Why Law Firms are Leaving Hong Kong's CBD
International law firms have historically been among the stalwarts of the Central occupier market but over the last 12 months decentralisation of the legal sector has been occurring. Will this trend prompt other Central tenants to look at opportunities further afield?
An increasing number of tenants are choosing to relocate their offices outside of Central as rents close in on the record highs set just prior to the Global Financial Crisis in 2008.
One tenant group that's been making headlines recently is the legal sector. International law firms, especially those from the US and UK, have historically been among the stalwarts of the Central occupier market. But over the past 12 months, we've seen a number move out.
UK-based Berwin Leighton Paisner (BLP) got the ball rolling when it announced back in May 2016 that it would be relocating its offices from Central to Taikoo Place in Quarry Bay. This marked the first time that an international law firm had opened an office in the district. BLP's move was closely followed by London-headquartered Ince & Co, which also opted to move its office to Quarry Bay.
While rising rents in Central—which are already, on average, four times higher than the city's most affordable office market, Kowloon East—would've played a key role behind these moves, it wouldn't have been the only consideration. Being close to their clients would've also come into play.
"Here in Hong Kong, BLP and Ince & Co specialise in practice areas including aviation, shipping, infrastructure, real estate, insurance, international trade, energy and natural resources," says Denis Ma, JLL Hong Kong's Head of Research. "Most of these industries have their offices located outside of Central, so while it has also been easy to ring-fence these two deals as being unique and as 'one-offs', rather than a broader trend, it may be time to rethink that."
The situation has developed rapidly in recent months with Freshfields Bruckhaus Deringer (Freshfields) reportedly also committing to moving to Quarry Bay. If the deal proceeds, it will be the first time a 'Magic Circle' law firm has relocated out of Central. It would also herald the largest foreign law firm offices outside of Central at around 40,000 square feet.
Unlike the other two deals, Freshfields' purported move has the potential to be a game changer. Since the deal was reported, we've witnessed an uptick in the number of enquiries from the legal sector looking at locations outside of Central, including Wong Chuk Hang on the south side of the island.
"These latest transactions have really ignited the interest of many of our clients," notes Andrew Yates, Head of Tenant Representation with JLL Hong Kong's office leasing team. "With new, high quality buildings in the pipeline, as well as new infrastructure and technology innovations, the office landscape is really opening up, providing occupiers with increased options about where to position their business."
Like the banking and accounting sectors before it, the legal profession now appears on the verge of being the next industry willing to cut ties with Central. This will be a boon for landlords outside of Central. With most of the city's biggest investment banks already having decentralised large portions of their office portfolios over the past 10 years, the pool of potential rental refugees who are able to absorb above-market rents in decentralised locations had shrunk considerably. The legal sector, which currently accounts for about 10% of the Central Grade A office market, or about 2.5 million square feet, represents a significant source of potential demand that was previously overlooked given the sector's preference to be based in Central.
Office markets that are likely to benefit from the decentralisation of the legal sector will initially be restricted to those on Hong Kong Island. Hong Kong East, which includes the district of Quarry Bay, appears to be the biggest winner right now given that's where most foreign law firms are choosing to relocate. But new high quality Grade A office buildings being built in Wanchai/Causeway Bay, which lies closer to Central, may also come into play down the road.
"Office leasing will become much more evenly spread across Hong Kong, to the benefit of the city as a whole," predicts Ben Dickinson, JLL Hong Kong's Head of Agency Leasing. "There is no longer a barrier to where tenants are prepared to locate and this should encourage more non-core Grade A developments – in turn cementing a new normal for the local office market."
Still, an immediate mass exodus out of Central is unlikely. US law firms, for example, are likely to hold out longer than their UK counterparts; who have experience in relocating into decentralised offices in London. Moreover, the pace of decentralisation will only move as fast as lease expiries allow.
"Although we remain confident that rents in Central will continue to rise over the near term, given the tight vacancy environment of less than 2% landlords' ability to continue to push rents higher will now likely be more limited," adds Ma.
Monthly Grade A office rents currently stand at an average of HKD 112 per square foot in Central, versus HKD 64 per square foot in Wanchai/Causeway Bay and HKD 48 per square foot in Hong Kong East. Even after factoring in the capex hit involved in the reinstatement and fit-out of a new office—currently at about HKD 25 per square foot per month amortised over a standard three year lease— a relocation still offers room for significant savings.
The decentralisation of the legal sector may be a trigger for more tenants traditionally rooted in Central to look at opportunities further afield. Hong Kong's office market landscape is constantly changing with new emerging markets creating the opportunity for industries to agglomerate in new districts. The decentralisation of the legal sector will only accelerate this change.