Retail Store Euphoria

A recent Wall Street Journal article described the migration of major U. S. retailers to Hong Kong as one of the worlds “top luxury shopping cities” and the fact that this surge is driving up rents for retail space. Hong Kong has great appeal as the Mecca for shoppers from mainland China because luxury goods can be purchased cheaper than in mainland China. Walking along Canton Road, past the Harbour City complex, one of the largest shopping centers in Tsim Sha Tsui, creates the illusion that there is “no tomorrow”. Shoppers (mostly young) line up on the sidewalk outside of stores like Louis Vuitton, Yves St. Laurent etc. waiting for their turn to enter the store. This is by no means a universal phenomenon. There are more than ten, major urban shopping centers in Hong Kong. In fact, walking around the environs of Nathan Road in Tsim Sha Tsui and around Central in Hong Kong the impression is created that the City is one gigantic shopping center. Major international retailers do not confine themselves to one of the major centers but, rather have units in multiple centers.
Walking through the many centers suggests that, unlike the U. S., vacancy is not a serious problem. Rents are rising to dizzying heights and if the trend continues, the more marginal retailers will be forced to exit the market. Abercrombie & Fitch reportedly leased a 25,000 square foot store in the Pedder Building, across the street from the Landmark Center in Central. The reported rental is $901,000 U.S. per month or $10,812,000 U.S. per year. This rent translates to $432.48 U.S. per square foot per year. If one applied the unbelievably high percentage of 12% to this rent, volume would have to reach $3,604 U.S. per square foot per year. The Gap is reported to be opening a 20,000 square foot store at a price of HK$5,000,000 per month which translates to over $645,000 U.S. per month, almost $7,742,000 U.S. per year, which indicates an annual rent of $387+ per square foot. Again, using the yardstick of 12% suggests that volume would have to reach $3,226 U.S. per square foot per year. Similarly Forever 21 is reportedly opening a 50,000 square foot store at a rental of HK$11,000,000 per month in Causeway Bay or $1,419,355 U.S. per month translating to $17,032,258 U.S. per annum which reflects a square foot rent of $340.65 U.S. per year. Again, at a volume figure of 12%, this rental would necessitate sales of almost $2,839 U.S. per square foot per year. Finally, the WSJ article reported that the average rent for retail spaces in the Causeway Bay shopping district were up 34% in the last two years to $1,849 U.S. per square foot, a number that sounds almost impossible based on the sales volume that would be necessary to sustain that rent. If a measure of 12% of sales for rent is used, this rent level would mandate sales of $15,408 U.S. per square foot per year.
These numbers have the earmarks of a bubble based on irrational expectations. There are reasons for this concern. First, an allocation of 12% of sales volume to rent is very substantially above anything seen in the United States where the majority of retailers have traditionally used a yardstick of 5% – 10% at the high end. Thus, the sales volumes needed to sustain the rents reportedly being paid would, in reality, have to be much higher than the examples above. Secondly, shopping center sales volumes, across the spectrum in the U.S., do not reach levels of over $1,000 per square foot for large stores. As store size increases sales volume per square foot tends to decrease which is one reason in-line shops pay substantially more rent per square foot than department store/large store anchors. Thus, sales of over $3,000 per square foot per annum would be very optimistic for a 20,000 square foot store. Retail sales in Hong Kong rose 20% in the first quarter of 2011 from a year earlier. That, in and of itself, is very impressive but it does not mean that same store sales universally increased by that amount. The sales boost is attributed to the surge of mainland Chinese tourists to Hong Kong where prices are lower because Hong Kong does not tax retail sales. If that is a driving force, it would be good to keep in mind that the Chinese government, if nothing else, is very pragmatic and could, in an instant, adopt policies to bring that buying power back to mainland China.
Another area of concern is the fact that the American retailers paying extremely high rents to enter the Hong Kong market may be buying into the illusion created by people waiting in lines to gain entry to a luxury store as if they were going to be able to buy a ticket to a major sporting event where tickets can only be obtained from scalpers. A walk through of many of the major Hong Kong malls during five good weather days at the end of March provided a picture of many beautiful stores with no customers in them rather than one of abundant customers.
Foot traffic in the public corridors of the malls seemed relatively heavy but, much of the traffic appeared to be destination oriented rather than shopper oriented. Because many of the malls have connections from Point A to Point B or to the MTA (as is the case with malls developed by the transportation authority) people find it more comfortable to walk through the malls rather than staying out on the street even when weather is not a factor. In a visit to Elements, a major mall developed in conjunction with the MTR Kowloon Station, the absence of in-store shoppers was very noticeable. The same was true of Pacific Place, Harbour City (interior) and Landmark. The time of day did not appear to be a factor. It is possible that the time of year may have been a period of low tourism but there was a major rugby tournament taking place at the time with visitors from all over the world.
As said earlier, many of the luxury brands have multiple stores in Hong Kong leading one to question whether they end up “cannibalizing” their own trade. On a different note, real estate people quoted in the news article suggested that retailers may be allocating part of their marketing budgets to rent because it makes the rent appear more reasonable.
Is it possible that a “herd mentality” may be inducing American brands to compete fiercely for prime Hong Kong locations? Experience in dealing with retailers of all sizes over the years points to a much different leasing mentality from the period when the retailers were still family owned and managed. In that era, if the retailer did not think a store would turn a profit (after a period of development) based on sales, then a lease usually didn’t happen. With corporate and public ownership the pressure to continuously demonstrate growth may drive managers to “stretch the envelope” in a search for growth opportunities. As has been seen in the U.S. not all retail brands remain viable and, with viable brands not all individual stores remain successful. So, the jury will be out for sometime before it is known as to whether this overseas expansion strategy will prove good or bad for the retail companies taking the leap.