Consultants Envision High Returns Converting Hong Kong’s Unloved Office Buildings

With falling rents and a surge in new building completions taking a toll on Hong Kong office occupancy, consultants see opportunities for achieving five-year internal rates of return (IRR) of around 20 percent by converting unloved office buildings into multi-purpose hubs combining living, working and social space.

Cautious tenants and new supply entering the market are expected to drive overall office vacancy in Hong Kong to 15 million square feet (1.39 million square metres), or almost four times the pre-pandemic level, by 2030, according to a CBRE report released last week. That rise in vacancy comes as office rents have already fallen about 40 percent from their 2019 peak.

These challenges are hitting the office market at the same time that Hong Kong continues to see rising demand for rental housing as the city’s government rolls out policies to attract skilled professionals and students from mainland China to help fill 180,000 jobs in the next five years. These property market trends could provide an opportunity for landlords to profit by converting office buildings for new uses, CBRE said.

“With demand for buildings that combine living, working, and social elements continuing to grow, the trend of living and working under the same roof will likely become more common in the coming years,” said Ada Fung, head of advisory and transaction services at CBRE Hong Kong. “We recommend landlords to adopt a hub-based commercial buildings with accommodation provided within a specific industry ecosystem. This can create synergy among occupants, enhance management and collaboration, and ultimately increase occupancy rates.”

Solutions for the Less-Loved

“Holding on with the office assets with increasing vacancy will force landlords to find an alternative solution. We strongly believe landlords will invest in such conversion if the government could provide certain incentive and there are the right policies to support such conversion,” Reeves Yan, executive director and head of capital markets at CBRE Hong Kong told Mingtiandi.

Since converting office buildings for lodging requires substantial investment to meet requirements on fire safety, natural lighting, and plumbing and other regulations, conversion is most suitable for smaller footprint buildings located in second tier areas already facing occupancy challenges, CBRE said.

“We recommend that landlords of mature office buildings located in prime business districts maintain their current position, as competitive lease structures are generally robust enough to ensure high occupancy. In contrast, owners of smaller buildings in less desirable locations should consider adopting a hub-centric approach to attract tenants within a specific industry ecosystem,” said Yan.

CBRE recommends creating complexes which combine residential, office and social or recreational space – a live, work, play concept – as a way to meet the requirements Hong Kong’s emerging industries such as education, technology, healthcare, and cultural businesses. High-earning expats prefer to live close to their workplaces the agency said, and affordable co-living units in office buildings could align with the needs of younger professionals.

CBRE suggested that spending HK$200 million ($25.7 million) to convert a 220,000 square-foot office building into an integrated education hub with classrooms, offices, student housing and retail space could achieve an IRR of 22.4 percent over five years. 

Those returns are based on assumptions that the repurposing would boost occupancy, achieve a a 38 percent increase in monthly rent, compound annual rental growth of 1.2 percent, and a 61 percent rise in valuation, the report said.

The consultancy also provided an alternative scenario for converting the same building into a healthcare hub incorporating in-patient suites on some floors through a HK$260 million investment which it suggested could achieve a five-year IRR of 19.9 percent.

Practical Challenges

CBRE’s proposal is at risk of being “a little too forward-thinking” in the opinion of Alex Leung, chief surveyor at CHFT Advisory and Appraisal.

“Projects involving an education hub, as suggested in CBRE’s report, could be more effectively executed if it were led by the educational institution itself, rather than by a landlord making modifications to their property and then seeking a tenant,” Leung said.

Regarding the healthcare hub plan, portions of many office buildings have already been re-purposed to attract clinic and other medical tenants in hopes of higher rental income, but face fierce competition for occupiers, Leung said.

“Their suggestion to include in-patient suites on certain floors sounds like a good idea. There has been an increasing number of talents and professionals moving to Hong Kong, and their residences may be small for postpartum care. We see similar building designs in Shenzhen,” Leung added.

CBRE acknowledged regulatory hurdles in converting offices for residential use. 

While the city’s government last year announced plans for a pilot scheme to facilitate the conversion of commercial buildings into student hostels, and signaled further relaxation to allow greater flexibility in land use for commercial property last month, the authorities have yet to make specific moves toward encouraging conversions of office buildings to accommodate other types of talent.