Hong Kong’s million-dollar retail rent challenge
By Chris Oliver, MarketWatch
An earlier version of this report misstated the location of Forever 21’s corporate base and the source for its rental information. The report has been corrected.
Chris Oliver/MarketWatch
Forever 21’s outlet in Hong Kong, seen here, carries rent of $1.4 million a month, the Los Angeles-based retailer’s highest in the world.
HONG KONG (MarketWatch) — Reaching the Chinese consumer may come at the ultimate price in Hong Kong, where U.S. apparel makers are waging a very expensive retail arms race for hearts and minds.
In what amounts to a brand-building gamble just as China’s growth rate is beginning to cool, recent store openings in the city by Abercrombie & Fitch Co. (NYSE:ANF) , privately held Forever 21 Inc. and The Gap Inc. (NYSE:GPS) come with costly property-leasing arrangements that retail experts say will consume much of the profits — or even result in ongoing losses — for these outlets.
Abercrombie & Fitch, which opened a flagship central Hong Kong location in August, is reportedly paying around $1 million per month to lease retail space in an area renown for luxury-goods shopping.
Gap too has a location in the expensive central district, opened in November of last year, although its rental terms weren’t made public.
For its part, Forever 21 launched a store in the nearby Causeway Bay neighborhood in January, reportedly paying $1.4 million a month for premises in the pedestrian-friendly fashion district anchored by a Japanese department store and karaoke bars.
The monthly rental is the highest paid by California-based Forever 21, either in terms of cost per square foot or in total price, according to a recent Bloomberg report.
For an indication of how high rents can get in a neighborhood once dominated by large banks, analysts say to look to a bidding war that erupted down the street this summer for a similar — albeit larger — location.
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Spanish retailer Zara, known for mass clientele and quick inventory turnaround, plans to open a 30,000 sq.-foot store, adding to the nine outlets it already operates in the city.
Zara — owned by Industria de Diseno Textil SA (STN:ES:ITX) (OTN:IDEXF) — reportedly agreed to rent of $1.4 million a month, or double that of Swedish mass-market retailer Hennes & Mauritz AB (STO:SE:HMB) , which will make way for the rival retailer next year after failing to reach a lease renewal agreement with the landlord.
Allan Zeman, chairman of Lan Kwai Fong Holdings Ltd. and local business magnate, says foreign brands have been piling into Hong Kong, in some cases paying “crazy” rents, all in a bid to reach the mainland Chinese consumer.
“It shows the public you’re this hot brand, you’re special,” Zeman said. He doubts that brands such as Abercrombie & Fitch ever had the intention of showing a profit, given the amount of revenue needed to pay the rent.
Zeman, who in the 1970s established and later sold a company that sourced clothing in China for export to Canada, says these high-profile locations are likely loss-making in an effort to create lasting impressions with new consumers rather than seek short-term profits.
Attention garnered by the opening of Abercrombie & Fitch, including extravagances such as flying in scores of muscle-bound male models to pose with customers in a three-month promotion, have helped to make a statement for the brand, according to Zeman.
“I’m sure in the past, if you asked a lot of people who Abercrombie was, I don’t think they knew,” Zeman said.
The strategy, he believes, could pay off down the road, considering the rising spending power of mainland Chinese shoppers who visit the territory in droves.
The tourist is king Hong Kong, widely considered to be China’s most international city, is also regarded as an important staging ground for brands, particularly apparel and luxury-good makers who one day hope to make a success in China.
One reason is the sheer number of China tourists that stream into Hong Kong: So far this year, around 2.7 million mainland tourists crossed into Hong Kong per month on average, a rise of about 15% from last year, according to HSBC.
About 1 in every 4 dollars exchanged at retail locations can be linked to the mainland shopper, a total of about $10 billion to $13 billion last year, according to HSBC.
Many China tourists come ready to splurge on branded goods that have the seal of authenticity and which are up to 20% cheaper than the same items sold in mainland Chinese cities.
But recent signs of waning shopping interest on the part of China tourists could pose problems, according to retail experts who point to softening spending and shifting preferences.
Sales were disappointing during the key Golden Week holiday which ended Sunday, as visitor numbers and spending declined for first time since the peak of the financial crisis in 2009. See related story on Hong Kong holiday week sales
The spending decline, reflected mainly in cooling interest for high-end items such as luxury watches and high-end fashion, could also be an early signal of a new trend in which mainland shoppers are becoming more thrifty.
UBS analyst Carl Berrisford said he advised clients last year to exit retail themes tied to mainland Chinese consumers in the belief that the sector’s growth rate had peaked after years of rapid gains.
At the time, he was concerned that sales momentum was headed lower. More recently, Berrisford said that retail sales linked to mainland consumers has continued to rise, but the outlook suggests more of a plateau as “growth in visitation and revenue has slowed right down to single digits.”
Average outlays by China tourists even appears on track for contraction in coming months, according to Berrisford, who cites the apparent topping-out of China’s housing boom as one reason for the decline in spending.
He said that more mainland tourists are visiting Hong Kong on day-trips, taking advantage of an easing in individual travel permits.
Meanwhile, many of China’s wealthy are also skipping Hong Kong all together and flying directly to Paris or New York to do their luxury shopping, according to Berrisford.
He believes that China’s well-heeled are also feeling the pinch of harder times, with the slowdown in retail spending that began in the fourth quarter of last year now spreading to the upper bracket.
“High-end shoppers are beginning to become price-sensitive, and it’s taken a while for that to kick in,” Berrisford said.
HSBC’s consumer-brands and retail analyst Erwan Rambourg agreed, saying wealthy Chinese are growing wary of flaunting their wealth.
He believes that a new modesty is taking hold, with affluent China consumers avoid flashy logos although not abandoning brands altogether.
Nonetheless, many mainlanders still find shopping in Hong Kong a bargain. Gains for the Chinese yuan against the Hong Kong dollar, along with Hong Kong’s low tax regime, translate into significant savings when it comes to prices for comparable goods, with some visitors saying prices are about 20% cheaper.
Likewise, HSBC’s Rambourg says the current slowdown may be more of a “hiccup” than a major change in direction.
“China will continue to be a fantastic driver for most of the branded space, and if you want to start brand-building in Asia, Hong Kong is an absolute hub,” Rambourg said.
Will rents ease too? But one plus for retailers from the falling trend in shopping is an apparent softening in the market for retail space.
Colliers International analysts said Hong Kong landlords have recently cut asking prices on retail leases by 20% to 30%, as shop owners were “turning conservative,” according to a report Wednesday in the South China Morning Post.
Colliers forecast retail rents in Hong Kong to remain flat in the fourth quarter after rising 7% in the first nine months of the year.
Hong Kong already commands the highest average prices for prime retail space of any city, according to real-estate group CBRE.
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Shop owners can expect to pay $3,867 per square foot on an annual basis, a rate puts the Hong Kong well ahead of No. 2-ranked New York at $2,500 per square foot, according to CBRE data for the second quarter.
Daiwa Capital Markets economist Kevin Lai sees trouble brewing.
Soaring retail rentals is symptomatic of Hong Kong’s growing inflation problem, according to Lai. who worries that the city is being whipped along by excess credit that fuels a boom/bust bubble dynamic..
Mounting cracks are appearing, according to Lai, who points to data showing Hong Kong had a current-account deficit in the second quarter, its first since 2009.
“The costs are eating into everybody’s income, everybody’s profit,” Lai said, adding that he fears a sudden crash could knock 40% off equity and real-estate values.
Lan Kwai Fong chief Zeman sees the current slowdown in mainland Chinese tourist spending a natural pull-back in a longer-term growth story.
He cited to revenue growth at Macau casinos, as well as Ocean Park, a theme park he helps manage on behalf of the government. These, her said, are signs that consumption trends remain strong, especially among China’s rising middle class.
“It’s only down a few percent. … I think it’s just leveling off,” Zeman said.
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