Uncovering value when it’s hidden by the price
The true value of a property investment is in how an area is likely to evolve, not simply the transaction price
“Price is what you pay, value is what you get.” – Warren Buffet.
The best long-term investments are frequently questioned at the time of transaction by market scribes, with current pricing used to validate decisions. However, this focus on price, particularly in the context of previous transactional evidence, can be misleading and misrepresents the most critical component – value.
The Lands Department recently announced that Sino Land and Empire Group had won a plot of land in Wong Chuk Hang with a bid for HK$2.528 billion, a record price per square foot in the area. This raised eyebrows among some observers who queried the upside potential of the transaction. However, the reality is that Wong Chuk Hang will undergo radical transformation over the coming years, the result of (i) huge infrastructure improvements brought about by the upcoming new MTR line, (ii) improved commercial stock as developers and investors recognise the potential, and (iii) a major upscaling of the occupier base as large corporations are attracted by these two elements.
To establish the value of the purchase by measuring prices paid previously in the area is not comparing “like with like”. One must consider how an area is likely to evolve into a destination and how this translates into the alpha element of project returns, over and above the beta return delivered by the Hong Kong market as a whole.
Just five years ago Kowloon East was considered by many professionals in the real estate industry as not suitable for large multinational companies. It was too far away, the buildings were not up to scratch, services were not available and, most of all, it was not Central! Indeed, it was hard to get Hong Kong Island occupiers to view buildings in Kowloon East during the supply boom of 2006-2008. However, as the saying goes, build it and they will come. In one month, September of 2008, over 2 million square feet was added to the market through the completion of four new office buildings, sending the vacancy rate above 35 per cent almost overnight. Not only was this space filled; it also provided a platform for strong rental growth in the area.
“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” – Winston Churchill
All of this should appear logical in a market as physically constricted as Hong Kong. First-mover advantage here has proved to be particularly rewarding in the commercial real estate sector.
Manulife moved to Kwun Tong in 2009 at a time when many companies were concerned that decentralisation would harm their chances of attracting and retaining talent. These fears proved to be without foundation, and a number of other insurance companies followed suit. Manulife then purchased the West Tower of One Bay East in 2012 with some market commentators doubting the wisdom of such a large purchase when prices had never been higher in the area. Fast-forward four years, and it is widely considered to have been a very shrewd purchase.
It is not only Kowloon East that has benefitted from a seismic shift in occupier perceptions and preferences. In 2013, Kwai Chung became an accepted office location when Bank of America Merrill Lynch established a major footprint for itself on the Western corridor, relocating from Hong Kong Island. A year later, CBRE Global Investors purchased the mid-zone of KCC Tower 2, secured a major anchor tenant and subsequently sold the asset to another property fund, demonstrating the solid return that early buyers/investors/movers can generate in Hong Kong.
“You will never do anything in the world without courage. It is the greatest quality of the mind next to honour.” – Aristotle
We needn’t look to decentralised locations to witness how the panorama can quickly change. At the turn of the decade, it seemed inconceivable that a major investment bank would cross the harbour to Kowloon, until Morgan Stanley, Credit Suisse and Deutsche Bank relocated operations to ICC. More recently, we have seen some legal firms adopt Hong Kong East as their new home, and there may be more to follow. North Point will also undergo significant change with the development of a high-spec, grade-A office at 18 King Wah Road. The completion of the Central-Wan Chai by-pass will undoubtedly encourage tenants from Central to consider the building.
The best organisations and the most savvy investors tend to lead the market and show a keen appreciation of the value inherent in quality office space in emerging locations. There are numerous cases exemplifying this around the globe, none more so than New York. Times Square was a largely run-down, unappealing area in the 1980s, its redevelopment hindered by a recession, objections and lawsuits. Publisher Conde Nast then became the first major corporation to settle in the area by leasing 800,000 sq ft in 1996. Other large organisations such as Morgan Stanley and Viacom followed.
Market fundamentals and Hong Kong’s maturity continue to attract local, regional and global flows of capital. However, aside from Hong Kong private wealth and mainland Chinese companies, many investors find it difficult to justify the price or lump sum involved. Hong Kong is a safe haven for long term capital, offering value-added opportunities and high returns, but these are often hidden behind tight initial yields. Investors should carefully consider the story behind each investment, and go the extra yard if they like what they hear.
John Davies is an executive director of institutional investment properties at CBRE