The current pandemic situation is leading to increased demand for data services. Closure of schools, working from home policies and social distancing have placed greater demand on web-based platforms such as online meetings and classes. While Hong Kong’s real estate market as a whole is facing price and rental corrections, the data centre market has a strong outlook and is likely to attract more investors looking for an upside. Data centre rent will continue to go up by 4% in 2020, and its yield will stay at 3.5%-4.0% range which is more attractive compared to other sectors.
More interestingly, data demand from the introduction of 5G coverage in Hong Kong will grow the underlying need for storing and processing data exponentially. As such, data centre and cloud services operators are actively looking for more space in Hong Kong.
To capture this opportunity, investors may consider the following options:
Option 1 - strata title industrial buildings
Strata title industrial buildings can be repurposed for data centre use by obtaining a special waiver, which is handled by the tenant. As fitout and basic infrastructure such as chillers, power sub-stations and generators are the tenant’s obligation, a landlord’s required investment is minimal. However, obtaining licences for basic infrastructure locations from other strata title owners or DMC managers are a landlord’s obligation.
Given the significant initial capex investment requirement from the tenant-operators, they require a secured lease of at least 10 years. However, not many individual landlords are willing or able to accommodate such a long-term tenancy.
While this option provides a quick return with lower capital investment, many industrial units may not meet operational requirements, such as ceiling heights and limitations on cable and duct installation. There is also the risk of forceful redevelopment by other majority owners in older buildings.
Option 2: - enbloc industrial buildings
Conversion of existing enbloc buildings can also be carried out with a special waiver, giving more flexibility to repurpose building features such as cargo lifts or parking floors and providing good yield for shell and core without significant costs, but with some additional complexity.
The key here is finding a larger operator who can occupy the whole building as an anchor tenant, as premium data centre operators will seldom want to be located within the same building or even in close proximity - which means the enbloc building needs to be occupied by a single operator. As there are only a handful of these larger operators in the market, it is crucial for the landlord to carefully negotiate terms with potential tenants.
This option also requires the landlord to secure approval for increased power supply from CLP or Hong Kong Electric, adding uncertainty around timeframe and feasibility. We recommend investors discuss this with power companies in advance before reaching out to potential tenants.
Option 3 - redevelopment sites
Redevelopment sites allow for a build-to-suit, higher-tier quality data centre. As this allows for more tailor-made and efficient building features, the landlord can attract larger operators with better terms. Industrial lots can also enjoy a 20% additional bonus plot ratio, based on Revitalisation Scheme 2.01 (subject to TPB and land premium if any). This gives investors more attractive development options.
Although new government industrial land sale sites allow for both industrial and technology & telecommunications uses, the original structure for such designations dates back to the 1830’s, long before any modern uses could be forseen. As such, building a data centre on industrial land requires lease modification for which premium assessments can be as high as HKD3,000 per square foot on maximum permissible GFA. Assuming typical industrial land values range from HKD4,000 to 6,000 per square foot, raising up-front costs significantly and putting pressure on potential rewards for development, as well as raising rents which tenants will be expected to pay upon completion. This makes the high cost of land the biggest obstacle to overcome for investors.
In summary, data centres represent a promising niche market, with some special requirements which need to be carefully analysed. Given its higher potential yield and less volatile performance through times of uncertainty, they represent an attractive opportunity for long-term investors. Given the continually growing demand for cloud-based services and proactive government policy support, investors should keep a close eye on the industrial market for sites to be converted or redeveloped.
 allow relaxation of the maximum permissible non-domestic plot ratio by up to 20% for redevelopment projects of these pre-1987 industrial buildings located outside “R” zones in Main Urban Areas and New Towns.