Premium calculations for industrial buildings in HK should be modified

Two months ago, the SAR government decided to raise stamp duty on residential property transactions to help cool down the real estate market. Starting from Nov 5, 2016, all non-first-time buyers have to pay a uniform 15 percent stamp duty when they purchase a residential flat.

Property prices have been soaring in the city — this is not only the case for residential units, it is also true for commercial offices. According to a report by PwC, Hong Kong ranked as the second most active commercial property market in Asia after Tokyo in the first half of 2016, with transactions worth HK$6.8 billion — an increase of 17 percent compared with the same period in 2015. Rents for high-level offices in prime locations such as Central and Causeway Bay have reached as high as HK$278.5 per square foot — the highest rate in the world and almost double that in Tokyo and New York, the second and third highest in the international rankings.

The fever in the commercial property market has been largely fueled by mainland investors or companies, who are snapping up more and more commercial buildings in the city. The first 10 months of 2016 witnessed more than HK$23 billion of mainland investment in local properties, most of which are commercial buildings. The third quarter of 2016 alone accounted for HK$10.4 billion. Some of those big deals hit the front pages of local newspapers. These included Everbright’s purchase of a building in Wan Chai for HK$10 billion, Shenzhen Cheung Kei’s purchase of a Hung Hom prime office tower for HK$4.5 billion, and Minmetals’ winning bid of a site in Yau Tong at the price of HK$4 billion.

One of the reasons behind this new wave of mainland investment is a weakening renminbi. With expectations for further renminbi devaluation remaining high, more mainland investments are likely to pour into Hong Kong’s property market. Another reason is Hong Kong’s many advantages. As an international financial center, Hong Kong always has strong appeal to mainland companies as an ideal place to set up their regional headquarters. It provides a big boost to their corporate image if they acquire a commercial building in Hong Kong and attach their corporate name to it. This is in addition to Hong Kong’s ideal business environment, which is free of foreign exchange control, has flexibility in capital distribution, a simple tax regime, and standards for business operation that are suitable for both mainland and international commercial systems. All of these are preferred requirements for overseas investment by mainland companies.

While it is generally beneficial to the city’s economic development if more mainland businesses come here, their inroads into the local market have also had some negative effects, adding pressure on local small- and medium-sized enterprises (SMEs) which are already facing tough challenges. As of June 2016, there are about 320,000 SMEs in Hong Kong, accounting for over 98 percent of total business units and providing jobs to nearly 1.3 million people. The SAR government should find ways to help the market to provide more affordable office space for the SMEs.

One efficient way is revitalizing old industrial buildings into commercial sites. The government The author is the president of the Chinese Manufacturers’ Association of Hong Kong.

If the government can change its method of calculation, the 1,400 old industrial buildings in the city wouldn’t be kept idle and wasted.

stopped receiving applications for revitalizing projects in March 2016. During the six years of the application period, only 226 cases of wholesale conversion and 22 cases of redevelopment were filed officially; of these 248 applications, only 125 were approved. So why was the market lukewarm about this preferential policy?

The ultimate answer is it’s not preferential enough. It is common knowledge that land for industrial use is substantially cheaper than that for commercial use. So a land premium must be paid when an owner applies for land conversion. The basic principle for land premium calculation is to subtract the “before value” from the “after value”. The government and the market differ mainly in the calculation of the before value amount.

Say someone just bought an industrial building at the rate of HK$5,000 per sq ft, and intended to convert it into a commercial building. From his point of view, the building on top is of zero commercial value for it will eventually be dismantled. And if they use the property price of commercial buildings in the neighboring area for reference (say, HK$7,000 per sq ft), it is acceptable and reasonable for them to pay a HK$2,000 per sq ft premium to the government.

But the calculations of the government do not go like this. The government thinks that the HK$5,000 per sq ft is the gross development value that includes all areas built, so the method of residue is adopted to calculate the before value. Consequently, the before value would only be HK$2,000 per sq ft if the development cost and developer’s profit are calculated at HK$3,000 per sq ft. This is to say that if a property owner wishes to revitalize the building, he will now have to pay HK$5,000 per sq ft (HK$7,000 minus HK$2,000) for land premium instead of HK$2,000.

In this case, it would be so much easier and less costly to simply buy commercial buildings in the first place.

If the government can change its method of calculation, the 1,400 old industrial buildings in the city wouldn’t be kept idle and wasted; they could provide more affordable office spaces for SMEs upon proper conversion.