China’s Ghost Cities Are a Problem for Europe’s Luxury Brands, Too
Chinese consumers watching the value of their homes fall are losing the confidence to spend on designer goods
3 min
How closely is demand for $3,000 handbags tied to home prices in China? Quite closely, it turns out, which is unfortunate for luxury brands.
Europe’s luxury stocks fell in early trading Tuesday after China’s economic planning agency failed to announce additional measures to kickstart growth that some investors had hoped for. The sector is still up 10% on average since Beijing launched its initial stimulus plans late last month.
Beijing hopes a cut to mortgage rates, and lower down-payment requirements for buyers of second homes, will jump-start the country’s troubled housing market. A package of loans to brokers and insurers to buy Chinese shares has had initial success at lifting the stock market.
Luxury spending in China has traditionally been more correlated with its home prices than with the financial markets or overall economic growth. Around 60% of net household wealth was tied up in property before prices peaked in 2021. Barclays estimates that falling home prices have destroyed about $18 trillion in household wealth since then, which is equivalent to roughly $60,000 per family.
This, along with worries about the wider economy, is hurting consumer confidence. Retail sales rose just 2.1% in August compared with the same month last year, according to data from China’s National Bureau of Statistics. When global luxury brands start to report their third-quarter results next week, Chinese demand is expected to have slowed since they last updated investors.
Flagging sales come at an unhelpful time for Europe’s luxury companies, which rely on Chinese consumers for a third of global luxury spending. After several bumpy years during the pandemic, luxury brands and their investors hoped that a comeback in Chinese spending would compensate for a slowdown among Europeans and Americans.
This looks increasingly unlikely. Luxury sales to Chinese shoppers are expected to shrink 7% in 2024 and by 3% next year, according to UBS estimates. As luxury brands have high fixed costs, including the most expensive retail rents in the world, a slowdown with such key customers could have an outsize impact on profit margins.
The last time the luxury industry went through such a rocky patch in China, barring the pandemic, was between 2014 and 2016 when Beijing was cracking down on corruption, including officials who were gifting Louis Vuitton handbags and Rolex watches in exchange for political favours. The global luxury industry barely grew for two years during China’s anticorruption drive, which also coincided with a property-market correction in the country. It didn’t help that shoppers in other markets were also tiring of logos back then.
Europe’s luxury stocks look expensive today compared with that time. As a multiple of expected earnings, listed brands’ shares now trade at a roughly 40% premium to their 2014 to 2016 average.
To justify the higher price tag, Beijing’s housing and wider economic stimulus would need to indirectly lift luxury demand. Measures rolled out so far may not be enough to slow the slide in home prices. China’s housing market is oversupplied by around 60 million units, according to Bloomberg Economics estimates.
New incentives to kick-start consumption are expected soon but will probably target mass-market products like white goods. China already rolled out trade-in subsidies for home appliances earlier this year and a range of consumption coupons.
None of this is very helpful for sellers of expensive luxury goods. For brands to see a recovery, Chinese consumers that spend anywhere from $7,000 to $43,000 a year on luxury products would need to feel much better about their finances than they currently do. Spending by this group has fallen 17% so far this year compared with the same period of 2023, according to a report by Boston Consulting Group.
Half-finished, abandoned housing estates are a big headache for China’s government, and are also on the mind of executives in Paris and Milan. Though the fortunes of luxury bosses likely isn’t high on Chinese officials’ priority list, their fates may be intertwined.
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A legacy “partner” lease structure tied to sales, not fixed rent, is drawing investor attention as a potential hedge against inflation.
2 min
A McDonald’s restaurant in Yass has been brought to market with one of the last remaining pure turnover leases in Australia, offering investors a direct share of revenue rather than a traditional fixed rental return.
The asset, located at 1713 Yass Valley Way, is being marketed by JLL via an expressions of interest campaign closing on 30 April. It is underpinned by a legacy lease structure no longer offered by McDonald’s in Australia.
Under the arrangement, the landlord receives 6.5 cents for every dollar spent at the restaurant, creating uncapped income growth linked directly to sales performance.
The lease is structured as triple net, meaning no operational risk, capital expenditure obligations or management responsibilities for the owner.
According to JLL, the property has recorded compounded annual sales growth of 4.26 per cent since 2003, with rental income rising by 150 per cent over the same period.
JLL’s David Mahood said the structure allows investors to “participate directly in the sales growth” of the business, rather than relying on fixed annual rent reviews.
The newly commenced lease runs to 2036, with four additional 10-year options extending to 2076, providing a weighted average lease expiry of 9.92 years by income.
The asset sits on a 3,571 square metre freehold site in Yass, with significant frontage to the Hume Highway, one of Australia’s busiest freight corridors.
The location benefits from high volumes of passing traffic, including an estimated 75,000 vehicles per day.
The quick service restaurant sector has remained resilient through economic cycles, including the pandemic and recent cost-of-living pressures, with McDonald’s continuing to expand its footprint and invest in store upgrades across Australia.
JLL pointed to strong investor demand for McDonald’s-backed assets, with recent transactions typically yielding between the high 2 per cent to mid 3 per cent range.
The Yass listing is expected to attract interest due to the scarcity of turnover-based leases, which provide a natural hedge against inflation by linking income growth to consumer spending rather than predetermined increases.
McDonald’s Yass is available for sale via an Expressions of Interest campaign closing at 3:00pm (AEST) on Thursday, April 30.
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