Lloyd Hanford

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.

A recent newspaper article described the high apartment rental costs faced by tenants in many American cities, sometimes reaching 50% of their income. There is little doubt that high rental costs cause people to forego other necessary spending on items that, at the time, such as health care, do not have the same urgency as shelter. Despite the large number of vacant homes the rental market remains very difficult. Understanding the reasons behind the high rental costs may provide suggestions for alleviating the problems.
The imbalance of supply and demand is common to all markets but the causes are probably not the same. When there is greater demand for rental units than there are units available for rent, under normal economic circumstances, rents will rise until a strong resistance level is reached. Conversely, when there is a surplus of units available for rent, rents will decline. The solution to rising rents lies in increasing the supply. Thus, it is worthwhile visiting the root causes of supply shortages.
The collapse of the mortgage markets in 2008 effectively acted as a brake on financing for new projects. Thus, many markets facing rising rentals have not had any new supply of housing units commenced in three years. Home foreclosures forced former homeowners to become renters. These factors assured absorption of any surplus supply of rental housing in most markets. If the foreclosed homes had immediately become part of the rental supply, the problems would not be so pronounced. But, for the most part the units in the process of foreclosure or those already foreclosed remain vacant awaiting sale.
Some causes of supply shortages may be artificially induced by restrictive land use policies governing the construction of multi-family housing and allowable densities. For example, many years ago, when apartment construction was booming, San Francisco, in response to political pressure, substantially reduced allowable density in many residential neighborhoods, by 50%. Height and bulk limits in many jurisdictions plus open space requirements also contributed to density reductions. These kinds of controls are subjective and wholly artificial. Cities must revisit their land use policies in recognition of the fact that the population is growing and putting pressure on housing demand. Restrictive land use policies of the past may not any longer be appropriate either now or for the future. Cities can control development but they must recognize that they cannot control population growth and must act to assure available shelter for all. Planning must cease being a political process where the decisions are based on an idealized set of criteria reflecting the desires of current influential citizen groups and become a true process of planning for the future.
Another factor contributing to shortages in many markets is the time consuming and unbelievably expensive process of obtaining entitlements. These not only discourage developers because of the costs and risks but also substantially delay the introduction of new supply in addition to adding artificial costs to that supply. Much of this problem lies in the political process involved in obtaining entitlements. Cities must address this problem and create responsible zoning and land use ordinances that allow a quick project review and granting of entitlements without the accompanying political theater.
Creating avenues for increasing supply will not, alone, resolve the problem of escalating rents. Other artificial policies need to be changed as well. In some jurisdictions, every new project is required to include a percentage of “affordable” housing units as defined by local code. The original theory was that the developers would, thus, help contribute to the affordable housing supply. But, what the rule makers overlooked was the fact that the developers don’t pay for this. Rather, the cost is passed through to the market rate consumer who, in the end, subsidizes the “affordable” renter. Increasing property taxes, which are ordinarily passed on to tenants also increase the burden of rent.
In cities with residential rent controls, supply is artificially constrained as tenants with protected low rents are hesitant to move and give up their advantageous position unless there is no other choice. In most cases, because there is no shortage of labor and materials to build new projects, rent control is no longer necessary but has become a political entitlement that has spawned tenant’s rights groups to continue pressing for retention of controls. The best way to enjoy level rents is to maintain a steady supply of new units in a given market. Local government should search for methods of incentivizing developers rather than enacting land use policies, codes and ordinances that discourage risk taking by them.
It is inevitable that cities will experience a dominance of multi-family housing as population growth continues its natural course. The vast majority of the population can’t afford to own an urban single family home. Land is just too expensive to make that option a reality. With expensive land comes the need to use that land more efficiently. Allowing increased densities is a step toward more efficient land use. But, this needs to be done in concert with the development of efficient and convenient public transit in order to eliminate the traffic congestion caused by the proliferation of private automobiles. If municipal transit was efficient, most people would not need their autos and, instead might park them in large parking facilities on the periphery rather than in their building. However, this type of planning would also bring the need to permit residential projects and neighborhoods to become mixed use projects with essential retail and health care services to be located close by. Land use policies of this type would end the ban against retail uses mixed in with residential uses as those bans now appear in many single family neighborhoods.
What all of this suggests is that it does no good to complain about rising residential rents It would be a better use of time and energy to work for a major revision of land use policies that focus on the most probable future needs of a given community. Whatever changes may be enacted should be flexible enough to accommodate future, unknown or unidentified changes without cumbersome bureaucratic delay. Most importantly, planning for the future should not be a political exercise but rather should be only a planning exercise.