There is little doubt that Hong Kong office space is among of the most expensive in the world. Sitting in my spacious air-conditioned office, I feel deflated trying to calculate how many years it would take me to save just to afford my desk area.

Yet even as prices soar and rental yields dive, Hong Kong continues to draw deep-pocketed investors. As they are willing to pay higher entrance fees, they most likely anticipate handsome returns to match.

So let’s try to map this out.

Figure 1: Hong Kong Grade A Office Total Return Index (1Q87=100)
Source: JLL

JLL’s total return indices, which take into account rental yields and changes in capital value, are intuitive tools that can be used to quantify Hong Kong Grade A office investment returns. Grade A offices as an investment asset have generated a satisfying CAGR of 15.7 per cent over the past 30 years (Figure 1).

In the post-Global Financial Crisis era, it has posted an even juicier CAGR of 17 per cent. On the other hand, the Hang Seng Index (close price adjusted for dividends and splits) has been only able to record a 6.3 per cent CAGR for the same period.

Attractive returns for Hong Kong office assets

Gratifying returns continue to stir investment appetite for offices even as rental yields have compressed by 100 bps over the past seven years. While the current rental yield of 2.9 per cent may seem low, it remains significantly higher than risk free rates – US 10-year inflation adjusted treasuries (TIPS) are currently yielding 0.5 per cent (Figure 2).

Moreover, the potential for capital appreciation is now the predominant consideration for most investors. Rental income that generates cash flow is more like the icing on the cake – a bonus but not exactly the delicacy they are paying for.

To replicate the investor’s mindset, inflation should be adjusted in capital values instead of yields. While capital values of Grade A offices have grown by 10.1 per cent so far this year, the government projects inflation to rise by a modest 1.8 per cent. Looking at the investment market from this perspective, it’s easy math.

Figure 2: Hong Kong Grade A Office Yield vs. TIPS
Source: JLL, Federal Reserve System

Will investor interest in the office sector be sustained?

Today, the finance, insurance, real estate and business services sector contributes nearly 30 per cent of the city’s GDP. It is also the main occupier of Grade A offices, which means that the office market is highly dependent on the sector’s performance.

From 1987 to 2016, Grade A office total returns correlated strongly with the Hang Seng Index (81 per cent) and real GDP (92 per cent). Given that Hong Kong’s underlying economic fundamentals are still in good shape, we expect Grade A offices rentals to continue to be well-supported over the medium-term, especially with the influx of PRC companies looking to establish operations in the city.

Against this backdrop, investors are likely to remain confident about Hong Kong’s office market outlook. If there is a “black swan” on the horizon that will strike the economy, Grade A offices are still a better option compared to the bumpy stock market.

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