According to a new CBRE retail report - The Changing Retail Landscape: How to Survive the Slowdown in Hong Kong? - mid-market retail brands are set to take over luxury brands as the main driver of retail demand in Hong Kong.
The Hong Kong retail sector outperformed over the last decade with strong sales growth for high-end products. This generated an increase of 213% in average rents from 2003 to 2014 for core street shops in Causeway Bay, Tsim Sha Tsui, Mong Kok and Central.
But the tailwind for luxury retailers has slowed since 2014 hindered by a range of factors including Chinese government's anti-corruption measures, milder GDP growth in China, weakening Asian currencies and the loosening of policies on travel for mainland Chinese. These are all unfavorable factors for Hong Kong's tourism and retail sales. The total retail sales in Hong Kong from January to July 2015 edged down by 1.8% y-o-y, while sales of watches and jewelry plunged 15% in the first seven months of this year. Despite the gloomy outlook for the retail sector, opportunities are emerging for mid-market retailers.
"The retail sector is experiencing a structural change," said Joe Lin, Executive Director, Retail Services, CBRE Hong Kong. "Over the past decade, high-street shop landlords have reaped the benefits of strong demand from luxury retailers and massive rental growth. Landlords must now be more realistic on rental negotiations, as luxury retailers are adjusting their leasing strategies to save costs, and more mid-range brands are looking to tap into prime locations at relatively affordable rental levels. This opens the door for mid-market brands to expand. In the last quarter, we saw prime street shops leased to mid-market brands following the lease expiry of the previous luxury goods retailers."
Luxury Brands to Consolidate Networks; Mid-market Brands Become Demand Driver
To cope with the slowdown, luxury retailers are consolidating their second-tier shops, which will increase space availability in the market. Some high-end fashion, cosmetics and watch and jewelry retailers have either stopped renewing leases or surrendered spaces well ahead of expiry. However, they will still strive to secure flagship premises in strategic locations with prominent addresses and good visibility, which means a higher marketing value. They may also introduce secondary lines at accessible prices, targeting young consumers with a growing demand for mid-market products.
Consolidation by luxury retailers in Hong Kong implies that the tenant composition in some prominent retail locations will gradually change. Meanwhile, mid-range retailers previously not able to afford to lease a space in prime locations are now looking to take up vacant space surrendered by luxury brands. Landlords are more willing to negotiate with tenants for more affordable terms. While rents are generally falling, shops in the most strategic locations with good footfall and visibility are not expected to run into high vacancy risks as long as landlords are prepared to be flexible in leasing terms.
"The sales performance of luxury products is heavily reliant on the external factors mentioned," Marcos Chan, Head of Research, CBRE Hong Kong, Macau and Taiwan commented. "In contrast, the demand for mid-market goods from both tourists and local consumers is relatively steady. We foresee three trends in the next five years: (1) the main driver of demand for retail space are shifting from high-end consumer goods to mid-market brands; (2) local demand will gradually regain a bigger share in total retail sales compared with tourist spending; (3) decentralized areas will provide a significant proportion of new retail space, offering more leasing options. These trends suggest that retail market stakeholders, including luxury and mid-market brands, and street shop and shopping mall landlords, will have to reconsider their business strategies."
Local Demand Gaining Importance Along with Shift in Tourist Spending Patterns
In the past decade, the percentage of retail sales contributed by tourists doubled from 20% in 2004 to 42% as of 2015. This accounted for the tremendous sales growth in tourist-oriented products, including cosmetics, jewelry and watches as well as electronic goods. The number of cosmetics, leather goods and jewelry and watch shops grew by 1,975%, 62% and 29% respectively from 2003 to 2014. Some of these retailers have not only grown in number of shops but also the average size of their retail premises. Since 2014, Hong Kong has seen a decline in tourist arrivals from the mainland, and changes in tourist spending patterns from luxury to mid-range goods.
Local retail spending is robust but is often neglected. Local real private consumption expenditure registered an average annual growth of 4.9% between 2004 and 2014, and the median household income rose by 4% per annum during this period. Domestic consumption is set to remain healthy in the short to medium term, although short-term stock market volatility and an anticipated interest rate hike may marginally scale back household consumption.
Retail Leasing Opportunities Emerging in Decentralized Areas
The lack of supply in the market is another reason for pushing retail rents to a high in past years. CBRE believes that supply in the next five years will ease some pressure on retailers on rental expense but new options in the core shopping districts will continue to remain limited. The development of several new towns in more remote districts will result in substantial growth in residential and working populations that will need to be served with by shopping facilities. CBRE estimates that in the next five years, 70% of the new supply will be in non-core districts and 5.6 million sq. ft. of retail space will be shopping arcades for residential estates. This will provide opportunities for mid-range retailers to expand their store networks targeting the mid-to-high income households. Government statistics suggest that the catchment areas of these regional malls usually have an above-median household income.
"Structural changes in the retail landscape will ultimately result in a more balanced and sustainable retail market in Hong Kong," said Mr. Lin. "The tenant mix of both core areas and sub-markets will become more diverse, enabling both high-end and mid-market brands to offer a broader range of products to consumers. Domestic spending will get retailers' attention and the mid-market sector will see healthy growth potential. We would recommend mid-market retailers to continue to explore opportunities in emerging districts. This will ensure they obtain first-mover advantage. Meanwhile, street shop landlords should lower their rental expectations and consider leasing to mass-market brands to avoid long-term vacancy."