World’s highest rents aren’t too high for Chinese firms

Analysts say the high rents will not hurt Hong Kong’s competitiveness, even though non-Chinese firms have been forced to decentralise from the CBD.

PUBLISHED : Saturday, 20 May, 2017, 8:00am
UPDATED : Saturday, 20 May, 2017, 7:32pm

For 30 years that it has been in Hong Kong, Ince & Co. – one of the UK’s top maritime law firms with a history that stretches back to 1870 – has always had its place in the city’s central business district.

Ince, which opened its first Asia office in 1979, has also witnessed Hong Kong’s maritime rise as the world’s largest container port, and only to loose the glory to Shenzhen and Shanghai.

But the changing tide hit home harder last November when the firm fell prey to Central’s surging rents and was forced to move out of Citibank Plaza to One Island East in Quarry Bay.

Ince’s landlord had demanded a 50 per cent increase in rent, which would make the firm’s 12,000 square feet office cost HK$1.5 million to lease every month.

“When we renewed our lease last year, the landlord asked for HK$125 per sq foot, that is 50 per cent rise from what we signed three years ago, so we decided to leave,” said the firm’s regional business and finance director Lionel Noronha. “It’s just too expensive in Central, and we have to make sure our business maintains a profit margin.”

The firm ended up relocating seven subway stops eastwards to Quarry Bay, to Swire Properties’ relatively new building, where they can afford 12,000 sq ft of space within their 2016 budget.

Ince is not alone in the flight from Central’s rising rents, which have contributed to making Hong Kong the world’s most expensive city to work in.

It’s just too expensive in Central, and we have to make sure our business maintains a profit margin
Lionel Noronha, Ince and Co.

Legal firms, hedge funds, advisory firms have been decamping in the past 12 months to Quarry Bay, Causeway Bay, Tsim Sha Tsui and Kowloon East, where the prevailing average rent is half of Central’s.

More could follow, after Henderson Land Development’s purchase last week of the Hong Kong government’s Murray Road site at a record HK$23.28 billion. It is also the world’s most expensive land plot on a per sq ft basis.

Henderson, which has not won a land bid in two years, plans to build what co-vice chairman Martin Lee Ka-shing calls a “landmark” office tower on the site, due for completion by 2022.

Adding Asia’s highest construction costs and interest rates to the land cost, Henderson will need to ask for at least HK$200 per sq ft in rent to generate its standard profit margin.

Henderson pays US$3 billion for world’s costliest land plot at Murray Road in Hong Kong

For a typical corporate office with 125 employees operating in 23,000 sq ft of space, the annual rent at Murray Road will be as much as HK$55.2 million a year, according to an estimate by Leland Sun, managing director of Pan Asian Mortgage, a mortgage financier based in the city.

That means the company will need at least HK$184 million in annual revenue to afford the rent, if the leasing cost were to make up 30 per cent of revenue, said Sun.

High rents have not marred Hong Kong’s international finance centre status, despite a less costly rival in Singapore, where office rent in core business areas is 60 per cent lower at HK$47.2 per sq ft.

Sun said there were other push and pull factors to setting up a substantial presence in a city with higher office rents.

“ The major advantages that Hong Kong will always have over Singapore is its proximity to China and its air and sea connectivity,” he said.

“With not only the Belt and Road Initiative, but also greater emphasis to develop the Greater Bay area in the mainland, Hong Kong will continue to attract both financial capital and human capital, despite the marginally higher cost of doing business here.”

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John Siu, managing director for Hong Kong at Cushman & Wakefield believes that the location of regional headquarters for many firms was determined by their area of focus and how that relates to a city’s competitive advantages.

“For Hong Kong, much of that is tied to its proximity to China, so firms for which that is a key market, will want to remain in Hong Kong. While some firms have opened headquarters in the mainland, I think Hong Kong’s transparency, rule of law, and openness will all continue to give it a clear advantage to firms seeking to tap the China market,” he said.

Alex Barnes, Head of Markets at JLL agrees.

“Hong Kong’s office market is unique in that you can take a 5–10 minute taxi ride, or three to four MTR stops from core Central and be in a district where rents are 30 to 40 per cent of the price that are being achieved at top end of the market.

“Central rents make for good headlines but do not reflect the city’s offering as a whole. It’s a phenomenally competitive city at all price points,” he said.

Mark Bernard, managing director at OfficeAsia TCN Worldwide, which focuses on office leasing, said non-Chinese firms’ decentralisation was offset by demand from mainland firms entering Hong Kong with the aim to expand globally.

“With the Shanghai-Hong Kong stock exchange link and Shenzhen link, the demand has been strong from the mainland over past five years,” he said.

James Wang, chief investment officer of HNA Group, said mainland companies would make Hong Kong their first choice when they set up an overseas office, even though rents in Hong Kong are much higher.

HNA has its office at the IFC, Hong Kong most expensive grade-A office building, whose rent is as high as HK$185 per sq ft.

“There is something about the affection between Hong Kong and China. When we go to Singapore , we feel that we are in a foreign country. Hong Kong, as an international city, is part of the country as there are similarities such as culture, and we are Chinese,” Wang said.

“As a first move outside China, mainland firms will come to Hong Kong,” he added.

As a first move outside China, mainland firms will come to Hong Kong
James Wang, HNA Group

Mainland companies, which already occupy about 56 per cent of all new commercial office leases in April, were the most likely tenants that could afford these rents, and continue to underpin leasing activity in Central, according to JLL.

Foreign firms relocate their Hong Kong offices to outer suburbs as mainland companies take over Central

Don Taylor, director for office at Swire Properties said western financial firms and banks, as well as professional services firms, were currently reviewing their cost structures and exploring opportunities outside of Central, in places like Taikoo Place.

“Traditional Central-based tenants are looking further afield, based on limited vacancy and new supply; so Taikoo Place is likely to benefit from this spill over demand,” he said.

According to Cushman & Wakefield, Hong Kong average grade-A office net rents in Greater Central (Central, Sheung Wan and Admiralty) are now up by a massive 567 per cent at HK$122.16 per sq ft in the first quarter 2017, from a low of HK$18.3 per sq ft in the third quarter 2003.

“Supply and demand is behind the steep rise. There will not be new supply in Central for the next five years,” said Siu of Cushman & Wakefield.

“From our estimation, there are only 2.8 per cent of 12 super Grade-A office existing buildings available for lease and for occupation within 12 months at the moment.

“We have seen several companies bid for one office unit once it is put for lease,” he said.

Strong demand kept vacancy rate in Central at just 0.6 per cent in April, according to JLL.

Lau Chun-kong, international director at JLL projected that the building at Murray Road would have to achieve HK$71,800 per sq ft for sale or HK$211 per sq ft rental per month in order to generate a 15 per cent profit margin when it is put on the market in 2022.

“The property can be sold only in its entirety and no strata title sale can be allowed,” he said.

Colliers International says the high expectations for the Murray Road site have also driven up the prices of nearby Grade A buildings. Office units in Fairmont House and Far East Finance Central were recently transacted at record levels at HK$28,200 per sq ft and HK$38,000 per sq ft.

A 6,500 sq ft office unit at a lower floor of 9 Queen’s Road Central is up for sale at HK$500 million, or HK$76,923 per sq ft. Last month, a 3,664 sq ft unit on the 14th floor of the building was sold for HK$145.82 million, or HK$39,800 per sq ft, the highest transaction price for an office space to date .

“It is just gimmick. Land prices have no direct relation with rental and selling prices which determinated by supply and demand when the spaces put on the market,” said Alfred Lau, property analyst at Bocom International.

Demand from cash-rich Chinese firms played a big part in keeping rents high in Central, said Ince’s Noronha. The premises that Ince vacated were quickly snapped up by mainland tenants.

He said the rent for their new office at Island East was HK$60 per sq ft, or 50 per cent less compared to what they paid for in Central.

What’s more, he said the office building had better infrastructure such as full high window and more convenient IT facilities.

The firm has furbished the new office into a “Facebook” style, providing more space for staff to engage and share ideas with one another.

“After we moved in, already 15 law firms have visited our office and shown strong interest. So I believe more and more firms will leave Central for Island East,” he said.