Why Shop Rents Do Not Follow Retail Sales? A Case in Hong Kong

It is commonly recognized that there is a strong and positive correlation between retail sales change and the change of shop rents, because rent accounts for one of the major operational costs for retailers, especially in high rent cities such as in Hong Kong.

Figure 1 shows that the times series of retail sales change and the change in shop rents of Hong Kong track each other closely in the past 14 years, and the correlation coefficient is 60.95%, which is not low.

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Figure 1 Time Series of Retail Sales YoY and Retail Rental Index YoY, 2005Oct–2019 Aug, Data Source: rental index from the Rating and Valuation Department, retail sales data from the Census and Statistics Department

It shows that the annual growth rate of the retail sales amount is more volatile than that of the rental index, and more interestingly it is observed that the time series of the change of retail rental index is more reluctant to drop than rising together with the change of retail sales amount, which is probably due to the inflation and some institutional factors, including the terms and conditions of the tenancy and the government interventions in contractionary periods, but not in expansionary periods. Figure 2 shows the scatterplot of the 2 YoYs and the best fit polynominal curve shows the asymmetric relationship.

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Figure 2 Scatterplot of Retail Rental Index YoY (Y-Axis) and Retail Sales Amount YoY (X-Axis) of Hong Kong 2005Oct–2019Aug.

The average growth rates of retail sales and retail rental index in the period are 6.7% and 4.9%, both are higher than the average inflation rate of 2.9%. The relatively high growth rates are normally regarded as a consequence of the insufficient supply of retail space.

A Recent Case of Opposite Movements of the Two Series in Hong Kong

The retail sales amount figure has fallen for seven consecutive months now, and the latest figure of August 2019 is a record-breaking annual decline of 23%! (Figure 1) It is believed to be due to the US-China trade war and China’s economic slowdown, as the slowdown has started since 2018, and it has recorded a negative rate since February this year.

Many retailers are contemplating to close their businesses, and thus the vacancy rate of retail shops is rising. In fact, due to the increase in the supply of commercial buildings and shops in recent years, the vacancy rate has gradually rebounded since 2013, and risen to 9.4% at the end of 2018, which is close to the poorest record of 10.8% during the SARS period in 2003–2004. (Figure 3) It seems to refute the hypothesis of an insufficient supply of retail space.

Figure 3 Vacancy Rate of Commercial Properties, 1985–2018. Source: Rating and Valuation Department

It is expected to have an even higher vacancy rate at the end of 2019 due to the continuation of the trade war, economic slowdown, and social unrest. However, when I asked the retailers why they did not request the landlords to cut the rent in this difficult period, many of them are pessimistic and respond that the landlords would rather let the shops vacant but not reduce the rent. In fact, the data agree so.

Figure 1 shows that when the retail sales dropped substantially by 23% in August, but the retail rental index is still going up by 1.8%, the curve does not seem to be a lag-behind phenomenon. In fact, compared with the lowest figure in June 2003, the retail rental index in August 2019 has risen 128%! It implies an average compound growth rate of 5.3% per annum. The downside risk of the retail rental level has been smaller and smaller (Figure 4)

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Figure 4 Hong Kong retail rental index 1993 — August 2019. Source: Rating and Valuation Department

Intriguingly, when the retail rental index does not go together with retail sales amount, the retail price index follows closely the trend of retail sales. The price index has fallen for 7 months in the past 8 months, roughly similar to the change in the retail sales amount. The decline in the retail price index in August this year was also the biggest drop in the past eight months, reaching -6.5% (Figure 5). However, it must be pointed out that the retail price index has increased by almost 600% compared with the lowest point in July 2003! It implies an average compound growth rate of 12.7% per annum. The current price decline is trivial.

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Figure 5 Hong Kong retail price index 1993 — August 2019. Source: Rating and Valuation Department

The government-intervention hypothesis is also plausible in view of the recent government schemes of subsidizing retailers. It may have resulted in a legitimate expectation that the government of Hong Kong would subsidize other retailers when their businesses are adversely affected by the recession. For example, the government announced a subsidy scheme for the tourism industry day before yesterday [1]. It can plausibly explain why shop owners are not willing to reduce rent if they expect the government to subsidize their tenants (retailers) when the businesses are not good.

The modern financial governance principle is eccentric, big companies are said to be “too big to let them fail”, so the government has to bail them out in case of any crises. Now, even small and medium-sized enterprises are said to be “too small to let them fail”, so the government should subsidize them during the recession.

When retailers earn profits, they do not share with the public, but when they make a loss, the government subsidizes them. Is Hong Kong still the world’s freest economy? In fact, it is very rare for a government to subsidize directly a private retailer, and it cannot be sustainable if the recessionary period is long. It would even result in moral hazard when it becomes a common expectation.

The government does not have good reasons why a particular industry should be subsidized, especially when the landlords have not reduced their rent! Why the government should intervene instead of letting the market adjust itself?

[1] Now News (2019) The government spent 100 million yuan to provide cash assistance to local travel agencies, October 23. https://news.now.com/home/local/player?newsId=367289&fbclid=IwAR2xV2JO5a8sNIKxlxxHmHS8yjfoTvOMM-e6wsISZ76UiNyrgI05ykKgRTI

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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