In Hong Kong, Bet on the Landlords

DECEMBER 2, 2010 By ISABELLA STEGER WALL STREET JOURNAL

In Hong Kong, one of the world's hottest property markets, there are two kinds of companies: those on the right side of government policy, and those on the wrong side.

The city is clamping down on speculation. Transaction volumes have dried up in the two weeks since duties were added to properties resold within two years. Analysts expect more to come and forecast that residential sales volume could fall by as much as 30% in 2011. Meanwhile, margins will be squeezed by high—and rising— land costs.

Naturally, property developers' shares are faring poorly. Among the worst performers is Kerry Properties, which has dropped 9% in 10 days. Shares of real-estate agent Midland Holdings, meanwhile, have plunged 30%.

The outlook for commercial landlords, meanwhile, couldn't be any better. With companies staffing up, the vacancy rate for prime office space across Hong Kong is below 4%, says Colliers International. That compares with a historical average of 8%. Commercial property supply won't come online fast enough to meet demand, so Goldman Sachs is forecasting office rent increases next year of between 20% and 30%.

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The Hong Kong government is clamping down on real estate speculation in the territory.

Stock investors have caught on as well. Because they generate lower returns on equity, landlords have historically traded at a 15% discount to developers, relative to net asset value, Citi Investment Research says. That gap has narrowed to near parity as landlords have rallied this year. For example, Hongkong Land, which is heavily exposed to prime office space in the Central district, is up nearly 37% so far this year.

Still, upward revisions of the company's assets mean that despite that run-up, Hongkong Land shares remain at a 34% discount to Citi's forecast for net asset value. That should narrow as investors grow more bullish about the company's ability to generate profits from its assets. Since 1989, the stock has traded at an average discount of 28%.

Another opportunity lies with landlords with property outside the Central district, who will benefit as investment banks and large corporations break up their operations to move support staff outside of costlier neighborhoods. Shares of Wharf (Holdings), a big landlord on the Kowloon side of Victoria Harbour, and Swire Pacific, which has a concentrated portfolio in the eastern end of Hong Kong, haven't run up as much as Central-focused landlords.

Now is a good time to own the owners.