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Business influence on development decisions
OIY7-3Y75186 $3.00 + 0.00
HABITATINTL. Vol. 10. No. 112.pp. 219-227, 1986 Printed in Great Britain.
Pcrgemon Journals Ltd.
Business Influence on Development Decisions * C.Y.LEUNGt Jones Lang Wootton, Hong Kong
THE SIGNIFICANCE
OF BUSINESS PARTICIPATION
Hong Kong is one of the most built-up cities in the world. At the end of 1983 a total of some 55 million sq.m was under private ownership, including 524,345 privately-owned flats and houses. Nearly all offices and shops and about half of the domestic accommodation in Hong Kong were built by the private sector. The government itself in fact is one of the largest tenants in Hong Kong, renting domestic and office space for its own use. The production of industrial premises is also largely the responsibility of the private sector, which accounted for 84% of all industrial space built in 1983. In 1983, a total of 23,860 housing units were completed by the private sector, together with 1.55 million sq. ft of other types of buildings. The total construction cost was estimated to be in the region of HIS$‘7.S billion and the total value of real estate created was about HK$19 million. These are merely figures in a year that was plagued by both political and economic uncertainties. The other contribution of private business in the development field is of course the channelling of funds to the government through various forms of land acquisition. Average revenue from land sales and modification for the 5 years ending 1983 was HK$4,837.428 million. In the boom years of 1980 and 1981, land revenue accounted for a third of total government revenue. THE GOVERNMENT
FRAMEWORK
FOR BUSINESS PARTICIPATION
All building development by the private sector in Hong within a stable and definitive government framework. This governmental framework comprises two entwined the normal administrative role of government which is second role - that of the owner having ultimate control territory. Administrative
Kong is undertaken parts. First, there is complemented by a over all land in the
role
Hong Kong Government as a planning agency has the same kind of objectives as do other governments. The single most outstanding characteristic of planning in *This is an edited version of a paper 1984, in Hong Kong. TAddress fur eor~espo~de~ce: Jones Hong Kong.
presented
at the 9th EAROPH
Lang Wootton,
International
24th & 25th Floors,
219
Congress,
One Exchange
20-24
Square.
August Central,
Hong Kong is that the procedure is remarkably simple, has little effect on existing uses and has - in the main - no statutory power. Planning is carried out, first, through the preparation and publication of “Outline Zoning Plans”, each of which covers a district or new town. Within each plan, the district covered is further divided into a number of zones of different uses, such as “commercial/residential”, “industrial”, “residential”, and “government, institutions/community” efc. Each type of use is defined in more detail by the specific citation of some 40 uses that are always permitted and uses that may be permitted with or without conditions on application to the Town Planning Board. Developers use their business judgement and make their choice from the 40 uses. In theory, Outline Zoning Plans in Hong Kong have no statutory effect. However, legal backing is borrowed through the administration of the Building Regulations by the Building Development Department -another administrative arm of the government. Proposals for new development (which in any event must be approved by the Building Development Department) are rejected if the proposal does not conform with the zoning on the Outline Zoning Plan. The Building Regulations also provide some “ground rules” in determining the shape, size, height and use of buildings. At the same time, these ground rules give developers, and their architects, enough flexibility to ponder over the various options. The most classic case is the choice between commercial and residential development (both being acceptable to a commercial/residential zoning), and between the relative proportions of uses in a building, should it be decided that the building should contain both uses. It is evident that the combination of both planning control and Building Regulations still leave much room for business judgement. It will be seen later in this paper that in a volatile property market such as typifies Hong Kong from time to time, the business decision can indeed be a very taxing one.
Tenurial control Apart from its administrative role, the most significant function of the Hong Kong Government in the development process is its tenurial control over all land in the territory. All land in Hong Kong, with the exception of St. John’s Cathedral, is leasehold land, with the government, acting for the Crown, as either the freeholder or the immediate lessor. All land is therefore held from the government for a fixed term under some form of a Crown Lease, which is in nature a ground lease. Crown Leases granted before the last war were rather simple and contained not much more than the user clause and the stipulation to pay ground rent. The former was, in those days, very loosely worded and the term “non-offensive trades” for the type of activities allowed on the land was most popular. Modern Crown Leases are more sophisticated in their provisions. Apart from the ground rent (which is now very much a “peppercorn” or nominal rent), the most important clauses are as follows: Use. This could be as broad as merely “non-industrial”, “industrial”, or “private-residential”; or as specific as actually spelling out the design of the lower floors, the number of flats of certain sizes to be built, and the provision for car parking. User restrictions or stipulations in modern Crown Leases are always in conformity with both current town planning zoning and Building Regulations, so that if the Crown Lease is as detailed as specifying the plot ratio, it then becomes the sole arbiter in determining the ultimate density of the development.
Business
Influence
on Development
Decisions
221
However, most of the Crown Leases today still tend to leave as much flexibility as possible to the developer. Building covenant. To avoid the hoarding of and speculation in development land, Crown Leases provide as a matter of policy that the lessee must complete building construction of a certain value before a certain date. In theory, breach of this Building Covenant can lead to forfeiture of the land and the timing of development is therefore restricted. However, in practice, provided that the developer can prove at the expiration of the original Building Covenant period that he has the intention and ability to proceed with the development, extensions of this period can be obtained by the payment of fines. The developer therefore is again given the scope to exercise his business judgement in determining the timing of his completion relative to market conditions. All in all, the administrative and tenurial framework laid down by the government provides a considerable degree of flexibility for business participation.
BUSINESS
DECISIONS
Perhaps there is no better definition of the goal of business activities than to say that it is the pursuit of profit. Profit can be maximised by lowering costs and/or increasing revenue; in other words, by using the most economical form of development and making the development available on the market at a time and in a location that is most in demand. The developer also has to make sure that all the developments built at any one time can be readily absorbed by the market and nothing is left over to incur carrying costs. The development process, when compared with, say, the manufacturing process, is much longer. During this long process, market conditions will almost certainly change either in favour of or to the detriment of the development. There is therefore a period within this process for the developer to adapt to changing market conditions, to ensure that he arrives at the finishing post in the right style. In essence, all these evolve around the following three questions which the developer has to answer for himself, and the answer for which will invariably affect the development, and ultimately the whole of the city: What to develop? Where to develop? When and how much to develop? What to develop? To answer the question it is necessary to sub-divide it into: (a) use of development; (b) size of units; and (c) the standard of development. (a) Use of development. Of the above three decisions, the use that a development is designed for perhaps most affects the ultimate form of the city. It has been said before that, more often than not, the combination of Crown Lease conditions, zoning on town plans and Building Regulations only gives a loose definition of what the government deems desirable. The rest is left to the developer. One classic case and eminent case was that of the choice between commercial and residential use in fringe areas around Hong Kong’s commercial centres. Cyclical changes in the office market in Hong Kong exerted tremendous pressure on office accommodation towards the end of the 1970s. The lack of new developments, aggravated by the increasing demand generated by the prosper-
222
(‘.Y.
Leurrg
ing economy, pushed rents up by 80% in the year 1980 alone. Speculation in office premises was rife and there was one office floor in Admiralty Centre which was sold four times before the building was actually completed, each time bringing the vendor a handsome profit. In the face of such market signals, many sites and out-moded buildings in Wanchai, Causeway Bay and North Point on Hong Kong Island together with many similar districts in Kowloon became targets for development or redevelopment. In these areas, Crown Lease conditions allow anything that is “non-offensive” and town planning anything that is “commercial/residential“. blinding RegL~latio~~also had their part to play. For unknown reasons, when it comes to site coverage and plot ratio, the building regulations in Hong Kong are heavily in favour of non-domestic buildings. In the same site, a developer can put up a 15:l plot ratio non-domestic building and only a 10.5:1 plot ratio domestic building. At the same time, prevailing prices of office space were also higher than those of residential flats. The difference varied from say HK$l,~O per sq. ft in Wanchai to HK$200 per sq. ft in North Point. Accordingly, with the government’s land use framework, all the economic indicators were pointing to commercial developments. A survey in 1982 showed that of the 47 sites which had their building plans approved in the area between Gloucester Road to the north, Hennessy Road to the south and Arsenal Street and Percival Street to the west and east, 46 were earmarked for commercial use. In fact, this commercial fever went to such extremes as to prompt one developer to demolish a newly completed residential building in Wanchai and re-submit plans for a commercial building! The amount of newly-completed office space increased considerably and in a typical real estate cycle, rents and prices of offices plummeted. More seriously, some office developments were built in very fringe locations which buyers and tenants avoided as soon as other reasonable alternatives became available. The problem that developers had and still have to face is not just low prices but the outright lack of marketability. The comparative advantage of commercial development in those days affected not only the supply of office space. While sites which previously would have been used for residential purposes are now developed into office blocks, the supply of residential flats in these traditionally residential locations also diminished. The high value of office developments in the boom years have flushed out all the sites which even then were only marginally ripe for redevelopment. As real estate prices fell back and as office developments in these areas are no longer of “the highest and best use”, current prices of residential flats can no longer attract sites on to the market. The supply of sites for residential use is therefore frozen for many years to come. Having decided on the use of the site, the next decision to be made is, on a more micro-scale, the mix of uses between the various floors in the building. This applies particularly to commerical buildings, which in Hong Kong normally comprise an office tower on top of a retail podium; and to composite buildings which have both commercial and residential contents. The mix between two or more uses in a building very much reflects the developer’s belief that each use will bring him the maximum profitability. It is therefore not surprising when shop value reached its peak in 1981, when developers could sell off small shop units in shopping arcades at astonishingly high prices even before the building got off the ground, that some developments were to have 8 storeys of shops above ground floor level. (b) Size of units. While office and factory premises can be easily rearranged into units of different sizes without incurring much expense or going through the
Busrness hflurnce on Developmenr Decisions
223
rigmarole of applying to the authorities, residential units, once designed and built, cannot be easily converted into units of other sizes. It is obvious that the market considers residential units of different sizes as totally different products. There is no point in trying to sell to a buyer who requires a 3,000 sq. ft flat, 6 adjoining flats, each of 500 sq. ft. Flats of different sizes are different products and have different economics. In the latter 19’70s the size of the expatriate community in Hong Kong which required large housing units grew steadily. On top of this, the prosperity of the local economy, caused local demand for bigger and better housing also to increase. The lack of supply in the late 1970s aggravated the situation. Rents skyrocketed to such an extent that, in December 1979, Hong Kong Government found it necessary to enlarge the landlord and Tenant ordinance to provide rent control for all and sundry, including tenants of large flats and houses. Prices continued to spiral upwards and a considerable premium over and above small flats began to emerge. The trend of building large flats, say 3,000 sq. ft in good locations and over I,000 sq. ft in downtown areas caught on. The supply of large flats increased manifold. In what subsequently proved to be a late attempt to redress the imbalance, Hong Kong Government created - mostly out of virgin hillsides - large tracts of land for the development of large housing units. The government even stipulated in Conditions of Sale that the units could not be smaller than certain sizes. All these attempts finally fell victim to the typical real estate cycle. Supply increased while demand did not increase by as great an extent as expected. Prices softened and the speculative demand left the market, further dampening prices, until development of large units could not promise the same level of profitability as small units. Conversion was then set in train, very often involving a long process of altering the plans, changing building works and if the conversion was not in line with Crown Lease conditions, the payment of a premium to the government. The land hastily made available by the government in the countryside was often devoid of infrastructure. This situation means that the development process from the time when the developer takes over is therefore considerably longer, which in a volatile market, increases the developer’s exposure to market risks. The necessity of estimating the demand for and profitability of flats of different sizes applies not only to the top slice of the market. As the cost of ownership increases (a combination of high prices and high interest rates) and the demographic pattern of our community changes to comprise smaller households, small flats with cheaper price tags are much in demand. This has prompted developers into building flats that are really no bigger than bed-sitters with self-contained kitchenettes and bathrooms. As buying power relative to the cost of owning flats constantly changes, the game of guessing what will be the most popular and profitable unit size 2 or 3 years in the future goes on. On top of the revenue consideration, developers also need to take account of the higher cost of building small flats and the higher percentage of space that needs to be devoted to common areas. (c) Design and standard of development. Even in the face of higher cost of ownership and increasing building costs, developers in Hong Kong over the last 10 years have continued to recognise the increasing expectation from occupiers. Higher standards of design and construction are evident in all types of buildings. Better lighting and ventilation, and central air-conditioning have become more common and a number of large-scale housing developments are now selfsufficient in terms of schooling, shopping and other community facilities.
The current over-supply situation in the property market has highlighted the competitive edge of well conceived and well built developments, especially those with swimming pools and other in-house sports facilities. The higher price achieved and the better marketability have further encouraged developers to upgrade their products. As in other countries. the design of modern buildings in Hong Kong has been a compromise between functional and aesthetic priorities. The more or less indiscriminate use of curtain-walling in modern office buildings is a good case in point. Curtain-walled buildings are welcomed by the market, especially in waterfront areas which offer a panoramic harbour view, but arc not energy-efficient. It is hardly surprising that nearly all curtain-walIed buildings were built for sale by strata-title, whereby the individual owners have to pick up the bill for the high cost of cooling down the building. Where
to
develop?
Location is arguably the single most inlportant factor in the development business. Location also gives each development project its distinctively different characteristics and economics. In a static market, locational differentials in the prices of the raw materials (land and construction cost) and the finished product (completed buildings) remain constant, and free market forces would see to it that developers are attracted to less preferred locations by offering higher profits. But the market is not static. In fact, the real estate market is aI~ything but static. Going back to the example of office prices in the last 5 years. when there was an acute shortage of office space in the central areas, prices soared to such levels that some users had to move out to secondary areas. When the space in secondary areas was taken up and when the development industry was still working on new projects, prices in secondary Iocations also went up. Price differentials between the various central, secondary and fringe locations moved in the same direction and most probably increased by the same proportions. However, in absolute dollar terms, the gap between, say. central and fringe location space widened to such an extent that it became more economical for the foot-loose firms or the foot-loose departments of big corporations to move out to areas that were never conceived as viable office locations. Examples in Hong Kong are abundant: City Plaza in Quarry Bay and Nan Fung Centre in Tsuen Wan New Town are all products of business response to the market conditions at the time. The same phenomenon arose in the housing market. When good class residential properties in popular locations on Hong Kong Island were fetching HK$Z,OOO-3,000 per sq. ft, premises of similar design and environment in the New Territories, being offered at HK$l,OOO per sq, ft. became very real alternatives, despite the distance and the long journey time. When prices of both locations drop to their present level, i.e. HK$l,OOO against HK$400. the attraction is largely eroded. The same again applies to industrial developments. When prices of inner urban industrial areas such as Kwun Tong went up to HK$400 per sq. ft, Tuen Mun New Town became an attractive alternative at no more than HK$200. At the then prevailing rates, development of more New Towns to provide land for industries also became financially viable. Now that land value in Kowloon Bay has dropped to some HK$30 per sq. ft of building area, even if land in some of the proposed new towns such as Junk Bay could be made available for industria1 development at nil cost, the difference in cost between Kowloon Bay and Junk Bay is only HK$30 per sq. ft. Given that a 20,000 sq. ft factory is already a medium-sized establishment in Hong Kong, a difference of HK$6OO,OOC)in capital value or about HK$6,000 in monthly equivalent is not substantial enough to lure
Business
Influence
on Development
Decisions
225
the industrialist away from the urban areas, with all their proximity to skilled labour, transport facilities and other infrastructure. In a free market, such as Hong Kong, where the government does not wield “sticks” or dangle “carrots” to drive or attract industries and population into desired locations, literally everything is left to market forces. Choice of locations is based on none other than financial merits which in turn affect the demand for accommodation by end-users and for raw land by developers. A chain of business or financial decisions work through to affect eventually the success or otherwise of a location and the scale and timing of the development of new towns. If three-dimensional models are made to represent the real estate price of each user type in the various locations in Hong Kong, it will be seen that each model is roughly in the shape of a cone, the apex of which represents the high property value of that user type in a central (or for that type of use, prime) area. The outlying areas have gradually declining values until the periphery is reached where it is not worth anyone’s while to develop. In a dynamic mode, the gradient of the surface of the cone changes as the real estate market as a whole changes. At the peak of the market, the entire cone rises and the gradient increases. In that state, population, industries and commerce tend to flow out of the centre to outlying areas in the same way as water would on the model under gravitational force at a faster speed and in greater quantities. In a depressed market, the gradient flattens and everything tends to stagnate in the centre. At any one time, several of these cones co-exist side by side, one representing industrial values, one residential, one values of offices, etc. When the market changes, one way or the other, not all cones rise or flatten to the same extent. The relative tendency for industrial and population etc. to flow away from the centre is therefore different. Industrial, for example, may have the great urge to decentralise to avoid paying excessive rents, whilst workers, on whom industries have to rely, may be quite content to remain where they are. From a real estate point of view, the effect of business decision on development is by far the most significant in the overall development of the city. When and how much to develop? Property development as a profit-motivated business has to be mindful of the absorption capacity of the market at any given period. Whatever is surplus to the market requirement carries penalty in the form of carrying costs. Although building regulations, town planning and Crown Lease Conditions often allow far greater amount of space to be built at a time, developers very often have to resort to phasing to ensure that whatever is built can be sold. Apart from the carrying cost, developers are of course also wary of the adverse psychological effect on prospective buyers or tenants if a building is left largely empty for an unduiy long period. It was evident during the last property boom in Hong Kong that, when land prices were high and demand for space was keen, developers tended to use every single square foot available to the site - first, because of high land cost and secondly, because of ready demand for the finished product. Conversely, when the market softens, both factors are reversed and the net result is that developers can afford to pay more attention to other aspects of the development rather than concentrating on maximising floor area. More pleasing aesthetics and generous open space are amongst the many blessings in disguise. Where the original development was intended to comprise more than one use, different market prospects for the different uses could lead to postponement or outright abandonment of one in favour of the other. In certain locations in Hong Kong, retail value has weathered extraordinarily well against market decline
and has out-performed offices, the complementary use that often is built on top of retail shops. The negative or nominal marginal return on office space can only result in indefinite postponement. The Hoover Centre in Hong Kong is a very good illustration. The retail podium of this project, which is in a prime retail but secondary office location has recently been completed, with structural provision for the office tower as and when the office market recovers. The building is now the most quickly-built modern development in downtown Hong Kong.
THEUNPLANNEDFACTOR
When they are acting individually, businesses respond to market conditions. They interpret market signals and either take progressive actions to capitalise on the situation or defensive actions to safeguard their interests. Collectively, business decisions form a dynamic but yet fluid force that refuses to be harnessed by the wishes of our planners. It is perhaps more so in Hong Kong than elsewhere, due to the responsiveness and shrewdness of our business participants in the development field, that cycles are shortened to the point that the market is often so volatile as to defy any form of society and the ready exchange of views and information tends to produce an outlook of amazing homogeneity. The development industry is therefore not bullish or bearish, but rather feverish or doom-watching. The stop or go reactions of the business sector has often caught local planners and administrators totally off-guard. The development of the New Territories is an example that was examined earlier on. Decentralisation is now more a planning goal than economic reality and the government had to review the planning strategy of most parts of the New Territories. Then there was the mystery of demand for industrial space. As the prices of land and factory space went up, industrialists understandably were the first to make their concerns known to government - concerns over high production costs and loss of competitiveness over neighbours. The government came out with large tracts of industrial land, which were all well received for a year or two, and then the market collapsed. Land value became so low that they could barely cover formation costs. What might have been overlooked, amongst other things, is that there were going to be other suppliers of land in the market. Landowners in areas such as Kwun Tong and Tsuen Wan demolished their old buildings, sold the land or put up considerably more square footage in the replacement building, and simply satisfied the market while the government was still working on the infrastructure in newly-developed areas and planning their sales programme. Urban renewal programmes that could be self-financing or even profitable now have to be financed by public funds. Public housing programmes also suffer from market movements. When rents and prices in the private sector were high, there was little difficulty in moving part of the population into newly developed areas, despite the obvious inconvenience of living there. Estates, that were planned and built in the book, whether for sale or for rent, are now difficult to fill because the alternative in the private sector has become affordable. If planning is to be undertaken today, based on current circumstances, who is to say that the position will not be totally reversed again in 3 years? As long as Hong Kong maintains the laissez-faire system, it will be necessary to continue living with the effects of business judgement - be they good or evil. Nearly all the problems set out in this paper stem from the very fact that developers have to plan into the unknown 2 or 3 years, or in some cases much longer ahead. The scale of judgement error is proportional to the time-lag between planning and completion. It is this time-lag that should really be the
Business Influence on Development
Decisions
227
target of reform. The government as the most important source of land supply should maintain a land bank stocked with land ready for development, so that the development period after release by government can be reduced. The procedure for obtaining possession of redevelopment properties and for obtaining the consent of various authorities can also be looked into. By reducing the time-lag and the element of guesswork in development, both business and government could work in better harmony in catering for the need of the community.
HABITATINTL. Vol. 10. No. 112.pp. 219-227, 1986 Printed in Great Britain.
Pcrgemon Journals Ltd.
Business Influence on Development Decisions * C.Y.LEUNGt Jones Lang Wootton, Hong Kong
THE SIGNIFICANCE
OF BUSINESS PARTICIPATION
Hong Kong is one of the most built-up cities in the world. At the end of 1983 a total of some 55 million sq.m was under private ownership, including 524,345 privately-owned flats and houses. Nearly all offices and shops and about half of the domestic accommodation in Hong Kong were built by the private sector. The government itself in fact is one of the largest tenants in Hong Kong, renting domestic and office space for its own use. The production of industrial premises is also largely the responsibility of the private sector, which accounted for 84% of all industrial space built in 1983. In 1983, a total of 23,860 housing units were completed by the private sector, together with 1.55 million sq. ft of other types of buildings. The total construction cost was estimated to be in the region of HIS$‘7.S billion and the total value of real estate created was about HK$19 million. These are merely figures in a year that was plagued by both political and economic uncertainties. The other contribution of private business in the development field is of course the channelling of funds to the government through various forms of land acquisition. Average revenue from land sales and modification for the 5 years ending 1983 was HK$4,837.428 million. In the boom years of 1980 and 1981, land revenue accounted for a third of total government revenue. THE GOVERNMENT
FRAMEWORK
FOR BUSINESS PARTICIPATION
All building development by the private sector in Hong within a stable and definitive government framework. This governmental framework comprises two entwined the normal administrative role of government which is second role - that of the owner having ultimate control territory. Administrative
Kong is undertaken parts. First, there is complemented by a over all land in the
role
Hong Kong Government as a planning agency has the same kind of objectives as do other governments. The single most outstanding characteristic of planning in *This is an edited version of a paper 1984, in Hong Kong. TAddress fur eor~espo~de~ce: Jones Hong Kong.
presented
at the 9th EAROPH
Lang Wootton,
International
24th & 25th Floors,
219
Congress,
One Exchange
20-24
Square.
August Central,
Hong Kong is that the procedure is remarkably simple, has little effect on existing uses and has - in the main - no statutory power. Planning is carried out, first, through the preparation and publication of “Outline Zoning Plans”, each of which covers a district or new town. Within each plan, the district covered is further divided into a number of zones of different uses, such as “commercial/residential”, “industrial”, “residential”, and “government, institutions/community” efc. Each type of use is defined in more detail by the specific citation of some 40 uses that are always permitted and uses that may be permitted with or without conditions on application to the Town Planning Board. Developers use their business judgement and make their choice from the 40 uses. In theory, Outline Zoning Plans in Hong Kong have no statutory effect. However, legal backing is borrowed through the administration of the Building Regulations by the Building Development Department -another administrative arm of the government. Proposals for new development (which in any event must be approved by the Building Development Department) are rejected if the proposal does not conform with the zoning on the Outline Zoning Plan. The Building Regulations also provide some “ground rules” in determining the shape, size, height and use of buildings. At the same time, these ground rules give developers, and their architects, enough flexibility to ponder over the various options. The most classic case is the choice between commercial and residential development (both being acceptable to a commercial/residential zoning), and between the relative proportions of uses in a building, should it be decided that the building should contain both uses. It is evident that the combination of both planning control and Building Regulations still leave much room for business judgement. It will be seen later in this paper that in a volatile property market such as typifies Hong Kong from time to time, the business decision can indeed be a very taxing one.
Tenurial control Apart from its administrative role, the most significant function of the Hong Kong Government in the development process is its tenurial control over all land in the territory. All land in Hong Kong, with the exception of St. John’s Cathedral, is leasehold land, with the government, acting for the Crown, as either the freeholder or the immediate lessor. All land is therefore held from the government for a fixed term under some form of a Crown Lease, which is in nature a ground lease. Crown Leases granted before the last war were rather simple and contained not much more than the user clause and the stipulation to pay ground rent. The former was, in those days, very loosely worded and the term “non-offensive trades” for the type of activities allowed on the land was most popular. Modern Crown Leases are more sophisticated in their provisions. Apart from the ground rent (which is now very much a “peppercorn” or nominal rent), the most important clauses are as follows: Use. This could be as broad as merely “non-industrial”, “industrial”, or “private-residential”; or as specific as actually spelling out the design of the lower floors, the number of flats of certain sizes to be built, and the provision for car parking. User restrictions or stipulations in modern Crown Leases are always in conformity with both current town planning zoning and Building Regulations, so that if the Crown Lease is as detailed as specifying the plot ratio, it then becomes the sole arbiter in determining the ultimate density of the development.
Business
Influence
on Development
Decisions
221
However, most of the Crown Leases today still tend to leave as much flexibility as possible to the developer. Building covenant. To avoid the hoarding of and speculation in development land, Crown Leases provide as a matter of policy that the lessee must complete building construction of a certain value before a certain date. In theory, breach of this Building Covenant can lead to forfeiture of the land and the timing of development is therefore restricted. However, in practice, provided that the developer can prove at the expiration of the original Building Covenant period that he has the intention and ability to proceed with the development, extensions of this period can be obtained by the payment of fines. The developer therefore is again given the scope to exercise his business judgement in determining the timing of his completion relative to market conditions. All in all, the administrative and tenurial framework laid down by the government provides a considerable degree of flexibility for business participation.
BUSINESS
DECISIONS
Perhaps there is no better definition of the goal of business activities than to say that it is the pursuit of profit. Profit can be maximised by lowering costs and/or increasing revenue; in other words, by using the most economical form of development and making the development available on the market at a time and in a location that is most in demand. The developer also has to make sure that all the developments built at any one time can be readily absorbed by the market and nothing is left over to incur carrying costs. The development process, when compared with, say, the manufacturing process, is much longer. During this long process, market conditions will almost certainly change either in favour of or to the detriment of the development. There is therefore a period within this process for the developer to adapt to changing market conditions, to ensure that he arrives at the finishing post in the right style. In essence, all these evolve around the following three questions which the developer has to answer for himself, and the answer for which will invariably affect the development, and ultimately the whole of the city: What to develop? Where to develop? When and how much to develop? What to develop? To answer the question it is necessary to sub-divide it into: (a) use of development; (b) size of units; and (c) the standard of development. (a) Use of development. Of the above three decisions, the use that a development is designed for perhaps most affects the ultimate form of the city. It has been said before that, more often than not, the combination of Crown Lease conditions, zoning on town plans and Building Regulations only gives a loose definition of what the government deems desirable. The rest is left to the developer. One classic case and eminent case was that of the choice between commercial and residential use in fringe areas around Hong Kong’s commercial centres. Cyclical changes in the office market in Hong Kong exerted tremendous pressure on office accommodation towards the end of the 1970s. The lack of new developments, aggravated by the increasing demand generated by the prosper-
222
(‘.Y.
Leurrg
ing economy, pushed rents up by 80% in the year 1980 alone. Speculation in office premises was rife and there was one office floor in Admiralty Centre which was sold four times before the building was actually completed, each time bringing the vendor a handsome profit. In the face of such market signals, many sites and out-moded buildings in Wanchai, Causeway Bay and North Point on Hong Kong Island together with many similar districts in Kowloon became targets for development or redevelopment. In these areas, Crown Lease conditions allow anything that is “non-offensive” and town planning anything that is “commercial/residential“. blinding RegL~latio~~also had their part to play. For unknown reasons, when it comes to site coverage and plot ratio, the building regulations in Hong Kong are heavily in favour of non-domestic buildings. In the same site, a developer can put up a 15:l plot ratio non-domestic building and only a 10.5:1 plot ratio domestic building. At the same time, prevailing prices of office space were also higher than those of residential flats. The difference varied from say HK$l,~O per sq. ft in Wanchai to HK$200 per sq. ft in North Point. Accordingly, with the government’s land use framework, all the economic indicators were pointing to commercial developments. A survey in 1982 showed that of the 47 sites which had their building plans approved in the area between Gloucester Road to the north, Hennessy Road to the south and Arsenal Street and Percival Street to the west and east, 46 were earmarked for commercial use. In fact, this commercial fever went to such extremes as to prompt one developer to demolish a newly completed residential building in Wanchai and re-submit plans for a commercial building! The amount of newly-completed office space increased considerably and in a typical real estate cycle, rents and prices of offices plummeted. More seriously, some office developments were built in very fringe locations which buyers and tenants avoided as soon as other reasonable alternatives became available. The problem that developers had and still have to face is not just low prices but the outright lack of marketability. The comparative advantage of commercial development in those days affected not only the supply of office space. While sites which previously would have been used for residential purposes are now developed into office blocks, the supply of residential flats in these traditionally residential locations also diminished. The high value of office developments in the boom years have flushed out all the sites which even then were only marginally ripe for redevelopment. As real estate prices fell back and as office developments in these areas are no longer of “the highest and best use”, current prices of residential flats can no longer attract sites on to the market. The supply of sites for residential use is therefore frozen for many years to come. Having decided on the use of the site, the next decision to be made is, on a more micro-scale, the mix of uses between the various floors in the building. This applies particularly to commerical buildings, which in Hong Kong normally comprise an office tower on top of a retail podium; and to composite buildings which have both commercial and residential contents. The mix between two or more uses in a building very much reflects the developer’s belief that each use will bring him the maximum profitability. It is therefore not surprising when shop value reached its peak in 1981, when developers could sell off small shop units in shopping arcades at astonishingly high prices even before the building got off the ground, that some developments were to have 8 storeys of shops above ground floor level. (b) Size of units. While office and factory premises can be easily rearranged into units of different sizes without incurring much expense or going through the
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rigmarole of applying to the authorities, residential units, once designed and built, cannot be easily converted into units of other sizes. It is obvious that the market considers residential units of different sizes as totally different products. There is no point in trying to sell to a buyer who requires a 3,000 sq. ft flat, 6 adjoining flats, each of 500 sq. ft. Flats of different sizes are different products and have different economics. In the latter 19’70s the size of the expatriate community in Hong Kong which required large housing units grew steadily. On top of this, the prosperity of the local economy, caused local demand for bigger and better housing also to increase. The lack of supply in the late 1970s aggravated the situation. Rents skyrocketed to such an extent that, in December 1979, Hong Kong Government found it necessary to enlarge the landlord and Tenant ordinance to provide rent control for all and sundry, including tenants of large flats and houses. Prices continued to spiral upwards and a considerable premium over and above small flats began to emerge. The trend of building large flats, say 3,000 sq. ft in good locations and over I,000 sq. ft in downtown areas caught on. The supply of large flats increased manifold. In what subsequently proved to be a late attempt to redress the imbalance, Hong Kong Government created - mostly out of virgin hillsides - large tracts of land for the development of large housing units. The government even stipulated in Conditions of Sale that the units could not be smaller than certain sizes. All these attempts finally fell victim to the typical real estate cycle. Supply increased while demand did not increase by as great an extent as expected. Prices softened and the speculative demand left the market, further dampening prices, until development of large units could not promise the same level of profitability as small units. Conversion was then set in train, very often involving a long process of altering the plans, changing building works and if the conversion was not in line with Crown Lease conditions, the payment of a premium to the government. The land hastily made available by the government in the countryside was often devoid of infrastructure. This situation means that the development process from the time when the developer takes over is therefore considerably longer, which in a volatile market, increases the developer’s exposure to market risks. The necessity of estimating the demand for and profitability of flats of different sizes applies not only to the top slice of the market. As the cost of ownership increases (a combination of high prices and high interest rates) and the demographic pattern of our community changes to comprise smaller households, small flats with cheaper price tags are much in demand. This has prompted developers into building flats that are really no bigger than bed-sitters with self-contained kitchenettes and bathrooms. As buying power relative to the cost of owning flats constantly changes, the game of guessing what will be the most popular and profitable unit size 2 or 3 years in the future goes on. On top of the revenue consideration, developers also need to take account of the higher cost of building small flats and the higher percentage of space that needs to be devoted to common areas. (c) Design and standard of development. Even in the face of higher cost of ownership and increasing building costs, developers in Hong Kong over the last 10 years have continued to recognise the increasing expectation from occupiers. Higher standards of design and construction are evident in all types of buildings. Better lighting and ventilation, and central air-conditioning have become more common and a number of large-scale housing developments are now selfsufficient in terms of schooling, shopping and other community facilities.
The current over-supply situation in the property market has highlighted the competitive edge of well conceived and well built developments, especially those with swimming pools and other in-house sports facilities. The higher price achieved and the better marketability have further encouraged developers to upgrade their products. As in other countries. the design of modern buildings in Hong Kong has been a compromise between functional and aesthetic priorities. The more or less indiscriminate use of curtain-walling in modern office buildings is a good case in point. Curtain-walled buildings are welcomed by the market, especially in waterfront areas which offer a panoramic harbour view, but arc not energy-efficient. It is hardly surprising that nearly all curtain-walIed buildings were built for sale by strata-title, whereby the individual owners have to pick up the bill for the high cost of cooling down the building. Where
to
develop?
Location is arguably the single most inlportant factor in the development business. Location also gives each development project its distinctively different characteristics and economics. In a static market, locational differentials in the prices of the raw materials (land and construction cost) and the finished product (completed buildings) remain constant, and free market forces would see to it that developers are attracted to less preferred locations by offering higher profits. But the market is not static. In fact, the real estate market is aI~ything but static. Going back to the example of office prices in the last 5 years. when there was an acute shortage of office space in the central areas, prices soared to such levels that some users had to move out to secondary areas. When the space in secondary areas was taken up and when the development industry was still working on new projects, prices in secondary Iocations also went up. Price differentials between the various central, secondary and fringe locations moved in the same direction and most probably increased by the same proportions. However, in absolute dollar terms, the gap between, say. central and fringe location space widened to such an extent that it became more economical for the foot-loose firms or the foot-loose departments of big corporations to move out to areas that were never conceived as viable office locations. Examples in Hong Kong are abundant: City Plaza in Quarry Bay and Nan Fung Centre in Tsuen Wan New Town are all products of business response to the market conditions at the time. The same phenomenon arose in the housing market. When good class residential properties in popular locations on Hong Kong Island were fetching HK$Z,OOO-3,000 per sq. ft, premises of similar design and environment in the New Territories, being offered at HK$l,OOO per sq, ft. became very real alternatives, despite the distance and the long journey time. When prices of both locations drop to their present level, i.e. HK$l,OOO against HK$400. the attraction is largely eroded. The same again applies to industrial developments. When prices of inner urban industrial areas such as Kwun Tong went up to HK$400 per sq. ft, Tuen Mun New Town became an attractive alternative at no more than HK$200. At the then prevailing rates, development of more New Towns to provide land for industries also became financially viable. Now that land value in Kowloon Bay has dropped to some HK$30 per sq. ft of building area, even if land in some of the proposed new towns such as Junk Bay could be made available for industria1 development at nil cost, the difference in cost between Kowloon Bay and Junk Bay is only HK$30 per sq. ft. Given that a 20,000 sq. ft factory is already a medium-sized establishment in Hong Kong, a difference of HK$6OO,OOC)in capital value or about HK$6,000 in monthly equivalent is not substantial enough to lure
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Influence
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the industrialist away from the urban areas, with all their proximity to skilled labour, transport facilities and other infrastructure. In a free market, such as Hong Kong, where the government does not wield “sticks” or dangle “carrots” to drive or attract industries and population into desired locations, literally everything is left to market forces. Choice of locations is based on none other than financial merits which in turn affect the demand for accommodation by end-users and for raw land by developers. A chain of business or financial decisions work through to affect eventually the success or otherwise of a location and the scale and timing of the development of new towns. If three-dimensional models are made to represent the real estate price of each user type in the various locations in Hong Kong, it will be seen that each model is roughly in the shape of a cone, the apex of which represents the high property value of that user type in a central (or for that type of use, prime) area. The outlying areas have gradually declining values until the periphery is reached where it is not worth anyone’s while to develop. In a dynamic mode, the gradient of the surface of the cone changes as the real estate market as a whole changes. At the peak of the market, the entire cone rises and the gradient increases. In that state, population, industries and commerce tend to flow out of the centre to outlying areas in the same way as water would on the model under gravitational force at a faster speed and in greater quantities. In a depressed market, the gradient flattens and everything tends to stagnate in the centre. At any one time, several of these cones co-exist side by side, one representing industrial values, one residential, one values of offices, etc. When the market changes, one way or the other, not all cones rise or flatten to the same extent. The relative tendency for industrial and population etc. to flow away from the centre is therefore different. Industrial, for example, may have the great urge to decentralise to avoid paying excessive rents, whilst workers, on whom industries have to rely, may be quite content to remain where they are. From a real estate point of view, the effect of business decision on development is by far the most significant in the overall development of the city. When and how much to develop? Property development as a profit-motivated business has to be mindful of the absorption capacity of the market at any given period. Whatever is surplus to the market requirement carries penalty in the form of carrying costs. Although building regulations, town planning and Crown Lease Conditions often allow far greater amount of space to be built at a time, developers very often have to resort to phasing to ensure that whatever is built can be sold. Apart from the carrying cost, developers are of course also wary of the adverse psychological effect on prospective buyers or tenants if a building is left largely empty for an unduiy long period. It was evident during the last property boom in Hong Kong that, when land prices were high and demand for space was keen, developers tended to use every single square foot available to the site - first, because of high land cost and secondly, because of ready demand for the finished product. Conversely, when the market softens, both factors are reversed and the net result is that developers can afford to pay more attention to other aspects of the development rather than concentrating on maximising floor area. More pleasing aesthetics and generous open space are amongst the many blessings in disguise. Where the original development was intended to comprise more than one use, different market prospects for the different uses could lead to postponement or outright abandonment of one in favour of the other. In certain locations in Hong Kong, retail value has weathered extraordinarily well against market decline
and has out-performed offices, the complementary use that often is built on top of retail shops. The negative or nominal marginal return on office space can only result in indefinite postponement. The Hoover Centre in Hong Kong is a very good illustration. The retail podium of this project, which is in a prime retail but secondary office location has recently been completed, with structural provision for the office tower as and when the office market recovers. The building is now the most quickly-built modern development in downtown Hong Kong.
THEUNPLANNEDFACTOR
When they are acting individually, businesses respond to market conditions. They interpret market signals and either take progressive actions to capitalise on the situation or defensive actions to safeguard their interests. Collectively, business decisions form a dynamic but yet fluid force that refuses to be harnessed by the wishes of our planners. It is perhaps more so in Hong Kong than elsewhere, due to the responsiveness and shrewdness of our business participants in the development field, that cycles are shortened to the point that the market is often so volatile as to defy any form of society and the ready exchange of views and information tends to produce an outlook of amazing homogeneity. The development industry is therefore not bullish or bearish, but rather feverish or doom-watching. The stop or go reactions of the business sector has often caught local planners and administrators totally off-guard. The development of the New Territories is an example that was examined earlier on. Decentralisation is now more a planning goal than economic reality and the government had to review the planning strategy of most parts of the New Territories. Then there was the mystery of demand for industrial space. As the prices of land and factory space went up, industrialists understandably were the first to make their concerns known to government - concerns over high production costs and loss of competitiveness over neighbours. The government came out with large tracts of industrial land, which were all well received for a year or two, and then the market collapsed. Land value became so low that they could barely cover formation costs. What might have been overlooked, amongst other things, is that there were going to be other suppliers of land in the market. Landowners in areas such as Kwun Tong and Tsuen Wan demolished their old buildings, sold the land or put up considerably more square footage in the replacement building, and simply satisfied the market while the government was still working on the infrastructure in newly-developed areas and planning their sales programme. Urban renewal programmes that could be self-financing or even profitable now have to be financed by public funds. Public housing programmes also suffer from market movements. When rents and prices in the private sector were high, there was little difficulty in moving part of the population into newly developed areas, despite the obvious inconvenience of living there. Estates, that were planned and built in the book, whether for sale or for rent, are now difficult to fill because the alternative in the private sector has become affordable. If planning is to be undertaken today, based on current circumstances, who is to say that the position will not be totally reversed again in 3 years? As long as Hong Kong maintains the laissez-faire system, it will be necessary to continue living with the effects of business judgement - be they good or evil. Nearly all the problems set out in this paper stem from the very fact that developers have to plan into the unknown 2 or 3 years, or in some cases much longer ahead. The scale of judgement error is proportional to the time-lag between planning and completion. It is this time-lag that should really be the
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target of reform. The government as the most important source of land supply should maintain a land bank stocked with land ready for development, so that the development period after release by government can be reduced. The procedure for obtaining possession of redevelopment properties and for obtaining the consent of various authorities can also be looked into. By reducing the time-lag and the element of guesswork in development, both business and government could work in better harmony in catering for the need of the community.