09 October 2017

Record-breaking transaction prices and the ever-rising rental levels in Hong Kong office market have garnered much attention from investors to reposition their investment strategies.

The Murray Road Car Park’s colossal HKD50,064 per sq ft transaction is a prime example that demonstrates the favourable perception of the prospect of the core-CBD. The staggering price tag of the top floor of The Center likewise serves as evidence for the appeal of the anticipated return on rental appreciation. Besides, with Hysan’s Lee Garden Three being the only new supply in the next five years and the current low vacancy rate at 2.2%, Causeway Bay (CWB) office market is increasingly perceived as a good investment bet. Like many of us, I wonder why the Excelsior offer has fallen short. It was Mandarin Oriental’s (the owner’s) hope to realise a handsome capital return on this iconic building. However, they withdrew the sales tender on 28/9, announcing that there was a discrepancy between the bidding and asking prices. Considering its adjacent office tower the World Trade Centre and the promising outlook of this fringe-CBD market, it naturally begs the question of why the Excelsior tender did not come to fruition.

Scrutinising the difference between the current and future rental expectation of the site will provide hindsight into the matter. Before Mandarin Oriental withdrew the tender, general market speculated that the transaction value could reach HKD30 billion (USD3.84 billion). Based on this price, to achieve 15% return on investment with a construction cost of HKD8,000 per sq ft, the rental level of the converted building has to reach HKD130 per sq ft, which is comparable to the rental level in Central, in order to achieve a yield similar to the current market level at about 2.8%. From my point of view, the ambitious price may take more time to yield return.

Given that Excelsior enjoys a unique competitive advantage of a spectacular view of the Victoria Harbour, a prominent signage and is located at the heart of CWB, its rental level could reach above HKD130 per sq ft in five years if office prices continue to rise. However, it is not easy for investors to accept non-profitable rental levels for five years. Together with the negative growth of the tourism industry which has affected investors’ confidence in investing in the associated retail podium, it has contributed to the revocation of the sales tender.

The fact that Sun Hung Kai Properties (owner of the adjacent World Trade Centre) participated in the tender proves market interest in the site is far from scant. The market sentiment may attribute the outcome to the increasing Chinese capital outflow restriction, which has contributed to the diminished interest of PRC investors in overseas property markets. From our standpoint, we agree that the capital outflow restriction has prompted PRC investors to rethink their overseas investments. But let’s not forget that the Excelsior is classified as a global trophy asset that appeals to investors worldwide. As long as the future rental growth, total lump sum price and the yield fulfil their expectations, a sales agreement could be reached at any time. Since there is a disparity between the current and future rent expectations in CWB, potential buyers may reason that it is not a good time to acquire this iconic landmark. When the criteria for a good investment are met, I think the property could be sold through private treaty.

Taking these factors into account, we trust that the withdrawal of Excelsior from the sales market is only an isolated event which will cause little impact on investors’ confidence in the core-CBD or fringe-CBD office market. On the contrary, the blooming of the office sector in the core business districts will create a proliferation effect on price and rental levels of the secondary office areas, in which we believe we will witness more pronounced sales tenders or transactions in the near future.