Hong Kong facing a shortage of top grade offices

Despite office rents having dropped over 20% from their peak in 2008 to the end of 2012, Hong Kong’s central business district (CBD) is still one of the  most expensive places in the world to do business, a new report shows.

This is partly due to the limited amount of Grade A office stock and the Hong Kong government has unveiled plans to build another CBD and relocate existing government offices, in an effort to increase long term supply.

However, according to the latest Knight Frank Hong Kong office market outlook report, it is still unclear whether these plans can meet future demand.

At the end of 2012, the total floor area of Grade A office space in Hong Kong was over 74 million square feet. Around 23% of this total was located in Hong Kong’s traditional CBD, namely Central, while Kowloon East’s share of prime office space increased to almost 12 million square feet, or about 16%.

Vacancy rates of Grade-A offices have increases since the third quarter of 2011, rising around 1% to 3.4% by the end of 2012. Despite this, vacancy rates remain at a historically low level, the report points out.
 
Major financial cities, such as New York, London, Singapore and Hong Kong, face difficulties in accommodating long term business growth. Hong Kong has the smallest CBD area of all these cities, so direct comparison with Western finance hubs is inappropriate, says Knight Frank.

The firm believes that a comparison with Singapore is more relevant. The report says that Singapore and Hong Kong are the preferred locations for many international corporations setting up regional offices in Asia. While Singapore’s urban area is much smaller than that of Hong Kong, Singapore’s CBD area covers more than 1,600 hectares, twice the size of Hong Kong’s CBD.
 
Hong Kong’s limited CBD area, or rather its shortage of prime office space, has resulted in higher rents for Grade A office premises. Hong Kong is also facing an aging office market. Around 50% of the city’s Grade A offices is over 20 years old.

Aging office stock is particularly noticeable in the traditional CBD and Central submarket, where office buildings completed before 1990 account for 57% of stock. Buildings completed in the last 10 years account for only around 5% of stock.
 
In a bid to mitigate the office shortage, the Hong Kong government has launched ambitious plans that could provide some 50 million square feet of new office space. ‘However, many developments are still in the preparation stage and the effort to rebalance supply and demand levels is unlikely to be realised in the short term. We expect supply from 2013 to 2016 to reach an average of 1.7 million square feet per annum, still 0.2 million lower than the long term average,’ the report says.

‘The lion’s share of new supply over the next three years will be located in Kowloon East. Hong Kong will see a substantial increase in office supply in the coming decade, as well as the emergence of new office nodes once urban districts such as CBD2 and West Kowloon have materialised,’ it explains.

In addition, the Hong Kong government has also moved to increase commercial land supply. The 2013/2014 Budget reveals the inclusion of nine commercial sites in the latest Land Sales Programme, providing a total floor area of about 3.6 million square feet to the market. Most of the sites are located in Kowloon East to speed up the development of the CBD2.

‘However, as time is needed for planning and development, we therefore expect this new supply will only be released to the market after 2020. We expect the increase in new supply to begin to take effect in 2017 at the earliest, with an average of 1.9 million square feet per year during 2017 to 2020,’ it adds.

The report also points out it is unlikely that long term demand for office space will be satisfied by the current planning and development progress of major projects. ‘Assuming that the current economic and employment growth continues, Hong Kong is likely to face a shortage of office space of around four million square feet which could increase to over eight million square feet should the local economy expand at a faster pace,’ says the report.

‘Our analysis shows that by 2020, an additional four to eight office towers of a comparable size to Two IFC is needed, on top of the current development pipeline. We therefore see little scope for rent correction in the overall Grade A office market, at least until the end of this decade,’ it adds.

It predicts that supply in the short term will rely on the private sector and the amount of supply coming onto the market is unlikely to be sufficient, so the supply demand imbalance will remain.

‘However, landlords may start to feel the impact of the planned office clusters as the major developments start to materialise, probably in 2017 at the earliest. Competition for tenants may increase over the long term. Landlords may view the fiercer competition as a threat, but these planned developments will offer new opportunities and potentially new sites for developing quality office buildings,’ the report points out.

‘The development progress of these future office clusters need to be closely monitored and landlord and tenant responses need to be matched accordingly,’ it concludes.