Developers fear non-core locations may not produce reasonable returns on investment Hong Kong property developers have shown a cool response to the government's move to allocate 10 sites in non-core areas for hotel projects. They say the sites may not generate acceptable returns on their investment. Forecasting low single-digit investment returns on development costs that are expected to be 50 per cent higher than for residential projects, major developers say they are not keen on bidding for the sites. A source at Sun Hung Kai Properties, Hong Kong's largest developer by market value, said the hotel sites would not be attractive to most players because of their inferior location. He said hotels built on those sites would provide rental yields of just between 5 and 6 per cent. The new land application list released last month contains 62 sites up for sale, of which 10 are designated for hotel development as the government's response to the tourism industry's call for more hotel supply. The sites are in North Point, Wan Chai, Central, Kwun Tong, Tin Shui Wai, Tsuen Wan, Sai Kung, Hung Hom Bay reclamation area, and Kowloon Bay, where there are two. 'If a hotel development doesn't work, we could simply convert it into other uses,' the source said. 'But the 10 sites on the land application list are for hotel use only. We have to take on higher investment risk and will suffer if the project doesn't work.' HKR International managing director Victor Cha Mou-zing said a large capital commitment and low investment yields explained why developers had either held back on hotel projects or cancelled them entirely. Figures from the Hong Kong Tourism Board showed the average room rates jumped 11.4 per cent to HK$1,215 per room per night last year. However, the average room rates in budget hotels rose just 4.4 per cent from a year ago to HK$296 per room per night, while luxury hotel room rates gained 12.3 per cent to HK$2,124. 'In Hong Kong, high land costs make hotel investments even more challenging,' said Mr Cha, adding that margins on such projects had been squeezed significantly. Five years ago, many developers were weighing plans to redevelop their underused industrial buildings in Wong Chuk Hang and Kwun Tong into budget hotels, he said. 'Why are they not going ahead with these plans now? Because of high land premium charges,' said Mr Cha, whose group opted instead to operate luxury hotels in Bangkok. Citing HKR as an example, he said the firm's HK$1 billion 300-room hotel and retail complex in Discovery Bay had been deferred for several years as the group could generate higher returns by concentrating on other investments including residential projects. But Discovery Bay's master layout plan showed HKR was required to build the hotel, so the project would open in the middle of next year, he said. Henderson Land Development chairman Lee Shau-kee had said he was not interested in bidding for sites on the new list as the group had abundant agricultural land in the New Territories and there were also many sites for sale on the mainland. Alnwick Chan Chi-hing, an executive director at Knight Frank, does not expect developers to compete for hotel sites on the list as few were taking up long-term investments. Hotel construction costs were 50 per cent higher than residential developments, Mr Chan said, although the payback period was longer than the five years on housing projects. 'Most developers feel hesitant about hotel developments as the operating costs of hotels are also high, whether the occupancy rates are high or not,' he said. Mr Chan said the sites should be sold through a regular land auction rather than putting them in the land application list, as this process would be more transparent because the government would set a reserve price. Francis Li Chi-wing, an executive director at DTZ, said not all developers were keen to tackle hotel projects as they had no related experience. They also did not lack alternatives as the land application list provided different types of development sites. 'Residential sites are the most attractive to developers, while office sites are also attractive since the investment risk is lower. The payback period for hotel developments is about 10 years, longer than it takes for other developments,' Mr Li said. But while most developers have little interest in hotels, tourism experts believe Hong Kong will face a shortage of hotel rooms if no pipeline of new supply is created now. Hong Kong Hotels Association executive director James Lu Shien-kwai expects tourist arrivals to rise to a record 30.8 million this year from 28.2 million last year. 'Big developers may not be interested in these small sites but small operators may like them. Let's see how it goes,' he said. Assuming a 10 per cent rise in tourist arrivals yearly, the hotel industry would need a new supply of 3,000 to 4,000 rooms to meet demand, Mr Lu said. Hong Kong hotels had been enjoying an average occupancy rate of 85 per cent - the highest in Asia - for the past few years, he said. At the end of last year, there were 51,581 hotel rooms in Hong Kong, up 9 per cent from 48,300 in 2006.