The Trends of Price Drop and Vacancy Rise of Grade A Office in Hong Kong
In 2017, when the Government of HK put forward a proposal to the Legislative Council of dismantling the existing Central Post Office building to pave way for rebuilding a new Grade A office [defined in Endnote A] in Central, I have warned the officials that the vacancy rate of Grade A office has risen to near double digits and its price may be under pressure according to my analytical model. In view of the information, I emphasized that it was imprudent to increase substantially the floor space of Grade A Office in Central. Unfortunately, the Government insisted that the expected potential demand of Grade A Office would be large, and refused to consider my points.
By 2018, the Government has further proposed to provide 40 million square feet of commercial floor space more on a to-be reclaimed artificial island at East Lantau, the so-called Lantau Tomorrow Vision, a new CBD. I once again suggested that if there was too much commercial supply, developers could not absorb them. As a consequence, there would be idle land and a waste of resources. 
However, the Government had an optimistic estimation of future demand of Grade A office in Hong Kong. In a written response to a lawmaker’s query in Feb 2019 , the official replied that, since “The price and rent were rising continuously, indicating apparently that office supply could not fully meet the demand, and that the scarcity of land in Hong Kong was affecting the supply of economic land including offices.” It is clearly based on a linear extension of the past trend to predict the future.
The optimistic estimation is also due to a consultancy report titled “Review of Land Requirement for Grade A Offices, Business and Industrial Uses” (the Review) finished in end-2016 . The official told the lawmakers that “According to the estimate set out in the Review, if all committed and planned developments would materialise fully, there would be a deficit of 480 000 square metres of gross floor area (GFA) for Grade A offices in core business districts (CBD) in the next 10 years (from 2014 to 2023). In the long term (up to 2041), there would be a deficit of 1 million sq m of GFA in respect of CBD Grade A offices.” 
One of the major reasons why the consultancy report would make such an optimistic estimation is because of the over-estimation of the GDP growth of Hong Kong. Its econometric model is based on, among others, an assumption of 3.5% GDP growth in 2016–2021 and 3% in 2022–2025, and 2.5% in 2026–2041 [see endnote B]. But in reality, the GDP growth rate in 2019 is now expected to be just between 0–1%, which means it’s almost a 3% overestimation.
The sudden sharp plummet of the GDP growth rate is highly associated with the US-China trade war. In early 2019, I have already highlighted that the monthly change of the Grade A office price index has seen a decline of about -5%, and it has dropped -12.3% in comparison with the Oct peak. 
The latest update of the Rating and Valuation Department’s annual growth rate of the Grade A office price index for August 2019 is -14.5% (in comparison with -6.5% for retail and -1.2% for housing) and has followed the downward trend since early 2019 as shown in Figure 1. The downward trend is not unique in Grade A Office, but a general phenomenon for all types of real estate as shown.
(Note: Since there are less than 20 transactions of Grade A office in some months, the accuracy of the index is affected. For details, please refer . The overall office price index yoy is -3.2% in August 2019).
As the negotiations on the US-China trade war broke down in June, and the “Extradition (Amendment) Bill” raised by the Hong Kong Government has scared capital funds flowing out of the city. It is estimated that the office prices in August-October will still be falling even further.
In fact, it has been found that property prices are strongly affected by the flow of funds and have a strong cyclicality. It is not appropriate to estimate long-term demand changes based on an extension of a short period of rising or falling.
In fact, the vacancy rate of Grade A office has tango-danced with the price decline. According to the Rating and Valuation Department’s data, the vacant floor space of various office buildings has exceeded 1 million square meters in the end of 2018, and the vacancy rate reached 8.6%. Among them, the vacant floor area of Grade A office accounted for about 65%, and the vacancy rate was 8.7%, a bit higher than the overall office markets.
However, the Government argued that the vacancy rate of Grade A office in Central is decreasing and is much lower than that of the Grade B Office in Central or that of the Grade A Office in other districts. Figure 2 shows the vacancy rates of Grade A and B offices in the four major districts. This is a very intriguing argument that the private market cannot adjust by itself either by upgrading Grade B Office into Grade A in Central, or decentralizing tenants from Central to other districts.
Unfortunately, the recent DTZ (a real estate consultancy firm) study reported that “the vacancy rate of Grade A Office in Central has surged to 7.4%, broke the 14-year record high, and is expecting a rental drop of 6–8% in this quarter, and a further drop of 8–13% in 2020.” (the definition of Grade A office is different from the RVD’s)
In fact, even without the impact of the US-China trade war and the global economic downturn, the Review estimated that there will have a surplus of the Grade A office space in the non-core business district in the short term. The surplus will be increased to 1.8 million square meters in the medium term, and to 1.26 million square meters in the long run. In other words, it is not about insufficient supply but it is about a mismatch of demand and supply of Grade A Offices in different locations.
It is well understood that it is difficult, if not impossible, to accurately predict the demand of office space, but the government’s economic adviser may need to reassess the impacts of the current Hong Kong’s political and economic affairs on the demand of Grade A Offices. It is because in case the US-China trade war escalates, it can be turned into a currency war and lead to a global economic recession, the existing land supply for office buildings may be excessive. Yet, it is hard and inefficient to stop office developments within a short period of time. Thus, it may be a better idea for the Government to consider a public policy favoring office decentralization which can help achieve a more efficient and flexible use of surplus office buildings in responding to the market demand changes.
[A] A Grade A Office is defined by an office with “modern with high quality finishes; flexible layout; large floor plates; spacious, well decorated lobbies and circulation areas; effective central air-conditioning; good lift services zoned for passengers and goods deliveries; professional management; parking facilities normally available.” (RVD, 2019) 
[B] The footnote of the Review states “For the Base Case, the assumed growth rates for Hong Kong real GDP are (i) 2.5% for 2014, (ii) 2% for 2015 …, (iii) 3.5% for 2016–19, and (iv) 3.5% for 2020–21, 3% for 2022–25 and 2.5% for 2026–41 …” (The Review) 
 姚松炎 (2018) 明日大嶼人工島商業地如果賣唔出？立場新聞 11月8日。https://thestandnews.com/society/%E6%98%8E%E6%97%A5%E5%A4%A7%E5%B6%BC%E4%BA%BA%E5%B7%A5%E5%B3%B6%E5%95%86%E6%A5%AD%E5%9C%B0%E5%A6%82%E6%9E%9C%E8%B3%A3%E5%94%94%E5%87%BA/
 HK Government (2019) Press Release — LCQ18: Supply of commercial and office space, Feb 27. https://www.info.gov.hk/gia/general/201902/27/P2019022700629.htm
 ICF International (2017) Review of Land Requirement for Grade A Offices, Business and Industrial Uses: Final Consultancy Report, Jan 2017. https://www.hk2030plus.hk/document/Review%20of%20Land%20Requirement%20for%20Grade%20A%20Offices_Business%20and%20Industrial%20Uses(Eng)_FCR.pdf
 姚松炎 (2019) 中期盤點美中貿易戰對香港經濟的影響，獨媒 5月6日。https://www.inmediahk.net/node/1063961
 RVD (2019) Property Markets Statistics, Rating and Valuation Department, HKSAR Government. https://www.rvd.gov.hk/en/property_market_statistics/index.html
 姚松炎 (2019) 成交量不足影響價格指數的準確度，信報財經月刊，9月號，即將發表
 明報 (2019) 中區寫字樓空置率14年新高 料明年租金或跌13%， 10月3日。https://m.mingpao.com/fin/instantp2.php?node=1570093284829&issue=20191003&fbclid=IwAR3_SeV_0QTcGZHcQqdTxroruY7oigjyRolHmlCe3CEQ-VSCR34v5Xsa8MA