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Amid trade war, Hong Kong fund Gaw Capital makes $1bn bet on offices

Reservations over residential assets, but corrections seen as opportunity

Russell Street in Causeway Bay, one of the busiest commercial zones on Hong Kong Island, is the most expensive street in the world, according to Cushman & Wakefield. (Photo by Kenji Kawase) 

BANGKOK/HONG KONG -- Russell Street in Causeway Bay, one of the busiest commercial districts in Hong Kong, is now the most expensive retail location in the world. Last week it leapfrogged New York's Upper Fifth Avenue to reclaim the global top spot, with rents running to $2,671 per square foot, according to U.S. real estate service Cushman & Wakefield.

The annual survey of retail rents is a rare piece of good news for a Hong Kong property market that appears to be heading south at an accelerating rate, buffeted by fears over the impact of the China-U.S. trade war and rising interest rates. House prices have tumbled roughly by 3% since August, and estate agents are predicting a slide of 15-25% in residential prices next year. Yet, commercial properties are showing greater resilience.

Goodwin Gaw, co-founder of Hong Kong-based Gaw Capital Partners, is betting that growing concerns over the outlook for property in Hong Kong will yield some profitable opportunities in the commercial space. He believes there will be life in the island's commercial sector for a few years yet, despite China's economic slowdown.

Prime commercial offices on Hong Kong Island "will be in high demand for a sustainable period of time because there's no supply," he said recently in an interview with the Nikkei Asian Review in Bangkok. And there is still plenty of demand, he insists, from multinationals and local companies doing business with the mainland, as well as from Chinese companies seeking to expand abroad.

Gaw made his name as a young man in his 20s by buying the iconic but dilapidated Hollywood Roosevelt Hotel in Los Angeles, which hosted the very first Academy Awards in 1929. After a $24 million restoration, the hotel is back on the tourist trail.

Goodwin Gaw, co-founder and Chairman of Gaw Capital, remains bullish on Hong Kong's commercial property market, though he sees signs of downturn in residential assets. (Photo by Akira Kodaka)

And today, more than 20 years later, Gaw Capital owns properties around the world worth $18.3 billion. As of the second quarter of this year, it has raised almost $10 billion in funding -- some of which will now be directed toward Hong Kong's commercial districts.

Gaw admits he has reservations about the outlook for residential properties on the island. Due to concerns over interest rates and other external factors, he has been cautiously selling more assets than buying in the past 12 months. But when it comes to commercial property, Gaw believes there is a different story to tell.

Hong Kong, a traditional bridge between the world and China, has been facing competition with other mainland and Asian cities. Critics claim that the territory's reputation as a vibrant and dynamic place of business has taken a hit as pro-Beijing Hong Kong authorities crack down on free speech in the special administrative region. Many are alarmed by the deterioration of the "one country, two systems" arrangement, designed to guarantee that Hong Kong would have a certain degree of autonomy after it was handed back to China by Britain in 1997. But Gaw believes Hong Kong has no serious rivals as a gateway for international companies seeking to do business with China.

"What are the alternatives?" he asked. "Maybe Shanghai, but it's much harder to recruit expat managers, [considering] family, school and so on." The latest revision in the personal income tax code in China requires expats who stay 183 days, consecutively or not, in any year to be levied. This has taken "a lot away for multinationals to locate in Shanghai as an alternative."

Gaw is also letting his money talk. This month his Gateway Real Estate Fund VI bought a 49% stake of Cityplaza Three and Four -- two prime office towers along the northeast coast of Hong Kong Island -- from a mainland company, Henglilong Investment. The two towers, located in Tai Koo Shing, one of the territory's central business districts, or CBDs, was built by Swire Properties, the Hong Kong-listed arm of Swire Pacific. Gaw snatched about half the stake from the Chinese, who originally purchased 100% from Swire in June for 15 billion Hong Kong dollars ($1.92 billion).

Gaw Capital paid almost $1 billion to obtain a 49% stake in Cityplaza Three and Four, two Grade A commercial towers in one of the fastest-growing business districts on Hong Kong Island. (Courtesy of Swire Properties)

"I think it's very, very rare to be able to buy a high-quality commercial office [with] this kind of harbor frontage on Hong Kong Island in a key business district," Gaw said.

Island East, where the 21- and 24-story buildings stand, is a fast-developing commercial district, surrounded by upper middle class housing, but the average rent is still far lower than in the top Central district.

The towers' major tenants are blue chips, with global names like Adidas, Deloitte, American Express, Sony Pictures and FWD Group, a pan-Asian insurance group led by Richard Li Tzar-kai.

Gaw believes that commercial properties are less affected than residential by the risk that sentiment could be hit by rising interest rates. "It does take much more capital to play, so the capital tends to be more disciplined, and demand is strong," he says.

Property consultancy Jones Lang LaSalle shares Gaw's view. Even though it expects Hong Kong housing prices to drop at least 15% by the end of 2019, managing director Joseph Tsang told reporters last week that office buildings and shopping malls will be more resilient to the wider economic slowdown thanks to their stable returns.

"For commercial properties at the moment, it seems things are still rather OK," he said, noting that rental income from office and retail tenants remains strong.

Other drivers are also at work. Operators of coworking spaces are aggressively expanding in the city. And spending in Hong Kong remains strong, buoying commercial and retail properties, according to Denis Ma, head of research at JLL. "These guys are more resilient," Ma said.

JLL is also bullish on hotels, despite the failure last year of hotel chain Mandarin Oriental to sell the iconic Excelsior hotel in Causeway Bay. Plans are to turn it into an office block. Its October research points to a steady increase in visitor arrivals and a tight supply of rooms, leading to hotel occupancy rates reaching all-time highs and spurring a rise in hotel room rates. "The outlook of the Hong Kong hotel industry is very positive," said David Marriott, senior vice president of JLL's hotels and hospitality group.

Corey Hamabata, Marriott's peer at JLL, added that there is a "strong investment thesis for owning hotels in Hong Kong. As a result, we expect hotel investment to remain active in the coming 12 months." There have been 17 hotel acquisitions since last year, a total transaction value adding up to HK$15.72 billion.

However, others see darker clouds approaching as a result of China's slowing economy. Andrew Haskins, Asia head of research at Colliers International, said, "Among Asia's leading financial centers, the relationship between the stock market and Grade A office rents in CBDs is strongest in Hong Kong." Calculations by the American property management company, suggest a 3.8% drop in rents in the Central and Admiralty districts in 2019 due to this link. The benchmark Hang Seng Index has fallen by 12% year-to-date to Nov. 16.

Alan Lok, executive director at CBRE Hong Kong, echoes this view. "Leasing momentum [has] weakened compared to the past two quarters," he said. Lok believes this is down to mainland companies. "PRC firms, once the key demand drivers for office space, turned more conservative in their leasing strategies," he said in a note last month. He is predicting that rents in some offices will begin to fall by about 5% next year due to macro-economic uncertainties and softened expansion demand.

Even Ma of JLL, who is generally upbeat on commercial properties, has concerns over demand from mainland companies. While office buildings still have a very low vacancy rate, a slowing Chinese economy may dampen the pursuit of mainland companies for an office in Hong Kong's prime business districts, Ma said. "The top line looks OK, but there are a lot of question marks on whether what we saw in the past 10 years will be repeated in the next five to 10 [years]," he said.

Gaw is also preparing himself for the worst. Increasing financial market volatility has made him cautious. And then there is the trade war. "I am increasingly convinced now that the trade war is not going to be resolved anytime soon," he said. "We think a potential winter is coming."

But for now he has prepared his defenses. The Gateway Real Estate Fund VI was closed in October, raising a total of $1.95 billion -- $1.3 billion for the main fund and $650 million for the side fund. The investor profile is similar to Gaw's previous funds, including sovereign wealth funds, endowments and U.S. pension funds. His targets remain real estate assets in greater China, including Hong Kong and Taiwan.

"Obviously, we are more cautious these days," Gaw said. But, "if there is a significant correction in the market, then that would be an opportunity. We will step up and buy those assets."

Nikkei staff writer Nikki Sun contributed to this story.

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