Fitch Ratings has said in a just published special report, "2009 Hong Kong Commercial Property Market Outlook", that the outlook for 2009 for the territory's office and retail property markets are negative, underpinned by the current global economic downturn and the substantially weakened local market sentiment.

"Many companies have downsized or in the process of doing so, and this factor alone will depress the demand for office space," notes Michael Wu, Director on the agency's Asia Pacific Corporates team. Also, Fitch notes that the increase in the vacancy rate in core districts, such as Central, has been slow. Given that the supply of new office assets will be very limited in the next three years, landlords are unlikely to significantly cut rents. A gradual but consistent decline in rents is expected.

The picture is gloomier outside the core district, especially in Kowloon East. Kowloon East's vacancy rate is high (more than 16% at end-Q308), and projects in the pipeline are abundant. Competition for tenants willing to locate outside the core districts of Central/Admiralty will be fierce. Nevertheless, the impact on the rental income stream might be much smaller than the market expects. Positive rental reversion is a material mitigating factor, especially for the core districts, in which the current rent level is 50%-60% higher, compared to 2006 levels. The difference for the overall Grade-A office segment is 20%-30%. Office landlords therefore have a material buffer for their office rental income.

"Sluggish retail sales go hand in hand with a decelerating economy, and for the retail segment, the key factor for the declining spot rental level will be weakening retail sales. Furthermore poor wage growth prospects and rising unemployment will put pressure on sales," notes Mr. Wu. Tourist arrivals from the mainland will only partially offset this trend.

Top-tier retail properties are expected to perform better during the upcoming downturn. Historical records indicate that rental income for those with quality assets held up well during the most recent recession (2001-2003). Location and the quality of retail assets are the differentiating factors. The negative outlook for both the office and retail property segments has been factored into the ratings on Hong Kong-based companies in these sectors.

Real estate companies in Hong Kong will slow down and even scale back their business plans in mainland China in light of the current environment. Their management teams are experienced and understand the importance of maintaining a healthy cash flow position and sound capital structure during an economic downturn and a tight capital and banking environment will provide further motivation for them to do so.