What will the office market in Hong Kong look like in 2020? Thomas Lam offers a vision

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. This is partly due to the limited amount of grade-A office stock, while 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, whether these plans can meet future demand and when these blueprints can be delivered are still unclear.

In a bid to mitigate the office shortage, the government has launched ambitious plans that could provide some 50m sqft of new office space. These include the CBD2 plan in Kowloon East, one of the major centrepieces in Hong Kong’s future development strategy.

The development of a new central harbour front, the Guangzhou-Shenzhen-Hong Kong Express Rail Link terminus and West Kowloon Cultural District will also add a fair amount of office supply to the city. Hong Kong will see a substantial increase in office space in the coming decade when the emergence of these new office nodes has materialised. In addition, the government has also moved to increase commercial land supply. The 2013-14 Budget reveals the inclusion of nine commercial sites in the latest Land Sales Programme, providing a total floor area of about 3.6m sqft to the market.

However, most of the above-mentioned developments are still in the preparation stage and the effort to rebalance supply-demand levels is unlikely to be realised in the short term. Supply from 2013–16 would remain low, averaging 1.7m sqft pa, still 0.2 million lower than the long-term average. The lion’s share of new supply over the next three years will be located in Kowloon East.

The new supply from these government-led projects will only be released to the market after 2020. An increase in new supply might begin to take effect in 2017 at the earliest, with an average of 1.9m sqft per year during 2017–20.

So far, we have focused on office supply in Hong Kong over the mid-to-long-term, but the key issue is whether these projects can satisfy demand over this period. Therefore, by considering GDP growth and employment forecasts for the service sector, we can try to model how much office space will be needed between now and 2020.

Under normal circumstances, Hong Kong’s economy expands at an average of 3% per year, while service-sector employment grows at a rate of around 2.2%, taking a 15-year average. This growth will result in additional office space of around 16.9m sqft during 2013-20. Optimistically, if the local economy expands at an average of 4% per year while employment in the service sectors grows at a compound annual growth rate of 2.7%, nearly an additional 21.2m sqft of office space will be required during the next eight years.

Based on these projections, 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 4m sq ft, which could increase to over 8m should the local economy expand at a faster pace.

How significant is this shortage? 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.

What would happen if growth in the business sector slowed down over a certain period?
From the previous sensitivity analysis, we would expect a surplus of 3m sqft of office space to come onto the market, if both GDP and employment population growth slowed by one percentage point. The situation would be worse if a black swan event were to impact global markets.

Economic slowdown would inevitably lead to significant surplus in Grade-A office supply. However, Hong Kong’s grade-A office market – especially prime office buildings – has proven resilient to global economic headwinds over the past few years.

Two IFC is a relevant case study. This premium grade-A building was completed at the height of the SARS epidemic of 2003. During the first year, the vacancy rate remained at above 50%, despite rock-bottom rents of around HKD20–30 per sqft per month being offered. However, take-up swiftly improved following gradual recovery in the economy. It took less than two years for the vacancy rate to fall to a single-digit level, while rents increased to HKD100 per sqft per month in the subsequent three years.

Another example is Kowloon East. In 2008, supply boom in the district coincided with the onset of the US financial crisis, but a similar, rapid turnaround to that of Two IFC occurred. Grade-A office rents in Kowloon East started to surge as a result of strong demand in mid-2010 and vacancy levels dropped to 10% less than two years after the onset of the crisis.

Based on past examples, vacant, high quality office space was eventually taken up, even in the face of strong economic turmoil, due to sustained long-term demand for office space. We therefore remain positive about the long-term outlook for premium, Grade-A office buildings in the city, given that Hong Kong’s role as a major global financial centre is unlikely to change.

Looking ahead, whether plans for Hong Kong’s forthcoming major projects can be realised and whether the resulting new office developments match, lag, or outpace long-term growth in demand remain to be seen, but we are able to make certain observations.

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, the imbalance might see some relief as the major developments start to materialise, probably in 2017 at the earliest, although the quantity will still be less than enough. The development progress of these future office clusters need to be closely monitored and landlord and tenant responses need to be matched accordingly.

Thomas Lam is director and head of research and consultancy, Greater China, at Knight Frank

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