Survey reveals deep structure of Hong Kong Grade A office market

A recent survey by DTZ Research in Hong Kong has revealed some interesting facts about the underlying "deep structure" of the city's Grade A office market, how it has evolved over the past two decades, and how it is likely to be further transformed over the coming decade.

Unlike mainland China's tier-one cities, which have witnessed rapid growth in their office markets over the past 15 years, the Hong Kong office market expanded continuously but much more gradually.

A key finding is how remarkably concentrated the ownership of Grade A office properties is in the hands of local players. While 71.6 per cent of the Grade A stock is domestically owned, 59 per cent of the overall stock is in the hands of listed developers.

Given the cost and difficulty of assembling a Grade A office site in Hong Kong, companies that had the vision and wherewithal to develop such properties have generally been reluctant to dispose of them. The only exception to this rule is developments located in new and unproven areas, which are still subject to rapid transformation.

Yet another interesting fact revealed by our survey was that while Grade A office ownership has been very much developer-dominated over the past 15 years, corporate share of ownership of Grade A office stock rose from 4.6 to 7 per cent as a result of rising rentals.

The other point that emerged from the survey was that due to the rapid process of de-industrialisation that Hong Kong went through, combined with the constraints of Hong Kong's inner-city area and the government's ban on further reclamation of Victoria Harbour, the greatest opportunities for engaging Grade A office development were presented in the few inner-city areas, which once had large concentrations of manufacturing plants.

The process was further promoted in 2001 with the rezoning of Kowloon Bay and Kwun Tong for business use, thereby increasing the supply of modern office or mixed-use commercial properties. Meanwhile, in 2005, the provision of amenities in these two areas had improved to the point that major corporations - mostly banks and insurance companies - started to enter Kowloon East in force, setting up what were initially back-office operations.

The growing attractiveness of Kowloon East to tenants, owner-occupiers and investors has been borne out by the surge in major en-bloc transactions during the past three years to the point where, by 2014, it accounted for 58.7 per cent of the office transactions within Hong Kong's five sub-markets.

And yet, for all of this growing interest, our survey revealed that in some respects Kowloon East is still not a fully mature area. Of the city's total development pipeline of 14.6 million square feet up to 2020, about 60.5 per cent is concentrated in Kowloon East district.

However, in the face of huge future growth in supply in Kowloon East over the short term, rental growth has been suppressed while capital values have continued to appreciate significantly. As such, the yield of office space stayed at a low level and vacancy rates have remained relatively high, with the consequence that institutions are generally more willing to invest in core office properties other than in business districts.

The fact that these institutions have not fully appreciated Kowloon East's ultimate investment potential represents a window of opportunity for some investors who have a longer-term vision of the pattern of Hong Kong's evolution and have sufficient capital to back it up.

Because of the persistence of high office rents in Hong Kong's traditional core office districts, demand for accommodation in Kowloon East will remain robust and will gradually absorb the large amount of office supply either recently completed or under construction. This confluence of events will gradually reduce developers' incentives to dispose of their properties, as Kowloon East takes on more of the air of being an established business district in its own right.

The value of Kowloon East properties will be further amplified when Kwun Tong, Kowloon Bay and the Kai Tak redevelopment area gradually fuse together into the largest Grade A office hub in Hong Kong. This grand Kowloon multiple sub-district fusion will be enhanced by the Sha Tin-Central Link, a monorail system connecting the three MTR stations within the business districts and related facilities.

Tom Ko is director of DTZ investment and advisory