One of the interesting characteristics of property development in Hong Kong is that the use is defined by the underlying land lease rather than the type of building that is built upon the land. This has led to the development of a large number of curtain-walled buildings that look and serve as office buildings but are still defined as being industrial buildings. The use of these buildings as offices, however, technically comes with restrictions (e.g. the tenant must be from the industrial sector, or only a portion of the floor area can be used as an office).

Developers can remove these restrictions on building use by payment of a land premium; usually agreed to before development. However, the high land premium charged for lease modifications (i.e. from industrial to commercial use) brings many difficulties. In recent years, office prices have been rising at a faster pace than those of industrial buildings, widening the price gap between the two. In Kowloon East, one of the city’s former industrial enclaves, the average premium charged to modify the land-use in a lease has increased from about HKD 1,000 per sq ft in 2010 to about HKD 1,800 per sq ft in 2011. Based on my understanding, the premium is asking at about HKD 2,500-3,000 per sq ft more recently.

Moreover, with the prices of new industrial buildings climbing steadily, there is even less incentive for developers to consider lease modification. New high quality industrial buildings in other districts, such as CEO Tower and Grandion Plaza in Cheung Sha Wan, One Midtown and King Palace Plaza in Tsuen Wan, are currently transacting at about HKD 4,000-5,000 per sq ft. Based on these transactions, I believe that a brand new industrial building with decent finishes in Kowloon East could achieve at least HKD 5,000 per sq ft.

Developing industrial buildings for office use, however, is not without risks. Apart from market risks associated with any development project, demand can also be affected by stricter enforcement of user clause in government lease. Broadly speaking, industrial buildings are not meant to be used exclusively for office purposes without first obtaining permission, usually in the form of a lease modification (on an en bloc basis only) or a waiver (on an en bloc or individual unit basis), from the Lands Department. Whilst the introduction of the nil waiver fee conversion policy by the government has provided owners of some older industrial buildings to legitimise the use of their buildings for office use, this policy measure is not applicable to newer developments with building age less than 15 years.

A bulk quantum of the future Grade A office space under the government’s CBD2 plan will be coming from redevelopment of underutilised industrial buildings. Should the government wants to speed up the pace of the emergence of Kowloon East into Hong Kong’s next generation CBD, I reckon more creative ideas towards land use conversion is needed.

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