Traditionally office occupiers, particularly MNCs, have a tendency to lease rather than to own their office in Hong Kong, prefering single-owned office buildings to stratified office buildings, which is not unreasonable. High office prices, a lack of good quality office spaces for sale, and relatively inferior property management of stratified buildings are all relevant factors which drive occupiers to the leasing market. While all these factors remain relevant, we are of the opinion that office occupiers may start, if they haven’t yet, to review the option to buy and own their office premises in 2019.
Office prices are becoming reasonable...
Grade A office prices experienced a rapid hike from late 2016, gaining even more strength towards the end of 2017. It was underpinned by simultaneous increases in office rents and demand from mainland corporations. Nonetheless, from mid-2018 onwards, due to the intensification of the US-China trade war as well as mainland corporations withholding their expansion plan, office prices witnessed an obvious correction. A trend accelerated through some price-cutting strategies by property traders who purchased office spaces during the upswing and tried to unload them soon after the correction.
Since office prices are well recorded, the questions that follow would naturally be - how long will the downward movements last? And what is the extent of the adjustment?
The chart below provides a side-by-side comparison of office yield movement and the 3mth-HIBOR in the past 10 years, illustrating the spread between interest rates and office yield closing to a level in which positive carriage is almost negligible. Unless office rentals continue to increase, which is highly unlikely to happen; office prices must adjust downward for office acquisitions.
On the other hand, we do not think that this downward adjustment will be longlived, and the reasons are two-fold. First, it is widely believed that the current interest rate will remain flat for at least the next 12 months, releasing pressure for further price compressions. Secondly, future supply for quality office is still limited with around 3.5 million square feet of new supply becoming available this year and no new supply for 2020. We expect 2021 to record a total new supply of 1.6 million square feet only, one third on the island side. For the subsequent years, new supply of Grade A office will pick up again, but only 2.5 million square feet circa will be on Hong Kong island.
... and, viable stock is available in the market
Historically stratified office properties are usually not associated with quality office space, and Grade A office stock for sale is usually limited to No. 9 Queen’s Road C. in Central, a cluster in Admiralty district, and the Grand Millennium complex in Sheung Wan. However, in the past few years, a bullish market atmosphere has tempted owners, investors and developers to offer quality office space for sale, firstly en bloc then strata. With The Center in Central as the most notable example, plenty of others can be found in secondary areas like Wanchai and Sheung Wan. Even more amply available are Grade A office spaces found in decentralized areas such as Kowloon East and Island South.
Despite all of the above, there are plenty of concerns for office occupiers before switching from being a tenant to an owner. Initial capital outlay is always the first big consideration. In Hong Kong, as an international financial centre, arranging property financing is not complicated and is low costs. Equity tied up in such an acquisition is easy to release, and the same goes for cash back, in case of need because of the presence of an active and efficient strata sale market.
Property holding in Hong Kong is also user-friendly. Most, if not all, of the stratified quality office buildings are managed by professional property management companies at a decent service charge. Interest payment incurred from property mortgage is tax deductible. And last but not least, Hong Kong government levies no capital gain tax on capital disposal. It makes self-occupied office property a viable option for corporates to invest their surplus capital.