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Vertical limit
Alex Frew McMillan looks into the record price of office space in Hong Kong, and the phenomenal costs involved in building commercial supertowers
Hong Kong’s office space is the most expensive in Asia and, by some counts, the most expensive in the world, at least at the top of the range. But tenants still can’t get enough space in Central, where vacancy rates are at a record low. So prices – and buildings – look set to rise even higher as landlords try to meet that demand, despite the credit crisis hurting much of the rest of the world.
These are very, very good times for commercial landlords, but it is interesting to consider how skyscrapers are planned and financed. In a market that can be violently volatile, such as Hong Kong, developers have to make the most of the boom years to balance out the busts.
The space squeeze is encouraging developers such as Sun Hung Kai Properties (SHK) to manufacture entirely new neighbourhoods such as West Kowloon. The developer had a hand in Two International Finance Centre (Two IFC) in Central, and is now opening the first phases of its twin on the other side of the harbour, the International Commerce Centre (ICC), which is set to be the third tallest building in the world when it is completed in 2010.
Reaching record highs
The construction of buildings of this stature is only possible because of the record-high prices office space is commanding at the moment. According to Colliers International, the top rents in Hong Kong are just under HK$200 per square foot per month – they stood at HK$198.65 per month for December – once you throw in operating charges like property management fees, air conditioning and government rates.
The most expensive office space in Hong Kong, then, is more expensive than the top of the range elsewhere in the world. In terms of average rents for Class A office space, Hong Kong is second, at HK$118 per square foot per month, or US$182 (HK$1,400) per square foot per year.
That puts Hong Kong just behind London’s West End, which topped the charts at US$209 per square foot per year. The City of London ranks third, after Hong Kong, with average office rents of US$152 per square foot per year, followed by Singapore, central Tokyo, Moscow, Paris, Mumbai, London’s Docklands area, and midtown Manhattan.
Colliers attributes the top-ranking performance in Hong Kong to strong growth in demand from the financial services industry, as well as record-low vacancy rates of 1.7 percent in the core business districts of Central and Admiralty. China’s strong economic growth of 11.5 percent last year only adds more fuel to the fire.
As downtown Hong Kong is very densely packed, developers can only build ever-taller buildings or rely on reclaimed land to meet demand.
Although “supertall” buildings obviously yield more office opinionspace, they are also more expensive to construct. Antoniu Wu, the head of the investment department at Colliers, estimates that a supertall building costs HK$2,500 to HK$3,000 per square foot to construct.
“You need a much stronger foundation, and the building is normally two or three or four storeys underground,” Wu says. “That is a very costly exercise. Normal commercial buildings won’t cost that much.”
Wu says a typical Grade A office building in Hong Kong costs around HK$1,500 to HK$2,000 per square foot to build. “For supertall buildings, you are likely going to double your costs.”
At some point, the extra foundations you have to lay, as well as the additional heating and cooling systems, elevators and infrastructure you must install above ground, make it no longer economical to make the building taller.
The importance of location
There’s a payback for getting high, of course. Iain Chapman, the head of the tenant representation group for commercial clients at Colliers, says an “iconic” building, such as ICC, can command a premium in terms of rents. Companies that often entertain clients, or simply feel they have to be in the best building in town will pay extra to secure that location.
It goes beyond image. A professional services company that has several competitors offering similar services may well need proximity to the people that hire it, or risk losing business.
“If you are a legal firm, clients are constantly flitting between you and your competitors,” Chapman says. “If you move to Causeway Bay, you are out of contention suddenly. They have a problem moving out of Central.”
Chapman estimates a prestigious building can command a rental premium of around 25 percent as a result. And the premium isn’t restricted to Central – iconic buildings in Wanchai or Causeway Bay such as Times Square, Lee Gardens or Central Plaza command a 25 percent premium over their competitors in those neighbourhoods, too.
But the rentals in a new section of town such as West Kowloon are nowhere near the levels you can achieve in Central. Colliers estimates tenants are inking deals at HK$35 to HK$40 per square foot per month, compared with HK$180 per square foot per month in Central. SHK is then taking a sizeable risk in trying almost single-handedly to settle West Kowloon. Pioneers can seize new frontiers, but it isn’t always easy.
Developer’s bid to diversify
SHK says it is spending HK$20 billion to build three skyscrapers above Kowloon Station – the ICC, The Cullinan I and The Cullinan II. It declined to break out the individual construction costs for the buildings but reveals it is signing rental agreements at around HK$60 per square foot.
“We believe ICC will be one of the best business addresses in Hong Kong,” Jo Soo, a spokeswoman from public relations company Edelman who is representing SHK on the ICC, says. “Therefore, we have diversified target tenants, including financial companies, banking and technology companies, and multinational companies who are looking to site their regional headquarters at an address that benefits their status and prestige.”
ICC has 2.5 million square feet of office space for leasing, half of which has already been taken up. High profile tenants include Morgan Stanley, Credit Suisse and Deutsche Bank, the first investment banks to move their front-office operations across the water to Kowloon. ABN Amro recently signed on, too.
The building has 118 storeys in all, compared to the 88 storeys of Two IFC. It is opening in phases through 2010, with early tenants already moving into the lower floors. Although Two IFC has quickly become an iconic building in Hong Kong, it has not been without its problems. It does not include a viewing deck, meaning the public cannot access the upper floors, although there was a short-lived and short-sighted scheme in early 2004 to take mainland Chinese passport holders – and only mainland Chinese, for some reason – up to an unoccupied floor.
Perhaps having learned from mistakes with Two IFC, SHK has ensured that the ICC will have a public viewing deck on the 100th floor. Critics have also taken Two IFC to task for obscuring the view of Victoria Peak from Kowloon and parts of Hong Kong Island. The developers mainly have their eyes on the money, not the view.
Recouping land and construction costs
Property consultants say developers typically take a 10-year timeframe when calculating how long it will take a project to yield a profit. In other words, they hope to have recouped all the construction and land-purchase costs inside a decade.
That can sometimes backfire. Two IFC virtually could not have come on the market at a worse time. It was completed in May 2003, not long after September 11, 2001, and in the middle of the dot.com bubble bursting, which produced a recession in Hong Kong. This slump reached its depths around the time the building opened, with the onset of Sars.
Companies that snapped up favourable rents during or just after Sars may still be enjoying them. Commercial leases are longer than residential ones, normally lasting five years or so. And many include a clause enabling the tenant to renew it again for another term with a maximum cap on the amount the rent can rise – generally 30 percent.
“Because the building was put up in a crisis time you had some juicy deals,” Chapman says. “The average rent in Two IFC is probably only about HK$45 per square foot because about 60 percent to 70 percent of the building is under leases that have caps on renewals.” That explains why rents are rising very quickly now – the landlords want to recoup the rent they’re losing on capped tenants from the ones that aren’t.
MTR Corp. says the entire Hong Kong Station development – which is considerably bigger than Two IFC and includes a north and south site – cost around HK$24 billion to construct, a little higher than the cost of SHK’s three buildings in West Kowloon.
In Hong Kong, the cost of the land dwarfs the cost of construction. Where even a supertall building will only cost HK$3,000 per square foot for the actual construction, the land cost for prime space in Central is typically priced at around HK$12,000 per square foot, according to Wu at Colliers.
He calculates that the land for Two IFC probably cost around HK$30 billion, while the construction of the building itself added around HK$7.5 billion.
“The land cost is about four times higher,” Wu says. “It depends on the location, but that’s why it makes sense to buy a building and knock it down.”
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