Hong Kong's office rents have long had the unenviable reputation of being among the most expensive in the world and over the past few years they have overtaken even Tokyo, so long a by-word for sky-high corporate overheads.
No longer. A series of unfortunate events has contrived to de-throne Hong Kong and set Tokyo back at the head of regional markets. First we saw the emergence of the U.S.-China trade war in late 2018, followed by national security legislation and a period of widespread social disruption in 2019, and finally Covid-19 in early 2020. The combined impact of the three (arguably unresolved) factors set local rents on a downward trajectory from Q1 2019.
It is worth noting, however, that if we just look at rental costs in our most prime office buildings and compare them with other cities across Asia-Pacific, Hong Kong even now has no peer in the region.
So where is the local office market today after being ravaged by three years of disruption? Vacancy has certainly risen sharply. PRC firms found operating conditions problematic during the unrest, even before Covid shuttered borders. Meanwhile MNCs and local businesses alike are facing tough operating conditions locally and globally, and corporate downsizing has been the norm.
Co-working operators have also met a less receptive market since WeWork failed to list in the United States and Covid rendered shared offices less appealing. So despite an extremely limited number of new office completions over 2020 and 2021, subdued demand has meant that vacancy has ballooned to over 5.5 million sq ft (roughly four years of average annual take-up). With much higher levels of new supply expected in 2022 and 2023, this figure can be expected to rise further.
As vacancies rise, landlords must compete more aggressively to fill space and rents must inevitably fall, which is exactly what has happened. Office rents are around 20% below the peak levels of early 2019 and could slip further. When looking ahead we face the obvious uncertainty of how long entry at borders will remain restricted and how long social distancing will remain in place.
Mainland businesses are likely to become a major driver of office demand over the next few years and this could rapidly be unlocked by easier travel to the SAR. Another demand driver will be the IPO market, which could well post a record year this year, driving demand for financial, professional and business services. Potentially, tech businesses could also extend their reach from elsewhere in the Greater Bay Area (GBA) into Hong Kong.
How far rents decline and the timing of the recovery phase will not just be down to such demand drivers, however, but will in part be due to the success of vaccination programmes and the impact of Covid variants on local markets, factors that are impossible to predict.
Given its growing importance, it is worth taking a closer look at demand from Mainland companies. At the start of 2020, around 60% of companies listed in Hong Kong were Mainland (70% by market cap) with a rising dominance in media, insurance and real estate. Of the Hang Seng's 50 listed companies, Tencent is the largest, representing over 10% by market weighting. If we look to media, 35% of traditional media outlets have major PRC stakes including TVB and the SCMP, while of the territory's largest insurers, three are from the PRC and account for 40% of the market.
Traditionally, Mainland office demand has been driven by finance firms and asset managers, and such firms have sought out landmark buildings in core locations, mostly Central. They have been happy to pay higher rents for the "right address" – often a prime office with a dedicated drop off and harbour views. Already in 2021, we estimate that over 25% of Grade-A office space in Central is occupied by PRC firms, but this profile may now be broadening as a wider variety of Mainland companies look to take space in a more diverse range of business districts and buildings beyond the core CBD cluster.
Looking ahead, it is also hard to avoid the disruptive nature of new technology. Much was already discernable before Covid took over our lives, if you cared to look closely enough. Some executives were already selectively working from home, offices were being given a new sense of amenity and hot-desking was becoming more widely accepted. Some were even experimenting with new communications apps. There is a well-worn cliche in real estate that "form follows function" and with technology rapidly changing the way we work, accelerated by a pervasive virus, form has had to follow.
Work from home (WFH) has become a mandated way of working in many countries and – given roomier residential accommodation and lengthy, expensive and sometimes unreliable commutes – may well become an established practice, at least for a few days a week for office workers.
In Hong Kong, however, I am not quite so sure that we will see comparable levels of adoption, as transport infrastructure is modern, efficient and reasonably priced while housing is notoriously cramped. With a greater availability of offices over the next few years at more competitive rents, employers may find that they can afford lower worker densities and more genuine amenity, luring many of us back to mingle once again with colleagues.
Simon Smith, Head of Research & Consultancy, Savill