An attempt to answer a recent Twitter exchange ran over the 140 characters, so here it is. I have another post underway about MTR’s unusual value-capture business model and its implication on stations, so this is useful background research.

@MarketUrbanism I'd be interested to see the actual makeup of the developments. — The Overhead Wire (@theoverheadwire) September 23, 2013

Per analysis of MTR’s 2012 annual report, the typical MTR mall is ~100KSF (median 85KSF, avg 130KSF), which is certainly a neighborhood or community scale retail center. The report lists 19 held investment properties in retail use, accounting for 79.6% of the investment properties’ area; another 15.3% is in office. The “Property and Other” business unit also includes property management, Octopus, etc.

Three malls qualify as regional retail, with over 300,000 sq. ft. of leasable area (a typical million-foot regional mall in the USA will have about 300,000 leasable, with the rest tied up in various owned parcels like department stores): Maritime Square at 316,779, Telford Plaza at 640,245, and Elements at 498,762. Most serve a local market, as evidenced by the Chinese-language-only MTR Malls directory, but with Hong Kong’s density that market can be surprisingly deep. Elements, atop the airport express rail station and adjacent to the new high-speed rail terminal, certainly aspires to a higher-end audience with its Madison Avenue-caliber roster of haute couture — and English-first website.

55.4% of MTR’s total 2012 profits stemmed from property and in-station commerce: 36.1% from rents and management income and 19.3% in for-sale development. Profit margins on the property businesses are certainly healthy: 81.6% on investment property and 89.2% on in-station commercial, vs. 46.1% on Hong Kong transport and just 4.7% on the emerging international transport businesses. A near-90% margin practically qualifies as minting money. (In fact, it’s much better than minting money: the U.S. Mint cleared only 21% seigniorage on circulating currency in 2012.)

Note that in-station commercial offers the richest margins; over half of this business unit’s revenues come from in-station retail, with the rest from advertising and telecom fees within stations. MTR collected US$276.4 million on 608,729 square feet of in-station retail, for an unbelievable-for-the-US (but not for HK) average rental rate of $454/foot, well over twice the rents garnered per foot of investment property above the stations. Averaged across MTR’s 84 heavy-rail stations, that’s 7,247 square feet of retail per station.

A few facts that surprised me:

1. Retail accounts for most of ongoing income; office is just a sideline, and rental residential miniscule.

2. In-station retail rents for substantially more than the flashier malls above.

3. Aside from a few properties (of leviathan scale: Telford Gardens has almost 5,000 apartments; Elements is the retail portion of a Canary Wharf-sized, 12-million-foot mixed-use complex), the scale of station retail centers is usually fairly modest, although admittedly Hong Kong makes very good use of every available square foot.

4. Residential activities are almost all for-sale, unusual in a city that’s about evenly split between owner-occupiers and renters. However, its government owners probably want to focus housing development within HKHA/HKHS.

5. Margins on the core transit business are much stronger than I expected, particularly relative to the industry average.

6. Operating margins on the property business are generous, but comparable to REITs Stateside. Although net operating income (NOI) and operating margins aren’t GAAP measures, since different companies allocate costs like general operations or capex very differently, a quick review of three retail REIT financials (FRT, GGP, HHC) show the best with net operating margins in the low 80%s. The in-station retail’s 89% doesn’t sound much higher, but it implies operating costs half as high on a percentage basis, perhaps explained by the combination of higher rents, lower wages, lower taxes, and division of expenses between the property and transit businesses.