, the
US Fed raised the interest rate up to 20% to get inflation under control. We cannot rule out any scenario, but
investing is also about balancing the probabilities of various scenarios.
What we do know is that during the Greenspan era, interest rates seemed to become an instrument to fine-tune the
economy, and whenever the US economy has faced potential crises, the Fed has often resorted to rate cuts to pre-
empt the crises from materialising. And the US has now become the worlds largest debtor, with national debt
standing at about USD20tn.
Undoubtedly, a lot of money has been printed in recent years. But how much of that money has actually gone to
the real economy? It looks that loan demand in many OECD countries have not been too strong; and the banks
have not been that eager to lend. Hence, instead of being channelled to the real economy to create demand for
labour and other factors of production, it appears that a lot of the new liquidity has just gone to the bond market and
has mainly improved the liquidity and borrowing cost of the financial institutions.
In any case, in recent years, the main issue facing the global economy seems to have been more that of growth
than inflation. Indeed, many countries outside the US (notably Japan and the EU) have also been practising
quantitative easing to jump-start the economy.
At the same time, it is arguable that back in the days of Paul Volker (ie, the 1980s), the global economic order
consisted mainly of the OECD countries, as China and many other developing countries share of the global
economy was negligible then. Indeed, almost the entire labour force of China was not part of the global economic
order before China opened its doors in 1978.
However, from the 1980s onwards, the worlds population involved in the global economic order has continued to
increase, with the trend accelerating notably after China joined the WTO in 2001. In this light, we could argue that
over 2bn of the worlds population has been added to the global economic order since the 1980s. As such, the
supply of labour and other resources to the global economy has gone up considerably over the years. This is
before one takes into account the impact of the Internet and technology changes on the labour market.
Hence, to drive up aggregate demand to a level that can drive sustained growth in inflation and inflation
expectations, the threshold looks like have become a lot higher than the Paul Volkers days. Indeed, it appears that
in recent years, for many developed countries, the main challenge has been more in finding growth and
employment opportunities than in controlling inflation.
At the same time, we think the following extracts from US Fed Chair Janet Yellen on the goals of US monetary
policy and the role of the Fed throw light on the nature of the current US interest rate cycle and the longer-term
outlook for US interest rates.
What is monetary policy, exactly? Simply put, it consists of central bank actions aimed at influencing
interest rate and financial conditions more generally. Its purpose is to help foster a healthy economy. But
monetary policy cannot, by itself, create a healthy economy.
.I have said what monetary policy cannot do. But what can it do? It can lean against damaging
fluctuations in the economy. Nearly 40 years ago, the Congress set down two main guideposts for that
74
task maximum employment and price stability. We refer to these assigned goals as our dual mandates.
When the economy is weak and unemployment is on the rise, we encourage spending and investing by
pushing short-term interest rates lower.
As you may know, the interest rate that we target is the Federal Funds Rate, the rate banks charge each
other for overnight loans. Lowering short-term rates in turn puts downward pressure on longer-term interest
rates, making credit more affordable for families, for instance, to buy a house or for businesses to expand.
Similarly, when the economy is threatening to push inflation too high down the road, we increase interest
rates to keep the economy on a sustainable path and lean against its tendency to boom and then bust.
But what exactly do the terms maximum employment and price stability mean? .Does maximum
employment mean that every single person who wants a job has a job? No..
Does price stability mean having no inflation whatsoever? Again, the answer is No. By price stability, we
mean a level of inflation that is low and stable enough that it doesnt need to figure prominently into
peoples and businesses economic decisions.
No one likes high inflation, and it is easy to understand why... So, then, why dont we and other central
banks aim for zero inflation? There are several technical reasons, but a more fundamental reason is to
create a buffer against the opposite of inflation that is, deflation.
Another important reason to maintain a modest inflation buffer is that too low inflation impairs the ability of
monetary policy to counter economic downturns. When inflation is very low, interest rates tend to be very
low also, even in good times. And when interest rates are generally very low, the Fed has only limited
room to cut them to help the economy in bad times.
Now, its fair to say, the economy is near maximum employment and inflation is moving toward our
goal. Now, many of you would love to know exactly when the next rate increase is coming and how high
rates will rise. The simple truth is, I cant tell you because it will depend on how the economy actually
evolves over coming months. The economy is vast and complex, and its path can take surprising twists and
turns.
That said, as of last month, I and most of my colleagues the other members of the Fed Board in
Washington and the presidents of 12 regional Federal Reserve Banks were expecting to increase our
federal funds rate target a few times a year until, by the end of 2019, it is close to our estimate of its
longer-run neutral rate of 3 percent.
The term neutral rate requires some explaining. It is the rate that, once the economy has reached our
objectives, will keep the economy on an even keel. It is neither pressing on the gas pedal to make the car
go faster nor easing off so much that the car slows down. Right now our foot is still pressing on the gas
pedal, though, as I noted, we have eased back a bit. Our foot remains on the pedal in part because we
want to make sure the economic expansion remains strong enough to withstand an unexpected shock,
given that we dont have much room to cut interest rates
Nevertheless, as the economy approaches our objectives, it makes sense to gradually reduce the level
of monetary policy support. Changes in monetary policy take time to work their way into the economy.
Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road
either too much inflation, financial instability, or both. In that scenario, we could be forced to raise interest
rates rapidly, which in turn could push the economy into a new recession.
The factors I have just discussed are the usual sort that Central bankers consider as economies move
through a recovery. But a longer-term trend- slow productivity growth helps explain why we dont think
dramatic interest rate increases are required to move our deferral funds rate target back to neutral
..Because interest rates are the mechanism that brings the supply of savings and the demand for
investment funds into balance, more saving and less investment imply a lower neutral interest rate.
Although we cant directly measure the neutral interest rate, it is something that can be estimated in
retrospect. And, as we have increasingly realised, it has probably been trending down for a while now.
Our current 3 percent estimate of the longer-run neutral rate, for instance, is a full percentage point lower
than our estimate just three years ago..
75
The above was extracted from a speech delivered by Janet Yellen at the Commonwealth Club in San Francisco on
18 January 2017 and highlights the thought process behind the latest evolution of US monetary policy, in our view.
Of course, interpretations differ. Our view, however, is that the current round of rate hikes is more about the
normalisation of interest rates than a major reversal in US interest rates. The Fed appears to be targeting only a
long-term neutral rate of 3% which is a full percentage lower than what it estimated about 3 years ago. And it looks
as if there are pre-emptive elements in such a policy stance, and it might even consider lowering the rate when the
risk of slipping into recession looms.
Indeed, some observers have noted that one feature of the 15 March FOMC meeting is that the Fed did not do 4
things: 1) not raise the rate by 50bp, 2) not hint that there could be 4 rate hikes in 2017, 3) not mention that the Fed
would work on reducing the size of its balance sheet, and 4) not raise forecasts for US GDP growth and inflation.
As such, the real stance of the Fed could be les hawkish than it might first appear. In any case, as noted by Bob
Farrell, when all the experts and forecast agree - something else is going to happen. The positive reaction of
Hong Kong property stocks to the news of the latest US rate hike and the surge in primary market sales in the
subsequent weekend seem to suggest that the markets real response to this anticipated risk could well be different
from mainstream expectations.
Would a rise in interest rates cause a major outflow of capital from

Hong Kong?
There is also a theory that Hong Kong could suffer from significant capital outflows as a result of a rise in US
interest rates. Clearly, no economy can withstand a situation where a large portion of the capital being stored in it
flows out. The question, though, is: how sensitive is the capital that has been parked in Hong Kong to changes in
US interest rates? Or alternatively, to what extent was the rise in capital in Hong Kong over the past 10-15 years
driven by speculative and unstable hot money flowing from abroad?
Undoubtedly, inter-bank liquidity in Hong Kong as well as the territorys aggregate monetary base have expanded
substantially from 20 years ago. However, since Hong Kong is a jurisdiction where capital can flow in and out freely,
probably even the Central Bank in Hong Kong cannot ascertain the nature of the capital that has flowed in to Hong
Kong. It is possible that a large part of the incremental capital that has come to Hong Kong is leveraged money
banking on CNY depreciation with the Hong Kong banking system being the conduit for such massive carry trades.
Hong Kong interbank liquidity

(HKDbn)
450
400
350
300
250
200
150
100
50
0
May-97
May-98
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
May-12
May-13
May-14
May-15
May-16
Source: Bloomberg
Unfortunately, current publicly available data do not provide a conclusive assessment on this topic. However, we
do know that the CNY has kept on depreciating over the past 12 months. Hence, if the capital flowing into Hong
Kong is really largely leveraged money making carry trades on CNY values, the impact has probably been felt
already. Yet, the inter-bank market seems to have been calm so far. Nor have we really seen Hong Kongs banking
system facing significant pressure to shrink its capital base, which we think would have to be the case if there was
a large-scale unwinding of massive carry trades being conducted by the Hong Kong banking system.
Indeed, what we have seen is looks quite the contrary. That the inter-bank market in Hong Kong has become liquid,
with falling inter-bank rates and borrowing cost for many corporations, with now many Hong Kong companies can
secure borrowing at Hibor+100bp while the spread for the blue-chips are notably below 100bp.
76
Loan to deposit ratio in Hong Kong

(HKDbn)
14,000 180%
12,000 160%
140%
10,000
120%
8,000 100%
6,000 80%
60%
4,000
40%
2,000 20%
0 0%
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Total bank deposit Total bank loans Loan / deposit ratio (RHS)
Source: CEIC
If carry trades on the CNY are not the main reason for the inflow of capital to Hong Kong, then would a lot of the
capital that has gone into the Hong Kong equity and property markets be hot and leveraged money? While we
cannot be entirely sure on this, what we do know is that the amount that has gone into property is very small based
on current government measures, foreign buyers need to pay as much as 30% or more of the purchase cost upfront
for the various kinds of stamp duties in Hong Kong. Moreover, had there been a large-scale capital inflow to buy Hong
Kong property assets, it would have been spotted by the property agents, property developers, or the government.
Would it follow that such capital inflow is related to equity investments? Plausible, in our view. Note that while
several hundred billion USD is certainly not a small number, it is not really that large relative to the scale of the
Hong Kong equity market, whose market capitalisation has ballooned from just about HKD1tn back in 1993 to over
HKD30tn in 2Q15 and some HKD27tn (USD3.5tn) now. As such, movements involving hundreds of billions of USD
are not inconceivable. Note that average daily turnover (ADT) in Hong Kong was USD9bn in 2016, and it had
previously reached USD37bn (HKD290bn) in one trading day in 2Q15. We also note that since Tsingtao Brewery
listed on the Hong Kong market in 1993, Hong Kongs stock market has raised a total of about USD1.2tn of which
about USD730bn was for mainland corporations, according to the Hong Kong Stock Exchange.
Hong Kong interbank liquidity

(HKDbn)
450
400
350
300
250
200
150
100
50
0
May-97
May-98
May-99
May-00
May-01
May-02
May-03
May-04
May-05
May-06
May-07
May-08
May-09
May-10
May-11
May-12
May-13
May-14
May-15
May-16
Source: Bloomberg
At the same time, when we look at the development of inter-bank liquidity in Hong Kong, we note that there was a
spike in the aftermath of the GFC when QE1 was announced, but inter-bank liquidity did not seem to have
responded that much to the announcement of QE2 and QE3 subsequently.
On the other hand, there is also a theory that the money that has come to Hong Kong is related to Chinese money
coming out of the mainland. Theoretically, Chinese capital coming out of the country via Hong Kong could also
have a similar effect on Hong Kongs interbank liquidity as hot money using Hong Kong to do carry trades on CNY
as a channel to come out to overseas would have the same effects on Hong Kongs monetary base. Given that
Chinas M2 expansion since 2009 is as much as USD15tn, a modest portion of it would already have had a notable
impact in Hong Kong.
In any case, we have seen a surge in gaming revenue in Macau and Chinese investment companies and mainland
individuals have made in purchasing properties and businesses outside China. Could the expansion in interbank
liquidity in Hong Kong during this period have some relation to such outflows? Have some mainland individuals or
corporations been parking money in Hong Kong to prepare for foreign investments once this is needed?
77
M2 expansion in China
(Rmb bn)
180,000
160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Source: CEIC
At the same time, could some of the increase in bank deposits be internally driven? Hong Kong asset owners have
benefited from the boom in asset prices over the past few years.
Estimated cash flow profile of the private owners of HK assets

Size % of Size* Avg. Avg. Avg. Annual
(m sq ft/ total (m sq ft/ Owned by monthly monthly annual gross
m units) stock* m units) Amount investors rent psf rental cash rental
=(a) =(b)/(a) =(b) (HKDbn) (%) (HKDbn) (HKD) (HKD) return (HKDm) Remarks
HK private 1,145,454 28% 320,000 22 - 67,584 HK has over
residential 300,000 units not
owner-occupied**
HK office 121 40% 49 35 - 20,412
HK retail 118 50% 59 60 - 42,612
HK industrial 181 60% 109 8 - 10,451
HOS units 0.32 - - - -
Urban taxi 15,000 80% 12,000 40,000 - 5,760
New Territories taxi 10,000 80% 8,000 20,000 - 1,920
Minibus 10,000 80% 8,000 45,000 - 4,320
Bank deposits 11,727 40% 4,691 1.5% 70,362
HK stock market 26,820 10% 2,682 3.0% 80,460
303,881
% of income absorbed by property management expenses and interest 30% Over 60% of HK's
residential
properties are
without mortgage**
Pre-tax cash flow of HK asset owners and investors 212,717
% of income used for tax payments 15%
Net annual cash flow received by HK asset owners and investors 180,809
Note: * Not occupied by owners and not owned by listed companies; ** based on latest government surveys and estimates by Midland
At the same time, we note that Hong Kong has become a sizeable asset market, and the amount of dividends
generated by listed companies in Hong Kong would also amount to hundreds of billions of dollars based on Hong
Kongs current stock market capitalisation of HKD27tn, a 3% dividend yield would translate into about HKD800bn in
annual dividends every year.
Market cap of the Hong Kong stock market

(HKDbn)
30,000
25,000
20,000
15,000
10,000
5,000
0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
78
ADT of the Hong Kong stock market

(HKDbn)
120
100
80
60
40
20
0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
On the other hand, is it possible that the expansion in the monetary base in Hong Kong has been partly internally
driven? Given that Hong Kongs current market capitalisation is already HKD27tn, we estimate the annual
dividends generated by the listed companies in Hong Kong should be over HKD800bn.
At the same time, with bank deposits in Hong Kong amounting to HKD11tn, natural growth of 1.5% per year would
already amount to HKD17bn. In all, we estimate Hong Kong assets as a whole (before taking into account the
private businesses) generate positive cash flow for their owners of well over HKD100bn a year. At the same time,
for Hong Kongs working class as a whole, we estimate that they collectively should have positive cash flow of well
over HKD100bn a year.
Estimated cash flow profile of the working population in Hong Kong

Total Average Average Average
mortgage loan monthly monthly mortgage Annual
outstanding income rent payment/ cash flow
Number (HKDm) (HKD) (HKD) /month* (%) (HKDbn) Remarks
Working population 3.93 16,000 754.6 Latest median monthly
earnings
Expenses related to mortgages 1,119 0.07 (78.3)
Number of people renting units 320,000 20,000 (76.8)
Number of people renting public units 797,000 4,000 (38.3)
Transport expenses on subways (17.5) MTRC's domestic fare
revenue in 2016
Transport expenses on other means (17.5) Assuming that MTRC has
of transport 50% market share
Clothing & footwear retail sales 2016 (58.3) HK total, including spending
from tourists
Food and alcoholic beverages retail (41.1) HK total, including spending
sales 2016 from tourists
Note: * versus outstanding loan amount
Hence, we estimate that, for Hong Kong as a whole, it should be running positive cash flow amounting to hundreds
of billions a year this looks consistent with the situation of total bank deposits in Hong Kong continuing to rise
every year. In this light, could the rise in inter-bank liquidity and bank deposits in Hong Kong be partly driven by
internal factors?
79
Hong Kong bank loans and deposits

Total bank Total bank Loan /
loans deposits deposit YoY change (HKDbn) YoY change (%)
Date (HKDbn) (HKDbn) ratio Deposits Loans Deposits Loans
1990 1,231 1,789 145.3% 224 517 22.2% 40.6%
1991 1,375 2,244 163.2% 143 455 11.6% 25.4%
1992 1,503 2,470 164.3% 129 226 9.4% 10.1%
1993 1,726 2,857 165.5% 223 387 14.8% 15.7%
1994 1,946 3,265 167.8% 220 408 12.7% 14.3%
1995 2,226 3,739 167.9% 281 474 14.4% 14.5%
1996 2,458 3,915 159.3% 232 176 10.4% 4.7%
1997 2,710 4,122 152.1% 252 207 10.3% 5.3%
1998 3,000 3,304 110.1% 290 (817) 10.7% -19.8%
1999 3,251 2,813 86.5% 251 (492) 8.4% -14.9%
2000 3,528 2,461 69.8% 277 (351) 8.5% -12.5%
2001 3,407 2,185 64.1% (121) (276) -3.4% -11.2%
2002 3,318 2,076 62.6% (89) (109) -2.6% -5.0%
2003 3,567 2,035 57.1% 249 (41) 7.5% -2.0%
2004 3,866 2,156 55.8% 299 121 8.4% 5.9%
2005 4,068 2,312 56.8% 202 156 5.2% 7.2%
2006 4,757 2,468 51.9% 689 156 16.9% 6.7%
2007 5,869 2,962 50.5% 1,112 494 23.4% 20.0%
2008 6,058 3,286 54.2% 189 324 3.2% 10.9%
2009 6,381 3,288 51.5% 323 3 5.3% 0.1%
2010 6,862 4,228 61.6% 481 939 7.5% 28.6%
2011 7,591 5,081 66.9% 729 853 10.6% 20.2%
2012 8,296 5,567 67.1% 705 486 9.3% 9.6%
2013 9,180 6,457 70.3% 884 890 10.7% 16.0%
2014 10,073 7,276 72.2% 893 819 9.7% 12.7%
2015 10,750 7,535 70.1% 677 258 6.7% 3.5%
2016 11,727 8,023 68.4% 977 489 9.1% 6.5%
Source: CEIC
If this is the case, then the sensitivity of capital flows to Hong Kong to US interest rates may well be lower than
some have thought.
Nor we do think that the Hong Kong market participants have been leveraging up that much. Indeed, the loan-to-
deposit ratio in Hong Kong has been coming down and it looks as if the banks are facing problems more related to
how to lend rather than retaining deposits and capital.
Note also that Hong Kong has also been the No. 1 (in terms of the amount of funds raised) IPO market in the world
in 5 of the past 8 years.
Hong Kongs ranking in IPO funds raised
Source: HKEx
Hence, while there is a theoretical possibility that Hong Kong could see a major capital outflow, there are many
possible reasons to explain the rise in interbank liquidity in Hong Kong and we have not seen much evidence of a
sizeable outflow happening yet. The impact from US rate hikes may not be that large and it could be a natural
development in line with Hong Kongs evolution as an international financial centre.
80
We also note that the scale of Hong Kongs interbank market has become much larger than 20 years ago. Hence,
using speculative attacks in the interbank market to squeeze up local interest rates has become much more difficult.
Monetary environment in Hong Kong

July 1997 29-Jan-16
Financial data
Aggregate Balance (HKDbn) 1.5 363.4 (244.4 times)
Exchange Fund Bills and Notes (HKDbn) 98.7 857.1 (7.7 times)
Monetary Base (HKDbn) 189.6 1,609.5 (7.5 times)
Exchange Funds foreign currency assets* (USDbn) 67.6 422.3 (5.2 times)
Hong Kong Stock Market

Market capitalisation (HKDbn) 4,607 21,616 (3.7 times)
HSI P/E ratio 19.2 8.0 (-58.3%)
HSI P/B ratio 2.3 1.0 (-55.6%)
Source: HKMA
Note: ( ) denotes the magnitude of change; *refers to figures in Jun 97 and Dec 2015
Overall, we believe the scale of capital flowing through Hong Kongs financial sector has notably increased since
the city has evolved into the worlds top market for IPO fund-raising and after China has become a sizeable
investor and consumer outside the country. In this light, it is possible that the increase in monetary base and inter-
bank liquidity in Hong Kong could be partly just a reflection of the citys evolution as an international financial sector
and the scale of the financial resources commanded by China.
In any case, our read is that there is now a metamorphosis happening in Hong Kong as a city, and much would
depend on how far Hong Kong can go an issue we examine in greater detail in the next section.
81
82
Question 5
What could drive Hong Kong property
to the next level?
83
Q5: What could drive Hong Kong property to the next level?
Pursuing protectionism is like locking oneself in a dark room. While wind and rain may be kept outside, that dark
room will also block light and air.....China undoubtedly has benefitted from globalisation; but China has also been a
contributor to globalisation as well.... Chinas door is open. When this door is open, the world can enter into China
and China can enter into the world.
- Inaugural speech at World Economic Forum at Davos, January 2017, Xi Jinping
The historian of science may be tempted to claim that when paradigms change, the world itself changes with them.
Led by a new paradigm, scientists adopt new instruments and look at new places. Even more important, during
revolutions, scientists see new and different things when looking with familiar instruments in places they have
looked before. It is rather as if the professional community had been suddenly transported to another planet where
familiar objects are seen in a different light and are joined by unfamiliar ones as well..
- Thomas Kuhn
The conundrum in Hong Kong property
In our view, the situation facing Hong Kong and Hong Kong property looks challenging. GDP growth momentum
has been uninspiring for a number of years, and in the eyes of many, the government has not been able to assume
a leadership role in society.
At the same time, social grievances seem to have been building, while social and political opinions have been
divided on many issues. Hence, many observers believe Hong Kong society and the economy are not moving
forward.
Indeed, the general social mood in Hong Kong in recent years seems to have been characterised by pessimism
and helplessness.
That said, when looking at various other indicators such as corporate profit tax paid, number of employed people in
the economy, wage growth and growth in bank deposits, the situation does not look that bad.
Salaries tax paid in Hong Kong

(HKDm)
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
1989/90
1990/91
1991/92
1992/93
1993/94
1994/95
1995/96
1996/97
1997/98
1998/99
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
2011/12
2012/13
2013/14
2014/15
2015/16
Source: CEIC
The performance of Hong Kongs real estate sector also suggests that there has been reasonable vibrancy and
resilience in the sector.
The mainstream view used to be that there was little new demand for office space in Hong Kong. Yet, over 10m sq
ft of Grade A office space in Kowloon East that came onto the market in the late 2000s has largely been taken up,
while prevailing rents in Kowloon East have risen from HKD10/sq ft or below to over HKD30/sq ft.
In addition, almost all new Grade A office buildings in existing core districts over the past 10 years have also largely
been taken up.
84
In the retail property market, there has been a significant drop in retail sales since 2014 and numerous media
reports of fewer mainland tourist visits. Yet, we do not see much vacant retail space in Hong Kong and there has
not been a significant rise in unemployment in Hong Kong.
In the residential property sector, the governments various cooling measures (implemented since 2000) could be
viewed as draconian, and have had a significant suppressive effect on property demand, especially upgrading
activity (ie, people moving from smaller and older flats to larger and newer ones). At the same time, secondary
market transaction volume has fallen and which has adverse implications for various related sectors, such as
property agencies, home decorators, and property advertising.
However, we note that the unemployment rate has remained stable and bank deposits have kept growing.
Residential property prices in Hong Kong are high, but demand for primary market units also remains strong.
So what is the true story? Have the official figures missed something and could there be a positive undercurrent in
Hong Kong which has yet to become widely recognised?
Creative destruction an important force in shaping Hong Kong
We do not have answers to the above questions.
What we do know is that businesses have been renting office space, hiring employees and paying taxes. We
believe salary tax and corporate profit tax paid are reliable indicators for the minimum aggregate income and
aggregate corporate profits made by businesses, as presumably no individual or company would overstate their tax
liabilities. What we also know is that, historically, Hong Kong has always found itself facing contradictory signals
and challenges.
In hindsight, Hong Kong property looks like an easy game to play. A buy early and hold strategy would have
reaped sizeable gains. However, few people have succeeded in doing this. The main reason in our view, is that at
each point in the curve, there were always legitimate reasons to expect that the end was imminent.
Indeed, it appears that the future of Hong Kong remains uncertain.
In the mid-1980s, there was talk of the threat posed by the end of Hong Kongs manufacturing capability. While
some manufacturers tried moving factories to the mainland, many were of the view that infrastructure support in
China (such as electricity supply, water and roads) was inadequate and unreliable, and that there were many
problems associated with dealing with local governments and the workers on the mainland.
The aforementioned problems were genuine. However, the number of companies moving their factories into China
began to gain critical mass, while many of the previously mentioned problems began to fade, resulting in a
manufacturing boom in Southern China from the late 1980s.
In the 1990s, many were concerned about the uncertainty facing Hong Kong and the risks the territory was handed
back to China. While Tsingtao Brewery listed on the Hong Kong Stock Exchange in 1993, many market observers
did not expect to see a lot of mainland Chinese companies listing in Hong Kong, instead expecting them to list in
New York.
In addition, while the Individual Visit Scheme (IVS) was implemented in 2H03, many did not expect the amount of
mainland tourist spending to be very large. As it turns out, there has been a significant surge in IPO fundraising in
Hong Kong since the mid 2000s, while the amount and size of mainland Chinese tourist spending has amazed
many, and resulted in many international brands taking a serious look at the importance of the Hong Kong retail
market in their global strategy.
In hindsight, Hong Kong has probably been lucky during each period, as promising sectors have emerged to help
make up for the declines in other sectors, providing impetus to drive another wave of capital and talent. Along the
way, some individuals and companies have suffered, while others have risen and flourished.
The relocation of manufacturing capabilities across the border may have been the new driver for Hong Kong during
the mid-80s to the mid-90s, while the finance and retail sector have been the drivers of the Hong Kong economy
since the mid-90s.
85
But does Hong Kong have any new drivers in the years ahead? As things stand today, the investment banking
sector in Hong Kong is not in good shape, while luxury watch and jewellery retailers are facing difficult times. Does
this spell the end for Hong Kong? Or are there some positive undercurrents ahead?
The trick of assessing demand for property
We cannot say. But given the way a capitalist economy works, if one is able to identify emerging sectors before
they become widely noticeable, then one would stand to make a good gain. As Schumpeter put it: profit is the
payment you get when you take advantage of change.
Hong Kong is likely to continue to face challenges given its size and the role the city plays as a connector between
east and west, between China and the rest of the world, and the pace of change taking place in China and the way
technology (and the Internet) is progressing.
Some sectors of the Hong Kong economy may well disappear. But overall, we believe the future of Hong Kong will
depend on whether economic participants are creative and entrepreneurial enough to discover new opportunities,
and whether these are large enough to offset the adverse impact resulting from the decline in other sectors.
Indeed, a free market is driven by contradictory forces, and there are always optimists and pessimists. If optimists
are able to gather critical mass, they would be seen as visionary. If they cannot, then they would be viewed as
blind optimists. However, the winning side may be perceptible only after the facts, as Alan Greenspan put it.
In the property sector, we believe the main conundrum now is demand. Indeed, demand is often seen to be the
most tricky part of analysis within real estate fundamentals. There are ways to get reasonably good estimates on
the supply outlook in a real estate market over the next 3-4 years. However, we are unsure about demand, until it
has been expressed.
The absence of a strong net uptake in space could reflect 3 possible scenarios:
1) a lack of demand,
2) some new demand but offset by the exit or downsizing of others, or
3) pent-up demand, but waiting for the right catalyst.
Looking back at the scenario in the late 2000s, when many observers were expecting a glut to emerge from new
supply in Kowloon East. Similarly, in February 2013, when the government announced major cooling measures on
residential properties, some observers expected demand to be constrained by government measures and that new
supply from the developers would lead to a vicious price war. Did these expectations come to fruition?
We also note that historically, take up of office space in Hong Kong has tended to be supply-led. This means that
when supply increases, demand would often also increase. We believe this is natural, given our view that the Hong
Kong property market is a phenomenon created by decades of cumulative undersupply, high prevailing rent, and
limited vacant space.
As a consequence, many market participants have seen demand suppressed or satisfied by non-optimal means
(such as shared or smaller offices), which is not the most desirable outcome.
As and when such offerings become available at a reasonable price, it is logical to assume that demand would
follow. As such, we believe it is reasonable to expect that there is some pent-up demand in Hong Kong, the main
uncertainty is whether and when this demand would play out.
At the same time, we acknowledge that the world and Hong Kong are continuously changing. Hence, new sectors
often emerge. This constitutes another wild card in the demand equation for Hong Kong offices, in our view.
86
Many economic participants have not given up trying to find new

opportunities, and some are actively seeking them
As a city, Hong Kong continues to change and evolve. Although the pace of change cannot match cities in China, it
is fast by international standards, in our view.
This means that some established sectors or practices have become out-of-fashion. At the same time, there is
always the possibility that new industries or practices will emerge.
Interestingly, while locals constitute the largest portion of Hong Kongs population, the drivers for change may not
necessarily come from the local perspective.
The local population is more likely to be bound by a traditional preset view of Hong Kong and are less likely to be
able to think outside of the box with regards to future opportunities for Hong Kong. In contrast, people who have
grown up outside of Hong Kong are more likely to see Hong Kong and opportunities available from a fresh
perspective, and hence are able to come up with more novel and creative ideas on what one can do in the city.
With regards to the further development of Hong Kong, we believe the key is to get more people and companies
willing to try to find new opportunities. As long as this process continues, there is a chance that someone will
discover something promising.
Importantly, in the property market, it appears to us that there are market participants willing to try to find new
opportunities. We believe this situation is the clearest within the office market.
Admittedly, we have not seen the high profile office demand that we were used to seeing in the 1980s and 1990s.
However, the actual net take-up in office space over the past 10 years has been significant. In our opinion, this
situation might actually be healthier as high profile uptakes are often driven by hype in certain sectors, while the
expansion decisions of large MNCs can be influenced significantly by their CEOs and the global economic climate.
In contrast, the bit-by-bit expansion of smaller enterprises is often more reflective of the outlook for their respective
industries, as managements have to bear the consequences related to such decisions.
A number of companies have been prudently exploring opportunities
In our view, after several decades of continuous development, the Hong Kong office sector has evolved to become
reasonably sophisticated, with a diverse occupier profile spread across various industries.
A recent study from CBRE (The evolution of the Hong Kong Grade A office market a telescopic analysis, Autumn
2016) on the Hong Kong Grade A office market looked at the office take-up in over 200 office buildings in Hong
Kong, covering the bulk of the entire Hong Kong Grade A office stock.
One finding was that while Hong Kongs finance sector is large in terms of the office space is occupies, the office
rental market in Hong Kong is not dependent on the finance sector given its actual share of total Grade A office
space in Hong Kong is only around 37%, according to CBRE.
According to the study, finance sector office space is spread over 5,000 companies and is not only limited to
investment banks. Indeed, we believe that the Hong Kong finance sector offers reasonable depth and
sophistication.
Moreover, according to the study, there was a 4.1m sq ft net take-up of space in the Hong Kong Grade A office
sector during 2013-16. This was driven by a broad-based across-the-board rise in office demand across almost all
of the 10 major industries in Hong Kong, with the exception of logistics and trading, and retail and wholesale.
This suggests to us that during 2011-15, there was a broad-based rise in the take-up of office space, and the rise in
occupied office space was not driven by only 1 or 2 sectors.
87
Steady growth in office occupancy across most industry sectors.
Steady growth in office occupancy across most industry sectors.

(m sq ft NFA) 3-year Net Absorption (Apr 13 - Mar 16)
1.5
1.0
0.5
0.0
(0.5)
(1.0)
(1.5)
Banking & Insurance Real Estate & Legal Retail & Logistics & IT, Tech & Manufacturing Other Miscellaneous
Finance Construction Services Wholesale Trading Telco Professional Trades
Services
Over 2011-15, all other sectors took up new space with the exception of the trade and logistics sectors, according
to the CBRE report. Note that during this period, Grade A office rents in Hong Kong were broadly rising, signalling
that many companies were willing to expand their office space.
It is true that during this period, there were companies that faced financial difficulties and downsized or closed
operations. However, for the corporate sector as a whole, it appears that the net effect was positive net absorption
of Grade A office space, meaning that the new space rented was larger than the space vacated from downsizing/
corporate closures.
Moreover, based on the study, Hong Kongs Grade A office sector consists of around 12,000 companies, which on
average each lease around 3,000-4,000 sq ft. In our view, this implies that there is reasonable breadth in the Hong
Kong office sector given the broad variety of occupiers.
If we dissect these office occupiers into 2 groups (being small-to-medium sized companies, occupying up to 30,000
sq ft, and medium-to-large companies, occupying an area of 30,000 sq ft to over 300,000 sq ft), the companies are
concentrated mostly at the smaller end of the segment. For companies in the small-to-medium sized segment
(about 8,000 in total, on our estimates), some 60-70% are now renting office space of 5,000 sq ft or below,
according to the CBRE report. Meanwhile, for companies in the medium-to-large category (about 4,000 in total, on
our estimates), the bulk of them are renting 20,000-50,000 sq ft of office space.
This suggests to us that for each office market segment, there are far more office occupiers at the smaller end of
their respective segments. This structural characteristic bodes well for organic expansion potential of these
companies. Mathematically, if each company rents 5% more space (about 200-300 sq ft for small companies and
2,000-2,500 sq ft for medium-sized companies), this would create about 4m sq ft of new office demand.
88
New sectors have emerged
It is also worth noting that new sectors have emerged to take up office space in Hong Kong during the past 10
years. For example, going back 10 years ago, it was difficult to imagine that that the health & beauty and hospital
firms would take up Grade A office space in Hong Kong, but this has occurred.
On the other hand, social media companies such as Facebook and LinkedIn did not occupy office space in Hong
Kong back in the early days; nor did auction houses such as Sotheby's and Poly Auction. We also believe that
Central is evolving into a market where a larger number of companies would each occupy a smaller space, and
believe the addition of 10-20 companies renting a few thousand sq ft of office space would probably be enough to
have some impact on the office market.
Grade A office demand from health & beauty and medical tenants
Companies Buildings Districts Leased area (sq ft)
HK Sanatorium & Hospital One Pacific Place Admiralty 50,000
One Island South Island East 30,000
HK Integrated Oncology Centre 3 Garden Road Central 40,000
Town Health Group Central Building Central 90,000
Neo Derm Langham Place Mongkok 27,000
One Island East One Island East 7,000
Two Pacific Place Admiralty 40,000
Pure Fitness Hutchison House Central 16,000
3 Garden Road Central 30,000
PCCW Tower Island East 28,000
California Tower Central 24,000
Fitness First Tower 535 Causeway Bay 21,000
Source: Knight Frank, Hong Kong Economic Times
Grade A office demand from business centres and co-working centres

Companies Leased floor Buildings where major business centre Districts where major business centre
areas companies have a presence companies have offices
Regus Business over One IFC, Central Plaza, Shui On Centre, ICC, Central, Wanchai, Causeway bay, Quarry Bay, Sheung
Centre 300,000 sq ft Miramar Tower etc. Wan, Tsimshatsui, Mongkok, Kowloon Station
Compass over Citibank Tower, Lee Gardens, Langham Place, Central, Wanchai, Causeway bay, North Point, Sheung
Offices 330,000 sq ft Infinitus Plaza, Man Yee Building, AIA Tower, Wan, Tsimshatsui, Mongkok
Worldwide House etc.
The Executive over Two Exchange Square, Wheelock House, 28 Central, Wanchai, Quarry Bay
Centre 140,000 sq ft Hennessy Road, Three Pacific Place, Nexxus
Building etc.
Jumpstart over Wheelock House, Times Square, Millennium City, Central, Causeway Bay, Tsimshatsui, Kwun Tong
40,000 sq ft Silvercord Tower etc.
Servcorp over Two IFC, HK Club Building, One Peking Road etc. Central, Tsimshatsui
4,000 sq ft
WeWork over Tower 535, 33 Lockhart Road Causeway Bay, Wanchai
130,000 sq ft
Meanwhile, business centres are another segment that not to be ignored. Around 10 years ago, it would have been
difficult to imagine that business centres or co-working spaces would be occupiers of Grade A office space. We
estimate that the total amount of space occupied by business centres today in the Hong Kong office sector is over
1m sq ft. The very fact that there is business centre demand for office space would suggest that there are
companies trying to explore business opportunities in Hong Kong, with some looking to potentially occupy 2,000-
3,000 sq ft or more.
On the other hand, we also note that office occupiers looking to purchase office space has become a more
prominent trend in the past few years. Traditionally, MNCs have rarely purchased office space, but this has
changed over the past 5 years, with notable buyers including western MNCs such as Citi and Manulife, with the
purchase amount in the hundreds of millions of US dollars. We view this as a sign that some MNCs may have
made a decision to commit to Hong Kong for the long term, and hence needed to find a sensible solution to office
costs in Hong Kong.
89
Major purchases of Grade A offices by end-users

GFA Price Psf price
Date Property assets District (sq ft) Buyer Vendor (HKDm) (HKD/sq ft)
Oct 2016 Wang Chiu Rd / Lam Lee St site Kowloon Bay 555,035 Local investor Swire Properties 6,528 11,762
Sep 2016 Golden Centre Sheung Wan 156,000 Local investor Henderson Land 4,368 28,000
Jul 2016 One HarbourGate (east tower) Hunghom 280,000 Cheung Kei Group Wheelock 4,500 16,071
Jun 2016 The Center (79/F) Central 13,213 A mainland investor Hysans Lee family 500 37,841
Feb 2016 Dah Sing Financial Centre Wanchai 400,113 China Everbright group SEA Holdings 10,000 24,992
Nov 2015 MassMutual Tower Wanchai 345,433 Evergrande Chinese Estates 12,500 36,186
Nov 2015 One HarbourGate (west tower) Hunghom 393,000 China Life Insurance Wheelock 5,850 14,885
Jun 2014 One Bay East (east tower) Kowloon East 512,000 Citigroup Wheelock 5,425 10,595
Dec 2013 9 Chong Yip Street Kowloon East 136,595 Prosperity REIT Hutchison Whampoa 1,010 7,394
Dec 2013 DCH Commercial Centre Island East 389,000 Swire Prop & an inv fund CITIC Pacific 3,900 10,026
May 2013 Kowloon Commerce Centre (5 floors) Kwai Chung 116,756 China Mobile SHK Properties 1,027 8,800
May 2013 Citibank Plaza (4 floors) Central 78,316 Champion REIT HKSAR Government 2,160 27,581
Apr 2013 One Bay East (west tower) Kowloon East 512,000 Manulife Wheelock 4,500 8,789
Feb 2013 113 Argyle Street Mong Kok 328,866 Hang Seng Bank Nan Fung (unlisted) 2,900 8,818
Oct 2012 AIA Tower (formerly Stanhope Hse) Island East 299,615 AIA Hang Lung Properties 2,398 8,004
Dec 2012 Exchange Tower (7 floors) Kowloon East 195,875 Hang Seng Bank Sino Land 1,560 8,000
May 2012 50 Connaught Road Central 180,000 Agricultural Bank of China National Electronics 4,880 27,111
Jan 2012 CCB Centre Kowloon East 348,620 China Construction Bank Sino Land 2,510 7,200
Source: Savills, CBRE, Hong Kong Economic Times, Daiwa
We note that there have been numerous office purchases in recent years, with the total amount adding up to about
USD10bn. This scale of purchase is unprecedented for Hong Kong. Does this mean that there are subtle changes
happening in the way some corporations view Hong Kong? Have some of these companies now come to view
Hong Kong as a strategic long-term market, with the office purchases a prelude of more investment to come?
Mainland Chinese companies have become a new and important force in the
Hong Kong office sector
We view Mainland Chinese companies as an upcoming and genuine source of new demand for office space in
Hong Kong. Although these companies do not occupy significant Grade A office space, they have been a major
source of office demand in recent years. These firms have been taking up a lot of office space in Central vacated
by the departure of some US and European firms.
PRC companies leasing deals in Hong Kong Grade A offices

(sq ft)
600,000
500,000
400,000
300,000
200,000
100,000
0
2008 2009 2010 2011 2012 2013 2014 2015 2016
Banking Securities Private Fund / Asset Management Energy & oil Others
Source: Savills
More importantly, the number of Mainland Chinese companies in Hong Kong is still a small fraction of the number
of major companies in China. For example, in the banking industry, we estimate that there are at least 832 banks in
China, and so far less than a 100 have a presence in Hong Kong.
In the insurance industry, we estimate that there are 140 companies in China, with less than 30 present in Hong
Kong. Similarly, in the securities industry, there are more than 126 registered securities companies but so far less
than half of these have established a presence in Hong Kong.
There are also 729 private equity and asset management companies with over CNY2bn under management in
Mainland China, while the total number is likely be thousands. But as yet, we estimate less than 20% of them have
a presence in Hong Kong. And in addition there are regional banks, financial institutions and regional enterprises.
90
If Hong Kong becomes an important city in terms of fund raising and investing for Mainland Chinese companies,
we think it is likely that many more of these firms would look to establish a base in Hong Kong. Currently, there are
around 12,000 companies who rent Grade A office stock in Hong Kong, while the number of Mainland Chinese
companies in the finance industry is likely to be greater than this.
We also believe that with more and more Mainland companies having a presence in Hong Kong, some
international companies that seek to do business with mainland companies would likely consider establishing a
presence in Hong Kong instead of/in addition to having a presence in China.
Moreover, we believe many Mainland Chinese companies have a modest local presence in Hong Kong. For
example, when compared with major banks and insurance companies, the space occupied by Chinas largest
banks and insurers in Hong Kong is much smaller. As such, we see considerable scope for these companies to
expand their presence in Hong Kong over time.
PRC banks presence in Hong Kong Grade A offices

(sq ft) Office occupancy, international vs PRC banks
600,000
500,000
400,000
Average = 277,000 sq ft net
300,000
200,000
100,000 Average = 30,500 sq ft net
0
JPM MS UBS DB CS BoAML Barclays BOCI CCBI CICC ICBCI BOCOMI ABCI
Source: Savills
PRC insurance companies presence in Hong Kong

(sq ft) Office occupancy, international vs PRC insurance firms
900,000
800,000
700,000
600,000
Average = 452,000 sq ft net
500,000
400,000
300,000
200,000 Average = 93,800 sq ft net
100,000
0
AIA Prudential Manulife FWD AXA China Life China Taiping Ping An
Source: Savills
Indeed, we have observed that the number of Mainland Chinese companies has been increasing in recent years,
with most starting with an office size of less than 5,000 sq ft. These firms generally start with a smaller office, but
when they expand, it may not necessarily be in a gradual, step-by-step manner. Instead, some of them could well
opt for a multiple times expansion in office space.
91
Chinese enterprises typically start with small offices

(No. of firms)
1,000 Firms < 30k sq ft footprint Firms > 30k sq ft footprint
800
600
400
200
0
0 - 5k 5k - 10 k 10k - 30 k 30k - 50 k 50k - 100k 100k - 200k 200k - 300k 300k - 500k 500k +
Size range (sq ft)
Banking & Finance Insurance Real Estate & Construction Legal Services Retail & Wholesale
Logistics & Trading IT, Tech & Telcos Manufacturing Other Professional Services Miscellaneous & Unidentified
Based on CBREs study, the presence of Mainland Chinese companies in each major office area in Hong Kong is
moderate, and notably below that of their US and European counterparts, but is likely to change over time.
A growing presence of Mainland Chinese enterprises in Hong Kong

Occupancy of Grade A office space by company origin (% of occupied space)
100%
80%
60%
40%
20%
0%
2013 2016 2013 2016 2013 2016 2013 2016 2013 2016 2013 2016 2013 2016 2013 2016
Central ADM & WC WC & CWB HKE TST KLN E KLN others NT
PRC US EMEA HK Others

If Hong Kong were to evolve into a more important financial centre for Mainland Chinese corporations and a hub for
financial firms in China, it is conceivable that there would be many more companies looking to establish a presence
in Hong Kong, which could lead to new investment; which brings us to an important question: can Hong Kong play
a strong and productive role in the financial architecture of modern China?
Recent cases of Mainland Chinese companies leasing Grade A office space

in Central
PRC firms Industries Buildings Approx area (sq ft)
HNA Group Conglomerate Three Exchange Square 88,000
HNA Group Conglomerate Two IFC 15,776
Chianlin Securities Securities ICC 12,164
Agile Group Property Three Pacific Place 15,465
Shanghai Pudong Devt Bank Banking One Pacific Place 15,000
Hai Yin International Conglomerate Three Pacific Place 15,465
New China Asset Management Asset management Two IFC 7,300
ZZ Capital Asset management Cheung Kong Center 13,300
China Bohai Bank Banking Two IFC 15,635
Huarong Asset Management Asset management One Pacific Place 22,500
China Orient Asset Management Asset management One IFC 15,500
China Zheshang Bank Banking Three Exchange Square 11,200
CITIC Private Equity Private Equity One Pacific Place 10,000
China MinSheng Investment Asset management AIA Central 12,550
Industrial Bank Banking Three Garden Road 16,169
Zhong Zhi Capital Asset management Cheung Kong Center 14,773
China Minsheng Bank Banking Two IFC 22,700
Bank of Beijing Banking Two IFC 13,700
Source: CBRE, Knight Frank, Savills, HK Economic Times, SCMP, Daiwa
92
Can Hong Kong play a broader and deeper role in the financial architecture
of modern China?
On Chinas financial sector, we highlight the following 4 points.
First its considerable size. Chinas monetary supply (M2) is around twice the size of the US. Chinas bank
deposits, at USD33tn, are also about double that of the US, with deposits growing at an average of USD2tn per
annum over the past 5 years.
The US, China and Hong Kong financial sectors

(USDtn) US China HK
GDP 18.6 11.2 0.3
Banking assets 16.0 32.8 2.7
Equity market cap 27.4 7.3 3.2
Annual stock market turnover 28.4 19.1 1.4
M2 13.2 22.5 1.6
Source: World Federation of Exchanges, CEIC, Daiwa
Note: as at end-2016
China has a working population of over 500m and may launch its own version of the 401k (retirement plan),
according to Daiwa financial sector analyst Leon Qi. Given the size of its economy, we would expect the financial
assets in the country to be sizeable. Indeed, China has the potential to have the largest asset management and
insurance industry in the world, in our view.
Second Chinas financial assets are still largely domestic while the economy is still subject to capital
controls. The populations knowledge of the outside world remains relatively limited and insurance industry assets
are largely in domestic bonds and equities.
Hong Kongs share of Chinas insurance and wealth management sector

(CNY tn)
16 15
14
12
10
8
6 5
4
1.4
2
0.07
0
HK offshore insurance annual new China life insurance annual new China annual increase in WMP China annual increase in bank
premium premiums balance deposits
Source: CIRC, CBRC, PBOC, Daiwa estimates
China Insurance Sector: overseas investment as % of assets

(USD bn) 1.9%
40 2.0%
35
1.4%
30 1.5%
25
20 1.0%
15
10 0.5%
5
0 0.0%
End-2014 End-2015
Overseas assets As % of total assets (RHS)
Source: 21 CBH, Daiwa
Indeed, one might argue that China is the only country left with a sizeable pool of money that has yet to be
deployed on the global financial markets.
93
Third Chinas financial sector is still developing. We note that in the past, Chinas banks were mainly policy
banks, a legacy of its command economy. However, China is principally financed by its banks. As a result, the
countrys capital markets look small relative to the size of its banking assets and M2, quite a contrast to the
Western world.
The relative size of banking assets, equity markets and bond markets in the
US, Hong Kong and China- 2015
Source: Daiwa
Development of Chinas capital markets
94
Reforms in Chinas securities and financial sectors

New business matrix of China securities companies Deregulation of insurance investment rules
Brokerage Investment banking Asset management Investment
Asset class Percentage allowed *
Collective Asset
Retail mass market Equity Private equity
Management (CAM) Liquid asset No restriction
Target Asset Management
Institutional Bond (corporate bond)
Traditional intermediary (TAM) Bond No restriction
Special Asset Management
QFII Bond (notes) Equity <=30%
(SAM)
Financial advisory Customer deposit mgmt
Property <=30%
OTC market-making Asset-backed securities
Equity market-making Other assets (trusts, WMPs, credit-backed
Capital intermediary
securities, special asset management <=25%
Fixed-income market-making
products, debt/equity investment schemes)
Margin finance Prop trading
Capital-based Securities repo Principal investment Overseas investments <=15%
Buyout fund
China insurance sector: annual insurance premium forecasts

(CNYtn)
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E
Total premium Life premium P&C premium
We believe there is a limit to the expansion of Mainland Chinese banks balance sheets. As such, we expect
Chinas debt and capital markets to continue to rise. However, we believe the markets lack the relevant instruments
to be able to adequately store wealth in the Mainland.
Fourth Chinas financial sector continues to have a domestic focus. Chinas financial sector only has a 2
decade track record since being established by the regulator. The sectors policy objectives and priorities appear to
revolve around state objectives. This is in sharp contrast with the rest of the world, where it is market first, while the
role of the state is to regulate.
Sector net profit comparison: securities sector versus bank sector

(CNY bn)
1,800 35%
1,600 29% 30%
1,400
25%
1,200
1,000 20%
800 15% 15%
14%
600
10%
400 8% 9%
6% 5%
200 4% 3% 3%
0 0%
2007 2008 2009 2010 2011 2012 2013 2014 2015
Bank sector net profit Securities sector net profit Securities sector as % of bank sector (RHS)
Source: CBRC, Securities Association of China, Daiwa
China stock market average daily turnover (ADT)

(CNYbn)
2,000 1200%
1000%
1,500 800%
600%
1,000
400%
500 200%
0%
0 -200%
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
ADT 5-year moving avg YoY (RHS)
Source: CEIC, Daiwa
95
Former US Fed chair Alan Greenspan offered this insight into the issues involved in reforming or transforming a
command economy:
Much of what we took for granted in our free market system and assumed to be human nature was
not nature at all, but culture. The dismantling of the central planning function in an economy does not,
as some had supposed, automatically establish a free market entrepreneurial system. There is a vast
amount of capitalist culture and infrastructure underpinning market economies that has evolved over
generations: laws, conventions, behaviours, and a wide variety of business professions and practices
that have no important function in a centrally planned economy.
In our view, the culture, or the values and principles that underpin a command economy are fundamentally different
from those of a capitalist market economy. China may be the first example of a command economy that is trying to
transform itself into a semi-command and semi-market economy, and is still likely to be a command economy at
heart, with free market characteristics and yet can have market forces operating rigorously.
Most observers would probably agree that China has done an impressive job so far. But will China be able to
establish a robust and vibrant market within its command economy?
We remain uncertain. The main challenge for China is to establish a set of institutions, practices and values which
have taken capitalist market societies many decades to form. Yes, China can always copy these institutions, rules
and practices, but will their essence change after being transplanted into China?
These are complex issues, compounded by the fact that we do not have any precedence.
In our view, given that Chinas financial system is so large and entrenched, it is difficult to believe that it would be
perfectly compatible with the rest of the world. However, it is also unlikely for the rest of the world to change its
ways of doing things just to accommodate China.
The Stock Connect is an important breakthrough in institutional structure
Hence, we view the Stock Connect schemes as an innovative and important breakthrough in the institutional
framework of Hong Kong and China.
We believe the Stock Connect schemes allow China and the rest of the world need to maintain a status quo, as
long as China is able to connect its system with Hong Kong, and the rest of the world is comfortable doing business
with Hong Kong.
This means that Hong Kong has a constructive and productive role to play, in terms of connecting China and the
rest of the world in the interim, before China and the rest of the world find a way to seamlessly connect with each
other. Hence, Hong Kong has the chance to participate in the modernisation of Chinas institutions as a result of
this special role.
Indeed, we believe such opportunities exist within the financial sector. In the 22 years since the listing of Tsingtao
Brewery in 1993, Hong Kongs role in Chinas financial reform was mainly related to capital formation, ie, raising
capital for Mainland Chinese companies in the international market.
Up until 2013, Hong Kongs role as a financial sector did not extend far beyond equities. The commodity market
was almost non-existent, and there was a lack of major bond and currency related markets. As such, one could say
that the scope of Hong Kongs financial markets was narrower when compared with genuine global financial
centres such as London and New York.
In our opinion, if Hong Kong is to become a genuine global financial centre, the market needs to evolve beyond
pure equities. We believe commodities, fixed income, equities, currencies and derivatives, complement each other
in different ways. If Hong Kong were able to develop a sizeable presence in all areas, this would be a major leap
forward for the territory.
96
The institutional gap and the role of Hong Kong
Source: Daiwa
However, given Hong Kongs limited resources, we believe it would be next to impossible for the territory to evolve
much beyond a pure equities market business. After all, Hong Kong is a city with only 7m people, when compared
to other global financial centres.
But if a Mutual Market (a market that belongs to both Hong Kong and China, using Western systems and practices
but serves Chinas interests) were to emerge in Hong Kong, the quantum leap forward for Hong Kong to become a
genuine international financial centre would become much more conceivable, in our view.
The Stock Connect - Now and the Future
Source: Daiwa
97
The Hong Kong-China Mutual Market
Source: HKEx, Daiwa
In theory, there are a broad range of possibilities for the further broadening and deepening of Hong Kongs role as
a financial centre under a Mutual Market framework.
For example, in equities, Hong Kongs role may not only be limited to that of a fundraiser for mainland corporations.
The Stock Connect has created a Greater China Equity Market which is over USD10tn in combined stock market
capitalisation, the second largest market globally. As such, this market should appeal to major global companies,
due to the sheer size of potential investment capital in China.
The Greater China equity market

(USDbn)
20,000
16,000
12,000
8,000
4,000
0
NASDAQ
NYSE Euronext
TMX Group
Shenzhen SE
India (BSE + NSE)

Japan Exchange
Deutsche Brse
Australian SE
Shanghai SE
Korea Exchange
London SE Group
SIX Swiss
HK + Shanghai +
HK Exchanges
Exchange
Shenzhen
Group
Source: World Federation of Exchanges, Daiwa

Note: As at end-Nov 2016
98
Given that the Stock Connect has allowed mainland investors to access equities outside China, and given
companies listed in Hong Kong exposure to investors in Mainland China, it would be theoretically possible in the
future for corporations listed on the China A share market (either Shanghai or Shenzhen) to be automatically listed
in Hong Kong, and vice versa (this was the idea of the primary Connect proposed by the Hong Kong Exchange).
In our view, the regulatory framework governing IPOs in Hong Kong is closer to that of a Western system. Hence,
for major global companies looking to access investment capital on the Mainland, it would probably make sense for
them to list in Hong Kong first, rather than being subject to Chinas rules and regulations governing IPOs.
We note that, Saudi Aramco, a major oil company in Saudi Arabia, is planning a global IPO to raise about
USD100bn which will likely set a record in terms of IPO funds raised. We believe that this could be the first
example of primary connect where major companies listed in Hong Kong would automatically have their shares
offered on the A-share market, and A-share listed companies would automatically be listed in Hong Kong.
As such, Hong Kongs role in equities could extend beyond channelling global capital to Mainland Chinese
corporations. A mirror image of this ie, channelling mainland capital to overseas corporations could well happen.
China has also become the worlds largest importer and consumer of many commodities. However, we understand
that despite Chinas huge involvement in the global commodities sector, and with the CNY exchange exhibiting
much greater volatility than the past, many commodity related transactions in China remain essentially unhedged.
Chinas commodity platform and future evolution
Source: HKEx
99
Architecture of Chinas commodity sector and Hong Kongs role within it
Source: HKEx
This is understandable, given that hedging is a novel idea for a command economy and that there is a lack of
robust hedging mechanisms in the China market. To quote Alan Greenspan: the culture, institutions and practices
related to hedging and risk management do not have major roles in a planned economy.
Hence, many commodity exchanges in China do not seem to offer effective hedging and it is questionable whether
many of the commodity exchanges are really serving the industry and its commercial needs.
In western markets, it appears to us that commodity markets are based firstly on the physical market and genuine
industry and business needs. Hence, physical delivery of commodities and warehousing are essential parts of the
western ecosystem.
However, Chinas system looks very different to us and it appears that commodity exchanges in China are focusing
more on the financial aspects of the commodity business, with a much lower emphasis on the underlying hedging
and industry needs.
In our opinion, Chinas system may not be aligned with the long-term interests of the China commodity industry and
the State over the long run. With a rising volume of commodity related transactions, we believe that there are
significant hedging and risk management needs, especially given the governments policy to allow greater
fluctuation in CNY exchange rates.
However, given that Chinas commodity industry is made up of hundreds (or even more) of commodity exchanges,
and that many practices are entrenched, the market looks to be very difficult to physicalise, in our view. We
believe the industry should serve the real economy rather than financial players.
100
Against this backdrop, we believe there is a role for Hong Kong. Although Hong Kong does not have a strong
background with commodity markets, this may be a positive as it allows a platform to be created to serve Chinas
specific needs.
We also note that Hong Kong has not succeeded in creating a large-scale bond market. The fact that the economy
has a population of 7m and lacks a liquid long-term bond market represents a natural handicap in developing a
large-scale bond market.
However, China has a sizeable bond market. In our opinion, the Stock Connect is a major breakthrough in the
institutional framework in both Hong Kong and China and its application may not necessarily have to be limited to
equities. A bond connect, which would allow overseas investors access to Chinas bond markets is also a
possibility. This could enable Hong Kongs bond market to see a critical mass which would otherwise take many
years to develop.
The Bond Connect
Source: Hong Kong Economic Times, Daiwa
A comparison of the bond markets in Hong Kong and China

Hong Kong China
Size About HKD3tn About CNY70tn (ranking 3rd in the world, after US and Japan)
Daily turnover About HKD20bn Over CNY500bn
Currency denomination Mainly HKD or USD Mainly RMB
Issuers HK Exchange Funds, followed by banks, HK The Government, banks and enterprises
enterprises and overseas enterprises
Investors Mainly institutional investors in the world Mainly domestic institutional investors and financial institutions.
Recently opened to financial institutions and central banks
outside the country.
Source: HK Economic Times
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Meanwhile, the rapid development of the ETF market in recent years has also presented Hong Kong with
numerous opportunities. If the Stock Connect model can be applied to equities and bonds, we believe it should also
be applicable to ETFs. The rapid development of ETFs in Hong Kong could potentially allow Mainland investors to
use ETFs in Hong Kong to access a wide variety of asset classes and investment products globally, and vice versa
(ie, also allow overseas capital to access investment products in China via ETFs).
Turning to the currency markets, where following the acceptance of the CNY as a reserve currency, we believe the
currencys importance will rise in tandem with Chinas role as a global trading and manufacturing centre and capital
exporter.
As the CNY has become a more important and widely held currency, this has led to rising demand for CNY-
denominated investment products. This is another area where Hong Kong has an important role to play.
We note that, in recent years, Chinas government has allowed greater flexibility in CNY movements. This has also
given rise to many issues, not least the need for entities in China to hedge their risks. However, does China have a
robust enough currency hedging system?
This does not appear to be the case, and is not surprising given hedging and transfer of risks are not commonplace
in a command economy. In our opinion, hedging requires professional expertise and a robust regulatory framework,
which may not be readily available in China and would likely take considerable time to develop. This is another
area where Hong Kong may have a role to play, in our view.
Does the HKEx allow Hong Kong to play a role in the aforementioned
scenarios?
Indeed, the Hong Kong Exchange (HKEx) has already set out some of these ideas in its 2016-18 Strategic Plan. In
our opinion, HKExs strategy is ambitious as it aims to be a leading force in the creation of Chinas financial
architecture.
Of course, only time will tell if these ideas can be properly executed. However, we believe it is a positive that the
relevant parties are now looking at the execution of these ideas and that HKEx has seen considerable progress
towards achieving its goals.
The HKEx Strategic Plan 2016-18
Source: HKEx
More importantly, given that the above-mentioned markets are all sizeable and likely to be in the trillions of dollars,
a breakthrough in just one market would be a boon for the future of Hong Kong.
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Is a new vision for Hong Kong already in the making in the free market?
No artist is ahead of his time. He is his time. It is just that others are behind the time.
- Martha Graham
Over a hundred years ago, Catchick Paul Chater, a prominent British businessman of Armenian descent had a
vision that Hong Kong would evolve beyond a trading port. He advocated the building of electricity plants and
reclamation work, leading to the founding of various major companies in Hong Kong such as Hongkong Land,
China Light and Power, HK Electric and Wharf, in addition to the Praya Reclamation Scheme which resulted in the
creation of Central.
In hindsight, without these initiatives, the creation of modern Hong Kong would likely be next to impossible.
Although the building of power plants and the provision of land seems basic today, these initiatives were met with
considerable controversy when they were first proposed, as many questioned whether Hong Kong would ever
develop beyond a trading port.
In short, Hong Kong can be viewed from many different perspectives, depending on an individuals point of view.
And there exist many visions of Hong Kong, and historically such visions have changed and evolved over time.
An old saying in Hong Kong holds that Hong Kong is a borrowed place on borrowed time. We believe this remark
holds true as many people who arrived Hong Kong from China viewed Hong Kong merely as a stop on the way to
their final destination the Chinatowns of London, Europe or the US.
The concept of Hong Kong citizenship and Hong Kong as a home has only been around since the 1970s. Many
Hong Kongers were originally refugees escaping from Communist rule in China, seeking refuge from a relatively
isolated China.
In our opinion, an isolationist view is shared by many people in the city. However, if everyone held this relatively
narrow view, then it would be unlikely that Hong Kong would have achieved all that it has. Hong Kong has already
achieved much for a city with just 7m people, most of whom started out with nothing a few decades ago.
And we believe one main reason was that a certain part of the population especially the industrial and
commercial has taken a pragmatic and realistic view on the circumstances, which drove them into manufacturing
and trading in the 1950s and 1960s, and then back to China (a place where many of them had escaped from in the
past) to strengthen their manufacturing capabilities from the 1980s onwards.
In the finance and retail sectors, many people in Hong Kong have seen China as a major client for some time while
in the corporate sector, many Hong Kong companies have been investing in China, like other major markets, for 2
decades or more already.
This, however, is not to deny that, socially, there are still many in Hong Kong who cling to a narrow and isolationist
view of Hong Kong; and we think this might have been one background factor to the Occupy Central event in late
2014. Given that Corporate Hong Kong, or what may be called Hong Kong Inc., has been taking a much broader
and more international view about the future of this city for some time, we wonder whether one must forever hold
onto a relatively isolationist view of Hong Kong or whether one should consider modifying it in the light of changing
circumstances.
What we would say is that the isolationist perspective is not the only way to look at Hong Kong. Or alternatively put,
there exist other visions of Hong Kong.
One simple and pragmatic way to look at the Hong Kong-China relationship is from an economic or commercial
perspective, in our view.
As a city, Hong Kong has developed a commercial relationship with almost every country and one may wonder
whether this is also the approach to take from a Hong Kong-China perspective.
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In our view, Hong Kong could be a part of China, and also connected globally, making it a genuine international
metropolitan city. While other cities in China are likely to assume more international dimensions over time, we
believe it would be hard for them to develop into genuine international cities in 5-10 years. In our view, Hong Kong
has certain unique aspects, and we believe it is entirely conceivable that Hong Kong could keep its identity as an
international city while at the same time also existing as a major city within China.
In other words, we believe there exists a wide spectrum as to how Hong Kong can be seen. One vision for Hong
Kong could be an isolationist one, but equally we believe Hong Kong can position itself as a major city within
Greater China; or better still, both a major city within Greater China and an international city that connects with
China as well as virtually all other major countries in the world.
In our opinion, major corporations in Hong Kong, such as HSBC and Cheung Kong Hutchison Group, have already
found Hong Kong to be too small for their businesses since the 1980s and they have now grown to become more
like global companies. Since the 1990s, many local property companies have started to build their presence in
China, and we have found that many of them now have well over USD5bn in investments in China with a few of
them (such as Hang Lung Properties, Wharf, New World, SHK Properties, etc.) having well over USD10bn of their
assets in China.
Geographical breakdown of CK Hutchisons 1H16 EBIT
Source: Company
104
Another example is MTRC. This company started off as a local company, and while it is still local in some respects,
it has also built up a meaningful international business over the past 10 years. It has established a meaningful
presence in the subway sector in China, especially Beijing and we estimate is now the largest foreign investor in
Chinas subway sector.
Another example is HKEx. While the stock exchange was mainly a local business in the past, HKEx started to gain
China exposure with the listing of Tsingtao Brewery in Hong Kong in 1993, and since then China has become its
largest market. More importantly, in recent years, it appears to be leveraging on China to turn it into a leading
exchange globally and to excel not only in the equities business, but also in commodities, ETFs, FICCs, etc.
In other words, other than the isolationist perspective, we believe that one could also take a Greater China
perspective on Hong Kong, and even a global perspective as well. Importantly, our read is that Hong Kong Inc has
taken a Greater China perspective for many years, and a few companies have already moved beyond this stage to
become more like global companies, though at the same time, retaining their roots in Hong Kong and China.
We believe the future of Hong Kong as a city depends critically on the vision of the people living in the city. In our
view, pressure has been building up for some of the local population to shed their isolationist views on Hong Kong,
and if they are unable to do so, then it may be up to others from China or elsewhere. Our read is that Corporate
Hong Kong has been well ahead of Social Hong Kong in terms of facing this issue, and we do not foresee major
issues in terms of Hong Kong Inc continuing to move forward in terms of its presence in China and the global arena.
Seen in this light, we think there is a limit to the constraint on the development of Hong Kong as a city even if
Social Hong Kong would want to cling to an isolationist view on the city for much longer. From an economic and
commercial perspective, we see considerable opportunities ahead for Hong Kong as a city, though whether these
opportunities go to the local population or another part of the population, or some people who have yet to come to
live and work in Hong Kong, remains uncertain.
Different visions on Hong Kong
Source: Daiwa
105
What are the implications of viewing Hong Kong in a different light?
In our opinion, the traditional view of Hong Kong as an isolated entity is narrow given that Hong Kong has already
made significant economic strides despite having a population of only 7m.
We believe it would be a challenge to find drivers for the next stage of the citys growth if Hong Kong were to move
towards a relatively isolationist policy with its resources (including its 1,100 sq km of land) and opportunities limited
to its 7m inhabitants.
If Hong Kong were viewed in the context of the global environment as the place where East meets West, where a
capitalist system and Chinas command economy look for ways to connect with each other, and as the centre
where overseas companies manage their businesses in China and Asia, and where Mainland Chinese companies
manage their businesses in the outside world then this would likely open up potential new opportunities for the
city.
Could Hong Kong be a platform for China to leverage on and build the offshore component of its financial
architecture? Or conversely, could it be the place where overseas capital and seekers of capital access investment
opportunities and capital in China?
HKExs long-term goals
Source: HKEx
Can Hong Kong become an alternative centre for China to allocate its capital and a market where Mainland
Chinese companies manage various kinds of risk related to fluctuations in currencies and interest rates?
Moreover, Hong Kongs role may not only be limited to finance. In retail, for example, can Hong Kong become
more than just a hub for luxury goods? Could it become a hub for the food and beverage sector and a trend-setter
for consumers in China and Asia?
The future of Hong Kong probably lies in how well the economic participants already in the city and those who may
come to here evaluate the pros and cons of the various possibilities above, and how well they execute them.
Changing the way Hong Kong is perceived involves many challenges. Historically, many cities in the world
gradually fade out from the scene because they cannot cope with the challenges associated with transformation.
But historically, Hong Kong has been a city that has constantly redefined itself. Whether the Creative Destruction
force coined by Joseph Schumpeter can stay rigorous and alive would probably determine whether Hong Kong
could overcome such a challenge, in our view.
In our opinion, connectivity is key to the importance of different cities in our modern world and this is likely to be
more the case in the times to come. Our view is that Hong Kongs connectivity with all major cities in China and the
rest of the world has the potential to still significantly increase in the years to come, and the future of Hong Kong
would probably depend critically on whether its economic participants are willing to explore and take on such
opportunities.
106
Hong Kong, China and rest of the world now
Source: Daiwa
Hong Kong, China and rest of the world future
Source: Daiwa
Whatever the outcome, what we do know is that the physical infrastructure linking up Hong Kong and China is
likely to come online soon. Effectively, Hong Kong cannot be isolated from China and the social and economic
impact of China getting closer and closer will probably become increasingly pronounced in the years ahead.
Hong Kong only has a 7.1m population while Guangdong Province alone has around 100m people. Like it or not,
Hong Kong cannot adopt an isolationist stance towards China for much longer, in our view.
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The Guangzhou-Shenzhen-Hong Kong Express Rail Link (Hong Kong section)
Source: MTRC
In our opinion, in as much as China is a threat to Hong Kong in many respects, it is equally possible to see that it is
a spinner of potential opportunities. We believe that how to revitalise its SOEs has been one main difficult issue
faced by the leaders in China since they first embarked on structural reform.
Our read is that one important component of the strategy of the China government to drive improvement in
productivity and efficiency of its SOEs is to encourage them to go abroad and compete in international markets. As
such, Hong Kong could be the coordination centre for overseas companies coming to China and for Mainland
Chinese companies looking to go outside of China.
We note that CITIC Group one of only 2 enterprises in China that is directly under the State Council is now
based in Hong Kong, and the Group declared a few years ago that it chose to establish its headquarters in Hong
Kong because this is the way it could adopt good practices in the global corporate world. We see this decision as
sensible and visionary and believe more and more Chinese corporations will make a similar decision in the next
few years, or at least consider using Hong Kong as the centre to manage all of their international businesses.
Other than the corporate front, we also see China as potentially a major spinner of opportunities in Hong Kongs
retail space. For in retail, we believe Hong Kong can leverage on the scale of Mainland Chinese consumers to
become a much more important market in the eyes of international retailers. Indeed, if Hong Kong can provide the
space and rental options to attract a much greater variety of retailers from all over the world to come to the city, it
has the credentials to become a trend-setting city for consumers in China and Asia.
And in the realm of finance, it is clear that China offers many opportunities to significantly boost Hong Kongs
potential as an international financial centre, and our read is that HKEx has been actively working on capitalising on
such opportunities for many years.
We believe China provides Hong Kong with the critical mass for the city to consider larger and more ambitious
roles in the global arena. Most importantly, our read is that the private sector has been exploring this area for a
number of years and has achieved considerable progress. This gives us some assurance that Hong Kong as a city
has a fair chance of still being able to move forward, even if Social Hong Kong is still clings to an isolationist view
on Hong Kong for more time to come.
108
Is the China property sector about the building of metropolitan cities?
Importantly, if we take one step further, we wonder whether the entire China property sector is about the building of
metropolitan cities.
Indeed, we foresee 5 major metropolitan zones emerging within China and see Hong Kong as part of the
metropolitan zone of southern China. And we think it is important to note that Shenzhen appears on track to
become the Silicon Valley of China. Geographically, Shenzhen is on the doorstep of Hong Kong, and the 2 cities
have long historical and cultural ties. There is also likely to be a major breakthrough in the transport infrastructure
linking Hong Kong, Shenzhen and the rest of China in the next 1-2 years.
The economic scale of Hong Kong and Shenzhen would be much greater if combined. And even more so if the
entire Southern China region were to become a more integrated economic entity with Hong Kong, Shenzhen and
Guangzhou being the 3 key cities within this large metropolitan zone.
As such, just capitalising on the opportunities associated with the metropolitanisation of southern China would
probably already create significant new opportunities for Hong Kong in the years ahead. But our read is that the
opportunities facing Hong Kong could be much more than this.
This is because in the foreseeable future, Hong Kong will likely remain the only city within China that has an
institutional framework and a critical mass of professionals and human resources that have worked with all other
countries in the world for several decades. As such, it could take on a broader role than most other cities in China.
We envisage that many cities in China, such as Shanghai, Beijing, Shenzhen, Guangzhou and Chengdu, would
need to modernise and have an expanding international dimension.
That said, we have doubts as to whether Mainland Chinese cities can fully exhaust all the roles that need to be
filled, unless there are fundamental changes in the institutional structure of China. This implies that there would
always be a role for Hong Kong to play.
Moreover, we would argue that Hong Kong is the most advanced among all the cities in China in the
metropolitansiation process, and as such, there should exist many opportunities to apply the experiences and
lessons learnt from the development of Hong Kongs property sector to other cities in China.
Indeed, our read is that such a process has already been ongoing for some time and it looks as if Hong Kong
property companies could become major players in the prime commercial property sectors in several major cities in
China, such as Shanghai, Chengdu.
In all, we see the metropolitansiation process in Hong Kong as well as China as a great spinner of opportunities
for property companies in Hong Kong, and it is incumbent upon their vision, capital and expertise to decide how
much they could get from such structural trend. This is an issue on which we focus in the next chapter.
109
The 5 metropolitan zones in China
Source: Daiwa
110
Chinas high-speed railway system
Source: Ministry of Railways
A breakthrough in the transport link by 2018
Source: Hopewell Highway Infrastructure
111
112
Question 6
Will Hong Kong property companies
be able to ride on the opportunities
that arise in the years ahead?
113
Will Hong Kong property companies be able to ride on a potential leap in

the scale of Hong Kong property?
There are three classes of people: those who see, those who see when they are shown, those who do not see.
- Leonardo Da Vinci
The problems of the world cannot possibly be solved by sceptics or cynics, whose horizons are limited by the
obvious realities. We need men who can dream of things that never were, and ask why not.
- John F. Kennedy
The market is more reasonably priced than it appears
As we have argued in previous chapters, while Hong Kongs property market does give the appearance that it has
become too expensive to sustain, and hence would be at risk of entering a prolonged ending trajectory soon, a
deeper analysis suggests that many market participants in Hong Kong have been mindful of such risks all along
and have been continuously seeking ways to capitalise on the opportunities created by high property prices in
Hong Kong.
The opportunities created by high property prices, in turn, seem to have turned out to become competitive market
forces that have restrained and corrected those excesses in the market, ensuring that what Schumpeter calls the
force of Creative Destruction can operate in the physical Hong Kong property market.
As a consequence, we believe the Hong Kong property market, in its totality, is actually much more reasonably and
realistically priced than it appears. And we think this is probably why so far the sector has shown considerable
resilience against the impact of many adverse factors, such as the GFC, sovereign debt crisis in Europe,
devaluation of the CNY, government cooling measures, anti-corruption campaigns in China, the Occupy Central
movement, etc.
The myths about Hong Kong property prices

Commonly held views Our alternative perspective
Hong Kong property prices are driven by forces and factors specificThe forces driving the Hong Kong property market and property prices are
to HK not really different from what have been driving other major metropolitan
cities in the world.
Hong Kong property prices have become ridiculously high Only a certain segment of Hong Kongs property market commands very
high prices. And the prices for these assets have stayed high for a reason.
High property prices in Hong Kong are making Hong Kong Market prices can also be seen as signals given out by the market process
uncompetitive and, in a free market, prices often reflect anticipated competitiveness and
productivity rather than determining competitiveness.
Hong Kong property prices are high because the major property The Hong Kong property companies, by and large, have just rode on the
companies in Hong Kong and the government have colluded to keep it continuous transformation of the Hong Kong property sector, and the
that way resulting surge in the values of the properties they owned.
What many Hong Kong property companies have done are arguably mainly
rational commercial responses to the market signal of high property prices
in Hong Kong, which actually have had the effect of taming property prices
in the city
Source: Daiwa
We do not deny that US interest rate normalisation could be a larger challenge than any of the above. That said,
we also contend that many market participants in Hong Kong have probably been aware of the eventual
emergence of this risk for quite some time (probably over a decade for some). As such, US interest rate
normalisation is likely a risk that has not been entirely unanticipated.
However, anticipation has always been a tricky factor in investing. According to Bob Farrell, one of the 10 rules for
investing is: when all experts and forecasts agree, something else is going to happen. It appears that many experts
and forecasters expect US rate hikes to be the trigger for a major correction in property prices in Hong Kong. And
our read is that some investors could have already shorted Hong Kong property stocks on this basis, and that such
concern has prevented some investors from investing in Hong Kong property stocks for quite some time.
114
Under such circumstances, we believe that in terms of the actual real impact of US interest rate normalisation, we
see room for such an event to surprise more on the upside than the downside. Indeed, the Hong Kong property
stocks reaction to the hike in US interest rates on 16 March, as well as the subsequent surge in primary market
sales the following weekend, seems to suggest that the actual market impact of rate hikes is much milder and
much more positive than many have previously thought.
Still room for the quantity and total market value of Hong Kong property
assets to rise
Undoubtedly, the ASPs for some Hong Kong property assets are high. However, we think this needs to be
balanced by the recognition that exceptionally high prices apply only to a limited segment of property assets in
Hong Kong, and that this is the case for a reason, and that such a situation has persisted for a long time.
More importantly, we estimate the total market value of Hong Kong property assets is still moderate relative to the
established metropolitan property markets in the world arguably Hong Kong is now merely being priced like a
high growth mid cap stock which have higher PERs, but Hong Kongs ranking in terms of total market cap still
look reasonable compared with the established metropolitan markets like New York and London.
In any respect, our view is that the total market capitalisation of the Hong Kong property market is still not out of
kilter with the wealth that is being stored in the city and the productivity its office and retail space are delivering.
Indeed, one may say that the prevailing prices and rents for Hong Kong property assets be they office, retail or
residential may just reflect the markets realistic expectations of their underlying productivity as well as the wealth
and income of the people/retailers companies who want to buy or to rent these assets.
In our view, over the next couple of years, the supply outlook of various major property asset classes in Hong Kong
remains benign in that the supply picture looks far from excessive to us.
Supply of office property space in Hong Kong

(m sq ft)
7 16%
6 14%
5 12%
4 10%
3 8%
2 6%
1 4%
0 2%
(1) 0%
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016E
2017E
2018E
2019E
2020E
Net supply (LHS) Take-up (LHS) Vacancy (RHS)
Supply of residential property space in Hong Kong

(No. of units)
100,000
90,000
80,000
70,000
60,000 Avg (Total) (1985-2015): 53,422
50,000
40,000 Avg (Private) (1985-2015):
30,000 22,247
20,000
10,000
0
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016E
2017E
2018E
2019E
2020E
Private Public rental Subsidised flats Average (Total) Average (Private)

115
Supply of retail property space in Hong Kong

(sq ft) Shopping centre supply by region (2003-2019E)
3,500
3,000
2,500
2,000
1,500
1,000
500
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E
HK Island Kowloon New Territories

Source: Savills
The price umbrella of top-end assets is favourable for companies making

productive new investments
In our view, the very high ASPs commanded by some Hong Kong property assets is precisely a result of the
principal feature of Hong Kong property the phenomenon created by a decades-long cumulative undersupply of
land.
With the supply of new land in Hong Kong having been unable to catch up with the growth in demand over the past
few decades, what in most other cities would be manifested in volume expansion (ie, geographical expansion of
the size of the city) has been manifested in terms of price increases in the Hong Kong context.
We believe the very high prices commanded by the most prime property assets in Hong Kong is a result of there
not being enough supply of land to absorb the positive economic forces the market has been faced with, combined
with the psychological barriers the market participants in Hong Kong have had to overcome in terms of accepting
new locations. As a result, a large part of the economic forces, which in other markets would have been manifested
in the expansion of the size of a city and mid-tier assets, have gone on the ASPs of a limited amount of scarce
property assets in the Hong Kong context.
It would be less than prudent to assume that such a situation will last forever. The number of wealthy people and
high-margin retailers and corporations is finite and it would take extraordinary circumstances to have a
continuously growing number of this group of people and economic entities flowing into any particular city.
That said, elite groups from other parts of the world continue to come to Hong Kong while some originally working
class people or small corporations in Hong Kong have managed to become among the most wealthy and profitable
in the world.
This factor should have provided some protection to Hong Kong property on the demand side. But we think the
most important force to take note of is that, all along, self-correcting naturally market forces have been generated
by the Hong Kong property sector to address this issue, which has resulted in the emergence of more and more
competitive alternatives in the market over time.
Importantly, such forces of Creative Destruction have had the effect of restraining prices and rents at the top end
and attracting new and productive players to the market, thus bringing in greater rationality to the price contour of
the whole Hong Kong property market over time.
Major developments in the market which have helped to restrain Hong Kong
property prices
Developments Consequences
The rise of Pacific Place and its Wanchai South extension Have expanded the boundary of Central and provided alternatives to firms
finding rents in the top tier office buildings in Central unaffordable
The rise of Island East as an office hub Have provided an alternative for firms which want to stay in the Island but
have found Central rent to be too expensive to afford
The emergence of Kowloon East as another office hub Have provided a lower cost option for companies which want to expand or
to relocate the middle or back departments
Source: Daiwa
116
The creation of Pacific Place as an extension of Central, the emergence of Causeway Bay and Island East as more
vibrant and upmarket commercial hubs, the transformation of suburban malls, the rise of Tseung Kwan O as a
middle class locations etc. are among some of the more obvious examples of major developments in the market
that have helped restrain property prices, in our view.
Seen in this light, we would argue that, as a property market, Hong Kong has demonstrated a level of vibrancy,
dynamism and sophistication which do not appear that common and widespread in many property markets in the
world. As such, it should be attractive for real estate companies operating in this market, in our view.
Can the total market value of Hong Kong property assets eventually get close
to those metropolitan property markets in the world?
If the Hong Kong property market can really make a leap forward from one that is for merely 7m people into one
that serves a much larger hinterland, or even the key city to connect China with the rest of the world or the city
where the investing and commercial capital of China and the rest of the world converges, it is not inconceivable
that, over time, the Hong Kong property market could eventually evolve into one of most vibrant, dynamic and
sophisticated metropolitan property markets in Asia, or even the world.
From an investing perspective, we think one important point to note is that, if only say 10-20% of the above
scenario can really play out, this would probably already be enough to drive a significant leap in the total market
value of the Hong Kong property assets.
Just a casual observation is probably enough to tell that the current scale of the major metropolitan property
markets in the world such as London, New York, Tokyo, etc. are substantially larger than that of Hong Kong, which
is considered a less than one hour city in that nearly all the economic activities of the city are conducted within
one hour travelling time of the city centre. Indeed, we think one might even say that Hong Kong at this point is still a
30-40 minutes city in that the bulk of the economic activities in the city can be done within 30-40 minutes from the
city centre.
The metropolitan property market into which Hong Kong is evolving

A metropolitan property market serving a
A property market for 7m people much larger pool of people, firms and retailers
Office
Scale 121 m sq ft > 150 m sq ft
Number of companies About 15,000 > 30,000
Market value AboutHKD1tn >HKD1.5tn
Retail
Scale 118 m sq ft >130 m sq ft
Number of retailers <3,000 >5,000
Market value About HKD2tn >HKD3tn
Residential
Scale About 610 m sq ft >900 m sq ft
Number of private units 1.15m 1.5m
Number of private units >700 sq ft 0.23m 0.5m
Market value HKD6.5tn >HKD10tn
Source: Hong Kong Property Review, Daiwa
Our estimate is that while the ASPs of the most prime property assets in Hong Kong are as high as anywhere in
the world, there would probably still be a gap between the total market value of Hong Kongs property assets and
the worlds major metropolitan property markets even if the total market value of Hong Kong property assets (which
we estimate to be about USD1.2tn now) expanded by say 50% from now.
Note however that what we are referring to above is an expansion in market value (price x volume) and not price.
Indeed, our view is that, the structure of Hong Kong property prices is a transitory phenomenon, resulting from the
demand for space and especially the demand for higher-quality property space and prices have so far been
growing much faster than the growth in land supply can accommodate. As such, one might say that the sky-high
prices commanded by some Hong Kong property assets are the markets way of saying/signalling that there is not
enough space available, and that the economic participants would be well-advised to work on creating more value-
for-money alternatives in the market.
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Can the Hong Kong property market provide the mid-tier assets to support a
major expansion in its scale?
In our opinion, a metropolitan property market is characterised by one with an ever-growing scale and depth. Its
size keeps on expanding while the number of layers and variety of the property segments within the whole
structure as well as their interaction can continue to expand, evolve and multiply.
Conceptually, we think there are 2 ways such a market can be established over time. One is what we call bottom-
up and filling up. By this, we mean the city starts with the lower end of the value chain and then as it continues to
move up the value chain, it provides the market with more and more higher-end space to accommodate. Such a
trajectory seems to be more likely to happen for cities with abundant land and one where there is a central co-
ordinator which releases land to the market in phases to match the requirements at that time.
By way of contrast, we call the second trajectory top down and spreading out. By this, we mean that the city starts
with one generally accepted prime area or district. Then, while the city continues moving up the economic value
chain, the real estate values of the prime areas continue to go up forcing those market participants which cannot
rise as fast to seek alternatives in more peripheral areas.
As a consequence, the geographical boundary of the prime area continues to expand and gradually other districts
emerge as value-for-money alternatives to accommodate market participants which can no longer afford to stay in
the central areas, or which find that there is no genuine commercial need to pay the higher price associated with
being very close to the prime areas.
When such a process continues to carry on, one would likely see the emergence of a variety of different districts,
each of which would tend to focus on different segments or industries or social groups. Or one might see a number
of districts evolving into composite districts which tend to serve different types of economic activities rather than just
one or two. In all, the direction of cities evolving under this trajectory is that of getting larger, more complex, more
variety and more depth, ie, increasingly large, sophisticated and vibrant and may well resemble ecosystems in their
own right.
The top-down trickle-down model on the creation of metropolitan cities

New supply in the established prime areas Very limited
Location of new supply Currently peripheral areas of the city
Impact if there is not enough demand when the new supply comes out Could create downward pressure on prices but the impact could be confined
to that area
Impact when the supply comes out Provide market participants with choices, eg, trading more commute time for
more space and a better living environment?
Impact on the existing older property assets Conducive to them keep on upgrading
Impact on the most prime assets Generally, the stronger the peripheral, the even stronger the core
Impact on the city's evolution Geographical size continues to expand; many new areas to emerge and
gradually being upgraded over time, many opportunities for market
participants to explore and experiment new concepts; giving the market
more time to sort out the appropriate price contour
Source: Daiwa
Note that for the second trajectory, there may not be any central planner involved. It is arguably what Friedrich
Hayek called spontaneous order in that it is the spontaneous emergence of order out of seeing chaos, created by
the gradual and piecemeal interactions among thousands or tens of thousands of market participants each of which
would continue to explore, create and fine-tune.
Importantly, from the perspective of building real estate value, our observation is that the second trajectory has a
much higher chance of success. The City of London has seen its size and the value of its property assets
significantly expand over the past 2 decades. Our observation is that its development and evolution has been
shaped by a finite supply of land in the core city centre, and then the city has continued to expand, find new areas,
and transform old areas to accommodate the real estate needs of the city as it has continued to grow and prosper.
In our opinion, such a situation is almost the ideal environment for real-estate companies that already own a large
portion of the citys established prime assets. Our read is that, for cities evolving along such a trajectory, the
immediate competitive threat to the real estate values of the prime assets is usually quite mild, as it is often quite
difficult for a new district to be immediately accepted by the most productive and prestigious users of space in the
city.
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Very often, what happens is that it is the less productive users of space which will first try the more value-for-money
alternatives. Provided that the city can retain its existing productive and prestigious users of space, the value of its
most prime assets can usually at least hold up. Meanwhile, the moving out of some lower tier users of space may
then enable some new productive and prestigious users of space to come in, which can have the effect of further
expanding the critical mass and depth of the existing prime areas, making their status as prime areas potentially
become more sticky and broad-based.
Moreover, our observation is that, in real estate, generally, if the peripheral areas are getting stronger, the central
areas often get even stronger, provided that the newly emerged strong players in the peripheral areas aspire to
move up to the most prime central areas eventually. What this means is that, while the scale of the city keeps on
expanding, the values of the established prime real estate assets in the city can often grow at the same time, or
even at a faster pace.
Most important of all, our read on the evolutionary trajectory of the Hong Kong property market is that it falls into
the second type and may well follow the footsteps of London in some sense. Such a trajectory is conducive to the
growth in real estate values in the city and the value of its established prime property assets, in our view.
In all, our view is that, if the Hong Kong property market is to evolve along the lines of becoming a genuine
metropolitan property market in the world, the next logical step in its development should be the provision of a lot
more space for developing mid-tier assets where rents and prices are much more in line with the average in major
international cities.
As and when such space becomes available, we expect there to be an eventual corresponding spike in demand,
from companies or retailers who want to come/to expand but cannot find space that makes enough commercial
sense; and from people who desire living in larger homes or coming to Hong Kong but have found the housing cost
prohibitive.
When this happens, we expect there to be a surge in the amount and hence market value of mid-tier property
assets in Hong Kong, resulting in a notable rise in the total market value of Hong Kong property assets.
The end-game for Hong Kong property

Current state Ending state Remarks
(m sq ft) (m sq ft)
Office 121 >150 150m sq ft is about half of the current stock of office properties in Manhattan
We expect to see 4 major layers, with Kowloon East serving the USD4-6/sq ft segment, the 4 established
office areas (Wanchai, Causeway Bay, Island East and Tsimshatsui) serving the USD5-12/sq ft segment,
Central serving the USD10-20/sq ft or above segment, and the emerging office areas (Wong Chuk Hang,
Cheung Sha Wan, Kwai Chung and others) focusing on the USD2-5/sq ft segment
A lot more office space in the mid-tier segment with rents at USD3-5/sq ft
With a lot more stock of office properties in the USD3-5/sq ft category, the median price for Grade A office
rents in HK would gradually get closer to the norm in major international office markets
Hong Kong, Shenzhen, Qianhai and Guangzhou may become the 4 key office areas in Southern China,
each having their special focus
Retail 118 >130 Increase in retail GFA constrained by availability of sites suitable for retail developments
But the current mid/low-tier segments of the market could become mid/high tier retail assets over time
We expect many of the retail space on upper floors in Causeway Bay, Tsimshatsui, Mongkok and Central to
be converted into retail usage
We expect Causeway Bay, Tsimshatsui, Mongkok and Central to be the 4 territorial Grade retail hubs in HK
The next layer would likely be Kowloon East and Central Kowloon (Kowloon Tong and Wong Tai Sin)
We expect many of the current larger-scale suburban malls today to become mid to high end malls
eventually, with retail hubs emerging in Tseung Kwan O, Shatin, Sheung Shui, Tuen Mun, Yuen Long and
potentially Tsuen Wan and Tin Shui Wai as well
Other than a hub for luxury retail, Hong Kong may become a hub for F&B, designer labels, cosmetics, sports
as well as many other trades and for tiers, making it a retail hub with large critical mass and also an
important trend-setting city for consumers in Asia and China.
Residential 610 >900 900m sq ft would translate into an average of about 550 sq ft per household, assuming that Hong Kong has
3.3m households in the end and half of them living in private residential estates
We expect to see 4 zones in HK residential properties, with the Monaco zone (Mid levels and The Peak) at a
unit price of USD15m up, the Manhattan zone (the rest of the areas in HK Island, Kowloon) at a unit price of
USD1-15m, the New Jersey zone (Tseung Kwan O, Shatin, Tsuen Wan-Kwai Chung-Tsing Yi, Tai Po, Tuen
Mun, Yuen Long) at unit price of USD0.5m-3m, and the rest of HK (the new towns and other areas) at unit
prices of USD0.3-1m.
The median price for HK residential units would depend critically on the pace of: 1) the development of new
towns, 2) farmland conversion, and 3) redevelopment of industrial buildings. With the speed of such a
process accelerating notably, we would expect the median price for residential units in HK to gradually
converge to the norm for major global metropolitan cities.
Source: Hong Kong Property Review, Daiwa
119
Note that during this process, while prime property assets in Hong Kong may stay just as expensive or become
even more expensive, and the total market value of Hong Kong property assets grow, it is conceivable that the
median property prices in Hong Kong may well drift downward gradually as median property assets in the city are
increasingly oriented towards those newer property assets located in what are now not being seen as core areas at
the moment.
Such a scenario could well constitute the soft-landing end-game for Hong Kong property in the long run, in our view.
Of note, we think market forces have already been in motion for some time to create such mid-tier assets and
believe these assets are already present in the office sector (we see Kowloon East office constituting the mid-tier
segment of the Hong Kong office market), and are gradually emerging for retail (we expect the suburban malls in
several key districts in Hong Kong Tseung Kwan O, Kowloon Tong-Lok Fu-Wong Tai Sin, Shatin, Sheung Shui,
Tuen Mun) forming the core of the mid-tier segment of Hong Kongs retail property sector.
As things stand today, residential is the segment where such an issue has not yet been solved. However, our view
is that, if the Hong Kong Government can finally come out with a transparent, equitable, efficient and effective
mechanism to get farmland or industrial sites converted into residential use, and more new towns built, we believe
the residential sector could also have its Kowloon East equivalent eventually (which would likely be in the
northwest and northern New Territories).
Is the Hong Kong property market getting ready for a leap forward?
In our view, market forces are already in motion to propel the Hong Kong property market into what we see as
Stage III in the development of a metropolitan market. In this light, the market could have been merely waiting for
the pent up demand to culminate to a point when just natural market forces would already be enough to drive the
market to make a leap forward.
Importantly, our read is that the momentum has already started building in the office sector and it may not take that
long for retail and residential to show symptoms that they are making progress in building the momentum, too.
But most importantly of all, in our view, is that the direction the Hong Kong property market appears to be going in,
is actually very favourable for the incumbent property companies in Hong Kong. In this connection, we think it is
worth noting that in terms of various aspects such as financial strength, management expertise and execution
capability in real estate, asset structure etc., the Hong Kong property companies have actually improved
significantly from 10-15 years ago, and appear well-placed to seize the opportunities that lay ahead.
Hong Kong property companies seem to have responded rationally and

prudently to the industry environment
Whatever ones view on the quality of management of Hong Kong property companies, we think they have
responded to the developments of the Hong Kong property market in the past 13 years (since the end of SARS in
2H03) as well as the environment of exceptionally low interest rates, in a generally rational and prudent manner.
We think such traits could be related to what the Hong Kong property market has undergone. For many of the
market participants in Hong Kong have 4 decades plus experience of operating in this market and have
experienced much turbulence in the past.
In retrospect, one may say that the development of the Hong Kong property market over the past 13 years is very
conducive to property companies becoming somewhat euphoric, and hence taking on a lot more risk and leverage
than before. However, it appears that the Hong Kong players do not seem to have developed any euphoria over
this market even when it was in its heyday.
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Net gearing ratio of major Hong Kong property companies

Company Dec 2012 Dec 2013 Dec 2014 Dec 2015 Dec 2016
Cheung Kong 7.3% 2.3% 1.1% na na
CK Property na na na 5.7% 2.8%
Great Eagle Net cash Net cash Net cash Net cash 0.5%
Hang Lung Properties Net cash 0.5% Net cash 1.1% 2.1%
Henderson Land 17.2% 17.2% 15.7% 16.0% 12.7%
Hongkong Land 13.0% 11.0% 10.0% 8.0% 6.0%
Hysan 6.2% 5.3% 4.2% 3.0% 5.4%
Kerry Properties 22.4% 31.0% 28.5% 32.2% 34.9%
MTRC 11.0% 11.8% 7.6% 11.3% 20.2%
New World Development 35.2% 35.1% 26.1% 31.4% 34.4%
SHK Properties 16.5% 12.9% 13.8% 12.4% 8.8%
Sino Land Net cash Net cash Net cash Net cash Net cash
Swire Properties 15.0% 15.8% 16.3% 15.3% 15.7%
Wharf 21.7% 20.4% 18.9% 14.9% 7.3%
Wheelock 13.4% 21.1% 18.8% 16.0% 13.8%
Champion REIT* 20.4% 23.4% 23.1% 22.1% 21.7%
Fortune REIT* 28.3% 32.7% 29.4% 30.1% 29.5%
Link REIT*^ 14.9% 11.6% 11.0% 16.9% 17.6%
Regal REIT* 29.9% 29.8% 33.9% 37.1% TBA
Sunlight REIT* 25.9% 25.2% 23.3% 21.6% 21.8%
Prosperity REIT* 22.4% 20.9% 28.6% 27.2% 26.4%
Average 18.9% 18.2% 18.3% 17.9% 15.6%
Source: Companies, Daiwa
Note: *gearing ratios for REITs is defined as total borrowings over gross assets
^gearing ratios for Link REIT are as of September 2012-2016
Alan Greenspan once remarked that excessive optimism sows the seeds of its own reversal in the form of
imbalances that tend to grow over time. However, it doesnt appear that any of the major market participants in
Hong Kong property have ever been carried away by excessive optimism since the property upcycle started in
2H03; and hence we have not seen many imbalances being created in the physical market despite the fact that the
overall macro environment facing Hong Kong during this period was very conducive to such orientation, in our view.
What Hong Kong property companies have done in the past 13 years
1 Strengthening the management of commercial property assets in HK
2 Conducting AEIs on some of their property assets in HK
3 Building up China businesses, especially on commercial properties
4 Disposed of non-core assets
5 Corporate restructuring
6 Let gearing ratio comes down
7 Keep on raising dividend
What Hong Kong property companies have not done in the past 13 years
1 Geared up significantly to buy land in Hong Kong aggressively
2 Geared up significantly to invest overseas
3 Pursued aggressive expansion in the scale of residential development business in China
4 Committed major investments in new industries
Source: Daiwa
Indeed, on the contrary, many of the market participants in Hong Kong property appear to have been just taking
advantage of the price umbrella created by the property market booms to introduce some new alternatives and
lower cost substitutes which, in many ways, have had the effect of enhancing the depth and sophistication of the
Hong Kong property market.
We also think the major Hong Kong retail landlords squeezed retailers to the maximum limit during the retail market
boom of 2004-14. Our read is that, in those years, especially the 2009-13 period, many watch and jewellery
retailers appeared willing to pay almost any amount of money to secure prime retail space.
It, however, turned out that none of the owners of the major shopping malls in Hong Kong were led to just lease as
much space to maximise the rent they can receive immediately. Indeed, our observation is that major retail
landlords in Hong Kong do pay attention to the sustainable occupancy cost of their tenants and have not taken the
risk of stretching occupancy cost to its limit and beyond.
We see this as a sign that the major retail landlords are long-term and reasonably sophisticated in their retail
management expertise; and that they do anticipate potential risks on the horizon and have demonstrated restraint
and long-termism in order to pre-empt such risks from materialising or getting out of control.
121
Hence, instead of seeing a lot of imbalances develop, our view is that the Hong Kong property sector has actually
become richer, larger and more balanced, which looks more likely to be a recipe for another leg up than the
beginning of a multi-year decline, in our view.
In our opinion, Hong Kong real estate property companies, by and large, have done a reasonable job in coping with
the property market upcycle in Hong Kong which started in 2H03, in that generally, they have been prudent,
rational and long-term-oriented, which was not that easy against the circumstances they have faced which arguably
has been very conducive to euphoria sentiment and over-optimism.
Had a similar situation emerged in many other real estate markets in the world, some players would have likely
over-leveraged or over-invested or over-stretched their tenants during boom times, which would have meant heavy
bills to pay when times were not as good. However, it does not appear that the Hong Kong property companies and
Hong Kong property market have a lot of imbalances which they need to pay for in the coming years.
Indeed, if one were to draw a balance sheet on what the Hong Kong property companies have accomplished over
the past 13 years, we would say that they have shown quite a few achievements.
One of the most important among these achievements, in our view, is the growth in their recurrent rental income.
Indeed, the growth in recurrent rental income achieved by the largest property companies in Hong Kong over the
past 13 years has been impressive and we are not too sure whether any property industry in the world could beat
Hong Kong property companies in this regard.
We analysed the gross rental income of 5 major players in Hong Kong property since 2013 and found that their
aggregate gross rental income rose 3x from HKD20bn back in 2005 to about HKD60bn at the end of 2015,
representing a CAGR of 13%, thanks to the sustained rise in commercial rents in Hong Kong, the continued
upgrading of many of their Hong Kong properties, as well as the completion of new rental properties in both Hong
Kong and China. We note that quite a few Hong Kong players have gross rental income streams of over USD1bn
(SHKP has over USD2.5bn in gross rental in FY16) which is not small even by global standards and should provide
a solid and important anchor for the equity market valuations of Hong Kong property companies.
Aggregate gross rental income of the 5 major property companies

(HKDm)
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15
SHK Properties Henderson Land Swire Properties Wharf Hang Lung Prop
At the same time, we believe the opportunities that many Hong Kong property companies have been offered have
enabled them to achieve considerable advancement in terms of management expertise in the real estate business.
For example, the sales productivity exhibited by Harbour City is very impressive even by global standards indeed
it is probably the most productive shopping mall in the world and we do not think that this can be attributed
entirely to the fortuitous circumstances of a boom in China luxury spending during the period.
That is, we believe there were many retail properties targeting to get a share of the retail spending of Chinese
consumers during this period. However, Harbour City managed to get the lions share and we think this implies the
mall that it has been doing better than others in terms of serving this newly emerged group of consumers.
Moreover, despite its very high base and the plunge in China luxury spending, tenant sales and rents in Harbour
City have held up well despite the very challenging environment. Given that the size of Harbour City is 2m sq ft (in
GFA) and that it has well over 500 tenants, it cannot be the case that it has done well just because of China luxury
spending.
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Our read is that many different trades in Harbour City have been doing better than their stores in other locations in
Hong Kong and that many international retailers have found the mall to be one that is very conducive to attract
consumers and get them to spend and to come back regularly. And this applies to not only to Chinese consumers
but includes many local shoppers plus shoppers from other countries such as Korea, India and many other parts of
the world, we observe. This attests to the level of expertise that has brought to the management of this mall, in our
view.
Retail sales in Harbour City

(HKDbn)
40
35
2003-2016 CAGR = 15%
30
25
20
15
10
5
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Company, Daiwa
Main achievements of Hong Kong property companies over the past 13 years
1 A significant surge in gross rental income
2 A burgeoning China businesses, more in the realm of commercial properties in major cities
3 A relatively low cost residential land bank in China
4 Much strengthened capability in managing commercial property assets
5 A strong financial position
Source: Daiwa
Indeed, our read is that, over the past 13 years, Hong Kong property companies have made a big leap forward in
the realm of management expertise for retail property assets. From our industry channel checks, our understanding
is that many Hong Kong players have been seen by a lot of international retailers as among the most sophisticated
and professional real estate partners in the retail business, and the list includes some of the worlds largest and
most sophisticated retail groups and is not limited to the luxury segment.
Other than retail property management, we see large-scale mixed developments as another area where the Hong
Kong property companies have excelled. For example, IFC in Hong Kong is an impressive product in mixed
development and Pacific Place and IFC would rank as among the most successful large-scale mixed development
projects in Hong Kong, Asia and possibly the world.
Meanwhile we also see the transformation of Island East and Pacific Place as world class endeavours in global
property; one could say that Swire Properties use of large-scale mixed developments to drive the transformation of
locations is a kind of special franchise in global property.
While the level of real estate skills required may not be as high and sophisticated, Link REIT has done an
impressive job, in our view, in terms of rejuvenating what would be regarded by some industry players as bottom-
tier retail property assets, especially considering that it is a young property company that has had to build its
execution capability from scratch.
On the other hand, we also believe the Hong Kong property companies have shown considerable achievements in
terms of building up their businesses in China. We note that Hong Kong property companies started building their
China businesses in the early 1990s and generally have significantly accelerated their scale and pace since the
mid 2000s.
Most importantly, it appears that many of them have finally found the ways to manage prime commercial properties
in China, resulting in a surge in their rental income from China in recent years. On our estimate, over the years,
major Hong Kong property companies collectively have invested over USD60bn in China property, which is a
sizeable figure even in global property. But what is even more important is that they appear to be on track to start
harvesting time.
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Gross rental income from China

Company Interim / Final Dec 2015 (HKDm) Dec 2016 (HKDm) YoY change*
China gross rental income
Hang Lung Properties Interim 4,194 3,995 -5%
Henderson Land Interim 1,748 1,700 -3%
Hui Xian REIT Interim 3,059 2,895 -5%
Hysan Interim 295 281 -5%
Kerry Properties Interim 2,897 2,995 3%
Spring REIT Interim 624 585 -6%
SHK Properties Final 1,758 1,837 4%
Swire Properties Interim 2,463 2,614 6%
Wharf Interim 2,305 2,350 2%
Yuexiu REIT Interim 1,462 1,530 5%
Total 20,805 20,782 0%
China retail malls

Chengdu IFS Interim 726 804 11%
Beijing Oriental Plaza mall Interim 1,378 1,332 -3%
Plaza 66 Interim 885 793 -10%**
Grand Gateway 66 Interim 1,196 1,139 -5%
Note: *YoY change includes a 6% YoY decline in the CNY exchange rate.
**leased floor area has fallen 17% YoY due to renovation works
Last but not least, in our view, the Hong Kong property companies have demonstrated considerable restraint,
prudency and long-termism in the face of the circumstances they have encountered over the past 13 years. As
mentioned earlier, despite the very low interest rate environment, the Hong Kong property companies have not
leveraged up that much.
Although the Hong Kong property companies have invested substantially in China property, it appears that a large
part of it was financed by the profits generated from Hong Kong. As a result, the industry gearing ratio has kept
coming down. Given our view that the Hong Kong property companies China investments appear to be in
harvesting mode, we expect to see a further decline in the gearing profile of Hong Kong property companies over
2017-19.
In our summary, we believe that, as real estate companies, the Hong Kong companies are strong, in the following
ways:
Strengths of HK property companies

1 They own many of the most prime property assets in Hong Kong.
2 They have significantly sharpened and deepened their management expertise for commercial property assets.
3 They have strong and growing rental income.
4 They have successfully penetrated the prime commercial property markets of Chinas major cities.
5 They remain lowly geared and are far from fully utilising their balance sheet strengths
Source: Daiwa
This then bring us to one important question: what will be the position of the Hong Kong property companies in the
years ahead given our anatomy and analysis of the Hong Kong property sector? Our view is that they are well-
positioned in the years ahead; and to follow we outline their potential position under 4 different scenarios.
Scenario 1: Hong Kong property prices see a multi-year downturn
As we have argued in previous reports and the preceding chapters of this report, we believe the probability of Hong
Kong property prices seeing a multi-year downturn is remote. That said, even if it happened, we believe the largest
adverse impact would be felt by only those Hong Kong property owners and some banks which had leveraged up,
as well as new entrants to the Hong Kong property industry which had acquired land at aggressive prices.
In our view, the largest players in Hong Kong would be able to weather any such downturn, and some could
eventually end up being even larger players in Hong Kong. Our view is that the business model practised by the
major Hong Kong property companies is a safe one. They have significantly expanded their recurrent income base,
which can cover their corporate overheads by well over 10x.
Moreover, if they can sell their residential property assets at just half the market value, that alone would be enough to
pay down their outstanding debt 2 major Hong Kong property companies are actually in net cash position at the
moment. Indeed, even if they cant sell a single residential unit from tomorrow, they would still be financially sound.
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Hong Kong property companies under Scenario 1

Existing commercial properties in Hong Kong Prime assets (which these companies tend to own) are generally the last to fall in weak markets
Residential property business in Hong Kong Weak market may provide opportunities for the property companies to buy land at bargain prices
Commercial properties in China Earnings contribution rises
Residential property business in China The property companies continue to monetise the value of the residential property assets; reduce their
focus to a few major cities only
Financial position May continue to improve
NAV Likely to be more resilient than the overall market
Source: Daiwa
So, if Hong Kong property prices collapsed, the major Hong Kong property companies would be weakened to the
extent of seeing a rental decline and absence of property sales profits. But they would remain fairly lucrative
companies, still generating billions of recurrent cash flow every year, allowing them to keep paying dividends.
Indeed, if such an extreme scenario occurs, we would expect the major Hong Kong property companies to be in a
favourable position to capitalise on potential M&A opportunities or landbanking opportunities that would likely
emerge similar to what they have done in various past down-cycles.
Scenario 2: Hong Kong property prices hold up

In our opinion, as long as the Hong Kong property market doesnt collapse and we see a low probability of that
happening then the Hong Kong property companies are already a favourable position.
As mentioned above, we believe natural market forces are guiding the market participants to cope with the high
Hong Kong property prices, and our read is that the Hong Kong property companies generally are rational
commercial companies which have been following rational commercial discipline in their investing decisions.

Existing commercial properties in Hong Kong Asset values should at least hold up
Residential property business in Hong Kong Buy sites selectively
Commercial properties in China Rising contribution
Financial position Financial position may rapidly improve due to the return of a growing amount of cash
NAV Likely to do better than overall physical market as they own most prime assets in Hong Kong
Growing NAV from China for those that have managed their major projects well
Source: Daiwa
In our opinion, as long as Hong Kong property prices hold up, then the returns from the new projects the Hong
Kong property companies have been embarking on which constitutes the future supply over the coming years
should be reassuring.
Another feature of the upcoming supply pattern is that: 1) the amount of GFA is not too large and is arguably
overdue, and 2) this supply is generally not in the Central areas. Our read is that, in property, when we are
assessing the impact of future supply, we need to distinguish between supply in the established core areas and
supply in new and peripheral areas.
For supply in core areas, we need to be careful for they could be below the existing price contours if prices and
rents in the most prime areas have become X, the prices and rents in the peripheral and non-core areas have to be
below X. However, our read is that, in property, the reverse may not hold and often it does not hold. Oversupply
and rental plunges in new and peripheral areas could well become a localised issue, and they may not necessarily
have a significant adverse impact on the prices and rents in the core areas, due to relocation costs, inertia and
many other factors.
Indeed, with the evolution of the City of London, restrained supply in the prime areas but growing demand was very
favourable to the development of the City of Londons property market and the creation of its real estate.
As the prices and rents for the top-end property assets in Hong Kong are already high, the creation of more credible
and value-for-money alternatives would probably generate enough opportunities for the real estate companies.
An important distinction between owners of real estate assets and companies operating in real estate is that the
latter do not necessarily need property prices to go up to create value. As long as they can find land at low prices
and develop it into property assets worth a lot more, they and their shareholders benefit. As such, as long as Hong
Kong property prices dont collapse and the top-end assets in Hong Kong remain scarce and expensive, there
would still be plenty opportunities for the Hong Kong property companies, in our view.
125
We envisage Greater Pacific Place (the original Pacific Place plus its southern Wanchai extension), Causeway Bay
and Island East will become higher-end locations in a few years time as long as rents for prime offices in Central
can remain at current high levels. On the retail side, we expect the suburban mall segment to become increasingly
important in the Hong Kong retail sector; and sports, lifestyle, F&B, affordable luxury, contemporary fashions to
become trades that are more important and can pay higher rents, which then create opportunities for malls that can
continue to adapt and innovate, and enables them to get an ever-expanding pool of sticky customers.
In retail property, the structural trend we see in Hong Kong and other parts of the world is always that of the
strongest retailers and shoppers gravitating towards the best malls. As such, the most popular malls can often
attract more shoppers and stronger retailers and this can develop into a kind of virtuous cycle so that they can
continue to take market share away from the weaker ones. Hence, even if the overall retail market stagnates, the
stronger malls might still be able to deliver growth, and our read is that the listed property companies in Hong Kong
own most of the strongest malls in Hong Kong.
As for residential, we see more and more Chinese and other players entering the Hong Kong residential property
market, keeping land prices for residential sites buoyant. At the same time, the governments cooling measures
could have the unintended consequence of greatly strengthening the relative bargaining power of primary market
flats. As such, the primary market would likely remain in a favourable position to tap the purchasing power in Hong
Kong for residential properties.
We estimate Hong Kongs primary market to achieve at least HKD100bn in annual revenue in 2017-19 (it reached
an all-time high of HKD180bn in 2016). Our read is that HKD100bn in annual sales revenue is probably enough for
the current major players. So as long as primary market sales value does not plunge by 50% or more which we
do not see happening then the major residential property developers should be still in good shape, and on track
to monetise more from the land they bought in previous years.
While how to replenish residential landbank is a challenge, some developers may not need to worry that much.
Take SHKP as an example. It has been the largest net buyer of residential sites in Hong Kong since 2011 and has
the ability in our view, to at least maintain its 2016 completion volume in 2017 which is already substantial higher
than its residential floor area completion in 2012-15.
Meanwhile, Henderson Land has become the largest owner of old buildings in Hong Kong. In retrospect, the price it
paid for the old buildings during 2004-16 was attractive, averaging below HKD5,500/sq ft. Moreover, it is sitting on
some 45m sq ft of farmland and we think it is only a matter of time before some of the value of this farmland is
monetised. Recall that government has already stated a few years ago that it is prepared to buy farmland from
private developers for the development of new towns, and the governments stated prices are about HKD1,000/sq
ft, while the average cost for multiples of Hendersons farmland on the book is only about HKD250/sq ft.
In addition, we believe mainland capital will continue to come to Hong Kong. While China seems to have tightened
capital flow, only a tiny portion of the capital in China is enough to have a significant impact on Hong Kong. We
note that the annual increment in Chinas M2 is over USD2tn, which is probably enough to buy out all the private
property assets be it residential, office, retail, industrial, hotels or car parks ever built in Hong Kong.
In any case, we are seeing cap rate compression globally in the past 3-4 years and it appears that real estate is still
in the early days of being seen as a core asset for major pension funds or sovereign wealth funds. As such, Hong
Kong property owners could now be facing what could be a once-in-a-lifetime opportunity where they could offload
billions and billions of property assets at a cap rate of 3% or below the lowest we have seen so far is Golden
Dragon Centre sold by Henderson which was transacted at a 1.8% gross cap rate.
Moreover, we note that the sale of non-core assets has become more accepted by Hong Kong property companies.
Apart from Link REIT, Henderson appears to be another that has begun to see selling non-core assets as a
recurrent activity.
Also, many entities could see Hong Kong in a different light from the local players and so far when the Hong Kong
property companies offload non-core assets, the achieved prices are often substantially above their book values, as
the cases of Wharf T&T and the asset sales of Henderson have shown. This is before we take into account the Hong
Kong property companies China investments. Our read is that the Hong Kong property companies have done well in
prime commercial property in China and are now in the harvesting phase. In the meantime, they have bought
substantial tracts of residential land in China before 2007 and are in a good position to monetise the value of this land.
In sum, as long as Hong Kong property prices dont collapse, we believe the Hong Kong property companies are in
good shape and can take their time to realise NAV through selling non-core property assets at premium valuations.
126
However, if Hong Kong property can even take a modest step forward in terms of expanding the scale of the Hong
Kong property market, the Hong Kong property companies would be in an even more favourable position.
The range of prices and rents of various property asset classes in Hong Kong
(HKD/sq ft, based on GFA) Capital value (HKD/sq ft, based on GFA) Rental value
300,000
600,000 300
3,000
200,000 200
100x 200x
100,000 100
10x
14x 12x
9x
0 0
Residential Office Retail Residential Office Retail
Scenario 3: Hong Kong property markets scale enlarges

In our opinion, if Hong Kong property prices just hold up, the Hong Kong property companies would already be in
good shape. But if prices advance even modestly, this would put the property companies in an even more
favourable position, because it would lead to more new companies arriving, more retailers coming, as well as more
professional and wealthy people arriving in Hong Kong. The net result would be a scale expansion of the Hong
Kong property market.
Hence, this scenario would offer the best outcome for the property companies among the 3 scenarios we have
discussed so far.
Greater Pacific Place, Causeway Bay, fringe Central and Island East would likely become stronger office hubs and
we could see some buildings in the 4 established districts (Wanchai, Causeway Bay, Island East and Tsimshatsui)
testing up to HKD100/sq ft note that ICC has already closed deals of about HKD90/sq ft although HKD60-70/sq ft
is still generally the higher end of prime buildings outside Central.
Moreover, the Kowloon East office market is probably not a concern, and we may see the upcoming supply there
being substantially taken up. If office rents in Kowloon East reach HKD30-45/sq ft, it should provide significant
support to rents in the 4 established areas given that the relocation cost alone is likely to be about HKD20/sq ft.
Meanwhile, with Kowloon East becoming a stronger market, we would expect to see a positive simulative effect on
emerging sub-markets in areas like Wong Chuk Hang, Cheung Sha Wan, and Kwai Chung, etc.
On the other hand, under this scenario, we would expect demand for office space in Central to remain strong or
even strengthen as some new companies arrive. If there is gradual emergence of sectors revolving around say
commodities, fixed income, RMB, ETF, derivatives etc., we would see the Central office market being more vibrant
and in demand for the higher-end segment of the market.

Existing commercial properties in Hong Kong Prime assets should do better than the industry average; may dispose of some non-core assets
Commercial properties in China Rising contribution; may embark on more projects when the opportunity arises
Financial position Financial position may rapidly and significantly improve due to the return of a growing amount of cash
NAV Likely to do better than overall physical market as they own most of the prime assets in HK
Growing NAV from China for those who have executed well in major projects
Source: Daiwa
Indeed, under our Scenario 3, Central would continue to expand and could eventually extend beyond Queens
Road East and merge with Hysans portfolio in southern Causeway Bay. At the same time, Island East would
emerge as a premier commercial hub, with the whole of Hong Kong Island becoming like a Manhattan.
On the Kowloon side, Tsimshatsui Hunghom could merge with Kowloon East to become a sizeable office cluster.
Indeed, we would see the Manhattan of Hong Kong encompassing Central plus the 4 core established districts plus
Kowloon East. But even so, in terms of total GFA, it is probably half the size of Manhattan at this point.
127
The Hong Kong Grade A office sector now
Source: Daiwa
The Hong Kong Grade A office sector future
Source: Daiwa
128
At the same time, under Scenario 3, Wong Chuk Hang, Kwai Chung and Cheung Sha Wan would become more
like satellite office areas, and we see each having the potential to develop into reasonably vibrant hubs. Sizeable
office markets are also likely to spring up in Shenzhen and Guangzhou, expanding the scale of the office market in
and around Hong Kong. While most of the office demand related to domestic companies in China would go to
Chinese cities, we believe some of these companies would establish their international and finance divisions in
Hong Kong.
Moreover, we expect more office space becoming available to have a positive impact on employment opportunities,
wages and private consumption.
In retail, we expect to see Hong Kong growing beyond a luxury hub, with critical mass in various other trades such
as sports, F&B, contemporary luxury, affordable luxury, etc. More mid-end retailers are likely to come to Hong Kong
and would have a larger presence.
Note that while these trades may not pay as high rent as the watch and jewellery and luxury brands, they would
bring greater vibrancy to the sector and enable Hong Kong to achieve a critical mass so that it can compete well in
the realm of efficiency, reliability, range of choices, availability of the most fashion items, service quality, etc.
Under this scenario, we would expect Causeway Bay to become the strongest retail hub in Hong Kong, as we think
it is an integrated hub well supported by offices and residential properties nearby. For Tsimshatsui, we would
expect Harbour City would remain strong, while the rest of Tsimshatsui could evolve into an integrated retail hub.
Having said that, Tsimshatsui would benefit from the expansion in the overall retail pie in Hong Kong, especially
with the Express Rail Link opening by 2018.
As things stand today, our read is that the scale of the strongest retail hubs in the world, such as Londons West
End, or Tokyos Ginza and Shinjuku, etc. in terms of geographical size and tenant sales is at least double that
of Causeway Bay and Tsimshatsui. If Scenario 3 prevails, we would expect the gap in scale between Causeway
Bay/Tsimshatsui and London West End/Ginza/Shinjuku to narrow.
Meanwhile, Mongkok would undergo some changes, potentially becoming a retail hub for the trendy and
youngsters. It is more a mass end retail hub but may offer a lot of variety, innovation and choices.
In comparison, Central is the wild card. While under Scenario 3 it would remain more of an office hub in the
foreseeable future, we envisage it taking on a more retail dimension in the years to come, and evolving into a kind
of high-end retail area.
Overall, we would expect the suburban malls to do well. We see several major districts falling into these categories,
such as Tseung Kwan O, Kowloon East, Kowloon Tong-Wong Tai Sin- Lok Fu, Shatin, Sheung Shui, Tuen Mun,
Yuen Long and possibly Tin Shui Wai.
In our opinion, Hong Kong retail has been highly dominated by 3 centres in the past and we expect it to become
more multi-centred, consistent with the population trend in Hong Kong where the middle class moves northward.
129
The Hong Kong retail property sector now
Source: Daiwa
The Hong Kong retail property sector future
Source: Daiwa
130
In the residential sphere, we expect to see 4 major zones emerge in Hong Kong: 1) the Monaco zone which would
consist only of The Peak and Island South, the wealthy and super-wealthy areas, 2) the Manhattan zone, which
would cover the entire Kowloon and Hong Kong Island area and potentially selected districts in the New Territories
as well, 3) the Between Manhattan and Mass Market zone, and 4) the Mass Market zone, encompassing the fringe
areas now, where several new towns could be built in the next 5-20 years.
We think if this scenario materialises (whereby the scale of Hong Kongs property market increases), the Hong
Kong property companies would be making much larger returns from their existing projects and their existing rental
properties would generate much higher returns as well.
At the same time, we expect their China businesses to continue to do well. Indeed, it is not inconceivable that the
Hong Kong players would become more prominent players in prime commercial properties in China, through taking
on more large-scale mixed development projects or even acquiring some land from property companies in China.
131
The Hong Kong residential property sector now
Source: Daiwa
The Hong Kong residential property sector future
Source: Daiwa
132
Scenario 4: Hong Kong property takes a major leap forward
Under Scenario 4, Hong Kong moves along the path of a truly metropolitan property market. More players would
enter the market, many of which would be from China, but also from abroad.
Creative destruction is the driving force, and competition, new ideas, new concepts drive the market under this
scenario. The incumbent Hong Kong players remain important players in Hong Kong property in the foreseeable
future, but when the markets size and scale expands, it can accommodate many new players as well. Indeed,
under this scenario, the market participants creativity, vision and execution capability determine what the Hong
Kong property market is like in terms of structure.
We believe there is tremendous agglomeration economies associated with scale. We see Tokyo as the largest
metropolitan city in the world and it seems to dominate the property landscape of Japan, with all the countrys
capital, talent clustering in this metropolitan city. Our read is that, for a city with a 30m population, it can support
many different kinds of retailers and industries as some niche ideas or products would already have sufficient
critical mass to survive.
In our opinion, it is not inconceivable that Hong Kong may evolve along similar lines. Of course, Hong Kong is very
unlikely to have enough land to accommodate such expansion. But we think a lot depends on whether there is an
integration of Hong Kong-Shenzhen-Guangzhou. If this is to happen, we could see a mega-sized metropolis
emerge which may be the only one in China and could be compared with the metropolis of the Yangtze River Delta.
We envisage that the whole metropolis could be 100m people plus and this would create something the world has
never seen.
In our opinion, China has the potential to host among the largest metropolitan markets in the world. We envisage
that, over time, there will be 5 major metropolitan zones in China, of which 2 will stand out as the strongest: the
Yangtze River Delta and Pearl River Delta zones. It would be up to the vision, capital, and creativity of the market
participants to make the most of this trend. We see such developments being a boon for companies with capital,
vision and creativity, and the breeding ground for some of the strongest property companies the world has seen.
HK property companies under Scenario 4

Existing commercial properties in Hong Kong Prime assets should do better than industry average, may dispose of some non-core ones
Commercial properties in China Rising contribution; may embark on more projects when the opportunity arises
Residential property business in China Keep on monetising the values; focusing on a few major cities, may use surplus cash to capitalise on
M&A opportunities in the industry
Financial position Financial position may rapidly and significantly improve due to the return of a growing amount of cash
NAV Likely to do better than overall physical market as they own the most prime assets in HK
Growing NAV from China for those who have executed well in major projects
Source: Daiwa
Indeed, under Scenario 4, it is not inconceivable that in Greater China, some of the largest and strongest real
estate companies in the world emerge. In all, our view is that prime commercial real estate offers one of the most
attractive ways to play the rise of mega-sized economies. We see Hong Kong as the most advanced city in China
in terms of development and there are plenty opportunities to apply the expertise in Hong Kong to China.
Indeed, we believe Hong Kong players could become major players in prime commercial properties in major cities
in the mainland. As such, they look set to become major players in Shanghai.
We see significant opportunities for companies with capital, vision and execution capabilities. In future, China could
have many cities with over 10m people, and the country has a large domestic population where its companies can
do well in the domestic market.
Hong Kong property companies could enter a new chapter if they can continue to modernise and professionalise,
and we see significant value to be unlocked for all. Indeed, if they continue to do well, they might well become
premier companies in global real estate.
133
Can Hong Kong property companies take a role in the metropolitanisation of

Hong Kong or even China ?
Seen from a higher level, we see the metropolitanisation of Hong Kong as part and parcel of the whole
metropolitanisation process in China, which arguably is what China property is all about.
In our opinion, what is happening in China is probably one of the largest metropolitanisation processes the world
has ever seen, and in the medium to long term, we envisage there to be 5 major metropolitan zones in China, with
Hong Kong and southern China becoming 1 of these 5 zones. Indeed, our view is that China property is about the
creation of metropolitan cities and Hong Kong has the credentials and potential to be an important part in the
metropolitanisation process of the country.
Note that inflow of capital and talent are 2 main drivers for metropolitan cities. If Hong Kong can continue to have
sustained inflow of capital and talent from China and the rest of the world if this most optimistic scenario is going
to prevail it is not inconceivable that Hong Kong could have one of the most vibrant, dynamic and sophisticated
property markets in the world after London.
The five metropolitan zones in China
Source: Daiwa
134
Investment porperties in major Chinese cities

(m sq ft)
35
30
25
20
15
10
5
0
Shanghai Beijing Guangzhou Chengdu Shenyang Chongqing
SHKP Swire Properties Henderson Land
Hang Lung Properties Wharf Hongkong Land
Kerry Properties Link REIT New World Development
Cheung Kong Shui On Land IP under development of these 11 companies
Summary: to be or not to be? Be local or go international?
But the Hong Kong property companies do not need to move forward. If they just sit on their current assets and
dont make any major mistakes, the assets they own and the returns from their existing projects would likely rise
significantly from current levels, allowing them to grow their dividends and earnings.
Mainland visitors to Hong Kong vs. domestic travellers

(m times) (m times)
5,000 50 Mainland
visitors to
4,000 40 HK (based
on RHS)
3,000 30
2,000 20
1,000 10 Mainland
visitors to
0 0 HK (based
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 on LHS)
China domestic travellers (LHS) Mainland visitors to HK (LHS) (to
Nov)
Mainland visitors to HK (RHS)
Source: CEIC
Note: China domestic travellers figures are only available on an annual basis
These companies collectively own among the most prime property assets in Hong Kong. Note that in many major
property markets in the world, the most prime property assets are not buyable. However, through buying the listed
property companies in Hong Kong, one can purchase most of the most prime property assets in Hong Kong, and
most importantly, at prices that can be a fraction of the levels in the physical market.
Moreover, these companies have been making money provided by the property market boom in Hong Kong since
2H03 to invest in China and appear to have finished the investing phase. Indeed, many seem to be entering the
harvesting phase. They are in a strong financial position and do not look likely to be affected much by rate hikes
and/or other factors.
In short, as long as they do not make major mistakes, the Hong Kong property companies should get a good share
of the earnings and asset value of the Hong Kong and China property market by merely holding onto what they
already own.
While they are not as large as the local players in the residential property sector of China, the big Hong Kong
property players have established themselves as strong players in China commercial property. Moreover,
financially, they are stronger than many of their Chinese counterparts and stand to be beneficiaries of the ongoing
consolidation of the China property sector.
135
Creativity, vision and expertise are key
Note that if Scenario 3 and 4 prevail, Hong Kong could be one of the most vibrant and sophisticated property
markets after London, benefiting from a sustained inflow of people, capital and talent for an extended period of time.
Moreover, our read about the supply picture in Hong Kong and the foreseeable future is that Hong Kong will fall
into what we call the top-down trickle-down model in the creation of cities, which we think would be conducive for
the building of real estate value. Prime assets would likely hold up in Hong Kong, while many new districts emerge
and many old ones are rejuvenated. We think this is the recipe for a dynamic and vibrant market.
Hence, for those real estate companies with creativity, vision and expertise, there could be substantial
opportunities ahead.
How will these companies be seen in global property?
In conclusion, we believe the property companies in Hong Kong occupy the sweet spot a situation that is rarely, if
ever, seen in global property. A lot depends on their managements, their vision, creativity and execution capability
to ride on the related opportunities that could take them to the next level.
Even if they do not make any major mistakes and hold onto what they already own, they could become much
stronger and more profitable companies. And they are facing a once-in-a-lifetime opportunity whereby they can
monetise the value of the assets at a cap rate of just 3% or even much lower than that. As mentioned earlier, many
Hong Kong property companies bought or developed their major assets years ago, at a fraction of the cost it would
incur today.
However, if they are ambitious and entrepreneurial enough, there would be many opportunities on offer for them.
As a result, Hong Kong could well catch up with London in terms of vibrancy and depth, for real estate companies.
Note that the Hong Kong players are recognised strong players in physical property market and are being seen as
high quality and reputable borrowers in the bond market and banking industry. The only thing is that the equities of
Hong Kongs property companies command low valuations in the capital markets.
How Hong Kong property companies as seen from different perspectives

Physical market Owners of many of the most prime property assets in Hong Kong; may not sell even if offered premium prices
Banking circle Among the most valued borrowers in Hong Kong
Bond market Among the safest borrowers
Stock market Not too sure about the major shareholders' alignment of interests with investors and the level of commitment the families put
on investor interests
Source: Daiwa
136
Can the Hong Kong discount be unlocked?
We see the Hong Kong discount as an anomaly in global property and offers the promise of significant investment
value to be unlocked (see our Hong Kong Property Toolkit in 2013, and 2 sector reports Hong Kong Property
Sector: Its time to be more greedy than fearful in May and Hong Kong Property: The first leg has come; awaiting
opportunities to position for the second September 2016 ).
There are many reasons for this situation; the main one is the transformation of the Hong Kong stock market, from
a regional market to an international market without the corresponding development of the secondary market.
Although the market cap of the Hong Kong property companies has expanded significantly by over 20x since 1993,
the funds dedicated to investing in this segment have not risen to the same extent. In a way, what the Hong Kong
stock market has been doing over the past 12 years is to finance the entire corporate sector of China through using
capital which is more than 12 hours away by plane.
Note that while China is already an economy of a size that is too large to be ignored, the world as seen by the
global investing community and as defined by the major equity indices appears to have yet to catch up with these
changes. Although eventually China A shares are likely to be included in the MSCI, the current situation remains
that China is an ignorable part in the indices tracked by major global indices.
The Greater China equity market

(USDbn)
20,000
16,000
12,000
8,000
4,000
0
NASDAQ
Shanghai SE
TMX Group
Shenzhen SE
Japan Exchange
Deutsche Brse
Australian SE
NYSE Euronext
India (BSE +
Korea Exchange
London SE Group
SIX Swiss
HK + Shanghai +
HK Exchanges
Exchange
Shenzhen
NSE)
Group
Source: World Federation of Exchanges, Daiwa

Note: As at end-Nov 2016
Hang Seng Index constituents: market capitalization

(HKDtn)
20
15
10
0
2003 2016
Real Estate Banks Casino and Gaming Conglomerate
Consumer Discretionary/Staples Electronic & Electrical Equipment Financial Services Information Technology
Life Insurance Media Mining Oil , Gas & Consumable Fuels
Telecommunications Transportation Utilities
137
The listed real-estate securities in Hong Kong

Bloomberg No. of Share price Market cap Stake of major Free flow no. Free flow
code Name shares (m) (HKD) (USDbn) shareholder(s) (%) of shares (m) value (USDbn)
Property Developers
1113 HK Property 3,800 53.00 25.9 30.7 2,635 18.0
16 HK SHK Properties 2,895 114.90 42.8 49.9 1,451 21.5
12 HK Henderson Land 3,637 48.05 22.5 73.2 977 6.0
83 HK Sino Land 6,261 13.84 11.2 54.8 2,833 5.0
20 HK Wheelock 2,037 60.95 16.0 11.9 1,795 14.1
17 HK New World 9,687 9.85 12.3 44.6 5,363 6.8
130.7 71.4
Property Investors
4 HK Wharf 3,033 68.05 26.6 61.1 1,179 10.3
1972 HK Swire Properties 5,850 24.15 18.2 82.0 1,053 3.3
HKL SP HK Land 2,353 USD7.24 17.0 50.2 1,172 8.5
101 HK Hang Lung Properties 4,498 20.55 11.9 56.1 1,972 5.2
14 HK Hysan Development 1,045 36.00 4.8 41.6 610 2.8
683 HK Kerry Properties 1,443 27.00 5.0 60.2 574 2.0
41 HK Great Eagle 678 36.60 3.2 66.9 224 1.1
86.8 33.2
REITs
823 HK Link REIT 2,213 52.85 15.1 0.2 2,208 15.0
87001 HK HuiXian REIT 5,462 3.18 2.5 44.2 3,047 1.4
2778 HK Champion REIT 5,812 4.65 3.5 66.2 1,962 1.2
778 HK Fortune REIT 1,902 8.80 2.2 28.0 1,369 1.6
1881 HK Regal REIT 3,257 2.18 0.9 75.0 814 0.2
405 HK Yue Xiu REIT 2,936 4.57 1.7 39.7 1,770 1.0
435 HK Sunlight REIT 1,634 4.60 1.0 38.2 1,009 0.6
1426 HK Spring REIT 1,131 3.31 0.5 36.5 718 0.3
808 HK Prosperity REIT 1,458 3.19 0.6 19.5 1,174 0.5
27.9 21.8
Niche property companies
878 HK Soundwill 283 14.40 0.5 71.7 80 0.1
173 HK K Wah International 2,957 5.19 2.0 62.7 1,103 0.7
497 HK CSI Properties 10,037 0.34 0.4 48.1 5,205 0.2
201 HK Magnificent Estates 8,947 0.18 0.2 71.2 2,579 0.1
369 HK Wing Tai Properties 1,346 5.48 0.9 59.4 546 0.4
488 HK Lai Sun Development 30,245 0.20 0.8 69.0 9,388 0.2
4.9 1.8
250.3 128.3
Note: prices as of close on 22 March 2017
In this light, as and when Chinas asset management industry becomes more developed, there could be a
significant change in the valuation dynamics of Hong Kong property stocks also. However, this could take years or
even decades, and during the transitional phase, Hong Kong property stocks may continue to be funded primarily
by global capital, if the investing capital in China does not decline significantly. This has created neglect in the
investing world for the property companies of Hong Kong as well as that of China and we see such neglect as an
opportunity for long-term value oriented investors.
Meanwhile, several developments could change the picture: more specifically, our read is that the 3 following
corporate actions would be major step forward to reduce the NAV discount of Hong Kong property companies.
1. Asset sales
2. Paying out higher dividends
3. Share buybacks
We elaborate on each of these in turn.
1. Asset sales
We think it is arguable that the Hong Kong property companies currently have what could be a once-in-a-lifetime
opportunity to sell non-core assets at good valuations.
Importantly, our read is that the buyers are not limited to mainland entities. It appears that one of the consequences
of quantitative easing (QE) in the developed countries is that there seems to be more capital available rather than
the quality of assets. As a result, it appears that there has been a compression trend for cap rates for property
assets in major international cities in the past 2-3 years, according to Savills.
138
Changes in portfolio composition in the worlds 300 largest pension funds
Source: Savills
Average SWF investor portfolio exposure to PE, infrastructure and real estate
Sample size CAGR 2012-15
34 48 44 57
13%
4.5%
2.8% 25%
3.6% 3.0%
3.1%
1.5% 2.1%
1.4% 6.5% 29%
4.3% 4.1%
3.0%
2012 2013 2014 2015

Real Estate Infrastructure Private Equity
Source: Savills
Cross border capital outflow from China

(USDbn)
25
20
15
10
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 9M16
Source: Savills
In any case, our read is that the book values of many property companies Hong Kong assets have erred on the
conservative side and so far, whenever Hong Kong property companies have sold assets, the realised prices have
invariably been higher than the market estimates. In all, we believe that if the Hong Kong property companies
become more active in pursuing opportunities associated with realising NAVs at valuations notably higher than
their values as stated in the book, that would be a powerful factor driving a narrowing of the NAV discount for Hong
Kong property companies over time.
139
Book values of HK property companies are conservative

Achieved price Valuation Profit Achieved price
Company Date (HKDm) (HKDm) (HKDm) vs book cost (x)
Sunlight REITs disposal of 3 non-core properties May 2015 920 586 333 1.6
Henderson Lands disposal of Golden Centre Sep 2016 4,368 2,372 1,996 1.8
Sunlight REITs disposal of 3 non-core properties May 2015 920 586 333 1.6
Fortune REITs disposal of Nob Hill Square Feb 2015 648 438 210 1.5
Link REIT's 5 batches:
Total 5 properties Dec 2016 3,636 2,818 818 1.3
Total 9 properties Mar/Apr 2016 3,652 3,060 592 1.2
Total 5 properties Oct 2015 1,716 1,317 400 1.3
Total 5 properties Sep 2014 1,716 1,593 123 1.1
Total 4 properties May 2014 1,240 896 344 1.4
Hang Lung Prop disposal of non-core assets 2013 6,800 4,652 2,148 1.5
Cheung Kong's disposal of Ginza Kingswood 2013 5,800 3,040 2,760 1.9
Major cases of NAV realisation in recent years

GFA Price Psf price Implied
Date Property assets District (sq ft) Buyer Vendor (HKDm) (HKD/sq ft) cap rate* Remarks
Office property
Oct 2016 Junction of Wang Chiu Rd / Lam Lee St Kowloon Bay 555,035 Local investor Swire Properties 6,528 11,762 3.1% En-bloc, under-
construction
Sep 2016 Golden Centre Sheung Wan 156,000 Local investor Henderson Land 4,368 28,000 2.0% En-bloc
Jul 2016 One HarbourGate (east tower) Hunghom 280,000 Cheung Kei Group Wheelock 4,500 16,071 <3.0% En-bloc
Jun 2016 The Center (79/F) Central 13,213 A mainland investor Hysans Lee family 500 37,841 nd 79/F
Feb 2016 770 Nathan Road Mongkok 284,829 Link REIT HKSAR Government 5,910 20,750 4.0% En-bloc
Feb 2016 Dah Sing Financial Centre Wanchai 400,113 China Everbright group SEA Holdings 10,000 24,992 nd En-bloc
Nov 2015 MassMutual Tower Wanchai 345,433 Evergrande Chinese Estates 12,500 36,186 2.0% En-bloc
Nov 2015 One HarbourGate (west tower) Hunghom 393,000 China Life Insurance Wheelock 5,850 14,885 3.0% En-bloc, under-
construction
Jun 2014 One Bay East (east tower) Kowloon East 512,000 Citigroup Wheelock 5,425 10,595 3.3% En-bloc, under-
construction
Dec 2013 9 Chong Yip Street Kowloon East 136,595 Prosperity REIT Hutchison Whampoa 1,010 7,394 3.0% En-bloc
Dec 2013 DCH Commercial Centre Island East 389,000 Swire Prop & an inv fund CITIC Pacific 3,900 10,026 3.8% En-bloc
May 2013 Kowloon Commerce Centre (5 floors) Kwai Chung 116,756 China Mobile SHK Properties 1,027 8,800 3.0% 5 floors
May 2013 Citibank Plaza (4 floors) Central 78,316 Champion REIT HKSAR Government 2,160 27,581 3.0% 4 floors
Apr 2003 One Bay East (west tower) Kowloon East 512,000 Manulife Wheelock 4,500 8,789 4.0% En-bloc, under-
construction
Feb 2013 113 Argyle Street Mong Kok 328,866 Hang Seng Bank Nan Fung (unlisted) 2,900 8,818 3.4% En-bloc
Oct 2012 AIA Tower (formerly Stanhope House) Island East 299,615 AIA Hang Lung Properties 2,398 8,004 3.6% En-bloc
Dec 2012 Exchange Tower (7 floors) Kowloon East 195,875 Hang Seng Bank Sino Land 1,560 8,000 3.8% 7 floors
May 2012 50 Connaught Road Central 180,000 Agricultural Bank of China National Electronics 4,880 27,111 3.5% En-bloc
Jan 2012 CCB Centre Kowloon East 348,620 China Construction Bank Sino Land 2,510 7,200 4.0% En-bloc
Retail property
Dec 2014 Laguna Plaza Kwun Tong 163,203 (GRA) Fortune REIT CLSA Property Fund 1,919 11,755 (GRA) 4.3% En-bloc
Aug 2014 Lions Rise mall Wong Tai Sin 126,319 Link REIT Kerry Properties 1,380 10,924 2.4% En-bloc
Jul 2014 Bigfoot Centre Causeway Bay 67,150 CLSA Property Fund Macau investor 1,600 23,827 nd En-bloc
Jan 2014 8 Russell Street Causeway Bay 81,000 Individual investors CLSA Property Fund 2,500 30,864 1.9% Strata-title sales
Jun 2013 Kingswood Ginza mall Tin Shui Wai 665,244 Fortune REIT Cheung Kong 5,849 8,792 4.1% En-bloc
Feb 2013 OLIV, 15 Sharp Street East Causeway Bay 37,500 Individual investors Local family 1,450 38,800 1.5% Strata-title sales
Jan 2013 The SHARP, Sharp Street East Causeway Bay 44,500 Individual investors Soundwill 1,500 33,576 1.8% Strata-title sales
Jul 2011 Festival Walk Kowloon Tong 1,195,248 Mapletree Investment Swire Properties 18,800 18,063 4.6% En-bloc
Source: Savills, CBRE, Hong Kong Economic Times, Daiwa
Note: implied cap rate is based on estimated sport rent for comparable buildings in the area; nd = not disclosed
Asset sales of Wharf - disposal of Wharf T&T

Announced 4-Oct-16
Expected completion 23-Nov-16
Assets being disposed The entire equity interest in Wharf T&T
Buyer A 50:50 JV between MBK Partners Fund III and TPG
Consideration (HKD) 9.50bn
Net asset value (HKD) Approx 2.1bn
Profit before / after tax in 2014 (HKD) 315m / 314m
Profit before / after tax in 2015 (HKD) 331m / 301m
Company est'd attributable gain accrued to Wheelock / Wharf (HKD) 4.5bn / 7.4bn
Valuation 4.5x of book value (HKD2.1bn)
140
Asset sales of Henderson - disposal of Golden Centre

Announced 15-Sep-16
Expected completion 1-Dec-16
Property Golden Centre ()
Location 188 Des Voeux Road Central, Central
Property type 27-storey office building
Year of completion 1991
Gross floor area 156,292 sq ft (office: 134,450 sq ft / retail: 21,842 sq ft)
Buyer An independent third party
Consideration (HKD) 4,368m
Company est'd gain on disposal attributable to reported profit (HKD) 1,996m
Company est'd gain on disposal attributable to underlying profit (HKD) 3,872m
Achieved price (vs. latest book cost) 1.84x
Achieved price (vs. historical cost) 8.8x
2. Higher dividends
HK companies have been raising dividends

Year DPS/DPU (HKD) Chg FY15/ CAGR
Company end FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY06 FY06-16
Cheung Kong Dec 2.20 2.45 2.45 2.70 2.95 3.16 3.16 3.48 3.65 na na na na
CK Property Dec na na na na Na na na na na 1.40 1.53 na na
SHK Properties Jun 2.20 2.30 2.50 2.50 2.70 3.35 3.35 3.35 3.35 3.35 3.85 75% 6%
Sino Land Jun 0.35 0.35 0.36 0.36 0.36 0.41 0.46 0.50 0.50 0.50 0.51 46% 4%
Wharf Dec 0.75 0.78 0.78 0.97 0.97 1.06 1.65 1.70 1.81 1.90 2.15 187% 11%
Henderson land* Dec 0.87 0.91 0.91 0.5 0.83 0.83 0.88 1.06 1.10 1.45 1.55 78% 6%
Hysan Dec 0.5 0.6 0.68 0.68 0.74 0.79 0.95 1.17 1.23 1.32 1.35 170% 10%
Link REIT** Mar 0.218 0.674 0.744 0.840 0.974 1.105 1.295 1.465 1.658 1.828 2.062 206% 12%
Hang Lung Prop Dec 0.51 0.56 0.66 0.66 0.71 0.71 0.74 0.75 0.76 0.75 0.75 47% 4%
Fortune REIT^ Dec na 0.351 0.370 0.302 0.244 0.263 0.324 0.360 0.417 0.469 0.492 40% 3%
MTRC Dec 0.42 0.45 0.48 0.52 0.59 0.76 0.79 0.92 1.05 1.06 1.07 155% 10%
Note: *Henderson declared a 1-for-10 bonus issue in FY12, FY13, FY14, FY15, and FY16
^Fortune REITs DPU growth since FY07, ** Link REITs DPU growth since FY07 as it was listed in November 2005
We note that over the past 5 years, nearly all of the major families who own the largest property companies in
Hong Kong have been raising their stakes in their listed companies. Our estimate is that so far over USD8bn has
been spent either through the families buying the shares directly or through other listed companies within the group,
which is the largest insider purchasing that Hong Kong has ever seen, and is probably still a sizeable sum even
from a global perspective.
Our read is that, generally, Hong Kong property companies are willing to pay higher dividends, as the above table
shows. However, relative to their substantially improved recurrent income base, we think there is still considerable
room for them to pay even higher dividends. That said, we believe Henderson Land and Wharf have demonstrated
a clear commitment to pay higher dividends to all shareholders in the recent years.
SHKP: gross rental income since 2005

(HKDm)
25,000
20,000
15,000
10,000
5,000
0
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16
Source: Company
141
SHKP: gross rental income vs. total dividends

(HKDm)
25,000 100%
20,000 80%
15,000 60%
10,000 40%
5,000 20%
0 0%
FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16
Gross rental income Total dividend Total dividend / Gross rental income (RHS)
Henderson Land: total dividends paid since 2005

(HKDm)
6,000
5,000
4,000
3,000
2,000
1,000
0
FY05 FY06 FY07 FY08 2009* 2010 2011 2012 2013 2014 2015 2016
1H 2H
Source: Company
Note: *for the 18 months to 31 Dec 2009 (company's year-end date was changed in 2009 from Jun to Dec)
Wharf: DPS record

(HKD)
2.4
2.0
1.6
1.2
0.8
0.4
0.0
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

Note: Phase I (1986-1996): Growing rental income and property sales profit
Phase II (1997-2003): Rebuilding its balance sheet after the Asia financial turmoil
Phase III (2004-2011): Investing in China property
Phase IV (2011-2016): New China IPs began to contribute
3. Share buybacks
While share buybacks are still not very common in Hong Kong, we do see them as an effective and equitable
method to narrow the NAV discount of Hong Kong property companies. Essentially, we see it as a way to arbitrage
between physical market prices and stock market valuations.
We believe share buybacks are tantamount to monetising the full market value of a companys property assets and
then using it to buy the companys underlying property assets at a significant discount; and this has to be beneficial
for shareholders. Indeed, with borrowing costs at prevailing levels and with companies determined to pay higher
dividends to shareholders, it would preserve a companys future cash flow for paying dividends if it could just use
new borrowings from the banks to fund share buybacks and then cancel those shares.
142
We also note that a few companies like Link REIT, Sunlight REIT, Hysan and CKP have been buying back shares.
We see this as a positive sign to note and reiterate our view that capital management is key to how global investors
look at Hong Kong property stocks.
Cheung Kong group: share buybacks since its reorganisation

Date No. of shares Avg price Total cost % of issued
bought (m) (HKD) (HKDm) shares
CK Hutchison
17-Nov-16 0.78 92.847 72.7 0.02%
18-Nov-16 1.22 94.872 115.5 0.03%
Total 2.00 94.079 188.2 0.05%
CK Property
18-Mar-16 11.53 46.520 536.1 0.30%
21-Mar-16 2.01 47.900 96.3 0.05%
23-May-16 0.65 45.237 29.2 0.02%
5-Dec-16 2.12 50.476 106.8 0.06%
7-Dec-16 10.18 51.085 520.2 0.27%
8-Dec-16 9.20 51.905 477.5 0.24%
16-Jan-17 4.24 49.534 210.2 0.11%
17-Jan-17 3.62 50.652 183.3 0.09%
18-Jan-17 3.72 52.238 194.2 0.10%
19-Jan-17 5.25 52.115 273.5 0.14%
20-Jan-17 6.98 51.169 357.0 0.18%
Total 59.48 50.170 2,984.3 1.55%
Source: Company, HKEx, Daiwa
Hysan: share buybacks

Period No. of shares Avg price Total cost % of issued
(Yr to Dec) Bought (m) (HKD) (HKDm) shares
2015 6.8 31.78 214.5 0.6%
1H16 11.7 31.01 363.7 1.1%
2H16 0.9 34.37 29.6 0.1%
Total 18.5 32.89 607.9 1.8%
Link REIT: unit buybacks

Period No. of units Avg price Total cost % of issued
(Yr to Mar) bought (m) (HKD) (HKDm) units
FY15 19.9 45.80 913 0.9%
FY16 50.2 43.74 2,197 2.2%
FY17 (to Jan) 31.7 53.46 1,697 1.4%
Total 101.9 47.17 4,807 4.5%
Sunlight REIT: unit buybacks

Period No. of units Avg price Total cost % of issued
(Yr to Jun) bought (m) (HKD) (HKDm) units
2H FY12 3.60 2.465 8.9 0.2%
1H FY13 1.50 3.155 4.7 0.1%
2H FY13 0.60 3.428 2.1 0.0%
1H FY14 1.50 3.056 4.6 0.1%
1H FY15 1.00 3.397 3.4 0.1%
1H FY16 6.66 3.857 25.7 0.4%
2H FY16 7.29 3.975 29.0 0.4%
1H FY17 4.84 4.714 22.8 0.3%
Total 26.99 3.747 101.1 1.7%
143
144
Company section
145
146
Cheung Kong Property (1113 HK)

Cheung Kong Property
Target price: HKD75.60 (from HKD75.60)

Share price (22 Mar): HKD53.00 | Up/downside: +42.6%
Capital management and deployment hold the key

Abundant cash for deployment in the coming years Jonas Kan, CFA
(852) 2848 4439
Share buyback and capital management are the wild cards jonas.kan@hk.daiwacm.com
Reiterating Buy (1) call and TP of HKD75.60
What's new: As part of our Hong Kong property thematic report, we take a Forecast revisions (%)
look at Cheung Kong Propertys (CKP) strategic position in light of our Year to 31 Dec 17E 18E 19E
Revenue change - - -
views on the longer-term development of the Hong Kong property market.
Net profit change - - -
Core EPS (FD) change - - -
What's the impact: More opportunities in realisation of asset value. Source: Daiwa forecasts
CKP does not appear to have actively pursued new investments in the
physical market in recent years and, other than its Central offices, it may Share price performance
not have any major assets that could become trophy assets under our (HKD) (%)
expected scenario. That said, we believe that its property portfolio and 60 110
China landbank have increased substantially following the merger with 56 104
52 98
Hutchison Property. We also believe that CKP has abundant non-core 48 91
property assets it could dispose of as and when prices are compelling. 44 85
Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
Potential longer-term M&A opportunities. We believe CKP has a CKP (LHS) Relative to HSI (RHS)
distinctive business model within global property, and that managing

property assets is not its greatest strength. Rather, we believe its strength 12-month range 44.45-58.45
lies in its investing discipline its ability to take decisive and strategic views Market cap (USDbn) 25.84
3m avg daily turnover (USDm) 43.35
on property markets in uncertain times and to evaluate investment
Shares outstanding (m) 3,787
opportunities beyond its traditional markets and the traditional boundaries Major shareholder Li family & Trust (30.3%)
of the property business. CKP has a war chest in place (it is in a net-cash
position, with the cash inflows from property sales expected to exceed Financial summary (HKD)
HKD150bn over the next 2-3 years, on our estimates) and its longer-term Year to 31 Dec 17E 18E 19E
prospects likely rest on whether it can capitalise on attractive M&A Revenue (m) 69,779 76,635 81,173
Operating profit (m) 28,091 30,722 32,492
opportunities that may emerge in global property in the coming 2-3 years.
Net profit (m) 19,146 21,108 22,430
Core EPS (fully-diluted) 5.055 5.574 5.923
Modern capital management pioneer. CKP was the first major Hong EPS change (%) 7.8 10.2 6.3
Kong family-owned property company to buy back its shares, and we Daiwa vs Cons. EPS (%) 8.2 9.2 n.a.
PER (x) 10.5 9.5 8.9
estimate the total amount spent on share buybacks since its listing in Hong Dividend yield (%) 3.3 3.7 3.9
Kong has reached HKD3bn. We believe that CKP can afford to spend DPS 1.750 1.950 2.050
HKD10bn a year on share buybacks and that a stronger equity-market PBR (x) 0.7 0.7 0.6
EV/EBITDA (x) 6.5 5.6 4.9
valuation should help CKP to capitalise on M&A opportunities that emerge
ROE (%) 6.9 7.3 7.3
in the coming years.
Source: FactSet, Daiwa forecasts
What we recommend: We reaffirm our Buy (1) rating and 12-month target
price of HKD75.60, based on a 30% discount applied to our end-2017E
NAV of HKD108. Key risk: major weakness in the Hong Kong/China
economy.
How we differ: Unlike some, we believe that CKPs investment of surplus

cash into non-property sectors may not represent a departure from the
traditional business model that has served it well in the past. We believe
that it should be judged on the achieved returns from these investments
and how it invests its surplus cash over the coming years.
Cheung Kong Property (1113 HK): 24 March 2017
Financial summary
Key assumptions
Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales revenue (HKDm) n.a. n.a. 26,348 49,059 56,804 55,494 61,690 65,686
Gross rental income (HKDm) n.a. n.a. 2,331 5,138 7,430 7,818 8,159 8,485
Hotel and serviced suites revenue
n.a. n.a. 2,895 4,005 4,850 4,722 4,992 5,192
(HKDm)
Profit and loss (HKDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales revenue n.a. n.a. 26,348 49,059 56,804 55,494 61,690 65,686
Gross rental income n.a. n.a. 2,331 5,138 7,430 7,818 8,159 8,485
Other Revenue n.a. n.a. 3,548 4,596 5,676 6,467 6,786 7,002
Total Revenue n.a. n.a. 32,227 58,793 69,910 69,779 76,635 81,173
Other income n.a. n.a. 537 500 347 966 1,027 1,068
COGS n.a. n.a. (12,985) (32,587) (41,552) (39,077) (42,915) (45,564)
SG&A n.a. n.a. (6,944) (4,127) (2,731) (2,972) (3,377) (3,520)
Other op.expenses n.a. n.a. (286) (507) (567) (606) (647) (665)
Operating profit n.a. n.a. 12,549 22,072 25,407 28,091 30,722 32,492
Net-interest inc./(exp.) n.a. n.a. (815) (549) (645) (346) (248) (182)
Assoc/forex/extraord./others n.a. n.a. 2,878 1,410 (26) 3 4 5
Pre-tax profit n.a. n.a. 14,612 22,933 24,736 27,748 30,478 32,315
Tax n.a. n.a. (2,313) (6,568) (6,306) (7,768) (8,532) (9,047)
Min. int./pref. div./others n.a. n.a. (248) (795) (394) (834) (838) (838)
Net profit (reported) n.a. n.a. 12,051 15,570 18,036 19,146 21,108 22,430
Net profit (adjusted) n.a. n.a. 12,051 15,570 18,036 19,146 21,108 22,430
EPS (reported)(HKD) n.a. n.a. n.a. n.a. 4.689 5.055 5.574 5.923
EPS (adjusted)(HKD) n.a. n.a. n.a. n.a. 4.689 5.055 5.574 5.923
EPS (adjusted fully-diluted)(HKD) n.a. n.a. n.a. n.a. 4.689 5.055 5.574 5.923
DPS (HKD) n.a. n.a. 0.000 1.400 1.530 1.750 1.950 2.050
EBIT n.a. n.a. 12,549 22,072 25,407 28,091 30,722 32,492
EBITDA n.a. n.a. 12,835 22,580 25,976 28,700 31,373 33,162
Cash flow (HKDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Profit before tax n.a. n.a. 14,612 22,933 24,736 27,748 30,478 32,315
Depreciation and amortisation n.a. n.a. 286 508 569 609 651 651
Tax paid n.a. n.a. (975) (3,866) (6,851) (7,768) (8,532) (8,532)
Change in working capital n.a. n.a. 6,993 6,787 11,976 11,911 11,987 12,320
Other operational CF items n.a. n.a. (7,292) (8,442) 624 330 236 170
Cash flow from operations n.a. n.a. 13,624 17,920 31,054 32,830 34,821 36,925
Capex n.a. n.a. (296) (483) (14,384) (12,050) (12,650) (12,890)
Net (acquisitions)/disposals n.a. n.a. 3,298 3,216 0 0 0 0
Other investing CF items n.a. n.a. 124 6,030 0 0 0 0
Cash flow from investing n.a. n.a. 3,126 8,763 (14,384) (12,050) (12,650) (12,890)
Change in debt n.a. n.a. (9,194) 45,951 0 0 0 0
Net share issues/(repurchases) n.a. n.a. 0 0 (2,056) (2,100) (2,100) (2,100)
Dividends paid n.a. n.a. (5,861) (33,266) (5,834) (6,440) (7,216) (7,216)
Other financing CF items n.a. n.a. (1,410) (4,337) (1,223) (1,284) (1,349) (1,349)
Cash flow from financing n.a. n.a. (16,465) 8,348 (9,113) (9,824) (10,665) (10,665)
Forex effect/others n.a. n.a. 0 0 0 0 0 0
Change in cash n.a. n.a. 285 35,031 7,557 10,956 11,506 13,370
Free cash flow n.a. n.a. 13,328 17,437 16,670 20,780 22,171 24,035
148
Financial summary continued

Balance sheet (HKDm)
As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Cash & short-term investment n.a. n.a. 10,354 45,861 62,601 72,780 86,005 88,520
Inventory n.a. n.a. 73,259 153,301 137,548 128,624 125,923 123,381
Accounts receivable n.a. n.a. 1,810 12,335 12,655 13,125 13,860 14,520
Other current assets n.a. n.a. 1,210 0 0 0 0 0
Total current assets n.a. n.a. 86,633 211,497 212,804 214,529 225,788 226,421
Fixed assets n.a. n.a. 9,928 18,614 33,695 34,610 35,269 35,847
Goodwill & intangibles n.a. n.a. 0 0 0 0 0 0
Other non-current assets n.a. n.a. 86,655 141,694 150,337 153,784 159,074 163,434
Total assets n.a. n.a. 183,216 371,805 396,836 402,923 420,130 425,702
Short-term debt n.a. n.a. 250 5,772 4,378 0 0 0
Accounts payable n.a. n.a. 4,502 14,785 17,396 15,620 15,820 15,980
Other current liabilities n.a. n.a. 78,044 16,070 21,983 17,375 17,786 17,980
Total current liabilities n.a. n.a. 82,796 36,627 43,757 32,995 33,606 33,960
Long-term debt n.a. n.a. 350 55,217 65,798 69,405 71,132 60,287
Other non-current liabilities n.a. n.a. 999 10,274 11,007 11,235 11,356 11,521
Total liabilities n.a. n.a. 84,145 102,118 120,562 113,635 116,094 105,768
Share capital n.a. n.a. 0 3,860 3,824 3,787 3,787 3,787
Reserves/R.E./others n.a. n.a. 96,254 259,236 266,375 279,266 293,929 309,722
Shareholders' equity n.a. n.a. 96,254 263,096 270,199 283,053 297,716 313,509
Minority interests n.a. n.a. 2,817 6,591 6,075 6,235 6,320 6,425
Total equity & liabilities n.a. n.a. 183,216 371,805 396,836 402,923 420,130 425,702
EV n.a. n.a. 147,886 210,303 199,130 187,900 175,847 162,332
Net debt/(cash) n.a. n.a. (9,754) 15,128 7,575 (3,375) (14,873) (28,233)
BVPS (HKD) n.a. n.a. n.a. n.a. 70.243 74.740 78.612 82.782
Key ratios (%)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) n.a. n.a. n.a. 82.4 18.9 (0.2) 9.8 5.9
EBITDA (YoY) n.a. n.a. n.a. 75.9 15.0 10.5 9.3 5.7
Operating profit (YoY) n.a. n.a. n.a. 75.9 15.1 10.6 9.4 5.8
Net profit (YoY) n.a. n.a. n.a. 29.2 15.8 6.2 10.2 6.3
Core EPS (fully-diluted) (YoY) n.a. n.a. n.a. n.a. n.a. 7.8 10.2 6.3
Gross-profit margin n.a. n.a. 59.7 44.6 40.6 44.0 44.0 43.9
EBITDA margin n.a. n.a. 39.8 38.4 37.2 41.1 40.9 40.9
Operating-profit margin n.a. n.a. 38.9 37.5 36.3 40.3 40.1 40.0
Net profit margin n.a. n.a. 37.4 26.5 25.8 27.4 27.5 27.6
ROAE n.a. n.a. 25.0 8.7 6.8 6.9 7.3 7.3
ROAA n.a. n.a. 13.2 5.6 4.7 4.8 5.1 5.3
ROCE n.a. n.a. 25.2 10.3 7.5 8.0 8.4 8.6
ROIC n.a. n.a. 23.7 8.4 6.7 7.1 7.7 8.1
Net debt to equity n.a. n.a. n.a. 5.8 2.8 n.a. n.a. n.a.
Effective tax rate n.a. n.a. 15.8 28.6 25.5 28.0 28.0 28.0
Accounts receivable (days) n.a. n.a. 10.2 43.9 65.2 67.4 64.3 63.8
Current ratio (x) n.a. n.a. 1.0 5.8 4.9 6.5 6.7 6.7
Net interest cover (x) n.a. n.a. 15.4 40.2 39.4 81.2 123.9 178.5
Net dividend payout n.a. n.a. n.a. n.a. 32.6 34.6 35.0 34.6
Free cash flow yield n.a. n.a. 6.6 8.7 8.3 10.4 11.0 12.0
Company profile
Cheung Kong Property (CKP) is a new entity created by the Cheung Kong Group reorganisation
announced on 9 January 2015, which, among other things, resulted in the creation of 2 separate
companies for the global capital markets: one a global conglomerate named Cheung Kong
Hutchison, and the other a pure property company, namely CKP. The company was listed on the
Hong Kong Stock Exchange on June 2015 by way of introduction. CKP is currently one of the
largest property companies in Hong Kong, with a 14m sq ft rental portfolio, 212m sq ft of
development landbank, and some 12,625 hotel rooms in Hong Kong, China and overseas.
149
CKP: potential sale of The Center CKP: potential sale of The Center
Date No. of shares Avg price Total cost % of issued Location Queens Road Central, Central
bought (m) (HKD) (HKDm) shares Property type 80-storey Grade A office building
CK Hutchison % owned by CKP ~75%
17-Nov-16 0.78 92.847 72.7 0.02%
Year of completion 1998
18-Nov-16 1.22 94.872 115.5 0.03%
Total 2.00 94.079 188.2 0.05% Attributable GFA 113,170 sq m
CK Property Attributable LFA 113,431 sq m (including 1,271 sq m retail)
18-Mar-16 11.53 46.520 536.1 0.30% No. of car parking spaces 402
21-Mar-16 2.01 47.900 96.3 0.05% Comments The price of HKD35.8bn as reported in various media would set
23-May-16 0.65 45.237 29.2 0.02% a new high for Hong Kong in terms of ticket price for an office
5-Dec-16 2.12 50.476 106.8 0.06% property asset. This would translate into about HKD29,000/sq ft
7-Dec-16 10.18 51.085 520.2 0.27% or a gross cap rate of under 3%, we estimate
8-Dec-16 9.20 51.905 477.5 0.24%
16-Jan-17 4.24 49.534 210.2 0.11%
17-Jan-17 3.62 50.652 183.3 0.09%
18-Jan-17 3.72 52.238 194.2 0.10%
19-Jan-17 5.25 52.115 273.5 0.14%
20-Jan-17 6.98 51.169 357.0 0.18%
Total 59.48 50.170 2,984.3 1.55%
Source: Company, HKEx, Daiwa Source: Company, Daiwa
CKP: PBR since listing CKP: share-price performance since listing

(x) (HKD)
1.2 80
70
1.0
Current PBR = 0.75x
60
0.8
50
0.6
40
0.4 30
Sep-16
Sep-16
Jun-15
Sep-15
Dec-16
Dec-15
Jun-16
Jun-15
Sep-15
Dec-16
Mar-16
Mar-17
Dec-15
Jun-16
Mar-16
Mar-17
Source: Company, Bloomberg, Daiwa Source: Bloomberg
CKP: the problem

Origin of the CKP had been an active seller of flats during the property market downturn in Hong Kong during 1997-2013 but it has also actively used the sales proceeds to buy land which was
"CKP problem" much cheaper versus the prices of the flats. It significantly scaled up its landbank in Hong Kong further after 2003 and the proceeds it obtained from property sales has allowed it to
significantly expand its landbank in both Hong Kong and China during 2003-2007, but without a substantial increase in gearing. In recent years, when it has turned into monetisation
mode, its net gearing ratio has continued to come down due to sizeable annual property sales proceeds from both Hong Kong and China. The significant rise in property prices in
China over the past 10 years and the sizeable landbank it has built up in China in the early days should result in sustained net cash inflow to CKP over the coming years.
The current CKP's announcement confirmed that it is already in net cash territory but its net cash position should further improve as it continues to monetise the value of the land it has acquired
situation in Hong Kong and China in the early years. It recorded some HKD56bn in property contract sales in 2015 and we estimate that its 2016 contract sales has reached HKD70bn.
We believe that share buybacks represent a very logical and sensible way to deploy its surplus cash. However, based on HK's current regulatory environment (where the major
shareholder cannot raise its stake by more than 2% a year), the maximum amount it can spend on share buybacks is around HKD10bn a year but its amount of surplus cash should
be more than this, in our view.
The problem CKP should have abundant surplus cash balances over the coming years which look likely to be more than higher dividends and share buybacks can absorb. It needs to find ways to
secure a higher return for its surplus cash before it can find attractive enough opportunities in the land market.
Source: Daiwa
Cheung Kong: the special model used to run its property business
Focus Getting into a property market at the right time and securing a low-risk way to get exposure to its subsequent growth and development
Features: When land prices are reasonable versus flats and the longer-term market outlook is clear, put a lot of emphasis on asset turnover and actively using proceeds from property sales to
fund land purchases which could reduce the amount of capital tied up and yet gives the company more exposure to upside potential in property values.
When land prices are high versus flats and the longer-term market outlook is not clear, stick with land purchase discipline and focus more on margin than asset turnover. This could
result in a significant build-up in its surplus liquidity, as it did in the early 1990s when it received substantial sales proceeds from its four mega-sized property projects (South Horizon,
Laguna City, Serenity Garden, Kingswood Villa). At that time, CK invested its surplus cash in convertible notes and stakes in red chips and began to monetise these investments to
buy land after a few years.
Having a sizeable treasury operation appears to be an inherent component of the CK model. It has moved its entire treasury operation into CKH after the reorganisation and in a way,
one may say that CK is just returning to the traditional CK way of running the property business, which is unusual in global property but appears to have served it well for decades.
CKPs disciplined approach to land acquisition and seeking higher returns from surplus liquidity also appears to have served it well.
Source: Daiwa
150
Hang Lung Properties (101 HK)

Hang Lung Properti es

Pioneer and major beneficiary of metropolitanisation

Among the most advanced in terms of its China presence Jonas Kan, CFA
(852) 2848 4439
Potential for Hong Kong assets to be upgraded, in our view jonas.kan@hk.daiwacm.com
Reiterating Buy (1) call; sentiment and newsflow look to be improving
look at Hang Lung Properties (HLP) in the context of our view on the Year to 31 Dec 17E 18E 19E
longer-term development of the Hong Kong property market.
What's the impact: A pioneer and major beneficiary of Source: Daiwa forecasts
metropolitanisation in China. In our view, HLP has maintained a clear
strategy of asset swapping since the early 2000s ie, using profits from Share price performance
Hong Kong residential property sales to fund the build-up of a sizeable pool (HKD) (%)
of prime commercial properties in major cities in China. We believe this can 21 125
be viewed as a form of price arbitrage, and is a sensible move over the 19 118
17 110
long-term. In this respect we view HLP as a pioneer in the 15 103
metropolitanisation of China. 13 95
Building on its expertise in managing prime commercial properties in HLung Prop (LHS) Relative to HSI (RHS)
China remains the key. We believe that within the commercial property
sector, Hong Kong property companies have an edge over most domestic 12-month range 13.70-20.75
property companies in China. The key for HLP, in our view, is whether it Market cap (USDbn) 11.85
can maintain that edge and sharpen it over time. So far, HLP has not been
as successful in cities outside Shanghai, but its Palace 66 development Major shareholder Hang Lung Group (54.3%)
looks on track and could be followed by Parc 66 in Jinan. Developing a
system and the expertise to run prime commercial properties across Financial summary (HKD)
various cities in China is difficult and takes time, in our view. However, the Year to 31 Dec 17E 18E 19E
requisite system and skills are in place, and can serve as an important Revenue (m) 11,716 9,328 8,965
entry barrier, in our view.
Net profit (m) 5,810 4,955 4,540
Numerous mid-tier property assets in Hong Kong. While HLP does not EPS change (%) (8.4) (14.7) (8.4)
have many trophy property assets in Hong Kong, it owns a number of Daiwa vs Cons. EPS (%) 8.5 1.7 (0.2)
PER (x) 15.8 18.6 20.3
assets in upcoming locations and on the fringes of core locations such as Dividend yield (%) 3.7 3.7 3.8
Causeway Bay, Central and Mongkok. Given our view that the Hong Kong DPS 0.760 0.770 0.780
property market will be characterised by its scale of expansion in the PBR (x) 0.7 0.7 0.7
EV/EBITDA (x) 11.6 13.1 14.1
coming years, we see interesting potential for some of HLPs assets if the
ROE (%) 4.6 3.8 3.5
proper asset enhancement initiatives can be carried out.
price of HKD23.70, based on an unchanged 40% discount applied to our
end-2017E NAV of HKD39.50. Key risk: inability to ramp up sales in new
malls.
How we differ: We believe that the situation faced by HLP is getting better
(or is at least not worsening) and this is the key to investor sentiment and
the stock price, which the market may have yet to recognise.
Hang Lung Properties (101 HK): 24 March 2017
Financial summary
Key assumptions
Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Gross rental income (HKDm) 6,098 6,642 7,216 7,751 7,737 7,960 8,156 8,587
Rental EBIT (HKDm) 4,896 5,286 5,589 5,704 5,710 5,849 6,057 6,387
Property sales profit (HKDm) 3,063 1,511 7,419 844 3,209 2,407 1,358 272

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Rental income 6,098 6,642 7,216 7,751 7,737 7,960 8,156 8,587
Property sales 1,274 2,496 9,814 1,197 5,322 3,756 1,172 378
Other Revenue 0 0 0 0 0 0 0 0
Total Revenue 7,372 9,138 17,030 8,948 13,059 11,716 9,328 8,965
Other income 2,774 829 922 1,104 1,002 1,022 1,042 1,063
COGS (1,630) (2,301) (3,995) (2,400) (4,140) (3,490) (1,944) (1,985)
SG&A (626) (642) (644) (622) (572) (583) (595) (598)
Other op.expenses 0 0 0 (33) (35) (36) (38) (39)
Operating profit 7,890 7,024 13,313 6,997 9,314 8,629 7,793 7,406
Net-interest inc./(exp.) (348) (437) (698) (1,041) (1,111) (1,120) (1,204) (1,218)
Assoc/forex/extraord./others 105 96 75 59 63 66 70 74
Pre-tax profit 7,647 6,683 12,690 6,015 8,266 7,575 6,659 6,262
Tax (944) (1,088) (2,146) (1,184) (1,513) (1,324) (1,232) (1,217)
Min. int./pref. div./others (525) (545) (522) (444) (412) (441) (472) (505)
Net profit (reported) 6,178 5,050 10,022 4,387 6,341 5,810 4,955 4,540
Net profit (adjusted) 6,178 5,050 10,022 4,387 6,341 5,810 4,955 4,540
EPS (reported)(HKD) 1.380 1.128 2.238 0.979 1.416 1.297 1.106 1.014
EPS (adjusted)(HKD) 1.380 1.128 2.238 0.979 1.416 1.297 1.106 1.014
EPS (adjusted fully-diluted)(HKD) 1.380 1.128 2.238 0.979 1.416 1.297 1.106 1.014
DPS (HKD) 0.740 0.750 0.760 0.750 0.750 0.760 0.770 0.780
EBIT 7,890 7,024 13,313 6,997 9,314 8,629 7,793 7,406
EBITDA 7,890 7,024 13,313 7,030 9,349 8,665 7,831 7,445
Cash flow (HKDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Profit before tax 7,647 6,683 12,690 6,015 8,266 7,575 6,659 6,262
Depreciation and amortisation 27 29 31 33 35 36 38 39
Tax paid (1,018) (1,088) 1,741 (1,650) (1,513) (1,324) (1,232) (1,217)
Change in working capital 554 314 740 (486) (560) 2,456 1,125 646
Other operational CF items 171 266 543 897 958 962 1,040 1,049
Cash flow from operations 7,381 6,204 15,745 4,809 7,186 9,705 7,630 6,779
Capex (8,088) (9,274) (6,620) (7,380) (4,555) (5,690) (5,760) (5,020)
Net (acquisitions)/disposals 0 0 0 0 0 0 0 0
Other investing CF items 129 134 136 140 145 148 149 150
Cash flow from investing (7,959) (9,140) (6,484) (7,240) (4,410) (5,542) (5,611) (4,870)
Change in debt 0 0 0 0 0 0 0 0
Net share issues/(repurchases) 0 0 0 0 0 0 0 0
Dividends paid (3,183) (3,582) (3,313) (3,582) (3,582) (3,626) (3,671) (3,716)
Other financing CF items (415) (430) (442) (317) (470) (475) (478) (482)
Cash flow from financing (3,598) (4,012) (3,755) (3,899) (4,052) (4,101) (4,149) (4,198)
Forex effect/others 0 0 0 0 0 0 0 0
Change in cash (4,177) (6,947) 5,506 (6,330) (1,276) 62 (2,130) (2,289)
Free cash flow (707) (3,070) 9,125 (2,571) 2,631 4,015 1,870 1,759
152

As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Cash & short-term investment 36,025 34,321 39,946 31,289 24,325 24,259 22,172 19,922
Inventory 6,109 5,695 4,046 3,830 2,352 1,256 650 320
Accounts receivable 1,270 2,865 1,916 1,173 3,939 2,819 1,505 1,320
Other current assets 452 0 0 0 0 0 0 0
Total current assets 43,856 42,881 45,908 36,292 30,616 28,334 24,327 21,562
Fixed assets 122,955 138,354 146,048 146,470 143,030 149,856 155,584 159,389
Goodwill & intangibles 0 0 0 0 0 0 0 0
Other non-current assets 1,053 1,045 1,223 1,256 1,261 1,320 1,390 1,420
Total assets 167,864 182,280 193,179 184,018 174,907 179,510 181,301 182,371
Short-term debt 1,113 1,657 5,657 4,693 568 430 368 352
Accounts payable 4,811 5,977 7,906 6,806 6,327 6,825 6,956 7,023
Other current liabilities 392 633 1,581 501 932 1,650 1,672 1,685
Total current liabilities 6,316 8,267 15,144 12,000 7,827 8,905 8,996 9,060
Long-term debt 28,623 33,322 29,441 28,078 26,514 26,525 26,630 26,685
Other non-current liabilities 8,947 9,524 9,591 9,048 8,421 9,641 9,908 9,980
Total liabilities 43,886 51,113 54,176 49,126 42,762 45,071 45,534 45,725
Share capital 4,477 4,479 4,479 4,479 4,479 4,479 4,479 4,479
Reserves/R.E./others 113,451 120,055 127,848 124,510 122,086 124,270 125,553 126,378
Shareholders' equity 117,928 124,534 132,327 128,989 126,565 128,749 130,032 130,857
Minority interests 6,050 6,633 6,676 5,903 5,580 5,690 5,735 5,789
Total equity & liabilities 167,864 182,280 193,179 184,018 174,907 179,510 181,301 182,371
EV 91,804 99,334 93,871 99,428 100,380 100,429 102,604 104,947
Net debt/(cash) (6,289) 658 (4,848) 1,482 2,757 2,696 4,826 7,115
BVPS (HKD) 26.341 27.816 29.544 28.799 28.257 28.745 29.032 29.216
Key ratios (%)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) 42.8 24.0 86.4 (47.5) 45.9 (10.3) (20.4) (3.9)
EBITDA (YoY) 101.5 (11.0) 89.5 (47.2) 33.0 (7.3) (9.6) (4.9)
Operating profit (YoY) 101.5 (11.0) 89.5 (47.4) 33.1 (7.4) (9.7) (5.0)
Net profit (YoY) 125.4 (18.3) 98.5 (56.2) 44.5 (8.4) (14.7) (8.4)
Core EPS (fully-diluted) (YoY) 125.1 (18.3) 98.4 (56.2) 44.5 (8.4) (14.7) (8.4)
Gross-profit margin 77.9 74.8 76.5 73.2 68.3 70.2 79.2 77.9
EBITDA margin 107.0 76.9 78.2 78.6 71.6 74.0 84.0 83.0
Operating-profit margin 107.0 76.9 78.2 78.2 71.3 73.7 83.5 82.6
Net profit margin 83.8 55.3 58.8 49.0 48.6 49.6 53.1 50.6
ROAE 5.4 4.2 7.8 3.4 5.0 4.6 3.8 3.5
ROAA 4.0 2.9 5.3 2.3 3.5 3.3 2.7 2.5
ROCE 5.5 4.4 7.8 4.1 5.7 5.4 4.8 4.5
ROIC 6.2 4.7 8.3 4.2 5.6 5.2 4.6 4.2
Net debt to equity n.a. 0.5 n.a. 1.1 2.2 2.1 3.7 5.4
Effective tax rate 12.3 16.3 16.9 19.7 18.3 17.5 18.5 19.4
Accounts receivable (days) 80.5 82.6 51.2 63.0 71.4 105.3 84.6 57.5
Current ratio (x) 6.9 5.2 3.0 3.0 3.9 3.2 2.7 2.4
Net interest cover (x) 22.7 16.1 19.1 6.7 8.4 7.7 6.5 6.1
Net dividend payout 53.6 66.5 34.0 76.6 53.0 58.6 69.6 77.0
Free cash flow yield n.a. n.a. 9.9 n.a. 2.9 4.4 2.0 1.9
Company profile
Hang Lung Properties (HLP) is the property arm of Hang Lung Group, which is one of the most
established property developers in Hong Kong. In the 1990s, it invested in 2 major commercial
property projects in Shanghai, which later became among the most popular commercial property
assets in Shanghai and China. Since the early 2000s, it has been pursuing a strategy of focusing
on the commercial property sector in China, and has subsequently acquired 8 major sites outside
Shanghai. It now has a stated strategy to transform itself into a leading player in commercial
property in Greater China.
153
HLP: share price performance HLP: Plaza 66 in Shanghai (left) and Center 66 in Wuxi (right)
(HKD)
45
40
35
30
25
20
15
10
5
0
Jan-05
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Source: Bloomberg Source: Daiwa
HLP: price/NAV multiple HLP: PBR

(Disc)/prem Hang Lung Properties (disc)/prem to NAV PBR (x) Hang Lung Properties PBR
40% 3.5 over- over- returning
Current NAV disc: -49.2% optimistic? pessimistic? to normal?
20% 3.0
2.5
0%
+1SD: -14.5% 2.0 Current PBR: 0.71x
(20%) Avg since 1990=
-35.0% 1.5 +1SD: 1.37x
(40%) average since
1.0 1990: 0.97x
(60%) -1SD: -55.5% 0.5
-1SD: 0.57x
(80%)
0.0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Datastream, Daiwa forecasts Source: Datastream, Daiwa
HLP: operating performance of its various properties

Year of Gross rental income Occupancy Retail sales YoY chg
opening 1H14 2H14 1H15 2H15 1H16 2H16 YoY HoH 2015 2016 YoY YoY HoH
(HKDm) (HKDm) (HKDm) (HKDm) (CNYm) (CNYm) chg chg (CNYm) (CNYm) chg 1H14 2H14 1H15 2H15 1H16 2H16 chg chg 2015 1H16
Palace 66 Shenyang 2010 80 86 84 86 71 71 na 0% 137 142 4% 90% 88% 84% 90% 89% 93% +3pp +4pp +2% slight +ve
Parc 66 Jinan 2011 171 165 168 167 137 125 na -8% 269 262 -3% 85% 85% 90% 88% 84% 91% +3pp +7pp -2% flat
Forum 66 (mall) Shenyang 2012 142 141 127 111 81 67 na -18% 191 148 -23% 93% 93% 88% 87% 84% 84% -3pp Flat -3% -5%
Forum 66 (office) Shenyang 2015 na na 9 35 40 42 na 4% 36 82 127% na na 30% 42% 49% 58% +16pp +9pp na na
Center 66 (mall) Wuxi 2013 145 144 125 92 80 70 na -11% 173 150 -13% 95% 91% 80% 72% 76% 80% +8pp +4pp -3% slight +ve
Center 66 (office) Wuxi 2014 na 4 30 49 42 32 na -23% 63 74 17% na 29% 60% 70% 58% 65% -5pp +7pp na na
Riverside 66 Tianjin 2014 na 63 121 120 97 94 na -4% 193 191 -1% na 87% 88% 86% 82% 82% -4pp Flat na +6%
Grand Gateway 66 Shanghai 2001 570 587 607 589 493 481 na -2% 960 974 1% 100% 99% 98% 97% 96% 96% -1pp Flat +1% -6%
Plaza 66 (mall) Shanghai 2002 402 413 452 433 338 340 na 1% 714 678 -5% 97% 97% 100% 97% 83% 93% -4pp +10pp +1% -2%
Plaza 66 (office) Shanghai 2002 423 380 395 389 327 300 na -9% 627 627 0% 95% 96% 96% 98% 96% 95% -3pp -1pp na na
Olympia 66 Dalian 2015 na na na 5 37 51 na 39% 4 88 nm na na na 54% 62% 66% +12pp +4pp na na
HK portfolio (HKDm) HK Various 1,633 1,667 1,744 1,813 1,869 1,873 3% 0% 3,557 3,742 5% nd nd nd nd nd nd na na nd nd
Note: nd = not disclosed
154
Henderson Land (12 HK)

Henderson Land

Big harvest ahead, realising value for all shareholders

Could be a big winner in Hong Kong residential property sector Jonas Kan, CFA
(852) 2848 4439
Asset disposal should provide extra earnings jonas.kan@hk.daiwacm.com
Committed to grow DPS; reaffirming Buy (1) and TP of HKD63.80
What's new: We have examined Henderson Lands (HLD) long-term Forecast revisions (%)
growth prospects in the context of our views on the long-term direction of Year to 31 Dec 17E 18E 19E
the Hong Kong property market, as discussed in the sector portion of this Revenue change - - -
report. Core EPS (FD) change - - -
What's the impact: Could be a big winner in the residential property
sector, as HLD is the largest owner of old buildings and farmland, both Share price performance
segments which newcomers in the industry cannot access. Our view is that (HKD) (%)
urban-area land in Hong Kong commands significant scarcity value and 49 110
HLDs position will be further enhanced by the fact that it is the dominant 46 104
player in this segment. Also, we expect that rising prices will eventually 44 98
41 91
result in the government becoming more active in facilitating farmland 39 85
conversion, and HLDs status as the largest owner of farmland should put it Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
in a strong position to benefit. Hend Land (LHS) Relative to HSI (RHS)
Asset disposal appears to have become a recurrent activity. We note 12-month range 39.73-48.05
that HLDs property sales profit used to be notably smaller than SHKPs Market cap (USDbn) 20.45
and CKPs in the past. Hence, there is considerable room for its property 3m avg daily turnover (USDm) 11.81
sales profits to catch up once the company can beef up its annual Major shareholder Lee Shau Kee (73.1%)
completion volume. At the same time, our read is that HLD is
supplementing its property sales profits with asset disposals (which extend Financial summary (HKD)
from non-core commercial properties to farmland sold to the government Year to 31 Dec 17E 18E 19E
for developing public housing), which should help underpin a sustained Revenue (m) 38,650 39,980 40,321
growth in its property sales profits over the coming years, in our view. Net profit (m) 15,650 16,220 16,280
Demonstrated commitment to grow DPS. HLD has declared 1-for-10 EPS change (%) 10.5 3.6 0.4
Daiwa vs Cons. EPS (%) 38.9 40.8 n.a.
bonus issues for 5 straight years, while growing its absolute DPS at the PER (x) 10.2 9.8 9.8
same time. With its abundant farmland and old buildings, Hendersons Dividend yield (%) 3.4 3.6 3.7
property development should strengthen significantly once it can make a DPS 1.650 1.750 1.800
PBR (x) 0.6 0.6 0.5
breakthrough in getting the farmland to be converted/sold and pushing its
EV/EBITDA (x) 7.7 7.4 7.3
ownership of more old buildings above the 80% level (the threshold for ROE (%) 5.8 5.8 5.6
mandatory land tender). If HLD decides to pay out more of the extra Source: FactSet, Daiwa forecasts
earnings as special dividend (as it did in the 1990s), this could constitute a
major share-price catalyst for the company, in our view.
What we recommend: We reaffirm our Buy (1) rating and 12-month TP of

HKD63.80, based on a 30% discount applied to our end-2017E NAV of
HKD91.10. Key risk: a major deterioration in the Hong Kong economy.
How we differ: We believe that HLD has entered into a harvesting phase
on its investments in old buildings, rental properties and farmland, and has
demonstrated its commitment to share the benefits with all shareholders.
This, however, may have yet to be recognised by the market, in our view.
Henderson Land (12 HK): 24 March 2017
Financial summary
Key assumptions
Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales profit (HKDm) 2,306 2,952 3,376 3,985 7,917 8,450 8,620 8,690
Rental EBIT (HKDm) 3,107 3,670 5,754 6,292 6,481 6,807 7,283 7,725
DPS (HKD) 1.06 1.06 1.10 1.45 1.55 1.65 1.75 1.80

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales 8,708 15,743 15,466 15,690 17,679 29,965 30,564 30,523
Rental income 4,494 4,994 5,445 5,589 5,559 5,980 6,520 6,850
Other Revenue 2,390 2,552 2,460 3,336 2,330 2,705 2,896 2,948
Total Revenue 15,592 23,289 23,371 24,615 25,568 38,650 39,980 40,321
Other income 0 0 0 0 0 0 0 0
COGS (8,167) (14,508) (13,590) (12,669) (14,702) (22,690) (23,416) (23,685)
SG&A (1,060) (1,200) (1,268) (1,298) (1,212) (1,523) (1,590) (1,598)
Other op.expenses (1,066) (1,456) (1,557) (2,078) (2,101) (1,674) (1,699) (1,711)
Net-interest inc./(exp.) (1,239) (957) (1,429) (1,442) (1,544) (1,320) (1,390) (1,392)
Assoc/forex/extraord./others 4,167 5,102 6,594 6,334 10,400 7,680 7,950 8,021
Pre-tax profit 8,227 10,270 12,121 13,462 16,409 19,123 19,835 19,956
Tax (1,005) (1,244) (2,707) (1,905) (2,102) (3,331) (3,459) (3,519)
EPS (reported)(HKD) 2.987 3.312 3.130 3.330 4.286 4.734 4.906 4.924
EPS (adjusted)(HKD) 2.987 3.312 3.130 3.330 4.286 4.734 4.906 4.924
DPS (HKD) 1.060 1.060 1.100 1.450 1.550 1.650 1.750 1.800
EBIT 5,299 6,125 6,956 8,570 7,553 12,763 13,275 13,327
EBITDA 5,463 6,296 7,134 8,762 7,751 12,962 13,479 13,534
Cash flow (HKDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Tax paid (1,020) (1,120) (2,436) (1,715) (1,892) (2,998) (3,113) (3,165)
Change in working capital 3,277 1,290 8,808 8,925 10,449 9,250 9,580 9,630
Other operational CF items 234 (1,194) (1,597) (1,418) (1,388) (2,308) (2,400) (2,433)
Capex (8,620) (9,274) (9,273) (17,261) (15,865) (16,859) (18,410) (18,652)
Other investing CF items 5,320 1,350 1,480 1,490 1,510 1,530 1,530 1,538
Dividends paid (2,362) (2,575) (2,939) (5,273) (4,868) (5,700) (6,650) (7,524)
Other financing CF items (1,651) (1,251) (1,881) (1,930) (2,018) (2,151) (2,225) (2,282)
Change in cash 3,569 (2,333) 4,460 (3,528) 2,535 86 (1,650) (2,726)
Free cash flow 2,262 143 7,800 2,185 7,911 6,407 5,696 5,542
156

As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Inventory 7,882 6,449 5,460 4,820 4,608 4,756 4,856 4,913
Other current assets 74,166 79,388 80,104 81,556 78,462 79,852 79,965 80,135
Fixed assets 101,072 108,872 119,705 128,597 131,850 138,803 149,019 158,446
Total assets 281,557 304,114 316,980 336,269 355,498 368,209 381,252 394,875
Short-term debt 2,826 7,418 13,590 10,216 20,152 13,477 13,876 14,201
Other current liabilities 1,404 2,111 1,346 2,990 1,086 1,135 1,168 1,190
Long-term debt 44,371 43,580 29,112 38,503 35,932 42,678 44,125 46,658
Share capital 4,830 5,398 52,010 52,345 52,345 52,345 52,345 52,345
EV 124,309 119,437 112,089 110,510 103,785 100,010 99,381 98,463
Net debt/(cash) 32,807 35,140 30,680 34,207 31,829 31,587 33,236 35,963
BVPS (HKD) 86.369 82.772 80.212 76.000 79.714 82.898 86.154 89.328
Key ratios (%)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) 2.7 49.4 0.4 5.3 3.9 51.2 3.4 0.9
EBITDA (YoY) 16.3 15.2 13.3 22.8 (11.5) 67.2 4.0 0.4
Operating profit (YoY) 16.5 15.6 13.6 23.2 (11.9) 69.0 4.0 0.4
Net profit (YoY) 27.7 25.9 4.0 18.5 28.7 10.5 3.6 0.4
Core EPS (fully-diluted) (YoY) 20.9 10.9 (5.5) 6.4 28.7 10.5 3.6 0.4
EBITDA margin 35.0 27.0 30.5 35.6 30.3 33.5 33.7 33.6
ROAE 3.6 4.2 4.0 4.5 5.5 5.8 5.8 5.6
ROAA 2.6 3.1 3.0 3.4 4.1 4.3 4.3 4.2
ROCE 2.1 2.3 2.5 2.9 2.4 3.9 3.9 3.7
ROIC 2.0 2.1 2.0 2.6 2.2 3.4 3.4 3.3
Net debt to equity 16.0 15.7 12.9 13.6 12.1 11.5 11.7 12.2
Current ratio (x) 5.2 4.3 3.3 3.4 2.8 3.3 3.3 3.2
Free cash flow yield 1.4 0.1 4.9 1.4 5.0 4.0 3.6 3.5
Company profile
Henderson Land is one of the largest property companies in Hong Kong and has diversified
investments in the residential-, office- and retail-property sectors. It is the largest holder of
agricultural land in Hong Kong currently and also the largest shareholder in HK and China Gas as
well as Miramar Hotel and HK Ferry. In recent years, Henderson Land has been increasing its
investment in China property, and has a landbank of more than 100m sq ft in the country currently.
157
Henderson Land: KPIs Hong Kong Property Sector: YTD share-price performance
(HKDm) 1H14 2H14 1H15 2H15 1H16
Wharf
BVPS* (HKD) 85.12 79.38 81.92 76.00 70.01 Hang Lung Properties
Property sales^ (HKDm) 6,108 10,694 7,083 9,724 6,136 SMALL/MID CAPS
- from HK (HKDm) 4,263 6,003 4,049 7,122 3,654 INVESTORS
- from China (HKDm) 1,845 4,691 3,034 2,602 2,482 Swire Properties
Gross rental income^ (HKDm) 3,854 4,050 4,027 4,125 4,070 SHKP
- from HK (HKDm) 3,146 3,278 3,169 3,235 3,214 Hysan
Midland
- from China (HKDm) 708 772 858 890 856 Sino Land
Sales and pre-sales in China (HKDm) 1,834 3,369 3,452 3,838 5,525 DEVELOPERS
No. of old bldg projects 72 80 81 79 78 MTRC
GFA of old bldg projects (m sq ft) 6.9 6.1 6.0 5.9 5.9 HK Land
Net debt (HKDm) 31,171 37,420 33,064 40,317 36,972 Henderson Land
Net debt to equity (%) 13.6% 15.7% 13.5% 16.0% 14.5% Yuexiu REIT
HK landbank (m sq ft) Champion REIT
CK Property
Properties held for/under development 13.1 13.0 13.6 13.4 13.5 HSI
Stock of unsold properties 0.9 0.9 0.7 0.9 0.8 Regal REIT
Completed investment prop (incl hotel) 10.1 9.9 10.0 10.1 10.0 H-REITs
24.1 23.8 24.3 24.4 24.3 Sunlight REIT
China landbank (m sq ft) Link REIT
Properties held for/under development 130.6 126.1 122.1 116.7 107.1 Prosperity REIT
Great Eagle
Stock of unsold properties 1.6 2.5 2.1 2.9 3.0 Fortune REIT
Completed investment properties 7.3 7.3 7.3 7.3 7.3
139.5 135.9 131.5 126.9 117.4 (10) (5) 0 5 10 15 20 25 30 35 40
Agricultural landbank in HK (m sq ft) 42.6 44.5 44.5 45.0 45.2 (%)
Source: Company Source: Bloomberg, Datastream, Daiwa
Note: *BVPS is before adjusting for the bonus issues ^including associates & JCEs Note: prices as at close on 22 March 2017
Henderson Land: gross rental income Henderson Land: property sales profit
(HKDm) (HKDm)
9,000 14,000
8,000 12,000
7,000
6,000 10,000
5,000 8,000
4,000
6,000
3,000
2,000 4,000
1,000
2,000
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 0
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
HK China
Source: Company, Daiwa Source: Company, Daiwa
Henderson Land: price/NAV Henderson Land: PBR
(Disc)/prem (%) Henderson Land (disc)/prem to NAV Henderson Land PBR

PBR (x)
40%
Current: -46.0% 4.5
Current PBR: 0.66x
20% 4.0
+2SD: 2.6% 3.5
0%
3.0
(20%) 2.5 +2 SD: 2.40x
+1SD: -18.3%
2.0 +1 SD: 1.78x
(40%)
1.5
average since
(60%) 1.0 1990: 1.16x
-1SD: -60.0% 0.5 -1 SD: 0.54x
(80%) 0.0 --2 SD: 0.08x
Avg. since 1990: -2SD: -80.9%
(100%) -39.1% (0.5)
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
Source: Datastream, Daiwa forecasts Source: Company, Datastream, Daiwa
Henderson Land: historical DPS** Henderson Land: dividends paid since 2005
(HKD) (HKDm)
3.5 6,000
3.0 5,000
2.5
4,000
2.0
1.5 3,000
1.0 2,000
0.5 1,000
0.0
0
FY91
FY96
FY90
FY92
FY93
FY94
FY95
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
2010
2011
2012
2013
2014
2015
2016
2009*
FY05 FY06 FY07 FY08 2009* 2010 2011 2012 2013 2014 2015 2016
Regular cash dividend Special cash dividend 1H 2H

Source: Company Source: Company
Note: *for the 18 months to 31 Dec 2009 (company's year-end date was changed in 2009 from June to Note: *for the 18 months to 31 December 2009 (company's year-end date was changed in
December) 2009 from June to December)
**Actual cash DPS declared, before adjusting for 1:10 bonus issue in 2012, 2013, 2014, and 2015
158
Hongkong Land (HKL SP)

Hong kong Land
Target price: USD8.70 (from USD8.70)

Share price (22 Mar): USD7.24 | Up/downside: +20.2%
Anchored in Hong Kong, growing in Asia and China

Central franchise should continue to hold its value for the group Jonas Kan, CFA
(852) 2848 4439
Residential business is maturing, with China being key jonas.kan@hk.daiwacm.com
Offers balance and quality; reaffirming Buy (1) call and TP of USD8.70
look at Hongkong Land in the context of our view on the longer-term Year to 31 Dec 17E 18E 19E
development of the Hong Kong property market. Revenue change - - -
What's the impact: Franchise in Central should continue to hold its Source: Daiwa forecasts
value for the group. In our view, the continued development of Central as
a commercial hub and decentralisation are 2 compatible trends. We believe Share price performance
Hongkong Land has adapted its leasing strategy to cope with the evolution (USD) (%)
of the Hong Kong office market, and thus do not expect its portfolio to face 7.5 125
any major threats in the foreseeable future. As such, we continue to see 7.1 119
Hongkong Lands Central portfolio as a valuable franchise that over time 6.7 113
6.2 106
can generate well over USD1bn in annual gross rental income. If the retail 5.8 100
dimension of Central strengthens further, the franchise value of Hongkong Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
Lands Central portfolio would also rise further, in our view. Hongkong L (LHS)
Relative to FSSTI (RHS)
Established the foundation for a Pan-Asia footprint, with China likely 12-month range 5.81-7.26
to become more prominent. As we see it, over the past 20 years, Market cap (USDbn) 17.03
Hongkong Land has been using the surplus cash from its Hong Kong 3m avg daily turnover (USDm) 13.83
business to build up its presence in virtually all major cities in Asia, and we Major shareholder Jardine Matheson (50.0%)
believe its China business is on track to gain more prominence. Its contract
sales and residential landbank in China have continued to grow, and we Financial summary (USD)
expect its China business to provide the group with sustained property Year to 31 Dec 17E 18E 19E
sales profit growth over the next few years. While we expect Hong Kong to Revenue (m) 1,802 2,045 2,246
remain Hongkong Lands most important profit centre in the foreseeable Net profit (m) 910 1,010 1,130
future, we see China and Southeast Asia gaining in importance over the Core EPS (fully-diluted) 0.387 0.429 0.480
next few years. EPS change (%) 7.3 11.0 11.9
Daiwa vs Cons. EPS (%) (2.1) 6.0 14.1
PER (x) 18.7 16.9 15.1
Not a focused Hong Kong play; diversity plus a growing China Dividend yield (%) 2.8 2.9 3.0
presence. In our view, Hongkong Land has laid the foundations for its DPS 0.200 0.210 0.220
PBR (x) 0.5 0.5 0.5
presence in virtually all major Asian cities, and its China business looks set
EV/EBITDA (x) 14.0 12.6 10.9
to grow in prominence. We do not see it as a high-growth company but do ROE (%) 2.9 3.2 3.5
believe Hongkong Land offers quality, safety and diversity, and will gain Source: FactSet, Daiwa forecasts
appeal if it can modernise its capital management.
price of USD8.70, based on a 30% discount applied to our end-2017E NAV
of USD12.40. Key risk: a major contraction in office demand in Hong Kong.
How we differ: Unlike some in the market, we believe Central will continue
to strengthen as a commercial hub while the office decentralisation trend
continues. We also believe Hongkong Land could evolve into a niche
player in the residential property market in China, though this may have yet
to be recognised by the market.
Hongkong Land (HKL SP): 24 March 2017
Financial summary
Key assumptions
Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Gross rental income (USDm) 746 811 843 851 859 895 947 1,062
Size of completed investment
4.9 4.9 4.9 4.9 4.9 4.9 4.9 4.9
properties in HK (m sq ft)
3.4 3.3 3.3 3.3 4.1 4.5 4.7 4.8
properties outside HK (m sq ft)
Profit and loss (USDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales 252 926 910 955 1,004 768 951 1,019
Rental income 746 811 843 851 859 895 947 1,062
Other Revenue 117 120 124 126 131 139 147 165
Total Revenue 1,115 1,857 1,876 1,932 1,994 1,802 2,045 2,246
Other income 5 11 14 63 12 0 0 0
COGS (235) (858) (719) (891) (921) (669) (816) (873)
SG&A (84) (91) (102) (107) (112) (114) (119) (123)
Other op.expenses (2) (2) (2) (2) (2) (2) (2) (2)
Operating profit 799 917 1,067 995 971 1,017 1,108 1,248
Net-interest inc./(exp.) (61) (64) (69) (74) (69) (73) (76) (80)
Pre-tax profit 904 1,088 1,121 1,062 1,019 1,112 1,232 1,376
Tax (124) (149) (188) (151) (168) (199) (218) (241)
Net profit (reported) 776 935 930 905 848 910 1,010 1,130
Net profit (adjusted) 776 935 930 905 848 910 1,010 1,130
EPS (reported)(USD) 0.331 0.397 0.395 0.385 0.360 0.387 0.429 0.480
EPS (adjusted)(USD) 0.331 0.397 0.395 0.385 0.360 0.387 0.429 0.480
EPS (adjusted fully-diluted)(USD) 0.331 0.397 0.395 0.385 0.360 0.387 0.429 0.480
DPS (USD) 0.170 0.180 0.190 0.190 0.190 0.200 0.210 0.220
EBIT 799 917 1,067 995 971 1,017 1,108 1,248
EBITDA 802 919 1,070 997 973 1,019 1,110 1,250
Cash flow (USDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Profit before tax 904 1,088 1,121 1,062 1,019 1,112 1,232 1,376
Tax paid (147) (139) (134) (120) 27 30 32 36
Change in working capital (453) 66 (251) 0 0 0 0 0
Other operational CF items 27 (33) 43 31 51 4 (10) (14)
Cash flow from operations 333 985 781 975 1,099 1,148 1,256 1,400
Capex (563) (174) (174) (139) (213) (508) (560) (560)
Net (acquisitions)/disposals (283) (203) 263 0 0 0 0 0
Cash flow from investing (846) (378) 88 (139) (213) (508) (560) (560)
Change in debt 914 287 (91) 0 0 0 0 0
Dividends paid (375) (405) (426) (440) (472) (510) (540) (540)
Other financing CF items (27) 46 (76) (80) (82) (84) (87) (87)
Cash flow from financing 512 (72) (593) (520) (554) (594) (618) (618)
Forex effect/others (0) 8 (15) 0 0 0 0 0
Change in cash (1) 543 262 316 332 46 78 222
Free cash flow (230) 811 607 836 886 640 696 840
160

Balance sheet (USDm)
As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Cash & short-term investment 982 1,406 1,663 1,569 1,909 1,923 2,012 2,122
Inventory 2,513 2,670 2,923 2,714 2,217 2,356 2,458 2,560
Accounts receivable 351 274 292 356 480 495 502 515
Other current assets 7 17 13 8 10 10 11 12
Fixed assets 23,499 23,602 23,722 24,991 27,757 27,748 27,876 28,048
Total assets 31,785 32,996 33,633 34,372 36,955 37,395 37,980 38,521
Short-term debt 365 712 289 169 221 245 256 268
Other current liabilities 60 71 102 69 80 84 88 93
Long-term debt 3,891 3,719 4,031 3,741 3,696 3,640 3,640 3,516
Other non-current liabilities 143 185 171 189 154 158 162 166
Share capital 235 235 235 235 235 235 235 235
Minority interests 37 42 50 35 20 23 25 27
EV 16,074 15,171 14,837 14,792 14,601 14,289 13,963 13,603
Net debt/(cash) 3,273 3,025 2,657 2,341 2,008 1,962 1,884 1,662
BVPS (USD) 11.113 11.415 11.709 12.192 13.301 13.488 13.707 13.967
Key ratios (%)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) (8.9) 66.6 1.0 3.0 3.2 (9.6) 13.5 9.8
EBITDA (YoY) (3.8) 14.7 16.4 (6.8) (2.4) 4.7 8.9 12.6
Operating profit (YoY) (3.9) 14.7 16.4 (6.8) (2.4) 4.7 8.9 12.6
Net profit (YoY) 10.3 20.4 (0.5) (2.7) (6.3) 7.3 11.0 11.9
Core EPS (fully-diluted) (YoY) 10.0 20.0 (0.5) (2.7) (6.3) 7.3 11.0 11.9
EBITDA margin 71.9 49.5 57.0 51.6 48.8 56.5 54.3 55.7
ROAE 3.1 3.5 3.4 3.2 2.8 2.9 3.2 3.5
ROAA 2.6 2.9 2.8 2.7 2.4 2.4 2.7 3.0
ROCE 2.7 3.0 3.4 3.1 2.9 2.9 3.1 3.4
ROIC 2.4 2.7 3.0 2.8 2.5 2.5 2.7 3.0
Current ratio (x) 2.5 2.0 2.7 2.7 2.6 2.6 2.6 2.7
Free cash flow yield n.a. 4.8 3.6 4.9 5.2 3.8 4.1 4.9
Company profile
Hongkong Land (HKL) is a major commercial property landlord in Hong Kong, which owns 4.9m sq
ft (NFA) of commercial properties in the heart of the Central district of Hong Kong. Since the mid-
1990s, it has been pursuing a strategy to build up its presence in other major cities in Asia.
Presently, it has 1.8m sq ft (NFA) of commercial properties in Singapore and 1.6m sq ft (NFA) in
various major cities in Asia, such as Jakarta, Macau, Hanoi and Bangkok.
161
Hongkong Land: Central office portfolio occupancy rate Hongkong Land: gross rental income
(USDm)
100% 1,000
96% 800
92% 600
88% 400
84% 200
80% 0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Hongkong Land: past-5-year share-price performance Hongkong Land: PBR

(USD) PBR (x) Hongkong Land PBR
10
1.6 Current PBR: 0.53x
1.4
8
1.2
1.0 +1SD: 0.96x
6 Average since
0.8
1990: 0.74x
0.6
4 5.66 5.62
0.4 -1SD: 0.52x
0.2
2 0.37x
0.0 0.23x
Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: Bloomberg Source: Company, Datastream, Daiwa
Hongkong Land: price/NAV Hongkong Land: contracted sales from China

Hongkong Land (disc)/prem to NAV (USDm)
(Disc)/prem 1,200
50% Current NAV disc: -41.9%
1,000
30%
800
10%
(10%) 600
+1SD:-14.1%
(30%) 400
(50%)
200
-1SD:-54.4%
(70%) Average since
1991: -34.2% 0
(90%) 2014 2015 2016
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Contracted sales Sold but unrecognised sales

Source: Datastream, Daiwa forecasts Source: Company
Hongkong Land: Central office portfolio average rent Hongkong Land: Central retail portfolio average rent
(HKD/sq ft) (HKD/sq ft)
120 250
100 200
80
150
60
100
40
50
20
0 0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
162
Hysan Development (14 HK)

Hys an D evel opment

A play on Causeway Bay

Causeway Bay looks on track to become a stronger commercial hub Jonas Kan, CFA
(852) 2848 4439
Hysan looks well-positioned to ride on Causeway Bays development jonas.kan@hk.daiwacm.com
Reiterating Buy (1) call and TP of HKD47.70
look at Hysan Development in light of our view on the longer-term Year to 31 Dec 17E 18E 19E
development of the Hong Kong property market.
What's the impact: We view Causeway Bay and Tsimshatsui as the Source: Daiwa forecasts
two most important retail hubs in Hong Kong, and believe that
Causeway Bay stands a better chance than Tsimshatsui in evolving into an Share price performance
integrated retail hub with rich and diverse offerings for a broad range of (HKD) (%)
consumer goods. We believe that Causeway Bay has already gone a long 39 110
way in addressing the problem of over-luxury, and the area could become 37 105
35 100
a richer and stronger retail hub if the whole district can continue to expand 33 95
both horizontally (by extending its boundaries) and vertically (by converting 31 90
more upper floor spaces for retail use), and continue to attract a greater Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
variety of retailers, which we believe is happening. Hysan Dev (LHS) Relative to HSI (RHS)
Hysans strategy looks conducive to a sustained strengthening of 12-month range 31.60-38.35

Causeway Bay. Our read is that Hysans strategy is focused on making Market cap (USDbn) 4.85
the whole Causeway Bay area a more appealing shopping destination and
commercial hub, rather than gaining market share from competitors in the Major shareholder Lee Hysan Estate Co Ltd (41.1%)
immediate future. We believe that this strategy bodes well for the districts
continued progress as a retail hub. We also think that, over the long term, Financial summary (HKD)
this strategy would benefit Hysan given that it is the largest landlord in the Year to 31 Dec 17E 18E 19E
district in terms of portfolio size. Revenue (m) 3,640 3,915 4,245
Net profit (m) 2,435 2,645 2,920
A modern approach to capital management another bright spot. We Core EPS (fully-diluted) 2.326 2.526 2.789
note that Hysan continued to raise dividends and has been consistently EPS change (%) 2.8 8.6 10.4
buying back shares. We see this as evidence of managements Daiwa vs Cons. EPS (%) (6.6) 8.4 13.8
PER (x) 15.5 14.3 12.9
commitment to improve capital management and we believe that Hysan Dividend yield (%) 3.8 4.2 4.6
could become an example for other Hong Kong family-owned property DPS 1.380 1.520 1.670
companies, by moving to a professionally managed but family owned PBR (x) 0.6 0.5 0.5
EV/EBITDA (x) 13.6 12.7 11.5
model.
ROE (%) 3.6 3.8 4.1
What we recommend: We reaffirm our Buy (1) rating and 12 month TP of
HKD47.70, based on a 30% discount applied to our end-2017E NAV of
HKD68.20. Key risk: a major deterioration in the Hong Kong economy.
How we differ: We believe that Hysans demonstrated commitment to pay

higher dividends, buy back shares and improve its portfolio should enable it
to trade at a higher valuation than a typical Hong Kong property stock. But
this may have yet to be fully recognised by the market.
Hysan Development (14 HK): 24 March 2017
Financial summary
Key assumptions
Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Completed investment properties (m sq
4.4 4.4 4.1 4.1 4.1 4.1 4.4 4.4
ft)
Blended average office rent (on GFA)
35.7 39.1 46.2 50.6 52.6 56.5 58.3 59.1
(HKD/sq ft)
Blended average retail rent (on GFA)
81.2 108.0 117.4 123.8 128.1 127.9 120.3 117.2
(HKD/sq ft)
Blended average residential rent (on
37.6 34.7 37.6 37.4 38.0 37.2 38.0 40.6
GFA) (HKD/sq ft)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property rental - office 908 1,085 1,136 1,243 1,292 1,390 1,609 1,807
Property rental - retail 1,250 1,678 1,801 1,902 1,969 1,966 2,016 2,126
Other Revenue 328 300 287 285 274 284 290 312
Total Revenue 2,486 3,063 3,224 3,430 3,535 3,640 3,915 4,245
Other income 73 77 68 54 50 53 63 65
COGS (423) (405) (404) (414) (428) (443) (483) (498)
SG&A (179) (200) (208) (226) (211) (235) (240) (244)
Net-interest inc./(exp.) (156) (242) (228) (204) (178) (186) (217) (220)
Pre-tax profit 2,004 2,522 2,684 2,878 2,997 3,061 3,272 3,592
Tax (288) (372) (386) (438) (463) (458) (458) (503)
EPS (reported)(HKD) 1.536 1.935 2.048 2.162 2.263 2.326 2.526 2.789
EPS (adjusted)(HKD) 1.536 1.935 2.048 2.162 2.263 2.326 2.526 2.789
DPS (HKD) 0.950 1.170 1.230 1.320 1.350 1.380 1.520 1.670
EBIT 1,949 2,527 2,672 2,836 2,938 3,007 3,247 3,560
EBITDA 1,957 2,535 2,680 2,844 2,946 3,015 3,255 3,568
Cash flow (HKDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Tax paid (204) (298) (309) (350) (370) (385) (410) (452)
Change in working capital 265 399 185 438 887 146 148 148
Other operational CF items (63) (3) (20) (50) (67) (62) (33) (40)
Capex (802) (950) (368) (380) (2,817) (1,873) (1,240) (1,020)
Cash flow from investing (802) (950) (368) (380) (2,817) (1,873) (1,240) (1,020)
Net share issues/(repurchases) 0 0 0 (215) (393) 0 0 0
Dividends paid (845) (1,056) (1,246) (1,193) (1,469) (1,542) (1,647) (1,647)
Change in cash 72 248 568 758 (1,608) (1,036) (297) 194
Free cash flow 1,208 1,678 2,180 2,544 638 895 1,745 2,236
164

As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Inventory 0 0 0 0 0 0 0 0
Other current assets 605 657 586 416 1,446 1,557 1,560 1,595
Fixed assets 580 604 710 705 720 722 735 756
Total assets 68,423 76,094 79,023 78,788 80,021 82,374 84,031 85,256
Short-term debt 699 1,055 1,589 250 1,180 210 245 280
Accounts payable 469 500 481 470 935 965 982 998
Other current liabilities 599 666 739 743 778 792 813 823
Long-term debt 5,242 6,449 4,858 4,609 5,113 7,131 7,427 7,213
Other non-current liabilities 967 1,243 1,227 1,348 1,329 1,401 1,426 1,437
Share capital 5,315 5,318 7,640 7,642 7,673 7,673 7,673 7,673
EV 39,887 39,747 39,440 39,260 40,036 40,905 41,181 40,980
Net debt/(cash) 3,630 3,381 2,813 2,055 3,663 4,700 4,997 4,803
BVPS (HKD) 55.041 59.968 63.485 64.557 64.460 65.436 66.582 67.851
Key ratios (%)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) 29.3 23.2 5.3 6.4 3.1 3.0 7.6 8.4
EBITDA (YoY) 24.1 29.5 5.7 6.1 3.6 2.3 8.0 9.6
Operating profit (YoY) 24.2 29.7 5.7 6.1 3.6 2.3 8.0 9.6
Net profit (YoY) 23.9 26.0 5.9 5.6 3.8 2.8 8.6 10.4
Core EPS (fully-diluted) (YoY) 23.9 26.0 5.9 5.6 4.7 2.8 8.6 10.4
EBITDA margin 78.7 82.8 83.1 82.9 83.3 82.8 83.1 84.1
ROAE 3.0 3.4 3.3 3.4 3.5 3.6 3.8 4.1
ROAA 2.5 2.8 2.8 2.9 3.0 3.0 3.2 3.4
ROCE 3.1 3.6 3.6 3.7 3.8 3.9 4.1 4.4
ROIC 2.8 3.2 3.2 3.3 3.4 3.4 3.6 3.9
Current ratio (x) 1.7 2.3 1.6 2.3 1.5 2.3 2.2 2.2
Company profile
Hysan Development (Hysan) was founded by the Lee family in 1970 to redevelop the familys
properties, and was listed on the Hong Kong Stock Exchange in 1981. Hysan currently owns an
investment-property portfolio in Hong Kong amounting to 4.4m sq ft (4.2m sq ft on an attributable
basis), of which 3.7m sq ft is in Causeway Bay. In addition, the group owns 0.69m sq ft of luxury
residential properties in Hong Kongs Mid-Levels, and has a 24.7% stake in Grand Gateway 66,
one of the largest and most prominent mixed commercial-property complexes in Shanghai.
165
Hysan: share buybacks Hysan: half-yearly turnover by segment

Period No. of shares Avg price Total amount % of issued (HKDm)
bought (m) (HKD) (HKDm) shares 2,000
2015 6.8 31.78 214.5 0.64%
1H16 11.7 31.01 363.7 1.12% 146 139 139 135
1,500 142 145
2H16 0.9 34.37 29.6 0.08% 155 145
Total 18.5 31.29 578.3 1.84% 163 618 625 635 657
561 575
532 553
1,000 165 474
153 160
434
404 416
500 893 908 950 952 986 983
740 844 834
382 407 510
0
1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 2H15 1H16 2H16
Retail Office Residential
Source: Company, HKEx, Daiwa Source: Company
Hysan: DPS history Hysan: dividend yield history

(HKD) (%)
1.6 7
1.4 Avg since 2003:
6 2.9%
1.2
5
1.0 +2SD
4 +1SD
1.09
1.07
0.8
1.00
0.95
0.6 3 Average
0.78
0.64
0.60
0.54
0.54
0.4 2
2007 0.12 0.48
-1SD
2006 0.10 0.40
2005 0.10 0.35
2000 0.11 0.31
2004 0.10 0.30

2001 0.100.28
2002 0.100.27
2003 0.100.27
0.2 1 -2SD
2016 0.26
2015 0.25
2014 0.23
2013 0.22
2012 0.17
2011 0.15
2008 0.14
2009 0.14
2010 0.14
0.0
0
Dec-09
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
1H 2H
Source: Company Source: Company, Bloomberg, Daiwa
Hysan: price/NAV Hysan: PBR

(Disc)/prem (%) (x)
10%
Hysan PBR
Current NAV disc: -45.3% 1.4 Current PBR: 0.56x
0%
1.2
(10%)
(20%) 1.0
+1SD: -28.3%
(30%) +1SD: 0.76x
0.8
(40%) Average since
(50%) 1991: -43.4% 0.6
(60%)
-1SD: -58.5% 0.4 -1SD: 0.47x
(70%) Average since
(80%) 0.2 1990: 0.62x
(90%)
0.0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
166
Link REIT (823 HK)

Link REIT

On the road to becoming a premier global REIT

Considerable room for value creation in its Hong Kong portfolio Jonas Kan, CFA
(852) 2848 4439
Achieved returns from China assets and new investments are key jonas.kan@hk.daiwacm.com
Credentials to become a premier global REIT. Reaffirming Buy (1)
look at LINK REIT in the context of our view on the longer-term Year to 31 Mar 17E 18E 19E
development of the Hong Kong property market. Revenue change - - -
Net-property-income chg - - -
DPU change - - -
What's the impact: Considerable room for value creation in Link Source: Daiwa forecasts
REITs Hong Kong portfolio. Link REIT is the largest retail landlord in
Hong Kong by GFA, and we believe Hong Kong needs more retail space to Share price performance
accommodate more new retailers (most are likely to be mid-range), (HKD) (%)
especially the creative ones. In our view, it would be hard to find the space 60 120
in the citys traditional retail hubs to meet such demand. An upgrading of 56 114
Link REITs portfolio as well as many other suburban malls could be 52 108
48 101
one way to capitalise on the related opportunities. We see Link REIT as 44 95
having been riding on this trend for many years, and we believe the trend Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
will continue and even accelerate in the coming years. Link REIT (LHS) Relative to HSI (RHS)
Past investments are on track to provide returns in the coming years, 12-month range 44.85-58.30
including a growing number of malls where asset enhancement initiatives Market cap (USDbn) 15.23
have been completed, as well as new rental properties in China and new 3m avg daily turnover (USDm) 29.21
projects in Kowloon East and Mongkok. We would see it as step forward for Major shareholder BlackRock, Inc (7.1%)
Link REIT if it can show that it can deliver respectable returns from these
investments. We believe there is considerable room in value creation for Financial summary (HKD)
mid-tier commercial property assets in Hong Kong and prime commercial Year to 31 Mar 17E 18E 19E
properties in major cities in China asset classes that Link has been Revenue (m) 9,427 10,306 11,282
Net property income (m) 7,103 7,912 8,633
positioning itself for. Distribution (m) 5,151 5,777 6,366
DPU 2.302 2.581 2.845
Potential to be seen as premier global REIT. Link REITs DPU has risen DPU change (%) 11.6 12.2 10.2
Daiwa vs Cons. DPU (%) 3.5 8.3 12.0
at a CAGR of 13.2% since its IPO in 2005. In terms of its DPU growth DPU yield (%) 4.4 4.9 5.4
record, scale and other factors, we believe Link REIT has the credentials to PER (x) 23.0 20.5 18.6
be recognised as a premier global REIT over time. Indeed, we think it has Core EPU (fully-diluted) 2.302 2.581 2.845
P/BV (x) 0.9 0.9 0.9
done much of the groundwork already, and what remains to be done is to ROE (%) 4.0 4.5 5.0
prove its ability to add value to property assets through management and Source: FactSet, Daiwa forecasts
create value through savvy acquisition and investments.
What we recommend: We reaffirm our Buy (1) rating and 10-year DDM-
derived 12-month TP of HKD61.60, which corresponds to FY17E and
FY18E DPU yields of 3.7% and 4.2%, respectively. The key risk: a major
deterioration in the Hong Kong economy.
How we differ: We believe that Link REIT has the potential to be seen as a
premier global REIT that can deliver organic growth that few other REITs
can match. The market may have yet to fully recognise this potential.
Link REIT (823 HK): 24 March 2017
Financial summary
Key assumptions
Year to 31 Mar 2012 2013 2014 2015 2016 2017E 2018E 2019E
Interest cover ratio (x) 8.7 11.0 13.7 16.1 12.3 12.7 13.4 14.7
Interest service ratio (x) 7.9 9.5 11.9 13.8 9.0 9.2 10.1 10.7
Average portfolio cap rate (%) 7.7 6.8 6.5 5.6 5.5 5.8 6.3 6.8
Funds from operations (HKDm) 2,939 3,369 3,851 4,109 4,657 5,175 5,802 6,393
Adj. funds from operations (HKDm) 989 2,473 2,828 3,173 (7,986) 3,805 4,522 2,592

Year to 31 Mar 2012 2013 2014 2015 2016 2017E 2018E 2019E
Total revenue 5,915 6,507 7,155 7,723 8,740 9,427 10,306 11,282
Operating expenses (1,740) (1,870) (1,932) (2,054) (2,227) (2,324) (2,394) (2,649)
Net property income 4,176 4,637 5,223 5,669 6,513 7,103 7,912 8,633
Other income 0 0 0 0 0 0 0 0
Management fees 0 0 0 0 0 0 0 0
Other operating expenses (229) (223) (222) (414) (345) (355) (365) (375)
Depreciation and amortisation (19) (20) (21) (23) (23) (24) (25) (27)
EBIT 3,928 4,394 4,980 5,232 6,145 6,724 7,522 8,231
Net-int. income/(expenses) (455) (402) (365) (327) (502) (531) (565) (561)
Share of associates 0 0 0 0 0 0 0 0
Revaluation gains/(loss) 0 0 0 0 0 0 0 0
Except./other inc./(exp.) 0 (9) (30) 0 (56) 0 0 0
Taxation (552) (634) (755) (819) (953) (1,042) (1,180) (1,304)
Min. int./pref. div./others 0 0 0 0 0 0 0 0
Net profit 2,920 3,349 3,830 4,086 4,634 5,151 5,777 6,366
Total return 2,920 3,349 3,830 4,086 4,634 5,151 5,777 6,366
Adjustments 0 0 0 106 0 0 0 0
Distributable income 2,920 3,349 3,830 4,192 4,634 5,151 5,777 6,366
Distribution rate 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
Distribution 2,920 3,349 3,830 4,192 4,634 5,151 5,777 6,366
EPU (HKD) 1.291 1.464 1.657 1.783 2.062 2.302 2.581 2.845
DPU (HKD) 1.295 1.465 1.657 1.828 2.062 2.302 2.581 2.845
Cash flow (HKDm)

Year to 31 Mar 2012 2013 2014 2015 2016 2017E 2018E 2019E
Net-interest expenses 459 441 393 327 502 531 565 561
Share of associate 0 0 0 0 0 0 0 0
Change in working capital 40 42 50 53 54 56 80 90
Tax paid (528) (422) (469) (535) (586) (670) (750) (820)
Other operating CF items 165 135 79 180 331 402 406 412
Cash flow from operation 3,628 4,199 4,659 4,953 5,911 6,536 7,283 7,940
Capex (1,950) (896) (1,023) (936) (12,643) (1,370) (1,280) (1,310)
Net investment and sale of FA 0 0 0 (2,532) 1,116 106 0 0
Cash flow from investing (1,950) (896) (1,023) (3,468) (11,527) (1,264) (1,280) (1,310)
Change in debt 900 0 0 2,500 0 0 0 0
Equity raised/(repaid) 680 773 761 (956) (2,197) (2,020) 0 0
Distribution paid (2,731) (3,117) (3,561) (4,084) (4,368) (4,892) (5,480) (6,051)
Change in cash (417) 412 680 (1,409) (12,834) (2,342) (195) (156)
168

As at 31 Mar 2012 2013 2014 2015 2016 2017E 2018E 2019E
Cash & cash equivalent 1,712 3,152 2,794 3,448 454 1,661 1,720 2,040
Other current assets 55 121 66 67 3,135 75 78 81
Investment properties 76,672 95,366 109,899 138,383 157,612 163,404 164,286 165,087
Fixed assets 598 572 470 618 1,816 1,833 1,848 1,881
Associates 0 0 0 0 0 0 0 0
Goodwill and intangible assets 0 0 0 0 0 0 0 0
Other long-term assets 0 0 0 316 0 0 0 0
Total assets 79,225 99,423 113,466 143,144 163,452 167,425 168,395 169,560
Short-term debt 0 1,793 2,885 2,017 1,022 1,050 1,080 1,090
Long-term debt 12,595 11,829 9,699 15,130 25,965 29,486 29,710 30,176
Unitholders' funds 62,735 81,642 96,351 118,106 127,387 127,507 128,067 128,627
Minority interests 0 0 0 0 54 85 110 130
Book Value per unit 27.731 35.683 41.694 51.535 56.678 56.974 57.224 57.474
Key ratios (%)

Year to 31 Mar 2012 2013 2014 2015 2016 2017E 2018E 2019E
Total revenue (YoY) 10.5 10.0 10.0 7.9 13.2 7.9 9.3 9.5
Net property income (YoY) 14.6 11.0 12.6 8.5 14.9 9.1 11.4 9.1
Net profit (YoY) 18.8 14.7 14.4 6.7 13.4 11.2 12.2 10.2
Distribution (YoY) 18.0 14.7 14.4 9.5 10.5 11.2 12.2 10.2
EPU (YoY) 17.2 13.4 13.2 7.6 15.6 11.6 12.2 10.2
DPU (YoY) 17.2 13.1 13.2 10.3 12.8 11.6 12.2 10.2
ROE 5.0 4.6 4.3 3.8 3.8 4.0 4.5 5.0
ROA 3.9 3.7 3.6 3.2 3.0 3.1 3.4 3.8
ROCE 5.6 5.2 4.9 4.3 4.2 4.3 4.7 5.2
ROIC 4.7 4.4 4.1 3.6 3.4 3.5 3.8 4.2
Debt to asset 13.7 10.5 8.6 9.6 16.2 17.2 17.3 17.2
Company profile
Link REIT was the first REIT listed in Hong Kong, and is by far the largest in terms of portfolio size.
Its portfolio comprises 174 properties and car parks, all of which are located near the homes of
some 40% of Hong Kongs population. Currently, it has a retail portfolio with an internal floor area of
11m sq ft and a gross floor area of 19m sq ft. In addition, it has about 76,000 car-parking spaces.
Since the beginning of 2015, it has acquired 2 property assets in China, 1 in each of Beijing and
Shanghai.
169
Link REIT: DPU yield and US 10-year Treasury yield Link REIT: implied DPU yield based on different unit price
(%) Unit price (HKD) FY17E FY18E FY19E
8 53.0 4.3% 4.9% 5.4%
7 52.5 4.4% 4.9% 5.4%
52.0 4.4% 5.0% 5.5%
6
+1SD: 5.20% 51.5 4.5% 5.0% 5.5%
5 Average: 4.56% 51.0 4.5% 5.1% 5.6%
4 50.5 4.6% 5.1% 5.6%
-1SD: 3.92% 50.0 4.6% 5.2% 5.7%
3 49.5 4.7% 5.2% 5.7%
2 49.0 4.7% 5.3% 5.8%
1 48.5 4.7% 5.3% 5.9%
48.0 4.8% 5.4% 5.9%
Nov 05
Nov 06
Nov 07
Nov 08
Nov 09
Nov 10
Nov 11
Nov 12
Nov 13
Nov 14
Nov 15
Nov 16
47.5 4.8% 5.4% 6.0%
47.0 4.9% 5.5% 6.1%
Link REIT DPU yield US 10Y Treasury yield 46.5 5.0% 5.6% 6.1%
46.0 5.0% 5.6% 6.2%
45.5 5.1% 5.7% 6.3%
45.0 5.1% 5.7% 6.3%
Source: Link REIT, Datastream, Daiwa Source: Daiwa estimates and forecast
Link REIT: yield spread (DPU yield vs. US 10-year Treasury Link REIT: yield spread (DPU yield vs. Hong Kong 10-year EFN
yield) yield)
(%) (%)
8 8
6 6
4 4
Average: 1.57% Average: 2.20%
2 2
0 0
-2 -2
Nov 10
Nov 05
Nov 06
Nov 07
Nov 08
Nov 09
Nov 11
Nov 12
Nov 13
Nov 14
Nov 15
Nov 16
Nov 06
Nov 10
Nov 05
Nov 07
Nov 08
Nov 09
Nov 11
Nov 12
Nov 13
Nov 14
Nov 15
Nov 16
Source: Link REIT, Datastream, Daiwa Source: Link REIT, Datastream, Daiwa
Link REIT: DPU yield history Link REIT: unit buybacks

(% ) Period No. of units Avg price Total cost % of issued
(Yr to Mar) bought (m) (HKD) (HKDm) units
8 FY15 19.9 45.80 913 0.9%
FY16 50.2 43.74 2,197 2.2%
7
FY17 (to Feb) 31.7 53.46 1,697 1.4%
6 Total 101.9 47.17 4,807 4.5%
+1SD: 5.20%
5 Average: 4.56%
4
-1SD: 3.92%
3
2
Nov 05
Nov 06
Nov 07
Nov 08
Nov 09
Nov 10
Nov 11
Nov 12
Nov 13
Nov 14
Nov 15
Nov 16
Source: Link REIT, Datastream, Daiwa Source: Company, HKEx, Daiwa
Link REIT: annual DPU Link REIT: rent-to-sales ratio

(HKD)
16% 14.1%14.6%
2.4
14%
FY07 - FY16 CAGR = 13.2% 11.6%11.9% 11.7%12.0%
2.0 12% 9.9% 10.1%
1.6 10%
8%
1.2
6%
0.8 4%
2%
0.4
0%
0.0 Food & Beverage Supermarkets & General Retail Overall
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Foodstuff
1H 2H FY16 1H FY17
Source: Link REIT, Daiwa Source: Link REIT
170
SHK Properties (16 HK)

SHK Properties

Likely to be a big winner in Hong Kong and Shanghai

Could be a big winner in all property segments, in our view Jonas Kan, CFA
(852) 2848 4439
Likely to emerge as a strong player in Shanghai commercial property jonas.kan@hk.daiwacm.com
Reiterating our Buy (1) rating and target price of HKD136.50
look at SHK Properties (SHKP) in the context of our view on the longer- Year to 30 Jun 17E 18E 19E
term development of the Hong Kong property market.
What's the impact: Likely to be a big winner in Hong Kong residential Source: Daiwa forecasts
property. SHKP was very active in landbanking during 2010-15, ie, before
2016, when land prices were bid up by newcomers. This has resulted in Share price performance
SHKP having by far the largest residential landbank in Hong Kong, which (HKD) (%)
includes several major urban areas that have the credentials to be 125 115
marketed as luxury or super-luxury projects, in our view. Moreover, we 115 109
105 103
believe SHKP will be the largest winner from Yuen Longs potential 95 96
emergence as a middle-class location, as the group has a substantial 85 90
amount of low-cost landbank in the area. Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
SHKP (LHS) Relative to HSI (RHS)
Also a big winner from suburban malls, given that SHKP owns several
of the top suburban malls in the New Territories. Meanwhile, besides IFC in 12-month range 86.25-120.90
Hong Kong, SHKP owns many offices in emerging office locations such as Market cap (USDbn) 42.83
Cheung Sha Wan, Kwai Chung, Wong Chuk Hang, which we believe will
continue to see their capital values running ahead of their rentals. Thus, we Major shareholder Kwok family (47.0%)
believe that SHKP could be a big winner in the emerging office sector if it
actively pursues opportunities to realise the NAVs of these assets. Further, Financial summary (HKD)
we believe SHKP has the assets and projects (over 15m sq ft) to become Year to 30 Jun 17E 18E 19E
one of the largest players in the Shanghai commercial property market. Revenue (m) 108,965 114,325 119,652
Net profit (m) 28,170 31,400 34,980
Scope to further modernise capital management. Our read is that Core EPS (fully-diluted) 9.731 10.846 12.083
SHKPs dividend payments are yet to reflect fully the big harvest it is EPS change (%) 16.5 11.5 11.4
reaping in the realm of commercial property. As such, we believe the Daiwa vs Cons. EPS (%) 10.8 14.4 23.5
PER (x) 11.8 10.6 9.5
company has an ability to deliver sustained growth in DPS over FY17-19E. Dividend yield (%) 3.7 4.1 4.4
More importantly, if it can actively pursue opportunities to realise NAVs for DPS 4.300 4.700 5.000
non-core and replaceable assets and use the proceeds to raise DPS or buy PBR (x) 0.7 0.7 0.6
EV/EBITDA (x) 8.3 7.5 6.8
back shares (or both), the currently large discount of its share price to its
ROE (%) 5.9 6.4 6.8
NAV could narrow, in our view.
What we recommend: We reaffirm our Buy (1) call and 12-month target
NAV of HKD195/share. Key risk: a major deterioration in the HK economy.
How we differ: SHKP has been derated in recent years, but its rental and
property sales business has already entered a harvesting period and we
believe the stock will see a rerating once the company demonstrates its
commitment to improve capital management. However, this may have yet
to be recognised by the market.
SHK Properties (16 HK): 24 March 2017
Financial summary
Key assumptions
Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Rental EBIT (HKDm) 11,069 12,236 14,272 15,352 16,481 17,664 18,970 20,048
28.3 28.6 28.7 28.8 29.4 29.4 29.4 29.4
9.4 9.5 9.5 11.6 14.3 15.2 16.1 17.0
properties in China (m sq ft)

Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales 37,032 20,060 36,330 21,704 43,356 47,260 49,935 53,258
Rental income 14,444 16,019 18,489 19,681 21,036 22,559 24,166 25,539
Other Revenue 24,585 17,714 20,281 25,398 37,354 39,146 40,224 40,855
Total Revenue 76,061 53,793 75,100 66,783 101,746 108,965 114,325 119,652
Other income 532 985 1,009 594 763 1,120 1,180 1,210
COGS (43,894) (27,013) (43,565) (36,597) (65,768) (68,807) (70,424) (71,345)
SG&A (1,361) (1,132) (1,200) (1,272) (1,320) (1,380) (1,420) (1,465)
Net-interest inc./(exp.) (1,532) (2,176) (2,339) (2,180) (2,418) (2,380) (2,325) (2,310)
Pre-tax profit 28,088 22,421 26,855 25,130 30,765 35,211 38,954 43,329
Tax (5,896) (3,454) (4,773) (4,880) (6,073) (6,506) (7,008) (7,797)
EPS (reported)(HKD) 8.435 7.245 8.018 7.070 8.349 9.731 10.846 12.083
EPS (adjusted)(HKD) 8.435 7.245 8.018 7.070 8.349 9.731 10.846 12.083
DPS (HKD) 3.350 3.350 3.350 3.350 3.850 4.300 4.700 5.000
EBIT 29,620 24,597 29,194 27,310 33,183 37,591 41,279 45,639
EBITDA 31,041 26,321 31,024 29,178 35,086 39,546 43,300 47,687
Cash flow (HKDm)

Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Depreciation and amortisation 1,421 1,724 1,830 1,868 1,903 1,955 2,021 2,048
Tax paid (2,606) (3,496) (4,020) (4,160) (4,430) (4,790) (4,920) (4,960)
Other operational CF items 1,889 2,392 2,679 2,620 2,958 3,008 3,085 3,145
Capex (26,206) (9,673) (33,630) (16,431) (29,003) (22,250) (25,680) (25,720)
Other investing CF items (425) (430) (450) (460) (470) (490) (512) (514)
Net share issues/(repurchases) 0 0 0 11,185 10,000 0 0 0
Dividends paid (8,610) (3,353) (8,948) (9,850) (10,860) (11,925) (12,125) (12,703)
Other financing CF items (1,349) (2,471) (2,680) (2,780) (2,565) (2,370) (2,370) (2,400)
Change in cash (4,391) 8,769 (17,044) 14,632 (142) 29 209 4,037
Free cash flow 5,992 15,023 (4,966) 16,537 3,753 14,814 15,216 19,654
172

As at 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Inventory 10,452 10,825 1,046 294 596 2,650 2,720 2,720
Fixed assets 257,324 286,564 307,112 334,826 343,905 346,833 360,217 363,193
Total assets 467,570 512,896 557,048 604,110 614,515 637,387 656,327 670,050
Short-term debt 9,801 8,060 9,241 10,816 17,486 10,120 10,030 9,030
Long-term debt 61,465 56,570 74,490 72,316 63,275 75,349 76,125 73,088
Share capital 1,308 1,335 1,335 1,335 70,384 70,384 70,384 70,384
EV 344,449 331,878 349,156 332,024 328,343 327,950 326,671 322,646
Net debt/(cash) 56,928 48,159 65,203 50,571 50,713 50,684 50,475 46,438
BVPS (HKD) 134.848 150.160 155.291 160.851 161.902 167.720 173.833 179.947
Key ratios (%)

Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) 21.6 (29.3) 39.6 (11.1) 52.4 7.1 4.9 4.7
EBITDA (YoY) 2.8 (15.2) 17.9 (6.0) 20.2 12.7 9.5 10.1
Operating profit (YoY) 2.8 (17.0) 18.7 (6.5) 21.5 13.3 9.8 10.6
Net profit (YoY) 0.9 (14.1) 15.0 (7.4) 21.9 16.5 11.5 11.4
Core EPS (fully-diluted) (YoY) 0.9 (14.1) 10.7 (11.8) 18.1 16.5 11.5 11.4
EBITDA margin 40.8 48.9 41.3 43.7 34.5 36.3 37.9 39.9
ROAE 6.6 5.1 5.3 4.6 5.3 5.9 6.4 6.8
ROAA 4.9 3.8 4.0 3.4 4.0 4.5 4.9 5.3
ROCE 7.5 5.6 6.1 5.2 6.1 6.6 7.0 7.6
ROIC 6.1 4.9 5.2 4.4 5.2 5.7 6.1 6.6
Current ratio (x) 3.7 3.3 4.1 3.5 3.4 4.3 4.4 4.7
Free cash flow yield 1.8 4.5 n.a. 5.0 1.1 4.5 4.6 5.9
Company profile
SHK Properties is currently one of the two largest property companies in Hong Kong, with
substantial investments in the residential, office and retail property sectors of Hong Kong. It also
has a total landbank of 50m sq ft in the territory. In recent years, it has been expanding into China,
with major investments in the commercial property sector in Shanghai and a landbank of about 70m
sq ft in the country.
173
SHKP: DPS record Hong Kong: development landbank

(HKD) (m sq ft)
5 18
16
4
14
3 12
10
2
8 old buildings
1 6 with >80%
ownership
0 4
FY05
FY12
FY00
FY01
FY02
FY03
FY04
FY06
FY07
FY08
FY09
FY10
FY11
FY13
FY14
FY15
FY16
FY17
2
0
1H 2H SHK Properties CK Property Henderson Land Sino Land
Source: Company Source: Companies, Daiwa
SHKP: price/NAV trend SHKP: PBR trend

(Disc)/prem (%) SHKP (disc)/prem to NAV PBR (x) SHKP PBR
40%
Current: -42.0% 2.5
Current PBR: 0.68x
20% +2SD
2.0 +2SD: 1.82x
0% +1SD
+1 SD: 1.49x
1.5
(20%)
(40%) 1.0
-1SD
-1 SD: 0.84x
(60%) 0.5
-2SD average since -2SD: 0.52x
Avg since 1990: 1990: 1.17x
(80%) -29.0% 0.0
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
SHKP: gross rental income SHKP: total dividend vs. gross rental income
(HKDm) (HKDm)
25,000 25,000 100%
20,000 20,000 80%
15,000 15,000 60%
10,000 40%
10,000
5,000 20%
5,000
0 0%
0
FY07
FY14
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY08
FY09
FY10
FY11
FY12
FY13
FY15
FY16
FY95
FY98
FY01
FY96
FY97
FY99
FY00
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
1H FY17
Gross rental income

Total dividend
Total dividend / Gross rental income (RHS)
Source: Company Source: Company, Daiwa
SHKP: Hong Kong residential GFA completion SHKP: Hong Kong property sales profit
(m sq ft) (HKDm)
FY17E-FY19E
5.0 16,000
avg = 3.6 m sq ft
14,000
4.0
12,000
FY10-FY16 avg = 2.1 m sq ft
3.0 10,000
8,000
2.0 6,000
4,000
1.0
2,000
0.0 0
FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 1H FY17
Source: Company Note: E = company guidance Source: Company
174
Sino Land (83 HK)

Sino Land

Share price (22 Mar): HKD13.84 | Up/downside: -2.5%
Waiting for its longer-term strategy to be revealed

Appears to have been in a defensive mode so far; strategy not yet Jonas Kan, CFA
(852) 2848 4439
clear
Much depends on how it manages the landbank challenge jonas.kan@hk.daiwacm.com
Maintaining our Hold (3) rating and TP of HKD13.50
What's new: We have examined Sino Lands position in the context of our Forecast revisions (%)
overall review of the Hong Kong property sectors prospects for growth. Year to 30 Jun 17E 18E 19E
What's the impact: Yet to come out with a clear strategy for long-term Core EPS (FD) change - - -
growth. Our read is that there is not much visibility on Sino Lands long- Source: Daiwa forecasts
term growth strategy, as the group seems to have been in wait-and-see
mode in recent years. In terms of its financial position, we believe Sino Share price performance
Land has never been stronger. However, it remains to be seen how it is (HKD) (%)
going to deploy its surplus cash and how it will carve out its long-term 14.5 115
growth strategy. 13.6 108
12.8 100
11.9 93
Does not yet offer major exposure to what we see as the key 11.0 85
opportunities in the industry in the coming years. Based on the assets Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
Sino Land owns today, we expect Tuen Mun Plaza Mall to stay as one of Sino Land (LHS) Relative to HSI (RHS)
the best prime suburban malls in Hong Kong. Further, we look for the
groups Kwun Tong redevelopment project to benefit from what we see as 12-month range 11.14-14.34
the forthcoming transformation of Kowloon East. But other than these, we Market cap (USDbn) 10.62
do not see Sino Land offering strong exposure to the opportunities we 3m avg daily turnover (USDm) 10.43
expect to emerge in the Hong Kong property over the coming years. Major shareholder Tsimshatsui Properties (52.1%)
Much depends on how it handles the competitive threat in residential Financial summary (HKD)
property; capital management is a wild card. We note that historically, Year to 30 Jun 17E 18E 19E
public land auctions and tenders have been the principal source of its Revenue (m) 13,568 18,220 18,356
landbank, and hence the arrival of Mainland players likely presents it with a Net profit (m) 5,360 5,670 5,950
challenge. That said, similar to all other major property companies in Hong Core EPS (fully-diluted) 0.899 0.951 0.998
Kong, Sino Land is asset-rich and owns many non-core assets which it can EPS change (%) 0.2 5.8 4.9
Daiwa vs Cons. EPS (%) 7.3 15.2 26.5
dispose down the line. Also, we believe the capital market would welcome PER (x) 15.4 14.5 13.9
any potential move by Sino Land to use its surplus cash to pay a higher Dividend yield (%) 3.6 3.8 3.9
dividend and buyback shares before it can identify attractive opportunities DPS 0.500 0.520 0.540
PBR (x) 0.7 0.6 0.6
in the market. Disposal of non-core and replaceable assets to realise NAV
EV/EBITDA (x) 10.3 7.9 8.0
should also be welcomed by investors, in our view, especially if this ROE (%) 4.3 4.5 4.6
translates into a higher dividend or share buyback (or both). Source: FactSet, Daiwa forecasts
What we recommend: We maintain our Hold (3) rating and 12-month TP

of HKD13.50, based on an unchanged 40% discount applied to our end-
2017E NAV of HKD22.50. Key upside/downside risks: successful
acquisition of several large pieces of prime sites at attractive prices/
inability to replenish its landbank at attractive prices.
How we differ: How well Sino Land can address its landbank
replenishment issue and whether it can achieve progress in capital
management are central to the prospects for its share price performance, in
our view.
Sino Land (83 HK): 24 March 2017
Financial summary
Key assumptions
Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Rental EBIT (HKDm) 2,558 2,791 3,014 3,195 3,420 3,590 3,720 3,890
10.1 9.9 10.0 10.0 10.2 10.2 10.3 10.3

Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales 4,279 3,359 2,741 16,957 5,761 8,308 12,840 12,768
Rental income 2,569 2,569 2,757 2,863 2,963 3,140 3,195 3,320
Other Revenue 1,548 1,891 1,953 2,019 2,080 2,120 2,185 2,268
Total Revenue 8,396 7,819 7,451 21,839 10,804 13,568 18,220 18,356
Other income 757 622 1,268 130 91 96 97 99
COGS (3,217) (3,401) (2,340) (16,038) (6,070) (8,421) (11,985) (12,045)
SG&A (793) (809) (866) (862) (895) (998) (1,020) (1,035)
Net-interest inc./(exp.) 117 238 135 298 295 (135) (138) (140)
Assoc/forex/extraord./others 1,977 3,600 1,638 2,030 1,981 3,406 2,711 2,948
Pre-tax profit 6,396 7,211 6,425 6,531 6,005 6,632 6,997 7,292
Tax (1,050) (538) (1,281) (1,126) (594) (1,210) (1,263) (1,275)
EPS (reported)(HKD) 0.907 1.123 0.843 0.890 0.898 0.899 0.951 0.998
EPS (adjusted)(HKD) 0.907 1.123 0.843 0.890 0.898 0.899 0.951 0.998
DPS (HKD) 0.460 0.500 0.500 0.500 0.500 0.500 0.520 0.540
EBIT 4,302 3,373 4,652 4,203 3,729 3,361 4,424 4,484
EBITDA 4,346 3,419 4,698 4,251 3,779 3,413 4,477 4,538
Cash flow (HKDm)

Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Tax paid (480) (512) (525) (540) (560) (580) (595) (620)
Other operational CF items (2,055) (2,294) (633) (2,408) (1,496) (2,491) (1,653) (1,873)
Capex (6,709) (4,520) (4,530) (4,620) (4,950) (6,650) (6,420) (6,680)
Dividends paid (365) (410) (450) (490) (540) (565) (590) (598)
Change in cash 2,423 5,376 4,944 7,287 9,342 (2,554) (996) (1,139)
Free cash flow 3,881 6,924 6,594 8,852 10,883 (917) 692 582
176

As at 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Inventory 1,519 966 1,618 4,386 1,130 1,150 1,190 1,198
Accounts receivable 2,520 835 1,117 2,701 1,350 1,410 1,450 1,465
Fixed assets 54,873 57,925 59,768 62,955 61,297 68,056 70,401 71,722
Total assets 113,137 129,263 136,928 141,803 149,058 151,629 156,279 162,141
Short-term debt 1,847 4,553 121 801 0 0 0 0
Long-term debt 7,824 5,640 7,920 5,239 4,442 3,136 4,580 7,144
Share capital 5,912 5,948 5,980 6,010 6,150 6,290 6,430 6,570
Minority interests 686 1,179 1,284 468 542 1,320 1,350 1,375
EV 64,987 52,731 47,995 42,557 33,289 35,210 35,266 36,194
Net debt/(cash) 3,949 (1,427) (6,371) (13,659) (23,000) (20,446) (19,450) (18,311)
BVPS (HKD) 15.323 17.728 18.736 19.892 20.492 20.915 21.369 21.851
Key ratios (%)

Year to 30 Jun 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) 41.3 (6.9) (4.7) 193.1 (50.5) 25.6 34.3 0.7
EBITDA (YoY) 46.6 (21.3) 37.4 (9.5) (11.1) (9.7) 31.2 1.4
Operating profit (YoY) 47.2 (21.6) 37.9 (9.7) (11.3) (9.9) 31.6 1.4
Net profit (YoY) 20.7 24.9 (24.3) 5.6 0.9 0.2 5.8 4.9
EBITDA margin 51.8 43.7 63.1 19.5 35.0 25.2 24.6 24.7
ROAE 6.2 6.8 4.6 4.6 4.4 4.3 4.5 4.6
ROAA 4.8 5.5 3.8 3.8 3.7 3.6 3.7 3.7
ROCE 4.4 3.1 3.9 3.4 3.0 2.6 3.4 3.3
ROIC 4.0 3.1 3.5 3.3 3.3 2.7 3.4 3.3
Net debt to equity 4.4 n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Current ratio (x) 4.8 3.1 4.2 4.0 3.3 2.9 3.0 3.2
Net interest cover (x) n.a. n.a. n.a. n.a. n.a. 24.9 32.1 32.0
Free cash flow yield 4.7 8.4 8.0 10.7 13.2 n.a. 0.8 0.7
Company profile
Sino Land is one of the largest property companies in Hong Kong. It focuses mainly on the
residential-property sector, and also has investments in the retail and office property sectors in
Hong Kong. In addition, the company has hotel and commercial-property investments in Singapore
and China.
177
Sino Land: phases of development and share performance Sino Land: growth in rental income
(HKD) (HKDm)
Ph. IV
30 4,500
3,684 3,834
25 4,000
Ph. III 3,451
3,500 3,185
20 2,936
3,000 2,642
2,265 2,397
15 Ph. I Ph. II 2,500
1,915 1,958
10 2,000
1,500
5
1,000
0 500
Mar-90
Mar-91
Mar-92
Mar-93
Mar-94
Mar-95
Mar-96
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Mar-14
Mar-15
Mar-16
0
FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 1H FY17
Source: Bloomberg, Daiwa Source: Company

Note: Ph. I (pre-2000): an outsider trying to break in to the Hong Kong property industry
Ph. II (2000-04): actively strengthened its residential landbank in Hong Kong
Ph. III (2004-07): a re-rating phase underpinned by the fruition of projects from land
acquired during 2000-02
Ph. IV (2007-now): a phase for deploying cash from property sales to replenish its
landbank
Sino Land: price/NAV trend Sino Land: PBR trend

(Disc)/prem (%) Sino Land (disc)/prem to NAV PBR (x) Sino Land PBR
40% Current: -39.6% 3.0
Current PBR: 0.64x
20% 2.5
0% 2.0
(20%) +1SD: -24.0% +1SD: 1.40x
1.5
Avg since 2004:
(40%) -39.1% 1.0 average since
2004: 0.98x
(60%) -1SD: -54.2% 0.5 -1SD: 0.56x
(80%)
0.0
Jan 07
Jan 09
Jan 10
Jan 04
Jul 04
Jan 05
Jul 05
Jan 06
Jul 06
Jul 07
Jan 08
Jul 08
Jul 09
Jul 10
Jan 11
Jul 11
Jan 12
Jul 12
Jan 13
Jul 13
Jan 14
Jul 14
Jan 15
Jul 15
Jan 16
Jul 16
Jan 17
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: Datastream, Daiwa estimates Source: Company, Datastream, Daiwa
Sino Land: land purchases from the government in Hong Kong since 2011
Award Total GFA Market estimated price Achieved price
date Usage Location Methods Winning bidder(s) (sq ft) (HKDm) (HKD/sf) (HKDm) (HKD/sf)
9-Aug-11 Resi Area 56A (site A), Kau To, Shatin Auction Kerry (40%) / Sino (40%) / 1,031,471 7,220-9,270 7,000-8,990 5,500 5,332
Manhattan (20%)
16-Dec-11 Resi Mui Wo, Lantau Tender Sino Land 49,407 84-173 1,700-3,500 55 1,113
1-Mar-12 Resi Lot No.676, Peng Lei Rd, Peng Chau Tender Sino Land 36,845 37-92 1,000-2,500 19 516
28-Sep-12 Resi Area 66C2, Tseung Kwan O Tender Sino Land (60%) / K.Wah (40%) 486,565 2,000-2,530 4,110-5,200 2,285 4,696
28-Sep-12 Resi Tung Wan (Site B), Peng Chau Island Tender Sino Land 14,372 17-25 1,200-1,730 31 2,157
17-Oct-12 Resi Long Ping Station (North), Yuen Long Tender Sino Land (40%) / K.Wah (60%) 523,938 1,572-1,886 3,000-3,600 1,708 3,260
9-Jan-13 Resi Sha Kok Mei, Sai Kung Tender Sino Land 249,133 997-2,240 4,000-9,000 1,455 5,840
18-Sep-13 Resi Sik On Street, Wanchai Tender Sino Land 11,195 78-112 7,000-10,000 140 12,500
6-Nov-13 Resi Hong Tsuen Rd, Sai Kung Tuk, Sai Kung Tender Sino Land 173,796 750-835 4,315-4,804 850 4,891
1-Sep-14 Resi Kwun Tong Town Centre Project (Areas 2 & 3), Tender Sino Land (90%) / Chinese 1,853,561 6,000-6,500 9,000-9,700 nd nd
Kwun Tong (URA) Estates (10%)
29-Sep-14 Resi Junction of Luen Hing St, Wo Fung St and Luen Tender Sino Land 209,909 525-693 2,500-3,300 730 3,478
Wo Hui, Fanling
29-Apr-15 Resi Hong Kin Road, Tui Min Hoi, Sai Kung Tender Sino Land 51,592 258-413 5,000-8,000 609 11,804
13-May-15 Comm / Junction of Cheung Yip St, Sheung Yee Rd and Tender Billion Dev (40%) / Sino Land 490,193 2,940-3,190 6,000-6,500 3,039 6,199
Office Wai Yip St, Kowloon Bay (30%) / CSI Prop (30%)
23-Dec-15 Comm Wang Yip St West/ Hong Yip St, Tung Tau Ind Tender Sino Land 497,620 1,493 - 1,742 3,000 - 3,500 1,690 3,396
Area, Yuen Long
12-Jul-16 Resi Fo Yin Road, Pak Shek Kok, Tai Po Tender Sino Land 412,500 1400-1570 3,400-3,800 1,622 3,932
12-Oct-16 Comm / Yip Kan St / Wong Chuk Hang Rd , Wong Chuk Tender Sino Land (60%) / Empire Group 284,945 5,000-8,000 1,425-2,280 2,528 8,872
Office Hang (40%)
25-Oct-16 Resi Kowloon Rd / Kiu Yam St (URA), Sham Shui Po Tender Sino Land 52,571 279-305 5300-5800 nd nd
1-May-17 Resi Peel St / Graham St Project (Site A), Central Tender Sino Land 99,999 1,300-1,500 13,000-15,000 nd nd
(URA)
Source: Hong Kong Economic Times, Lands Department, Daiwa
Note: nd = not disclosed
178
Swire Properties (1972 HK)

Swire Properti es

Positioned well in Hong Kong; progressing in China

Could be the big winner in the Hong Kong office sector Jonas Kan, CFA
(852) 2848 4439
Both Pacific Place and Island East are becoming stronger locations jonas.kan@hk.daiwacm.com
Reaffirming Buy (1) rating and target price of HKD32.80
Whats new: We have examined the longer-term growth strategy of Swire Forecast revisions (%)
Properties (SP) in the context of our view on the Hong Kong property Year to 31 Dec 17E 18E 19E
market (discussed in the accompanying sector report).
What's the impact: Could be the largest winner in the Hong Kong Source: Daiwa forecasts
office sector. In our view, Pacific Place is already an integral part of
Central, and the eastward expansion of Pacific Place reflects the Share price performance
deepening of the Central market. We look for this theme to support a (HKD) (%)
sustained uplift in the achieved rents of Pacific Place relative to those of 25 100
core Central. Meanwhile, we believe that SPs USD2bn investment in 24 97
22 94
redeveloping its techno-centres in Island East should serve as a strong 21 91
impetus for Island East to become the second-largest office hub on Hong 19 88
Kong Island. In turn, this process should yield continued upgrades in Island Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
Easts tenant profile and achieved rents in the coming years, in our view. Swire Prop (LHS) Relative to HSI (RHS)
Could virtually own 2 commercial hubs. Both Pacific Place and Island 12-month range 19.74-24.90
East have firmly established themselves as commercial hubs in Hong Market cap (USDbn) 18.19
Kong, in our opinion, and we believe there are emerging factors that will
further strengthen their credentials in the years to come. While Pacific Major shareholder Swire Pacific (82.0%)
Place Mall does face challenges, we do not believe these are
insurmountable; indeed, we believe the worst is probably over for the mall. Financial summary (HKD)
Moreover, we see considerable room for improvement in the retail aspect of Year to 31 Dec 17E 18E 19E
Island East and believe that Tung Chung could in time become a more Revenue (m) 19,086 19,613 14,359
important area for retail. Overall, we caution against under-estimating SPs
Net profit (m) 8,310 8,770 7,860
potential in Hong Kong retail. Core EPS (fully-diluted) 1.420 1.499 1.344
EPS change (%) 16.8 5.5 (10.4)
China potential seems to be overlooked. As we see it, SP has made Daiwa vs Cons. EPS (%) 1.5 17.7 4.2
PER (x) 17.0 16.1 18.0
considerable progress with its China projects, and it has several projects in Dividend yield (%) 3.1 3.3 3.3
the pipeline that will likely further enhance its presence in Chinas DPS 0.760 0.800 0.800
commercial property sector. Indeed, we contend that the companys China PBR (x) 0.6 0.6 0.6
EV/EBITDA (x) 15.3 15.0 17.2
projects have had a transformational impact on their respective locations
ROE (%) 3.7 3.8 3.3
and the value associated with SPs ability to use large-scale mixed
developments to transform locations is being undervalued by the market.
NAV of HKD46.85. Key risk: major deterioration in the Hong Kong
economy.
How we differ: We believe the market may have unduly penalised SP for
its exposure to Pacific Place Mall and overlooked the fact that offices
account for a much larger portion of its earnings and NAV while its China
investments look to be progressing well.
Swire Properties (1972 HK): 24 March 2017
Financial summary
Key assumptions
Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Completed investment properties in HK
13.2 13.4 13.6 13.6 13.6 13.6 14.6 14.6
(m sq ft)
Blended average rent in Pacific Place
66.0 65.9 71.0 76.7 82.1 87.5 90.0 93.0
portfolio (on GFA) (HKD/sq ft)
Blended average rent in Taikoo Place
34.0 35.3 36.9 38.8 39.6 41.0 44.0 46.0
portfolio (on GFA) (HKD/sq ft)
Completed investment properties in
4.7 6.0 6.0 7.0 7.1 8.9 8.9 8.9
China (m sq ft)
Pay-out ratio (%) 50.6 55.2 54.0 58.7 58.4 53.5 53.4 59.6

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Gross rental income 9,015 9,677 10,456 10,716 10,773 11,276 11,841 12,636
Property trading 4,147 2,207 3,842 4,463 4,760 6,502 6,440 369
Other Revenue 890 1,052 1,089 1,268 1,259 1,308 1,332 1,354
Total Revenue 14,052 12,936 15,387 16,447 16,792 19,086 19,613 14,359
Other income 0 0 0 0 0 0 0 0
COGS (3,770) (3,531) (5,176) (5,781) (6,486) (7,308) (7,530) (3,445)
SG&A (873) (974) (1,010) (1,304) (1,122) (1,346) (1,375) (1,380)
Net-interest inc./(exp.) (1,367) (1,447) (1,227) (1,195) (1,119) (1,116) (1,124) (1,082)
Assoc/forex/extraord./others 453 500 505 412 579 658 862 1,001
Pre-tax profit 8,273 7,240 8,222 8,309 8,362 9,679 10,149 9,152
Tax (1,199) (769) (892) (1,209) (1,226) (1,344) (1,353) (1,265)
EPS (reported)(HKD) 1.185 1.087 1.223 1.210 1.216 1.420 1.499 1.344
EPS (adjusted)(HKD) 1.185 1.087 1.223 1.210 1.216 1.420 1.499 1.344
DPS (HKD) 0.600 0.600 0.660 0.710 0.710 0.760 0.800 0.800
EBIT 9,187 8,187 8,944 9,092 8,902 10,137 10,411 9,233
EBITDA 9,409 8,431 9,201 9,362 9,184 10,432 10,708 9,534
Cash flow (HKDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Tax paid (875) (615) (842) (983) (1,049) (1,232) (1,245) (1,185)
Change in working capital 153 167 606 3,003 2,860 1,672 2,225 2,181
Other operational CF items (1,928) 808 1,264 665 336 222 43 (133)
Capex (3,004) (7,398) (7,890) (6,020) (9,064) (8,450) (8,690) (8,750)
Other investing CF items (1,367) (145) (165) (185) (194) (214) (214) (218)
Dividends paid (2,340) (3,393) (3,510) (3,744) (4,154) (4,505) (4,660) (4,660)
Other financing CF items (355) 0 0 0 0 0 (60) 0
Change in cash (1,221) (3,092) (2,058) 1,315 (2,621) (2,533) (2,155) (3,312)
Free cash flow 2,841 446 1,617 5,244 1,727 2,186 2,779 1,566
180

As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Inventory 0 0 0 0 0 0 0 0
Fixed assets 6,837 7,225 7,703 8,052 8,471 8,543 8,585 8,585
Total assets 237,060 251,957 260,355 272,724 281,688 291,118 298,352 305,061
Short-term debt 4,664 7,609 4,201 6,668 7,499 4,569 4,620 4,632
Other current liabilities 710 211 519 1,133 279 1,230 1,256 1,278
Long-term debt 26,197 26,946 32,744 30,474 29,559 36,466 39,048 42,395
Share capital 5,850 5,850 10,449 10,449 10,449 10,449 10,449 10,449
Minority interests 642 800 856 1,702 1,856 1,840 1,895 1,902
EV 155,242 157,212 157,463 155,810 158,165 159,370 160,878 164,197
Net debt/(cash) 28,921 32,034 34,071 32,756 35,377 37,910 40,065 43,377
BVPS (HKD) 32.925 34.590 35.503 36.965 38.525 39.185 39.884 40.428
Key ratios (%)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) 46.7 (7.9) 18.9 6.9 2.1 13.7 2.8 (26.8)
EBITDA (YoY) 51.3 (10.4) 9.1 1.7 (1.9) 13.6 2.6 (11.0)
Operating profit (YoY) 53.2 (10.9) 9.2 1.7 (2.1) 13.9 2.7 (11.3)
Net profit (YoY) 58.6 (8.3) 12.5 (1.0) 0.5 16.8 5.5 (10.4)
Core EPS (fully-diluted) (YoY) 58.6 (8.3) 12.5 (1.0) 0.5 16.8 5.5 (10.4)
EBITDA margin 67.0 65.2 59.8 56.9 54.7 54.7 54.6 66.4
ROAE 3.8 3.2 3.5 3.3 3.2 3.7 3.8 3.3
ROAA 3.0 2.6 2.8 2.7 2.6 2.9 3.0 2.6
ROCE 4.3 3.5 3.7 3.6 3.4 3.8 3.8 3.3
ROIC 3.7 3.2 3.3 3.1 3.0 3.3 3.3 2.9
Current ratio (x) 1.0 0.8 1.1 0.9 0.7 1.0 1.0 1.1
Company profile
Swire Properties is the property arm of Swire Pacific, one of the largest and oldest conglomerates
in Hong Kong. The company is a leading developer, owner, and operator of mixed-use
developments, principally commercial properties in Hong Kong, Mainland China, and the US. At the
end of 2016, it owned some 22.1m sq ft attributable GFA of completed commercial properties and
had a significant presence in 2 locations in Hong Kong: Admiralty (where it has built the Pacific
Place) and Island East (Taikoo Place). Swire Properties was listed on the Hong Kong stock market
in January 2012.
181
Swire Properties in five years Swire Properties: gross rental income from China
Attributable GFA by segment (m sq ft) Attributable GFA by region (m sq ft) (HKDm)
26.5 26.5 3,000
1.4 2.5
22.1 0.9 22.1 2,500
2.5
0.8 1.1
2.3 8.8
7.3 2,000
8.1
7.2
1,500
14.4 12.8
15.2 1,000
11.8
500
Dec 2016 2022E & onwards Dec 2016 2022E & onwards 0
Office Retail 2008 2009 2010 2011 2012 2013 2014 2015 2016
Hotels Residential & SA HK Mainland China USA & others
Under planning
Source: Company Note: E = Swire guidance Source: Company
Swire Properties: PBR since listing Swire Properties: expected attributable GFA of completed
investment properties
PBR (x) (Attri.GFA, m sq ft)
Swire Properties PBR
30
1.0 26.5
24.1 24.1 24.1 25.1
Current PBR: 0.64x 25 22.1 22.8
0.9 21.3
20
0.8 +1SD: 0.75x
15
0.7 average since
10
IPO: 0.67x
0.6
5
-1SD: 0.59x
0.5 0
2015 2016 2017E 2018E 2019E 2020E 2021E 2022E
0.4 onwards
2012 2013 2014 2015 2016 2017
Hong Kong Mainland China US & elsewhere
Source: Company, Datastream, Daiwa Source: Company

Note: As at 31 Dec 2016; E = Swire guidance
Swire Properties: expected attributable GFA of completed Swire Properties: attributable GFA of completed property
property portfolio in Hong Kong portfolio in mainland China
(m sq ft) (m sq ft) Attributable valuation (Investment prop) = HKD42.6bn
16 15.2 10
8.8
15 8.1
1.0 8 1.1 1.7
15 14.2 14.2 14.2
0.8 0.8
14 6 0.9 0.9
1.0 1.0 1.0 1.0
14
12.8 12.8 0.1 0.1 0.1 0.1
4
13 0.2 0.2 0.2 0.2 3.7 3.7
13 12.8 12.8 12.8 12.8 12.8 12.8 2
12 1.5 1.5
0 0.1 0.1
2016 2017E 2018E 2019E 2020E 2021E &
2016 2017E & onwards
onwards
Others Taikoo Li Sanlitun (Beijing)
Existing Portfolio 8-10 Wong Chuk Hang Tung Chung (TCTL 11)
TaiKoo Hui (Guangzhou) INDIGO (Beijing)
One Taikoo Place Two Taikoo Place Sino-Ocean Taikoo Li Chengdu HKRI Taikoo Hui (Shanghai)
Note: As at 31 Dec 2016; E = Swire guidance Note: As at 31 Dec 2016; E = Swire guidance
182
Wharf Holdings (4 HK)

Wharf Hol dings

Harvesting time in sight; unlocking value set in motion

Have made a step forward in capital management, in our view Jonas Kan, CFA
(852) 2848 4439
On track for monetising returns form major past investments in China jonas.kan@hk.daiwacm.com
Reaffirm BUY (1) rating with TP raised to HKD79
What's new: We have examined the position of Wharf in the context of our Forecast revisions (%)
overall view about the longer-term outlook of Hong Kong property. Year to 31 Dec 17E 18E 19E
What's the impact: The initiation of a Strategic Review is an important Core EPS (FD) change - - -
development to note, as we see the very willingness to consider distributing Source: Daiwa forecasts
its investment properties (IP) to shareholders as a positive step in the
capital management of the Hong Kong family property companies. Given Share price performance
that IP is the largest asset and the principal source of earnings of Wharf, (HKD) (%)
we consider the initiation of such Strategic Review as a sign of 70 145
management commitment to look into the issues for the benefit of all 61 133
shareholders even though such review may not necessarily result in any re- 53 120
44 108
distribution of its IP assets. 35 95
Wharfs distribution of IP assets could result in the creation of one of the Wharf Hldg (LHS) Relative to HSI (RHS)
most valuable landlord companies in global property. We note that the
earnings and sales productivity of Wharfs malls rank very high in global 12-month range 39.25-68.80
property market. As such, if it really geos as far as distributing all of them in Market cap (USDbn) 26.55
one-go and lift its pay-out ratio to levels comparable with premier global 3m avg daily turnover (USDm) 32.04
REITs and property companies, we see the potential for this new IP Major shareholder Wheelock and Company (60.0%)
company under Wheelock (20 HK, Not rated) to become one of the most
valuable landlord companies in the world. Meanwhile, if it just distributes Financial summary (HKD)
Plaza Hollywood first as a vehicle to focus on the segment of suburban Year to 31 Dec 17E 18E 19E
malls and possibly outlets, we would see it as modest step forward in terms Revenue (m) 48,180 53,820 59,466
of realising value for all shareholders. Net profit (m) 14,490 15,560 17,140
Risk period appears to be over; harvesting time in sight. Our read on EPS change (%) 5.0 7.4 10.2
Daiwa vs Cons. EPS (%) 3.9 6.6 8.9
Wharfs 2016 results is that the risk period faced by its two malls in Hong PER (x) 14.2 13.3 12.0
Kong could have come to an end, and its IP businesses in China is Dividend yield (%) 3.4 3.7 4.0
gathering momentum. Wharfs previous investments in development DPS 2.300 2.500 2.700
PBR (x) 0.6 0.6 0.6
landbank in China are also getting converted into cash which helped it to
EV/EBITDA (x) 10.9 9.7 8.6
lower the net debt by a further HKD23.4bn in 2016. ROE (%) 4.5 4.7 5.1
What we recommend: We reaffirm our Buy (1) rating. With the worst
period for its retail business behind us, and potential improvement in capital
management and group structure, we raise our 12-month TP to HKD79.0
(from HKD73.3), based on a 30% discount (versus 35% previously) applied
to our unchanged end-2017E NAV of HKD112.70. Key risk: a major
deterioration in the HK & China economies.
How we differ: We believe that the room for investment value to be

unlocked in Wharf share is very significant but this may have yet to be fully
recognised by the market
Wharf Holdings (4 HK): 24 March 2017
Financial summary
Key assumptions
Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Gross rental income (HKDm) 9,880 11,133 13,397 14,470 15,289 15,958 16,822 17,756
Rental EBIT (HKDm) 8,187 9,268 10,896 11,759 12,541 13,258 14,259 15,109
China property sales profit (HKDm) 3,562 2,565 1,669 2,266 4,276 4,965 5,760 6,210
11.7 11.7 12.2 12.2 12.2 12.2 12.2 12.2

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Property sales 12,207 11,514 15,539 18,018 23,275 24,909 29,393 33,802
Rental income 7,229 11,133 13,397 14,470 15,289 15,958 16,822 17,756
Other Revenue 11,420 9,240 9,200 8,387 8,063 7,313 7,605 7,908
Total Revenue 30,856 31,887 38,136 40,875 46,627 48,180 53,820 59,466
Other income 134 358 250 265 455 473 502 515
COGS (14,808) (16,512) (21,589) (23,383) (28,239) (28,832) (32,454) (35,869)
SG&A (550) (934) (738) (790) (850) (890) (902) (930)
Net-interest inc./(exp.) (939) (1,077) (1,701) (1,879) (1,361) (1,192) (1,008) (750)
Assoc/forex/extraord./others 2,114 2,716 (747) 2,108 2,906 2,640 1,978 1,839
Pre-tax profit 15,345 14,918 12,051 15,648 18,132 19,021 20,471 22,751
Tax (3,204) (2,869) (3,081) (3,344) (4,107) (3,991) (4,341) (4,816)
Min. int./pref. div./others (1,101) (751) (494) (772) (225) (540) (570) (795)
EPS (reported)(HKD) 3.645 3.730 2.798 3.806 4.554 4.782 5.135 5.657
EPS (adjusted)(HKD) 3.645 3.730 2.798 3.806 4.554 4.782 5.135 5.657
DPS (HKD) 1.650 1.700 1.810 1.900 2.150 2.300 2.500 2.700
EBIT 14,170 13,279 14,499 15,419 16,587 17,573 19,501 21,662
EBITDA 15,632 14,799 16,059 16,967 17,993 18,931 20,966 23,182
Cash flow (HKDm)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Depreciation and amortisation 1,462 1,520 1,560 1,548 1,406 1,358 1,465 1,520
Tax paid (3,204) (2,869) (2,773) (3,010) (3,696) (3,592) (3,907) (4,334)
Other operational CF items (640) (1,039) 1,115 1,189 (775) (648) (170) (274)
Capex (32,900) (19,120) (19,078) (14,560) (21,325) (18,440) (19,860) (22,156)
Net (acquisitions)/disposals 5,262 302 285 290 9,798 298 302 314
Dividends paid (3,938) (5,149) (5,452) (5,755) (6,058) (6,361) (6,664) (6,967)
Other financing CF items (1,174) (1,346) (2,126) (2,349) (1,701) (1,490) (1,260) (938)
Change in cash (12,160) (2,447) (1,187) 12,054 23,368 4,634 4,888 5,508
Free cash flow (12,290) 3,770 6,134 19,895 21,360 12,219 12,544 13,135
184

As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Inventory 45 47 48 46 29 31 34 38
Fixed assets 251,392 285,258 326,917 332,956 340,033 344,692 350,642 357,695
Total assets 368,998 415,052 444,658 443,916 443,827 448,966 455,366 461,748
Short-term debt 5,330 9,502 8,653 8,463 15,178 8,190 8,130 7,230
Long-term debt 69,090 73,085 69,331 62,244 45,616 48,538 44,645 40,729
Share capital 3,029 3,030 29,376 29,441 29,497 29,497 29,497 29,497
EV 234,019 234,172 232,588 227,444 207,494 205,596 202,880 199,616
Net debt/(cash) 55,625 58,072 59,259 47,197 23,837 19,203 14,315 8,806
BVPS (HKD) 82.041 90.973 100.857 101.560 104.552 107.085 109.822 112.879
Key ratios (%)

Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E
Sales (YoY) 28.5 3.3 19.6 7.2 14.1 3.3 11.7 10.5
EBITDA (YoY) 22.3 (5.3) 8.5 5.7 6.0 5.2 10.7 10.6
Operating profit (YoY) 24.4 (6.3) 9.2 6.3 7.6 5.9 11.0 11.1
Net profit (YoY) 36.6 2.3 (25.0) 36.1 19.7 5.0 7.4 10.2
EBITDA margin 50.7 46.4 42.1 41.5 38.6 39.3 39.0 39.0
ROAE 4.9 4.3 2.9 3.8 4.4 4.5 4.7 5.1
ROAA 3.2 2.9 2.0 2.6 3.1 3.2 3.4 3.7
ROCE 4.6 3.8 3.8 4.0 4.3 4.5 5.0 5.5
ROIC 4.0 3.3 3.0 3.3 3.6 4.0 4.3 4.8
Current ratio (x) 2.2 1.8 1.4 1.3 1.1 1.2 1.2 1.2
Free cash flow yield n.a. 1.8 3.0 9.6 10.4 5.9 6.1 6.4
Company profile
Wharf is one of the largest property investors in Hong Kong, with its two key properties, Harbour
City and Times Square, accounting for more than 60% of its assets and operating profit. In addition
to its investment-property portfolio, the company has investments in ports, as well as the media
sector. In recent years, it has been expanding its investments in China and has a long-term target
of having about half of its assets in Hong Kong and half in the Mainland.
185
Wharf: YoY change in retail sales vs. Hong Kong retail sales Wharf: DPS
Harbour City Times Square HK overall (HKD)
(HKDbn) (YoY) (HKDbn) (YoY) (HKDbn) (YoY) 2.4
2013 1Q 8.5 14.9% 2.3 -4.2% 129.3 13.9%
2Q 7.5 11.9% 2.0 0.0% 123.6 16.1% 2.0
3Q 8.1 8.0% 2.2 0.0% 114.5 7.5%
4Q 9.8 6.5% 2.9 7.4% 127.1 6.8% 1.6
FY 33.8 9.7% 9.4 1.1% 494.4 11.0%
2014 1Q 9.1 7.1% 2.8 21.7% 134.6 4.2% 1.2
2Q 7.7 2.7% 2.4 20.0% 115.0 -7.0%
3Q 8.6 6.2% 2.5 13.6% 116.3 1.6% 0.8
4Q 9.6 -2.0% 2.8 -3.4% 127.3 0.2%
FY 35.0 3.4% 10.5 11.1% 493.2 -0.2% 0.4
2015 1Q 8.6 -5.5% 2.6 -7.1% 131.6 -2.3%
2Q 7.0 -9.1% 2.1 -12.5% 114.0 -0.9% 0.0
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1H 15.6 -7.1% 4.7 -9.6% 245.6 -1.6%
2H 15.1 -17.0% 4.4 -17.0% 229.6 -5.8%
FY 30.7 -12.1% 9.1 -12.8% 475.2 -3.7% Source: Company, Daiwa
2016 1Q 7.0 -18.9% 2 -20.0% 115.2 -12.5% Note: Phase I (1986-96): Growing rental income and property sales profit
2Q 6.3 -9.6% 2 -10.3% 104.6 -8.3% Phase II (1997-2003): Rebuilding its balance sheet after the Asia financial turmoil
1H 13.3 -14.7% 3.9 -15.7% 219.7 -10.5% Phase III (2004-11): Investing in China property
2H 14.4 -4.6% 4.2 -4.5% 216.9 -5.5% Phase IV (2011-16): New China IPs began to contribute
FY 27.7 -9.7% 8.1 -11.0% 436.6 -8.1%
Source: Company, CEIC, Daiwa
Wharf: commercial properties completion schedule (Dec 2016) Wharf: gross rental income from China
(m sq ft) (HKDm)
60
2,500
9.4 11.2
8.9
40 4.1 4.1 2,000
2.7 0.8 2.7 0.8 2.7 0.8 2.7 0.8
2.2 2.2 4.6 6.5 6.5 6.5 Affected by the closure of
2.0 2.0
6.6 7.4 8.2 8.2 8.2 8.2 1,500 Chongqing Times Square Mall
20 3.9
5.7 5.7 5.7 5.7 5.7 5.7 5.7
14.0 14.2 14.2 14.4 14.7 14.7 14.7 1,000

0
2013 2014 2015 2016 2017E 2018E 2019E 500
onwards
HK commercial prop Other China commercial prop Chengdu IFS
0
Chongqing IFS Wuxi IFS Changsha Outlets
2005
2014
2001
2002
2003
2004
2006
2007
2008
2009
2010
2011
2012
2013
2015
2016
Suzhou IFS Changsha IFS

Note: E = companys estimate
Wharf: price/NAV trend Wharf: PBR trend

Wharf (disc)/prem to NAV Wharf PBR
(Disc)/prem PBR (x)
Current NAV disc: -37.0% 1.6
20% Current PBR: 0.66x
10% 1.4
0% 1.2
(10%) +1SD: 0.97x
+1SD: -23.3% 1.0
(20%)
(30%) 0.8
(40%) 0.6 -1SD: 0.55x
(50%)
0.4
(60%) Average since -1SD: -51.4% average since
(70%) 1990: -37.4% 0.2 1990: 0.76x
(80%) 0.0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: Datastream, Daiwa estimates Source: Company, Datastream, Daiwa
186
Our thoughts on possible scenarios related to Wharf's potential distribution of IP assets

Scenario 1 Scenario 2 Scenario 3
A determined move to unlock value for shareholders An in-between approach A test-the-water approach
Details Distributing all IP assets to shareholders A mix of IP assets in HK and/or China Distributing just Plaza Hollywood in Hong Kong
Book value HKD321bn HKD10-321bn HKD10bn
at end-2016
Pros Could potentially create one of the most valuable landlord Could create still a sizeable IP company while retaining Can see how the capital market really responds first before
companies in the world, given that premier global REITs some flexibility on the next move making the final decision on the plan related to its IP assets.
could trade at NAV or even premium to NAV. Shareholders The company could become a vehicle to focus on suburban
of Wharf could will end up owning an asset which malls and possibly outlet malls in China as well.
commands much higher valuation in the capital market
Cons Once decided, it would be irreversible and Wharf will no It may become a neither here nor there scenario. Not as The capital market could be disappointed by the scale of
longer own any IP assets and would not have a strong and impactful as Scenario 1 but at the same time could result distribution; and the disappointment could affect investor
reliable cashflow stream to fund new investments in some confusion on the group's level of commitment and perception on the final distribution of all its other IP assets,
determination. even if this were to happen eventually
Others The lP company's distribution policy needs to be Book value of its HK IP assets at end 2016 was HKD262bn (of
comparable to global REITs if it is to have the potential to which HKD172bn was from Harbour City; HKD55bn was from
command comparable valuation Times Square; HKD10bn was from Plaza Hollywood and
HKD25bn was from others). The corresponding value for its
China IP at end 2016 was HKD59bn.
Source: Daiwa
187
Daiwas Asia Pacific Research Directory

HONG KONG SOUTH KOREA
Takashi FUJIKURA (852) 2848 4051 takashi.fujikura@hk.daiwacm.com Sung Yop CHUNG (82) 2 787 9157 sychung@kr.daiwacm.com
Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles;
Jiro IOKIBE (852) 2773 8702 jiro.iokibe@hk.daiwacm.com Shipbuilding; Steel
Co-head of Asia Pacific Research Mike OH (82) 2 787 9179 mike.oh@kr.daiwacm.com

John HETHERINGTON (852) 2773 8787 john.hetherington@hk.daiwacm.com Banking; Capital Goods (Construction and Machinery)
Co-head of Asia Pacific Research Iris PARK (82) 2 787 9165 iris.park@kr.daiwacm.com
Rohan DALZIELL (852) 2848 4938 rohan.dalziell@hk.daiwacm.com Consumer/Retail
Regional Head of Asia Pacific Product Management SK KIM (82) 2 787 9173 sk.kim@kr.daiwacm.com
Kevin LAI (852) 2848 4926 kevin.lai@hk.daiwacm.com IT/Electronics Semiconductor/Display and Tech Hardware
Chief Economist for Asia ex-Japan; Macro Economics (Regional) Thomas Y KWON (82) 2 787 9181 yskwon@kr.daiwacm.com
Olivia XIA (852) 2773 8736 olivia.xia@hk.daiwacm.com Pan-Asia Head of Internet & Telecommunications; Software Internet/On-line Games
Macro Economics (Hong Kong/China) Kevin JIN (82) 2 787 9168 kevin.jin@kr.daiwacm.com
Kelvin LAU (852) 2848 4467 kelvin.lau@hk.daiwacm.com Small/Mid Cap
Head of Automobiles; Transportation and Industrial (Hong Kong/China)
Brian LAM (852) 2532 4341 brian.lam@hk.daiwacm.com TAIWAN
Rick HSU (886) 2 8758 6261 rick.hsu@daiwacm-cathay.com.tw
Auto Components; Transportation Railway; Construction and Engineering (China)
Leon QI (852) 2532 4381 leon.qi@hk.daiwacm.com Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design
(Regional)
Banking; Diversified financials; Insurance (Hong Kong/China)
Steven TSENG (886) 2 8758 6252 steven.tseng@daiwacm-cathay.com.tw
Yan LI (852) 2773 8822 yan.li@hk.daiwacm.com
IT/Technology Hardware (PC Hardware)
Banking (China)
Kylie HUANG (886) 2 8758 6248 kylie.huang@daiwacm-cathay.com.tw
Anson CHAN (852) 2532 4350 anson.chan@hk.daiwacm.com
IT/Technology Hardware (Handsets and Components)
Consumer (Hong Kong/China)
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Rating Percentage of total
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Hold** 21.9%
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Source: Daiwa
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** comprised of Daiwas Hold ratings.
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Hong Kong Real Estate 24 March 2017

Hong Kong Property Sector

Overview: Can Hong Kong make it once again?

Q2 Are Hong Kong property prices too high? 17

Can prices be sustained or is the upcycle coming to

Company section 145

Please also see:

Beginning of the end? Or end of the beginning?

As a regional-scale property market of 7m people, this is a fairly mature market by most

Jonas Kan, CFA, Head of Hong Kong and China Property

- A Tale of Two Cities, Charles Dickens

Hong Kong property appears to be at another transition point

The Hong Kong property market: stages of development

Can the forces of creative destruction be unleashed again?

In terms of financial resources, the situation today looks better than at

Financial resources of the major market participants

Typical triggers for the ending of a property cycle

Does the Hong Kong property market need a challenge to drive it

Is China set to enter the world stage?

Can Chinas financial architecture be readily connected to the rest

The evolving role of Hong Kong in serving Chinas financial sector

The HKEx Strategic Plan 2016-18

As a metropolitan city, Hong Kong still has considerable room to grow

New York City

Population of Hong Kong versus cities in China

The Hong Kong property companies look well-positioned to play any

USD100bn in investment value waiting to be unlocked

Source: Daiwa estimates

Q2: Are Hong Kong property prices too high?

- Frederich August Hayek

Hong Kong: an anomaly in global property

Hong Kong in 1841

Source: Daiwa, Google

Hong Kong today

Source: Daiwa, Google

Hong Kong: land area vs. major international cities

Hong Kong property: a market with depth and sophistication

Grade-A office stock in Hong Kong versus international peers

Source: CBRE Research

Distribution of Grade-A office space in Hong Kong

The range of retail rents in Hong Kong is even wider

The range of achieved retail rents in Hong Kong

Metro City Phase 1

Source: Companies, Daiwa estimates

The price range for residential properties is probably the widest

Hong Kong: changes in prices for different types of units

Change in price (Feb 2013** - Aug 2015)

Change in price (Aug 2015 - Dec 2016)

Q3: Can prices be sustained or is the upcycle coming to an end?

- Sir John Templeton

One of the most consolidated property markets in the world?

Downturns in Hong Kong property in the past

Have the Hong Kong players ever been driven by euphoria or

Are the Hong Kong players essentially guided by market forces to

Office: the leading segment in this cycle?

Current position of the 3 property segments in Hong Kong*

Hong Kong: corporate profit tax paid

Source: HKSAR Government

CKI: profit tax and effective tax rate

Profits tax Effective tax rate

Number of overseas companies with regional headquarters in Hong Kong

Source: HKSAR Government

The emergence of Kowloon East as an office hub goes a long way to

Kowloon East: a new generation CBD for Hong Kong