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 multistorey 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 more than 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
Despite a rebound in the beginning of 2019, the real estate market in Hong Kong has softened markedly over the rest of the year. For the first half of 2019, the number of residential property transactions jumped by 48 per cent and overall residential market prices rose by a noticeable 10 per cent. However, sentiment was dampened following the re-escalation of US–Mainland trade tensions in May. Amid prolonged local social incidents, escalated US–Mainland trade tensions and a weaker global economy, trading activities have slowed down visibly. With most buyers exercising more caution and sellers generally approaching price negotiations with softer stances, transaction volume fell significantly, and residential unit prices fell beyond the initial gain and slipped by 3 per cent during the third quarter of 2019. The commercial and industrial property markets have also turned quieter across all major market segments due to subdued local economic and social conditions.
In the 2019 Policy Address, the Chief Executive of Hong Kong announced the relaxation of mortgage lending rules by raising the cap on the value of the properties eligible for a mortgage loan of 90 per cent loan-to-value (LTV) ratio from HK$4 million to HK$8 million for first-time homebuyers, and raising the cap on the value of the properties eligible for a mortgage loan of 80 per cent LTV ratio from HK$6 million to HK$10 million. The increase in LTV ratio is expected to enable first-time homebuyers to procure higher loans for the securing of properties and to increase the liquidity in the secondary market, particularly for small to medium-sized flats.
In addition, the Chief Executive of Hong Kong proposed various initiatives to increase land supply, including the resumption of private land for developing public housing and starter homes, the furtherance of the Land Sharing Pilot Scheme and Lantau Tomorrow Vision, the replanning of the coastal development of Tuen Mun West and the review of 'Government, Institution or Community' sites that are earmarked for standalone public facility with a view of developing them under the 'single site, multiple use' model. Some property developers have also announced that they would provide or lend land for housing development and other public welfare uses.
ii Availability of finance
Regarding residential mortgage lending in Hong Kong, banks must comply with a 30 to 60 per cent 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 provided by HKMC Insurance Limited (HKMCI). 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 and up to 90 per cent LTV ratio for property valued below HK$4 million to eligible applicants. On 16 October 2019, HKMCI announced that, subject to an additional 15 per cent premium, the maximum property value eligible for mortgage loans of up to 80 per cent LTV ratio is increased to HK$10 million and eligible first-time homebuyers can take mortgage loans of up to 90 per cent LTV ratio for property valued below HK$8 million. 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. First-time homebuyers will still be eligible for mortgage loans of up to 80 or 90 per cent LTV ratio even if they cannot meet the stressed debt servicing ratio, subject to an additional adjustment to the premium based on relevant risk factors.
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 resale.
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 at least 183 days during a 12-month period will be considered as vacant and subject to the Special Rates. The Rating (Amendment) Bill 2019 was gazetted on 13 September 2019 and will be introduced into the Legislative Council following the first Council meeting in the 2019–2020 legislative session.
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 2019–2020 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 this 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 the 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, seven 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$2.3 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 has stirred concerns about the development of the artificial islands; thus the government will establish a platform for professionals and young people to take part in the process, and to explore how to link up the housing development plans on the artificial islands with the housing needs of Hong Kong.
iii The Lands Resumption Ordinance
In the 2019 Policy Address, the Chief Executive of Hong Kong proposed to invoke the Lands Resumption Ordinance to resume three types of private land for developing public housing and starter homes. These include: privately owned brownfield sites in the New Territories that may have development potential, private land that has been zoned for high-density housing development in statutory outline zoning plans but without any development plans yet and the urban private land located in three areas in Kowloon East. The government's approach of resuming land will require support from various sectors of the community, particularly developers. In this regard, the property development industry previously expressed that developers will not oppose such an approach.
VIII OUTLOOK AND CONCLUSIONS
An optimistic start to 2019 has been weighed down by economic, political and social issues, leaving the real estate market in Hong Kong with an outlook of caution. During the third quarter of 2019, the volume of sales transactions for residential property, office space, retail shop space and flatted factory space fell by 14 per cent, 45 per cent, 36 per cent and 61 per cent respectively from a year earlier.
Besides the ongoing US–China trade disputes, the decline is largely due to citywide demonstrations that have led to an economic slowdown and reduced the city's business sentiment. On 16 September 2019, Moody's Investors Service changed the outlook on the Aa2 issuer rating of the government of Hong Kong from stable to negative, reflecting 'the rising risk that the ongoing protests reveal an erosion in the strength of Hong Kong's institutions, with lower government and policy effectiveness than Moody's had previously assessed, and undermine Hong Kong's credit fundamentals affecting its attractiveness as a trade and financial hub'. The government also confirms that the economy has entered a recession as the local social incidents affected consumption- and tourism-related sectors.
In the commercial and industrial property markets, trading activities have dropped for all major market segments. Affected by the sharp deterioration in retail sales, it is reported that some landlords have granted rental concessions that are not reflected in the rental figures to help tenants through the difficult environment caused by continued social incidents. Another factor that may have contributed to the weakening demand for retail shop space is the rise of online merchandise. Competition from online businesses may affect retail businesses, forcing them to shift their sales online or realign their sales and service strategies. However, the impact of online merchandise on the rental market for retail shop space will remain limited due to the proximity of shopping centres and retail stores, which suppresses the need for online merchandise.
In the residential market, the economic slowdown and ongoing demonstrations are also reflected in a drop in both transaction volumes and residential prices, and homebuyers in general have become more cautious. However, the lack of appetite is somewhat alleviated by the relaxation of mortgage payment rules announced by the Chief Executive of Hong Kong in the 2019 Policy Address, which is expected to boost sentiments of first-time homebuyers and the secondary market. In October 2019, following months of decline, the number of residential property transactions rebounded for the first time by 16 per cent. In the short to mid-term, the demand for residential properties, for self-use and investment purposes, is expected to remain resilient because of traditionally strong domestic needs and investors' sentiments, which are yet to be significantly affected. Nonetheless, the long-term effects of the Sino-American trade war and the prolonged political instability in Hong Kong would pose a degree of uncertainty regarding the future of the Hong Kong housing market.
In terms of office space, there continues to be an extension of the central business district (CBD) from Central to Island East, which comprises North Point and Quarry Bay in the north-eastern part of Hong Kong Island. In addition to the increase of Grade A office stock, the Central-Wan Chai Bypass, completed in the first quarter of 2019, has been a major driver in the repositioning of Island East. This area is expected to continue to thrive as an increasingly important business district, providing more cost-effective options for CBD tenants.
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.