Mid-Year Letter from Ronnie Chan of Hang Lung Group

Hong Kong real estate tycoon Ronnie Chan of Hang Lung Group has a reputation for writing insightful shareholder letters.  His latest is available on pages 2-16 of his company’s 2017 Interim Report.  A bit of background about Hang Lung:

  • Reputation for very long-term outlook.  The company completed its Harbourside luxury apartment tower in Hong Kong in 2004 and held many units off the market until selling them in 2014 and realizing a 78% gross margin due to market appreciation.
  • Early investor in China.  The company completed its first shopping mall and multi-use commercial center in Shanghai (Grand Gateway) in 1999.
  • Heavily exposed to retail leasing.  The company now operates 8 luxury shopping malls in China which face many simultaneous challenges: rise of ecommerce, corruption crackdown, softer economy, and overbuilding in many cities. Hang Lung’s 2 Shanghai properties are market leaders, but current results  at some others are weak (e.g. Shenyang, Wuxi, and Dalian).  The company also has a smaller portfolio of retail space in Hong Kong.
  • Conservative financial management.  The company maintains a strong balance sheet (net debt to equity ratio just 3%) and prides itself on taking advantage of investment opportunities in bear markets.

Excerpts from the mid-year letter:

Comments on China and Global Affairs:

“The United States, which is the most self-righteous country in modern history, now has a president who regularly blurts out facts with alternative facts, and truths with untruths. The media, which has long been regarded as the bastion of the Western concept of liberty, is now daily inundated with fake news. The Internet certainly exacerbates the problem.

Relatively speaking, Asia today appears to be the more peaceful part of the world. China, which endured tremendous turbulence in much of the 20th century, has in the past 20 to 30 years enjoyed stability and peace. While the United States is in the long run stable, it is steeped with short-term uncertainties and noises. China on the other hand appears to be more tranquil, at least in the near term, a condition that can last for decades and even longer.

When economic growth rate is taken into consideration, the country looks even more
attractive as a destination for investments. For the foreseeable future, it should be more or less double that of the West, if not more. It is far easier to make progress when swimming along with the current than against it.

That said, we are keenly aware of possible sudden troubles. Chinese history of the post
World War II era tends to bear out this fact. But all things considered, we count ourselves fortunate to be investing in China. There is hardly another market, especially a sizable one, that is more alluring.

As in all significant ventures, there are two possible attitudes toward the BRI [Belt & Road Initiative] — to be the players or the observers. Some players will fail, as seen in all human endeavors; but others will succeed. The latter will be economically rewarded while the observers will pay a huge opportunity cost. 

The BRI presents a lot of upside and very little downside for China. This is good news for us. As China gets richer, people will consume more, and our malls and offices should both benefit.”

Comments on China Retail Sales:

“Let me now turn to China’s domestic market in the more immediate term, where I also have positive news to report. It is unmistakable that the country is emerging out of its economic malaise of the past six years. In particular, the recovery of the luxury goods sector is especially strong.”

Comments on Hong Kong residential real estate:

“… it is unrealistic to expect much cheaper residential prices in the long run. Let
me enunciate a few reasons here.  Historically, at least since World War II, real estate prices in Asian cities, which are generally highly densely populated, have always been relatively high by global standards. The situation in Hong Kong is particularly acute. Due to a long-held policy under the British, less than 25% of the landmass is developed, hence self-limiting the amount of buildable land. Country parks alone account for some 40% of the total area of Hong Kong.

Being predominantly ethnic Chinese, Hong Kong’s citizenry has a propensity to own bricks and mortar. In fact, they prefer new units. As a result, purchasing apartments for the purposes of investment is commonly practised. History has proven that real estate is a great way to preserve value.

I recall what our founder Mr. T.H. Chan said to me around 1980. He reminded me that many Hong Kong citizens did not need to work for a living, and yet could live rather comfortably. Owning an apartment or two for rental, and the high monthly income therefrom could feed a family. The appreciation in property value when they eventually sell might take care of their retirement needs. This was certainly not far from the truth.

Will Mainland private developers be successful in Hong Kong? I reserve my judgment. At times, I sense a slight disdain for Hong Kong players on the part of my Mainland friends. Perhaps their huge size back home has inflated not only their debt levels but also their minds.

One reason for my assessment is the high gearing of these new Mainland players. If they had a strong and reliable cash flow from other places, they would be fine. But as we all know, the real estate industry is known for its volatility, which may be market- or government-instigated.  Unlike rental income which is relatively predictable, developmental profit or cash flow therefrom can suddenly cease. What will happen then to their Hong Kong projects?

Another reason is that many of these newcomers have never seen a bear market. Even if they had, the Mainland government usually did not allow seriously troubled companies to go bankrupt. There were always means to keep them afloat. Such is certainly not the case in Hong Kong. The local players who are still standing have seen many ups and downs and so know how to protect themselves.

My next apprehension is echoed by many longtime market observers. It is hard to believe that a reasonable profit can be made from land prices they have paid recently. Our residential prices will not rise forever. Once the market understands that sufficient land supply is forthcoming, the price for both land and buildings will drop. We are already heading in that direction. When land prices begin to fall, those who have previously bought at unreasonably high prices may be spooked, but there will be many local developers with strong balance sheets — ourselves included — who are ready to go in for the kill. Some may have the opportunity to bail out the novices at much reduced prices.”

Comments on China residential real estate:

“… there is no denying that the period of making easy and big
money in residential development on the Mainland may well be behind us. Gone are the days when regulations were more relaxed than today. One could buy land and not pay for it until the apartments were sold. Bank financing was readily available. We the outsiders would never know how the land or loans were obtained. On the other hand, demand was deemed unlimited, and selling products was easy. As a result, everyone chased after volume, and we witnessed the fastest growth in the world in terms of the absolute market size of the industry.

To be sure, there are still plenty of opportunities on the Mainland. Family formation like everywhere else will provide a natural source of new demand. Most of the residential units constructed 20 to 30 years ago are of inferior, if not pathetic, quality. Whereas buildings in Europe in general can last for a few hundred years, in the United States a hundred years, and in Hong Kong 70 to 80 years, those on mainland China may only last say 40 to 50 years.  They will have to be torn down and rebuilt.”

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