Hong Kong The World s Most Expensive Location Or A City In Metamorphosis?

Hong Kong The World s Most Expensive Location Or A City In Metamorphosis?

Introduction With limited scope for future reclamation, together with a market mature relative to others in Asia, Hong Kong s advantages have recently been challenged by the suitable provision of real estate. This paper outlines some thoughts on how these challenges can be overcome, permitting short and medium term growth without compromise on cost, real estate quality or environment. Hong Kong is firmly established as the leading financial market in Asia Pacific and, currently, is experiencing its fiercest competition for Grade A office space. With continued focus on Hong Kong, as the undisputed gateway to China for global trade, the property market, business community and public sector all need new commercial accommodation. As the world s most expensive commercial real estate market (Figure 1), too much opinion has focused on core Central (CBD) supply shortages, escalating rents and affordability relative to other Figure 1: Average CBD Rentals of Major Financial Centres Net Effective Rents (HKD per sq ft per month) 140 120 100 80 60 40 20 0 4Q05 2Q06 4Q06 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09 2Q10 4Q10 Shanghai Pudong & Puxi Hong Kong Central London City Singapore Raffles Place New York Midtown Manhattan

Hong Kong The Worlds Most Expensive Location Or A City In Metamorphosis 3 city centres both regionally and internationally. This has the potential to unnecessarily frighten businesses away from Hong Kong. Jones Lang LaSalle has looked beyond the CBD with a re-examination of occupation patterns across all districts. This includes districts where the Government is promoting or is in support of further development towards the city s metamorphosis, enabling it to consolidate its prime position in Asia and the world, while providing adequate, affordable accommodation to existing, expanding and new occupants. Commercial development sites identified by the public sector within traditional business districts such as Central are unlikely to be available in the short term and will not provide a long term solution to ongoing demand for space. Jones Lang LaSalle is of the view that the catalyst for future sustained commercial development remains in and around the rapidly emerging non-core commercial district, Kowloon East. This location has steadily grown to the third largest office submarket in terms of Grade A office stock by area (Figure 2) and continues to provide a pipeline of new development (Figure 3 and Figure 4) despite repeated calls from many different sectors for the release of land in the CBD. We explain in this paper why we believe that Kowloon East will enable the release of space, particularly on Hong Kong Island, that will permit the expansion of the CBD across the Victoria Harbour hinterland. Figure 2: Grade A Office Stock Distribution by Submarket Other decentralised areas 15.1m sq ft,18% Tsimshatsui 9.7m sq ft, 11% Hong Kong East 11.1m sq ft, 13% Figure 3: Future Supply of Grade A Office Space million sq ft (NFA) 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Central 22.9m sq ft, 27% Wanchai / Causeway Bay 14.7m sq ft, 17% Kowloon East 11.6m sq ft, 14% 2011 2012 2013 2014 Central Wanchai / Causeway Bay Kowloon East Other decentralised areas Figure 4: Grade A Office Future Supply Distribution by Submarket 2011-2014 Central 0.4m sq ft, 9% Wanchai/Causeway Bay 0.3m sq ft, 7% Hong Kong s Midtown? The need for a CBD expansion With Victoria Harbour, by the Government s admission, likely to have experienced its last reduction in size, a CBD of Grade A office accommodation of just over 20 million square feet, together with the forecast growth in the region focused around Hong Kong and China, the time may be ripe for Hong Kong to break with its location-centric taboos and rethink traditional attitudes as to which industries need to be where. Other decentralised areas 2.0m sq ft, 41% Kowloon East 2.2m sq ft, 43%

4 Advance By international comparisons, Hong Kong s CBD at 23 million square feet* is tiny compared to London s West End and City at approximately 130 million square feet* and Lower and Midtown Manhattan at 240 million square feet*. Hong Kong requires further office space to satisfy occupier s needs (immediate and future). This need will not be satisfied by a handful more buildings in what is considered to be the China Decade. It can be argued that current price tensions relate to a high degree of rapidly expanding business service sectors, whose tenants seek to remain in a very congested and expensive CBD. However, is Hong Kong really that expensive relative to the rest of the region and world, or are its real estate users looking outside of Hong Kong altogether in response to CBD rent increases, when the logical solution to lower cost equivalent quality real estate lies a district away in the world s most compact and conveniently arranged city? The International Commerce Centre (ICC) in West Kowloon released some of this tension, by initially securing, among others, three large space users historic CBD dwellers as tenants, and is now almost fully leased. What this demonstrates is that our tenant community has the foresight to consider new locations when the opportunity appropriately presents itself. With limited further medium term development to supplement this location, occupiers are, and need to be, increasingly exploring options in Wanchai/Causeway Bay and Hong Kong East as an extension of the CBD. These districts, combined with the rest of Hong Kong Island, total approximately 50 million square feet* of Grade A office accommodation, a significant proportion of which is ripe for redevelopment, refurbishment or upgrading to facilitate an enlargement of the traditional CBD. The accountancy profession, a traditional occupant of the CBD, is an early adopter of this change in attitude, with many of the major players in this sector rearranging a high proportion of their portfolios out of the CBD without compromise on the external built environment, amenities, building quality or infrastructure. Figure 5 demonstrates the growth in total occupied space of the major submarkets in recent years. New York and London, two finance hubs often compared with Hong Kong, have already witnessed a comparable metamorphosis. In London Midtown * Net area

Hong Kong The Worlds Most Expensive Location Or A City In Metamorphosis 5 New York Midtown reaction to requirements for more modern and appropriate office space, as noted in our previous White Paper Leading Asia to Dominance, Midtown Manhattan, once secondary to and a much smaller commercial district than Lower Manhattan, has already surpassed Lower Manhattan in terms of the calibre and quantity of occupants. Organizations includes Morgan Stanley, Bank of America Merrill Lynch, UBS, Goldman Sachs and all the big four accountancy firms who were all previously dominant in Lower Manhattan have addresses in Mid-town now. Similarly, in London, the West End gave way to the City, which then spread into Midtown, now occupied by tenants such as Deloitte and Goldman Sachs, with a further 20 million square feet more recently added at Canary Wharf, home to occupiers such as KPMG, Morgan Stanley, Clifford Chance and HSBC. Kowloon East releasing market pressure So, is Hong Kong really too expensive or do we need to think more carefully about how we should utilize the City by district, to take advantage of more affordable premises without sacrificing any of the traditional benefits of location (Figure 6)? Figure 5: Total Occupied Space by Submarket million sq ft (NFA) 25 20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 0-10 -20-30 -40-50 -60-70 -80 Central Wanchai / Causeway Bay Hong Kong East Tsimshatsui Kowloon East Figure 6: Submarket Rental Discount to Central Net Effective Rents (HKD per sq ft per month) Wanchai/ Causeway Bay Tsimshatsui Hong Kong East Kowloon East as at end-2010

6 Advance No. of Buildings 35 30 25 20 15 10 5 0 15 Existing Grade A office Some of the many differentiators Hong Kong has compared to other cities globally include: Its compact nature and the ability to facilitate many meetings in one business day Easy and convenient commuting between home and office to indirectly enhance productivity and efficiency The provision of high quality Grade A premises Amenities and infrastructure around Grade A office districts/locations capable of properly supporting dense office occupation, such as Central, Causeway Bay and Hong Kong East. When discussing real estate quality and suitability the world over, location is key. However, location is largely judged on the points above alongside an element of prestige associated with the location in question. Further, prestigious locations generally expand over time to include what were previously peripheral locations, which is why today s core business districts in locations such as London and New York have expanded to 130 and 240 million square feet, respectively. This will also happen in Hong Kong. Figure 7: Kowloon Bay - Grade A Office Market Supply (Known as at 1Q11) 16 20 Upcoming Application List Planned* * Estimated number of buildings for the Kai Tak and Kwun Tong Town Centre redevelopment areas Research 30 The limited availability of brownfield redevelopment sites will require, in the medium term, refurbishing and developing around a significant amount of stratified accommodation not suitable for redevelopment. The nature of ownership stratification that we have in Hong Kong makes organic creeping district growth in some districts difficult. Barriers are created by rafts of strata-titled commercial buildings that are difficult to demolish or refurbish to make way for Grade A office accommodation. A good example of this is the area between Admiralty and Core Central. With no future reclamation for redevelopment likely and limited new sites available for development from either the private or public sectors on Hong Kong Island, developing the CBD in one district on Hong Kong Island is not a sustainable model for the successful growth of the city. In our opinion, there is a clear path for the sustainable growth of the business sectors in Hong Kong, satisfying both core and non-core requirements, broadly covered in the plans that the Government has in place for the city s future development. One of the future concentrations of Hong Kong s non-core office accommodation lies around the Kowloon East and Kwun Tong locations. Kowloon East is unique in having a high combination of privately and publically owned sites, ripe for conversion and development into Grade A offices, with potentially plentiful supply to build on the steady pipeline of the past five years. Generally, forecasts from Research will not take into account many potential sites until formal development plans have been approved by the Government, however, a deeper look at this location shows that a plentiful supply of future Grade A office space will potentially be available as indicated in Figure 7 and Figure 8.

Hong Kong The Worlds Most Expensive Location Or A City In Metamorphosis 7 This supply of redevelopment sites has the potential (with the appropriate consents) to filter into the market year on year and also offers the scope for design and built solutions for tenants in addition to developer/occupier partnerships. Along with the Government s intention to begin delivering the office components of the redeveloped Kai Tak Airport site from 2015/2016, which adds more than 7 million square feet* of office accommodation in a location immediately adjacent to Kowloon Bay and Kwun Tong, this highlights how Kowloon East is set to emerge as the largest commercial district in Hong Kong (Map 1). Figure 8: Kwun Tong - Grade A Office Market Supply (Known as at 1Q11) No. of Buildings 20 18 16 14 12 10 8 6 4 2 0 11 Existing Grade A office 16 18 Upcoming Application List Planned* * Estimated number of buildings for the Kai Tak and Kwun Tong Town Centre redevelopment areas Research 19 Map 1: Development Plan for Kai Tak Source: Kai Tak Outline Zoning Plan, Jones Lang LaSalle * Gross area

8 Advance Hysan Place A significant pipeline of development could easily be secured in Kowloon East beyond the next decade. The Government has already outlined the necessary additional infrastructure to help bond these locations as one and improve connectivity. With the appropriate level of private sector investment in both the development of Grade A office space and supplemented amenities, Kowloon East will become the city s major noncore business hub for the foreseeable future. The new cruise terminal and extensive redevelopment of the old Kai Tak Airport site adjoining the district should further support infrastructure, availability of accommodation and the gentrification of this district leading to increasing acceptance of Kowloon East as a future commercial hub of Hong Kong. As mentioned, the opportunity clearly exists for a strong pipeline of future Grade A commercial development. The potential to accelerate the availability of this accommodation would further be enhanced if public sector incentives and encouragement were also provided to developers. Growing and enhancing the existing CBD What then will become of the existing CBD? Referencing our comments on location earlier, Hong Kong, with its unique position adjacent to China and associated growth opportunities, has outgrown its ability to utilise Central s 23 million square feet as a CBD. The next decade will be one of growth, and the city must evolve to accommodate this. It appears that the Government is driving the market to complement the traditional CBD by facilitating further commercial development in Kowloon which will, in turn, release accommodation in other districts to permit tenants to grow in other areas of Hong Kong Island. The migration of non-core office users to Kowloon East will therefore free up accommodations for CBD-users currently located in Wanchai, Causeway Bay and Hong Kong East. The

Hong Kong The Worlds Most Expensive Location Or A City In Metamorphosis 9 further improvement of these Hong Kong Island submarkets will also see new office buildings become available, either through the refurbishment or redevelopment of existing buildings, providing core tenants with a wider choice of expanded CBD options in the medium and long term. This process is already happening, driven by a number of Grade A developments such as Hysan Place in Causeway Bay. Expanding the boundary of Tsimshatsui The piece of land at West Kowloon waterfront (Map 2) will eventually link Tsimshatsui with ICC and will supplement this CBD expansion in the longer term, provided the Government maintains its position to facilitate the four million square feet (gross) office space planned in the West Kowloon Cultural District and above the future Express Rail Link (XRL) Terminal. This supply is not scheduled to be available until toward the end of this decade, therefore being unable to accommodate pent up demand from occupiers seeking large space accommodation in the CBD in the short-tomedium term. The potential of the area to develop as a regional transportation hub and its close connectivity with Tsimshatsui, however, is set to increase its credentials as a future expansion of the CBD location. Both Kowloon East and West Kowloon will have world class infrastructure connections and commercial amenities that would comfortably accommodate organisations traditionally wedded to the existing CBD. These locations also pass that crucial Hong Kong test of being minutes apart from other office submarkets on Hong Kong Island, preserving the business efficiencies that the City is famous for. In addition, West Kowloon will only be 45 minutes away from Guangzhou in five years time, upon delivery of the new XRL service. Map 2: West Kowloon waterfront a natural extension, Tsimshatsui

10 Advance So, at a glance, while Hong Kong appears expensive, we see its potential in a different way: It appears that, in the very short term, there is a supply shortage and that this will lead to strong pent-up leasing demand in the medium term future. However, businesses continue to see Hong Kong as a key headquarters location in Asia. Expansion of the CBD in the way suggested above will likely allow the city to develop as required with a combination of re-use of existing premises and new development. It is possible to map out how this can happen based on the rate of historic take up of accommodation. Medium and long-term, this does not rely on the emergence of Kai Tak or the future relatively small amount of further accommodation due to be developed at West Kowloon as a new CBD. At the pace that the region is currently growing, waiting for the CBD to reposition towards Kowloon, rather than proactively encouraging the development of this location as a non-core hub, may mean that a substantial part of the opportunity to leverage short or medium-term growth will be lost. As highlighted, the quality of infrastructure, amenities and accommodation that exist in the areas we have highlighted gives them the potential to be expanded CBD locations, as does the development potential necessary to release current non CBD tenants from these locations into the Eastern part of Kowloon. Occupiers embracing this change alongside medium and longer-term strategic real estate thinking, have the opportunity to pioneer this change, in partnership with private sector owners and the Government who will be required to drive accommodation opportunities consistently. It has been proven historically that Hong Kong occupiers will embrace locations that break with traditional taboos, and have enjoyed successful outcomes. The catalyst for the establishment of such locations is generally the result of a partnership between a landlord, with some level of investment in the creation of the new district, and the initial tenants in the capacity of early adopters. On the basis outlined above, a realistic option for the future development of Hong Kong does not rely on a fundamental shift in the CBD, but consolidation by expansion into the districts on Hong Kong Island, mainly in an Eastern direction. An appropriate approach to facilitate and support this change, of which there is already evidence, would be investment by major tenants demonstrating a willingness to invest in new or reprofiled locations. In turn the landlord community will be required to invest in partnering with initial tenants, who through lease commitments will help shift perceptions of location, and act as a catalyst to the changing profile of the respective districts east of the current CBD. On this basis there is incentive for the public sector, private sector landlords and the tenant community to participate in Hong Kong s development in this direction, and a clear path ahead for creating adequate provision of commercial real estate in Hong Kong, at rents that will help to maintain the city s competitive positioning in the region.

Gavin Morgan Deputy Managing Director and Head of Leasing, Hong Kong gavin.morgan@ap.jll.com Gavin Morgan is the Deputy Managing Director and Head of Leasing at Jones Lang LaSalle in Hong Kong where he is also a ten year veteran of the real estate market. Gavin has also worked on behalf of a broad range of multinational corporations from the business sectors discussed in this paper. Marcos Chan Head of Research, Greater Pearl River Delta marcos.chan@ap.jll.com Marcos joined Jones Lang LaSalle in 2000 and is currently the Head of Research for Greater Pearl River Delta. Directly reporting to the Head of Research for Asia Pacific, Marcos oversees a team of research analysts and consultants across Hong Kong, Macau and the Pearl River Delta. He is a key contributor to various research publications and is responsible for consultancy assignments within his region.

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