MCKINSEY & CO INC HONG KONG AND OTHERS v. SKY ALLIANCE DEVELOPMENT LTD

Landlord and Tenant - Part IV applications for new tenancies - determination of prevailing market rent. - should rent be adjusted for defects such as damp penetration? - should a "break" clause be allowed in the new tenancy when the current tenancy does not have such a clause? Rent to be based on the concept that each party will honour its contractual duty to repair. - Only when a defect is not readily remediable or the cost of repair is out of all proportion with the value of the premises such that it would not make economic sense to carry out the repair should the premies be assessed as if the defect were not repaired. Break clause included with regard to the provision in section 119J that account be taken of "all relevant circumstances", and that break clauses are often included in leases at this level of the market.

Held : New tenancies granted for 2 years. Rents determined as follows : -

  House Al, King's Court, $110,000 from 20th November 1991.

  House A2, King's Court, $95,000 from 25th November 1991.

  House A3, King's from 18th October 1991.

IN THE LANDS TRIBUNAL OF HONG KONG

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D E C I S I O N

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1. These are applications for new tenancies under Section 117(1) of Part IV of the Landlord and Tenant (Consolidation) Ordinance, Cap. 7. The applications concern three houses in King's Court, 5 Mt. Kellett Road, the Peak. They are three separate applications for Houses A1, A2 and A3, but the same respondent is the owner of each of the houses. These are similar detached houses in a row of five, each having the same internal layout and area of about 350 m², as well as the same view overlooking Aberdeen, the Lama Channel and the islands beyond.

2. Only the rent is in dispute for House A1 and House A2, but the tenant of House A3, as well as disputing the new rent, also seeks an additional clause in the new tenancy to permit the tenant to give 2 month's notice to terminate the tenancy after the expiration of 12 months. This is commonly called a "break" clause.

TERMS

3. The applicant for House A3 called Mr. Patrick O'Conner, the office manager of the applicant company to give evidence of similar break clauses in other tenancies held by his company to accommodate its executive staff. Mr. Merry who appeared for the applicants in respect of House A2 as well as A3 said that the current tenancy for House A2 had such a clause. No such clause had been sought for House A3 previously. Mr. O'Conner explained that this was because his firm was not aware that such a provision was open to negotiation when it took the lease in 1989. However his firm has since obtained similar clauses in many other such leases elsewhere in Hong Kong. (Exhibit A1 of LT 2837/91).

4. The respondent opposed the granting of the clause but made no submission as to why it's inclusion was opposed.

5. Section 119J of the ordinance states that, with respect to the terms of the new tenancy, "the Tribunal shall have regard to the terms of the current tenancy and all relevant circumstances".

6. The current tenancy, does not have a break clause. So it would seem that, with respect to the current tenancy, the Tribunal should follow by not ordering such a clause to be included in the new tenancy. However by way of having regard to all relevant circumstances the Tribunal is permitted wider discretion. It is evident that break clauses have been successfully negotiated by the applicant for other tenancies on numerous occasions. Also it is fairly common knowledge that leases for premises at this level of the market often include break clauses.

7. As Mr. Merry pointed out the addition of a break clause does not seem to have affected the rent for House A2. Also, in what appears to be a rising market at the moment, I would not expect a landlord to be detrimentally affected by the granting of such a clause. In fact in a rising market it might be something of an advantage to a landlord.

8. I have not been persuaded by Mr. O'Conner's evidence concerning the occupant of House A3 being likely to be transferred during the tenancy, but I see no reason not to order the clause sought when break clauses are common place for similar tenancies throughout Hong Kong. However in view of the respondent's opposition I intend to make the notice to terminate the tenancy 3 months rather than the 2 months sought by the applicant, as 3 months seems to be generally more common than 2 months.

RENT

9. For House Al the applicant relied on the evidence and the valuation. report of Mr. William Sham, a chartered surveyor with Prudential Surveyors International Ltd. Mr. Sham assessed the prevailing market rent as at 19th November 1991 (The date the previous tenancy came to an end due to the serving of the appropriate notice under the Ordinance) at $95,000 per month exclusive of rates.

10. The applicants in respect of House A2 and House A3 relied on the evidence and reports of Mr. Paul Brown, who is a chartered surveyor and the Managing Director of Sallmanns (Far East) Ltd. He valued House A2 at $95,000 per month at the relevant date of 24/11/91 and House A3 at $91,000 at its relevant date of 17/10/91.

11. The respondent's valuer, Mr. Wu Kam Ming, a chartered surveyor with the firm of Richard Ellis, valued House Al at $127,000 per month exclusive of rates at the 19th November 1991. House A2 at $125,000 per month exclusive of rates at 24th November 1991, and House A3 also at $125,000 per month at the relevant date of 17th October 1991.

12. Mr. Brown reduced what he believed would normally have been the rental value of House A3 of $95,000 to $91,000 due to a damp problem which he said was particularly evident on the living room wall immediately below the dinning room, and the floor of the dinning area itself. Discolouration due to dampness was also evident around a number of windows throughout the house. Mr. Brown said that all the houses suffered some damp problem but not to the same extent as House A3.

13. His deduction was based on allowing for one month of the tenancy to be rent free as this was the time estimated for taking up repairing and replacing the dinning room floor. The proposition was based on the house being vacated for that period to allow such work to be done. This solution was mentioned to Mr. Brown by the occupant of House A3 as an option put forward by the landlord.

14. The respondent called Mr. Wang Wing Lak who is employed by the management company of the landlord. He denied that it was ever suggested that the occupants move out for one month to allow remedial work to be done. He said that he has not received any complaints concerning the dinning room damp problem since work was done to rectify it in January 1991. At that time water proofing of the flower beds outside that dinning room was carried out.

15. I inspected these houses with representatives of the parties and found that dampness was evident in each of them. If House A3 was any worse than the others, it was only marginal. This damp penetration was common to each of these houses and the landlord appeared to be taking steps to rectify what seems to have been an on going problem with these houses since they were first let 2 years ago. From Mr. Wang's evidence it seems some progress has been made. The point is that, although the damp problem may be persistent, it is much the same for each house. Accordingly House A3 should not command any special allowance.

16. Mr. Merry, in his submission, said that the Tribunal should value the premises in the state they are found at the valuation date. He suggested that the Lands Tribunal has in the past made no distinction between sound premises and those with permanent structural problems such as damp penetration, on the basis that each party to a tenancy agreement is expected to honour its contractual liabilities and a landlord has only to apparently show willing in order for necessary repairs to be ignored in a prevailing market rent assessment.

17. This is not so. Where it can be shown that such defects are not readly remediable or it would be uneconomical to the extent that one could not reasonably expect repairs to be carried out, then due account is taken in the rent determined for such premises. Such an allowance was made for House 7 at Strawberry Hill in the case of Nordic Asia Limited and Others v. Strawberry Hill Development Limited and Another LT's 32 to 37, 41 to 45 and 53 to 54 of 1982. In Arthur Andersen and Co. v. Tak Hing Lung Company Limited NT 2179/86, the subject house had particularly severe damp patches which had received attention on numerous occasions. It appeared major structural work was required to eliminate the problem. Due allowance was made in the prevailing, market rent because the fault could not be expected to be satisfactorily rectified.

18. Other cases which are relevant to the matter of repairs, and whether any allowance should be made or not are:

Union Carbide Asia Limited v. The Hong Kong Land Company Limited (1982) HK DCLR 735.

Cathay. Pacific Airways Limited v. Wharf Properties Limited (1985) HK DCLR 39.

Issacco Aronne Neumann v. Gain Field Limited, Lim Chin Beng and. Lim Chin Joo LT-105 of 1983, and, Kings1ey Shih and Andrew Wang Fat Wong v. Wah Yin Cheong Company Limited LT's. 3898 and 3798 of 1987.

19. In the last of these listed cases reference was made to the English Rating Case of Saunders v. Maltby (Valuation Officer) 1979 Rating Appeal 109, in which the English Court of Appeal dealt with the extent of the landlord's liability to repair within the definition of Rateable Value. The structural repairing convenant, as is the case in most tenancy agreements, is assumed to be the landlord's responsibility under the Rateable Value definition in both the English and Hong Kong statutes and as such, is for all practical purposes very similar to that which must be considered with respect to the Section 115 definition of Prevailing Market Rent.

20. All of these cases support the proposition that a landlord must be assumed to be obliged to honour his contractual duty to repair structural defects which are readily remediable except where the necessary expenditure might be out of all proportion with the value of the premises such that it would not make economic sense to carry out the repairs. In such cases it is reasonable to assume that the premises will be let at rents which reflect the state of disrepair. I cannot imagine that the likely cost in this case would not make economic sense, nor can I hold, on the evidence before me, that any repair concerning damp penetration is unlikely to have results. In any case each of the houses is similarly affected.

21. I now turn to the evidence associated with the rents to be determined for the subject houses based on comparable lettings in the area.

22. Mr. Wu valued House A1 at $127,000 per month and House A2 and House A3 each at $125,000 per month.

23. On behalf of the tenants Mr. Sham valued House A1 at $95,000 per month, while Mr. Brown valued House A2 at $95,000 and House A3, at $91,000.

24. I have concluded that no allowance should be made with respect to House A3 being any more affected by damp penetration than the other two houses, so Mr. Brown's figure for House A3 must now be assumed to be $95,000.

25. Mr. Wu relied principally on the rent recently realised for House A5 in King's Court. House A5 is at the end of the row of these five almost identical houses. It was let from 15^th November 1991 at $112,500 per month. Each of the houses has the same floor area but house A1 and A3 are laid out as mirror images of the others.

26. He used other rents outside King's Court but his method, which placed undue emphasis on size and age was not what I would consider conclusive. However it is safe to say that his comparable rents outside the King's Court complex showed support for the House A5 rent. I will deal with these rents directly.

27. House A5 and House A1, being at either end of the row are the best houses for outlook, view and privacy, Mr. Wu thought that House A5 was inferior to House A1 mostly because of the proximity of a children's playground which adjoins House A5. He also said House A5 suffered more from traffic noise on the access road beside A5 and lack of privacy due to it being overlooked from this access road.

28. I could not agree with him on any one of these reasons. The playground was at a lower level. The noise and privacy factors did not seem to me to warrant the significance given them by Mr. Wu when comparing House A5 to the other houses in the row. There is little to choose between House A1 and House A5, but, as A5 was able to realise $112,500 for a tenancy commencing in November 1991, then A1 should have been worth about $110,000 per month at the same time. The only difference that I could discern between the two was the more attractive terrace outside the dinning room of No. 5.

29. Similarly if these houses were to realise these rents then House A2 and A3 should each be worth about $95,000 per month which is the figure determined by Mr. Brown. It was not argued in court but my inspection revealed that a lack of privacy was evident with respect to House A2 and House A3 as they overlook each other's main terraces and dinning rooms.

30. The comparable rents cited by the valuers for houses outside King's Court were for gererally smaller houses with rents as at mid 1991 in the region of about $85,000 per month.

31. La Hacienda at Numbers 27 and 29 Mt. Kellett Road, is nearby. This development which also includes blocks of large flats as well as the terraced houses cited as comparables, has a larger swimming pool than King's Court and the addition of a tennis court. The rents ranged between $67,000 per month in April '91 to $88,000 per month in October '91. The last quoted rent was for a house which was larger than the others in the same development. It had a floor area of 327 m² compared to the other houses in the same development being in the region of 256 m² to 266 m². The subject houses of course are larger still having floor areas of a little over 350 m². The La Hacienda houses have no garden areas, but the subject houses have only lower level concrete terraces to which Mr. Wu has ascribed the euphenism of gardens.

32. House A1, 10 Bluff Path included by Mr. Brown in his list of comparable rents let at $85,000 in June '91. This house has an area of about 350 m² and a small garden, being a lawn area adjoining the living room.

33. This complex has a pool and the overall appearance and the view are similar to that of King's Court. It is a little older than King's Court but this should make little or no difference in this market where maintenance and management probably count for more than age. Age is not always readily decernable in the appearance of such properties and even when it is, many older properties on the Peak are as eagerly sought by prospective tenants as the newer ones.

34. A 1941 semidetached house of about 500 m² at 26 Severn Road let in June '91 for $110,000 per month. Another example is that of House J Kellett View at 65 to 69 Mt. Kellett Road which has an area of a little over 300 m² and let for $110,000 per month from August '91. This is a newer house that that a Severn Road having been built in 1976. The complex includes a pool. Another is at Strawbery Hill at 8 Plunketts Road, where a house of about 300 m², and also built in 1976, let in September '91 at $80,000 per month. Strawberry-Hill has a large pool and other facilities.

35. Mr. Brown also produced comparable rents for houses at 5 Mt. Austin Road, which let in April and May '91 at $85,000 per month. This complex has a pool and a tennis court but the houses are of a size and type similar to La Hacienda. The views are similar but the position is higher up the Peak than La Hacienda or King's Court.

36. Unlike Mr. Wu or Mr. Brown, I share Mr. William Sham's opinion that the rental value of such properties depends more on their design and layout as well as view, than on a strict unit area basis once an adequate size for this type of premises has been met.

37. My impression based on the rents for these properties outside King's Court was that King's Court rents, should be no greater than, or a bit less than Kellet View and only a little more than 10 Bluff Path. Given that rents have been increasing in the latter part of 1991, King's Court A houses should rent at about $100,000 or a little less at or about the relevant dates of October and November 1991. The letting of House A5 at $112,500 in November 1991 looks to be consistent with that opinion and it is therefore the most reliable of the comparable rents cited.

38. I therefore determine the Prevailing Market Rents for the three suit premises as follows

LT 3598/91, House Al, $110,000 per month exclusive from 20th November 1991.

LT 3685/91, House A2, $95,000 per month exclusive from 25th November 1991.

LT 2837/91, House A3, $95,000 per month exclusive from 18th October 1991.

39. The new tenancies are to be for 2 years and otherwise on the same terms and conditions as the previous tenancies, save for deposit clauses, which should be altered to reflect the new rents, and any rent free periods stipulated in the original leases, which should now be deleted.

40. House A3 should have an additional clause included to allow the tenant, after 12 months, to give 3 month's notice to terminate the tenancy.

Dated this 6th day of April 1991.