I INTRODUCTION TO THE LEGAL FRAMEWORK
i Ownership of real estate
In Hong Kong, land grants are made on a leasehold basis. The 'ownership' of the leasehold land is granted by way of a government lease or a government grant. The government grant will contain conditions, which, when satisfied, will lead to a government lease being deemed to be issued (the practice is that the government will not issue an actual government lease). The government lease or grant will usually specify the government rent, term duration, building covenants and user restrictions, the breach of any of which entitles the government to re-enter the land and determine the government lease or grant.
For multi-storey buildings, government leases are granted for the piece of land on which the building is erected. There are no separate government leases for the ownership of units in that building and all unit owners are 'co-owners'. A deed of mutual covenant governs ownership of each individual unit in a building by notionally dividing the combined land and building into a number of undivided shares and allocating a certain number of these undivided shares to each unit in the building. These undivided shares have attached to them the right to exclusive use and possession, and the purchase of a unit in a building is effected by way of an assignment of all the rights attached to those undivided shares for the remainder of the term of the government lease.
Following the change of sovereignty on 1 July 1997, all land in Hong Kong has become property of the People's Republic of China, and the responsibility for the management, use and development rests with the government of the Hong Kong Special Administrative Region of the People's Republic of China (Hong Kong). The Basic Law of Hong Kong provides that government leases granted prior to 1 July 1997 will continue to be recognised and protected under the laws of Hong Kong. All government lease terms are either granted or entitled to an extension for another 50 years or until 2047.
ii System of registration
Hong Kong operates on a system of document registration (as opposed to title registration) where instruments affecting real properties are lodged for registration with the Land Registry. The registered particulars and relevant documents are open to public inspection. Registration in the Land Registry confers priority on registered documents and serves as notice of registered instruments to anyone dealing with the particular property.
However, the document registration system in Hong Kong only determines the priority of registrable interests in real property. Under Section 2(1) of the Land Registration Ordinance, 'deeds, conveyances, and other instruments in writing, and judgments' affecting land are capable of being registered with the Land Registry. Consequently, a registered interest holder may be in competition with an unregistered interest holder of an unregistrable interest in real property. In these circumstances, priority is determined in accordance with common law principles.
All registrable instruments registered within one month after the date of execution will take priority from their execution date. All registrable instruments registered after one month after the date of execution will take priority from the registration date.
Although the register maintained by the Land Registry does not establish title to the property, it does act as a record of transactions that can be relied upon in establishing the details of the title to a particular property.
The Land Titles Ordinance was passed by the Legislative Council on 7 July 2004, which provides for the gradual conversion from the existing deeds registration system to a title registration system. However, the Land Titles Ordinance is not yet in force, and it is unclear when preparatory work will be completed to enable the commencement of the Land Titles Ordinance for a title registration system in Hong Kong.
iii Choice of law
A contract may have a clause expressly providing the governing law applicable, which will generally be upheld by the courts, but formalities, including conveyance and securitisation of the property and registration of instruments in the Land Registry, will usually be governed by Hong Kong law.
II OVERVIEW OF REAL ESTATE ACTIVITY
i Activity levels in real estate market
The real estate market in Hong Kong in 2018 saw a strong start followed by a decline in the second half of the year. The year started with a steady rise in the number of transactions; however, after its peak in June, the number has been falling constantly – the number of transactions in November is 57 and 45 per cent lower than that in June and in the beginning of the year, respectively. Uncertainties such as the looming US/China trade dispute, rising interest rates, tightening liquidity as well as softening business sentiments may have caused the real estate market to fall.
On 29 June 2018, the Chief Executive of Hong Kong introduced six new housing initiatives, which include revising the pricing policy for subsidised sale flats, inviting the Urban Renewal Authority to assign its non-joint venture project at Ma Tau Wai Road as a starter homes pilot project, relocating private housing sites for public housing, setting up a task force to assist the community to take forward transitional housing projects, and introducing special rates of about 5 per cent of the property value on completed homes left unsold for more than six months after receiving an occupation permit. This vacancy tax proposal seems to have prompted developers to sell flats rapidly. In October, 2,357 new flats had been sold, which was 87 per cent higher that in September, according to market data.
In the 2018 Policy Address, the Chief Executive of Hong Kong announced a proposal to build artificial islands near North Lantau that will eventually be developed into a Core Business District as well as a residential area. While the entire infrastructural development is said to be completed by the 2030s, it is expected that in the long run Lantau may gradually evolve to become a new hot spot for property purchasers and investors, hence pulling up prices in neighbouring areas, that is, the north-western part of the New Territories.
ii Availability of finance
Regarding residential mortgage lending in Hong Kong, banks must comply with a 30 to 60 per cent loan-to-value (LTV) guideline. Banks can only approve mortgage loans for over 60 per cent of the value of the property without incurring additional credit risk by joining a mortgage insurance plan. Under the mortgage insurance plan, banks can grant mortgage loans of up to 80 per cent LTV ratio for property valued below HK$6 million to eligible applicants. The maximum debt servicing ratio of mortgage loans of a mortgage applicant who has more than one property ranges from 30 to 50 per cent, depending on the location from which the applicant's income is mainly derived.
The Hong Kong Monetary Authority released a number of new requirements on mortgage lending for properties transacted after 19 May 2017. First, the risk-weight floor (the lowest level of capital reserve that a bank has to maintain) has been raised from 15 to 25 per cent for new residential mortgage loans approved. Second, the applicable LTV cap will be lowered by 10 per cent for property mortgage loans involving borrowers or guarantors with one or more pre-existing mortgage loans, in addition to the existing requirement of lowering the applicable debt servicing ratio limit by 10 percentage points for these loans (i.e., a 20 per cent reduction in the LTV cap for borrowers or guarantors with one or more pre-existing mortgage loans). Third, the applicable debt servicing ratio will be limited by 10 percentage points for property mortgage loans extended to borrowers whose income is mainly derived from outside of Hong Kong.
III FOREIGN INVESTMENT
While there are generally no legal restrictions on foreign investors owning, selling, leasing and developing real estate in Hong Kong, it may be more difficult for foreign investors to obtain a mortgage in Hong Kong. In addition to the aforementioned new requirement by the Hong Kong Monetary Authority, mortgage insurance plans are generally unavailable to applicants whose income is mainly derived from outside Hong Kong, unless these applicants can demonstrate a close connection with Hong Kong. Further, a legal opinion may be required to confirm that the foreign corporate investor has legal power to enter into the transaction, to deal with and to execute the relevant documents involving the Hong Kong property.
IV STRUCTURING THE INVESTMENT
The structuring of an investment in real estate in Hong Kong will likely be based on tax and accounting considerations of the investor. It is therefore prudent to obtain advice on tax and accounting implications for the investor in both the investor's own jurisdiction and in Hong Kong when investing in Hong Kong property. The availability of financing (and the LTV ratio) may also be a factor when determining the structure of the investment.
i Corporate entity
In Hong Kong, a company is a separate legal entity that can hold real estate assets and mortgage and charge the property it holds. It is not unusual for corporate special purpose vehicles (SPVs) to be set up to hold one or a portfolio of properties. Subject to the administrative requirements under Hong Kong company law, the investor may enjoy advantages of limited liability and tax advantages when realising the value and disposing of the real estate asset through a transfer in ownership of the SPV instead of through assignment of the property.
An investor may also make use of a corporate offshore SPV, depending on regulatory and tax considerations. Popular jurisdictions for setting up offshore SPVs include the British Virgin Islands, the Cayman Islands and Bermuda.
ii Partnership structures
When there is co-ownership and joint management of the real estate asset, a general partnership may be formed if the relation between parties is to carry on a business in common with a view of profit. When deciding whether the parties are partners, the law will look at the substance of the relationship. Partners in a general partnership are liable for each other's debts and liabilities.
The Limited Partnerships Ordinance provides for limited partners who would only be liable up to the amount of their investment. However, limited partners are subject to the restrictions specified in the Ordinance, including the limitation that limited partners are not allowed to participate in the active management of the partnership and the real estate assets held, which must be left to the general partners to manage.
iii Real estate investment trusts (REITs)
REITs are collective investment schemes constituted as unit trusts that invest primarily (at least 75 per cent of its gross asset value) in income-producing real estate assets and are listed on the Hong Kong Stock Exchange. The goal of REITs is to provide returns to investors derived from recurrent rental income. The Hong Kong Securities and Futures Commission has issued a 'Code on Real Estate Investment Trusts' (REIT Code) together with other guidance on the authorisation and operation of REITs. The REIT Code prohibits REITs from investing in vacant land other than in specific circumstances or engaging in property development activities unless certain conditions are satisfied and REITs are subject to a maximum borrowing limit of 45 per cent of their gross asset value. REITs have to distribute annually an amount not less than 90 per cent of their audited net income after tax to their investors as dividend.
iv Listed property company
In addition to investing in a REIT, investors may also indirectly invest in Hong Kong real estate by acquiring shares in a Hong Kong listed property company. Many of the major developers and owners of residential, office, retail, industrial and hotel properties in Hong Kong are listed on the Hong Kong Stock Exchange. This method offers a ready and liquid form of investment as well as the regulated governance of a publicly listed company. Conversely, however, a listed company will be subject to regulatory and disclosure requirements that may hinder the company's strategies in property investment.
V REAL ESTATE OWNERSHIP
The Town Planning Board is a statutory body established under the Town Planning Ordinance tasked with guiding and controlling the development and use of land and types of buildings suitable for erection, preparing new draft zoning plans, exhibiting draft plans for public comment, considering applications for planning permission, and submitting draft plans for approval by the Chief Executive in Council. Its executive functions are carried out by the Planning Department, which is responsible for creating plans on behalf of the Town Planning Board, providing technical services and enforcing zoning restrictions. The Town Planning Appeal Board hears appeals against the Board's decisions to reject planning applications.
The environment is an issue of significance for town planning and land development in Hong Kong. Governmental supervision is generally by way of proper land use planning, along with appropriate controls at the source through licensing and enforcement of environmental protection ordinances. Environmental planning is an early consideration when the government scrutinises and considers approving land use plans. The government review focuses on the impact of the development on air, noise, water and waste pollution levels.
Development projects that have the potential to cause significant damage to the environment may be classified as Designated Projects under the Environmental Impact Assessment Ordinance and are required to follow the statutory environmental impact assessment process to obtain the requisite environmental permits before construction and operation commence.
Stamp duty on disposition of immovable property
There are three types of stamp duty that may be applicable to the sale of property in Hong Kong. The ad valorem stamp duty (AVD) is applicable to all dispositions of immovable property. The government has also introduced a special stamp duty (SSD) and a buyers' stamp duty (BSD) with effect from 20 November 2010 and 27 October 2012 respectively for the sale of residential properties. The SSD and the BSD were introduced with the aim of cooling the overheating residential property market.
The parties legally liable to pay AVD, BSD or SSD are defined under the laws of Hong Kong. However, it is customary for a contract for sale to stipulate that the purchaser will pay the AVD and BSD and the vendor will pay the SSD.
Effective from 27 October 2012, BSD is payable on a contract for sale or a conveyance on sale of any residential property. BSD is charged at 15 per cent on the consideration or the market value of the property (whichever is higher). The BSD is subject to specific exemptions, including the sale of the property to a Hong Kong permanent resident. Any residential property acquired and resold within certain holding periods, up to 36 months, will be subject to the SSD ranging between 10 to 20 per cent of the value and consideration of the property, depending on the timing of re-sale.
AVD for residential properties has been increased to a flat rate of 15 per cent on the consideration or the market value of the property (whichever is higher). Persons who qualify for a lower rate of AVD must satisfy certain exemption criteria stipulated by the Hong Kong government. Examples of such exemption are when the buyer is a Hong Kong permanent resident and is not a beneficial owner of any other residential property in Hong Kong at the time of acquisition of the residential property or the buyer has divested himself or herself of ownership of all other residential property in Hong Kong within six months.
On 11 April 2017, the Hong Kong government tightened up measures on the existing exemptions to the effect that, unless specifically exempted or otherwise provided in the law, acquisition of more than one residential property under a single instrument executed on or after 12 April 2017 will be subject to the proposed new AVD flat rate at 15 per cent. The AVD chargeable on sale or transfer of non-residential properties in Hong Kong will remain at Scale 1 rates, which range from 1.5 per cent to 8.5 per cent, depending on the consideration and valuation of the property. If an exemption is applicable to the sale or transfer of a residential property, the AVD chargeable will be at the lower Scale 2 rates.
On 29 June 2018, the government suggested charging special rates on first-hand private residential units that remain vacant (Special Rates). It is proposed that owners (mainly developers) of first-hand private residential units that have satisfied building regulation and are fit for occupation for 12 months or more will be required to furnish annual returns to the government on the occupancy status of the units. Units that are not occupied or rented out for more than six months during such 12-month period will be considered as vacant and subject to the Special Rates. The government plans to introduce an Amendment Bill into the Legislative Council to amend the Rating Ordinance. Until then, the Special Rates remains a proposal.
Stamp duty on transfer of Hong Kong stock
The acquisition or transfer of shares in a property holding company is not subject to the AVD, SSD or BSD. However, parties will still have to pay stamp duty at the following rates if the transfer directly involves Hong Kong stock:
|Contract note for sale or purchase of Hong Kong stock||0.1% of the amount of the consideration or of its value on every sold note and every bought note|
|Transfer operating as a voluntary disposition inter vivos||HK$5 + 0.2% of the value of the stock|
|Transfer of any other kind||HK$5|
The parties legally liable to pay stamp duty on the transfer of Hong Kong stock are defined under the laws of Hong Kong. Customarily, the stamp duty is borne by the buyer and the seller in equal shares.
Rates and government rent
Owners of Hong Kong properties will also have to pay rates and government rent on their real estate assets.
Rates are a tax on the occupation of property. They are charged at a percentage of the rateable value being the estimated annual rental value of a property at a designated valuation reference date, assuming that the property was vacant and to be let out. The rates percentage charge is determined by Hong Kong's legislature, the Legislative Council. For the 2018–2019 financial year, the rates percentage charge is 5 per cent.
The basis of the government rent is from the government lease or grant that provides that rent is payable to the government. The government rent is calculated at 3 per cent of the rateable value of the property situated on the land leased and is adjusted with any subsequent changes in rateable value.
Property tax (levied on rental income)
Property tax is levied on property owners on the rental income derived from Hong Kong property. The tax is assessed on the net assessable value of the rental income. The current property tax rate is 15 per cent.
iv Finance and security
The financing of a real estate asset acquisition will usually involve the lender taking security over the property by way of a mortgage or a charge. The distinction between a mortgage and a charge is historical whereby the mortgagee has legal and equitable interest in the land subject to the mortgagor's right of redemption as compared to charge having certain rights, such as the right to sell, but legal and equitable interest still belongs to the chargor. Since 1984, a legal mortgage can only be created by way of a legal charge and the Conveyancing and Property Ordinance grants the holder of a mortgage by legal charge the same rights as a historical mortgagee.2 Other securities that are common include an assignment of sale proceeds, assignment of rental income and assignment of insurance proceeds. The security documents that effect property will constitute a registrable encumbrance on the property and should be registered with the Land Registry to establish the chargee's priority interest.
VI LEASES OF BUSINESS PREMISES
The parties to a commercial lease are generally free to agree to the terms and there is no specified form. With relatively few restrictions on lease agreements with all rules on security of tenure abolished, the law in Hong Kong is generally viewed as being more favourable to the landlord.
Subject to the remaining term of the government lease or grant, there is no limit on the term of the lease. In practice, the actual length of the term depends on the negotiations between landlord and tenant, taking into account a variety of factors including location, price, use, their respective bargaining power and market conditions. Generally, the lease term for a residential property may be negotiated in ranges between one and three years, whereas lease terms for a commercial property range between two and six years and may be extended with option terms open to negotiation between the commercial lessee or lessor.
A lease or tenancy agreement for a term exceeding three years must be executed as a deed to create a legal estate in land. Furthermore, all leases, save for bona fide leases at market rent for any term not exceeding three years that are exempted,3 are required to be registered with the Land Registry to establish notice (against a bona fide purchaser) and the lessee's priority interest in the property. An option to renew should be registered at the Land Registry even if the original term of the agreement does not exceed three years.4
iii Rent review
Rent is usually fixed during the fixed term of the lease. Any provision or mechanism for rent adjustment is negotiable between the lessee and the lessor, and would usually be agreed before entering into the binding agreement. A typical provision for rent review in the lease is for the rent to be determined in accordance with prevailing market rent. Generally, an option to renew or extend the term of the lease usually triggers rent review in accordance with prevailing market rent.
iv Lessee's right to sell and change of control
The general practice is for leases to contain an anti-alienation provision prohibiting the lessee from transferring, assigning or subletting the lease or possession of the premises to others whether directly or indirectly. Although this may be subject to negotiation between the parties, it is quite unlikely that the lessor would concede such prohibition or control.
v Lessee liability and security for payment of rent and performance of covenants
A lease or tenancy agreement is a contract and constitutes an interest in land.
Under privity of contract principles, the original contracting parties to the agreement remain liable for the performance of the covenants, terms and conditions that are binding on them. Therefore, the lessor or lessee remain liable to each other, even if the lease is assigned by one party. If the intention is to safeguard the assignor from future liabilities arising from the contract, all parties to the original contract and the assignee should enter into a novation of the lease. If a novation is not signed, then the assignor may consider procuring an indemnity from the assignee. However, that does not affect the assignor's contractual obligations (as the lessor) towards the lessee under the lease, which includes the lessor's obligation to repay the lease security deposit at the end of the lease term.
Under privity of estate principles, covenants that touch and concern the land will bind third parties. Therefore, assignees are only bound by covenants in the lease if they touch and concern the land. Such covenants include repairing covenants, user covenants and covenants for quiet enjoyment. This is beneficial from a lessor's perspective, because the lessor's assignee (in becoming the new owner of the property) would be obliged to perform or observe such covenants that touch and concern the land under the privity of estate principles, thus, releasing the lessor from his or her obligations.
vi Repair and insurance
Unless the parties agree otherwise, the lessee is obliged to maintain the premises in a good and tenantable condition and the lessor is usually responsible for structural repairs such as concealed wires and pipes drainages. While there is no statutory or regulatory requirement to procure property insurance, it is prudent and advisable for both the lessor and lessee to ensure that there is adequate insurance coverage for the property. Some commercial leases stipulate that insurance coverage must be procured by the lessee for a minimum threshold on any single claim.
There are a number of ways in which a lease may be terminated, including expiry of term, by notice or through an express condition, power or option provided in the lease. A breach of a condition or a covenant with a proviso for re-entry will allow the lessor to terminate the agreement by forfeiture; however, the lessee may be able to apply for relief from the court. A lessee can also repudiate the lease and if the repudiation is accepted by the lessor, the lease will immediately terminate and the lessor will be entitled to sue for damages.
viii Security of tenure
In 2004, several sections of the Landlord and Tenant (Consolidation) Ordinance were amended with the effect of abolishing security of tenure of residential tenancies and leases created after 9 July 2004.
VII DEVELOPMENTS IN PRACTICE
i The Residential Properties (First-hand Sales) Ordinance
The Residential Properties (First-hand Sales) Ordinance came into effect in April 2013 and sets out detailed requirements in relation to the conduct and materials used for selling first-hand residential properties concerning, inter alia, sales brochures, price lists, show flats, disclosure of transaction information, advertisements, sales arrangements, and mandatory provisions for preliminary sale and purchase agreements and formal sale and purchase agreements.
So far, five land developers have been fined for violating the Residential Properties (First-hand Sales) Ordinance for lack of information in and transparency of the sales brochures, failure to include certain mandatory provisions in preliminary sale and purchase agreements and general malpractice. The total fine exceeds HK$2.2 million.
ii Lantau Tomorrow Vision
In the 2018 Policy Address, the Chief Executive of Hong Kong proposed building artificial islands for the development of Lantau. In addition to building 260,000 to 400,000 residential units, it was proposed that new major transport infrastructures will link up the coastal areas of Tuen Mun, North Lantau, the artificial islands and the traditional business centre in Hong Kong Island North. The project will stir interest among stakeholders in the real estate and construction sectors.
VIII OUTLOOK AND CONCLUSIONS
While the property market started out strong in the beginning of 2018, the market, in particular the residential property market, is now witnessing a decline in both transaction volume and property value. According to the Centa-City Leading Index, the secondary home prices have fallen for two months and used-home prices in November saw its largest week-on-week decline of 1.3 per cent.
The decline is largely owing to the looming US-China trade dispute, coupled with rising interest rates and active launch of new developments in the first half of 2018. The depreciation of the yuan has soured inbound investment sentiments, especially investments originating from China, which have been very active in previous years. Those investors have taken a step back from investing fervently in the Hong Kong property market. The rising Hong Kong interbank offered rate (HIBOR), which increased mortgage rates, also contributed to the decline in the residential property market. The HIBOR has been increasing constantly since February and reached a 10-year high at 2.27 per cent in September, thus affecting those investors who previously enjoyed lower costs when leveraging, reducing cash flow for reinvestment. In addition, the Hong Kong government has taken up an active role in promoting stability in the property market balancing housing problems against healthy property prices and the shortage of land supply. Apart from pushing forward starter homes pilot projects, the government has been actively pursuing transitional housing projects and proposing reclamation projects, including the aforementioned Lantau Tomorrow Vision project. While it is anticipated that such initiatives may offer relief to the issue of housing supply and affordability, it may inevitably have a cooling effect on the volume of transactions in the market.
The industrial market continues to see a steady growth. With the limited supply of industrial premises and low vacancy, rental for industrial premises continues to rise. Investors are focused on redevelopment potential by usage modifications and conversions. Some industrial premises are revitalised for other popular uses, such as data centres and work/activity hubs, which are driving investment sentiments. The government has announced policies to relax usage restrictions on industrial buildings in Hong Kong in the 2018 Policy Address, it is anticipated that further details of the revitalisation scheme would be released in due course. The potential in converting industrial buildings for non-industrial use may encourage investors to enter into the industrial property market.
Despite uncertainty in the residential property market because of macro-economic and political influences, transaction volumes and valuations of commercial and industrial properties supports the view that the Hong Kong property market is still vibrant and very much in demand.
1 Dennis Li is the head of property at Slaughter and May in Hong Kong.
2 Conveyancing and Property Ordinance (Cap. 219) Section 44.
3 It is also possible, but not required for priority, to register bona fide leases at market rent for any term not exceeding three years. In practice, it is not uncommon to see leases for less than three years being registered at the Land Registry.
4 Markfaith Investment Ltd v. Chiap Hua Flashlights Ltd  2 AC 43.