GAININN CO LTD v. THE DIRECTOR OF LANDS

LDLR 5 and 10 OF 2006

IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

Lands Resumption Application No. 5 of 2006

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IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

Lands Resumption Application No. 10 of 2006

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J U D G M E N T

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Background

1. The Applicants in the captioned 2 proceedings LDLR 5 of 2006 and LDLR 10 of 2006 covered by this Judgment were the respective registered owners of the 2 properties (“the Properties”) known as No. 239 and No. 237 Queen’s Road East, Wanchai, Hong Kong (“Shop 239” and “Shop 237” respectively).  The 2 shops were resumed by the Government under the Lands Resumption Ordinance (“the Ordinance”) for the implementation of the Development Scheme H17 of the Urban Renewal Authority (“URA”) vide Government Notification No. 3215 dated 11 May 2004.  The Applicants applied to the Tribunal for determination of compensation payable under the Ordinance.  The 2 cases were heard together.  The Applicants called for the evidence of an expert valuation surveyor Mr. Wayne W. K. Lee (“Mr. Lee”) and the Respondent called for the evidence of another expert surveyor Mr. Lai Wah Chi (“Mr. Lai”). 

2. The 2 experts filed and exchanged a number of reports before the hearing.  During the hearing, they have agreed, for the present valuation purpose, to adopt the same areas, frontages and headroom for the Properties and all the comparables.  They have also agreed to adopt the same adjustments for all the comparables in respect of the factors of time, headroom and building age.  As a result, they have amended their valuations for the Properties.  In the final analysis, they valued the Open Market Value of the Properties, after adjusting (in the case of Mr. Lai) for the existing tenancy and the conversion works, as follows:

	Mr. Lee	Mr. Lai
For Shop 239	$8,903,522	$6,300,000
For Shop 257	$8,568,590	$6,100,000

The Properties

3. The Properties were 2 adjoining ground floor shops of the building situated at the junction of Queen’s Road East and Stone Nullah Lane in the Wanchai District of Hong Kong.  The building was 5-storey in height and was completed in 1956.  According to the Occupation Permit of the building, the whole building was permitted for domestic purpose only.  The Properties fell within the URA’s H17 Scheme, a small project involving all the units in Nos. 237 to 245 of Queen’s Road East, Hong Kong.

4. For the purpose of the present proceedings, the experts agreed the following basic measurements for the Properties: -

(a)	For Shop 239, the Effective Floor Area is 42.73 m2
(b)	For Shop 237, the Effective Floor Area is 41.00 m2

5. Counsel for the Applicants stated in the final written submission that for the avoidance of doubt, the experts agreed that no concession had been made as to the exact assumptions adopted by each of them but the parties agreed on the above Effective Floor Areas of the Properties for the valuation purpose.

6. It was common ground that immediately before the resumption, Shop 239 was subject to an oral monthly tenancy, which could be terminated by a 1-month notice and Shop 237 was owner-occupied.  Also, the existing use immediately before the date of resumption was “export fashion” for Shop 239, and “pawnshop” for Shop 237.  The experts agreed that the best use for the Properties were for retail purposes.

Other common grounds between the parties

7. The parties were in agreement on the following: -

(a)	The amounts of compensation awarded to the former owners of the Properties shall be the Open Market Value of the Properties at the relevant date of valuation, which was 21 August 2004 (i.e. the date of reversion of the Properties to the Government).
(b)	Both experts agreed to adopt the direct comparison method of valuation using the effective floor areas of the Properties and the comparables as the basis for comparison in arriving at the Open Market Values of the Properties.
(c)	During the hearing, they have also agreed to the choice of the best comparables, i.e. the experts agreed to use 8 of the comparables identified by them in the course of their valuations, the reports of which were filed to the Tribunal and exchanged between them before the hearing.  These are: AC2/RC1, AC3, AC5/RC2, AC6/RC3, AC7/RC4, AC8/RC5, AC10/RC6 and AC11.
(d)	For valuation purpose, the experts also managed to agree on all the effective floor areas and frontages of all the 8 comparables during the hearing; hence, the differences that existed for some comparables in the experts’ reports have been resolved.
(e)	Also, the experts agreed that the relevant factors for adjustments were time, location, headroom, frontage, size and building age.  During the hearing, they have also managed to agree on all the percentage adjustments in respect of the factors of time, headroom and building age for the 8 comparables.
(f)	Finally, the experts agreed that under the Occupation Permit of the building of which the Properties formed parts, the whole building was  built for “domestic” purpose.  Also, the zonal method of valuation was abandoned by the Applicants.

Issues before the Tribunal

8. The following matters require determination by the Tribunal: -

(a)	The appropriate quantum of adjustments for the factors of location, frontage and size;
(b)	Whether any adjustment for the existing tenancy at Shop 239 ought to be made and if so, by how much; and
(c)	Whether any deduction for the conversion cost and the waiting period (arising from the stipulation in the Occupation Permit that the Properties were certified for domestic use only) ought to be made and if so, by how much.

The comparables agreed to be used by the experts

9. I have set out in the following Table 1 the details of the transactions of the 8 comparables chosen by the 2 experts.  They agreed that they were the best comparables that ought to be used in this valuation exercise, out of all the comparables that had been considered and analysed in the valuation reports filed and exchanged by them before the hearing.

Table 1 – Details of the comparable transactions

Summary of valuations by the experts

10. Counsel for the Applicants have prepared 2 tables (one for each property) detailing the 2 experts’ adjustments to the comparables and the adjusted unit rates that could be applied for the valuation of the Properties.  These are summarized in the Table 2 below.  The analysis shows that both experts agreed that the Properties were inferior to all 8 comparables.  Mr. Lee gave total adjustments of between –8% and –40.9% whilst Mr. Lai gave more substantial adjustments of between –30% and –68%

Table 2 – Summary of valuation by the experts

11. There were originally differences between the parties as to the suitability of various comparables identified and analysed by the 2 experts.  They set out their opinion on these comparables in their valuation reports.  However, during the hearing, counsel for the parties confirmed that the 2 experts managed to agree on the use of the above 8 comparables, despite of the large differences in the unit rates of these comparables and the substantial adjustments that they gave to some of these comparables.

12. The analysis summed up in the above Table 2 shows that according to Mr. Lee, the appropriate unit rate for the valuation of Shop 239 is the average of his adjusted unit rates for the 8 comparables.  This equates to $208,367 per sq. m., which is less than 0.3% from that of the appropriate unit rate for the valuation of Shop 237, being $208,990.  Therefore, applying these unit rates, Mr. Lee arrived at the Open Market Values of Shop 239 and Shop 237, on vacant possession basis, in the sums of $8,903,522 and $8,568,590 respectively.  The small difference is due to the marginal differences in the adjustments of the comparables for the Properties in terms of the areas of adjustments for frontage and size.  I will discuss this point further below.

The Tribunal’s adopted adjustments to the comparables

13. I will consider below the quantum of adjustments as suggested by the 2 experts as well as my adopted adjustments to the comparables.

Location

14. This is the major area of dispute between the 2 experts.  During the site visit held on the first day of the hearing, the 2 experts explained the characteristics of location for each comparable.  The 2 experts basically agreed that the busiest part of Queen’s Road East, Wanchai is the portion around Hopewell Centre and Wu Chung Building.  However, even though Mr. Lee opined that the Properties were similar in location when compared with the comparables in the western part of Queen’s Road East, Mr. Lai thought that the Properties were inferior, with differences in the range of about 15% to 20%.  They also had different opinion for each of the comparables having a corner location.  So, whilst they had a slight difference of 5% each in the adjustments for Comparables AC5/RC2, AC7/RC4 and AC10/RC6, they had a greater difference of 15% to 20% each in the adjustments for comparables in the western part of Queen’s Road East (i.e., AC2/RC1, AC6/RC3 and AC11) or the comparable adjacent to Hopewell Centre (i.e., AC8/RC5), and a substantial difference of 30% in the adjustment for AC3.

15. Mr. Lai sought to use the analysis of “paired” transactions (Comparables RC7 and RC8) to justify his large location adjustments of between 20% and 45% for the comparables.  These transactions took place in August and September 2003.  They were not meant to be direct comparables for the Properties.  Instead, the purpose of the exercise was to illustrate the difference between the two locations of these transacted comparables, one in the vicinity of the Properties and the other just across the road from Hopewell Centre.  Mr. Lai contended that since the unit price difference of the 2 transactions, after adjustments were made for the size and frontage, amounted to as much as 49%, it followed that he was reasonable to suggest large differences for the adjustments in location between the Properties and the adopted comparables.

16. The Applicants raised a number of queries to the comparison exercise and suggested that no weight should be attached to it.  The major criticism was that it was a single comparison of 2 transactions.  I commend the effort taken by Mr. Lai.  As a matter of principle, the analysis of “paired” transactions does help to illustrate the magnitude of difference between the 2 transacted comparables if we can reduce their differences into one aspect.  Otherwise, the subjective adjustments of other aspects would have an effect on the last aspect of difference.  However, this is easier said than done, especially for retail properties for which there are not so many transactions.  Also, there are usually a number of factors affecting the transacted comparables in varying degrees.  Therefore, almost invariably, the experience and skills of valuation surveyors are called into play as far as market valuation of retail properties are concerned.  The same applies for the present valuation exercise.  For this reason, I agree that not much weight could be put on the “paired” transaction exercise carried out by Mr. Lai.

17. Having considered all the evidence adduced by the parties, I am inclined to agree more with Mr. Lai in the adjustments for location.  I adopt his adjustments for Comparables AC2/RC1, AC6/RC3 and AC10/RC6, but reduce his adjustments for the other comparables.  The adjustments I adopt are summarized in the Table 3 below.

Frontage

18. The differences for most of the comparables, with the exception of Comparables AC10/RC6 and AC11 were small.  I adopt Mr. Lai’s basic rate of adjustment of 2% per metre and his adjustments for all comparables except AC10/RC6.  For that comparable, I agree with Mr. Lee that because of the location of the street stalls immediately in front of the side frontage of the shop along Gleeson Street, the market street characteristic and usage of these stalls as well as the narrow width of the pavement of Gleeson Street, no extra frontage adjustment of value should be given to it even though physically, it does enjoy a side frontage.  As pointed out by Mr. Lee, the fact that the owner does not choose to make use of the side frontage to form an opening to the shop is also a factor I take into consideration.  However, it of course does not follow that whenever an owner or occupier of a shop decides not to make full use of a return frontage to form an extra shop opening, the return frontage will not attract extra value.  Lastly, for Comparable AC11, I adopt Mr. Lai’s adjustment, which, I find, is actually in the Applicants’ favour.

Size

19. During the hearing, the parties managed to agree on the basic rate of adjustment for size.   However, Mr. Lee proposed a “linear approach” of 0.25% adjustment for every square metre difference in size.  On the other hand, Mr. Lai adopted a so-called “step-wise” approach, allowing a 5% adjustment for every 20 sq. m. difference in size.  I adopt Mr. Lai’s approach and his adjustments as I agree with the Respondent that this approach of allowing threshold increases due to differences in size is more reasonable.

20. Adopting the adjustments as summarized above, I have analyzed the adopted 8 comparables below.  I find that I have adopted total adjustments of between –25% and –58% for the comparables.  Since the 2 experts were both in agreement that all the adopted 8 comparables could be used in this valuation exercise, I decide not to discard any of these comparables and at the end use the average adjusted rate of $173,251 per sq. m. in valuing the Properties.

Table 3 – Tribunal’s adjustments of the comparables (for both Shop 239 & Shop 237)

Adjustment for the existing tenancy of Shop 239

21. The parties agreed that, for Shop 239, “if adjustments were to be made for the existing lease, (a) the adjustment ought to be on the basis that the lease had one more month to run, as the lease in question was a monthly tenancy terminable upon one month notice, and (b) a rate of 6% ought to be adopted for calculating the present value of the rental income.”

22. However, the Applicants submitted that (a) no adjustment should be made because of the short presumed tenancy period of only 1 month, and (b) for the purpose of calculating the value of the reversionary interest, the best lending rate (at 5%) ought to be adopted instead of the property capitalization rate of 7% (which figure was agreed by the 2 experts).  On the other hand, the Respondent submitted that as a matter of principle, an adjustment should be made for the existing tenancy, however short it might be.  Also, the Respondent pointed that the Applicants had failed to provide any justification to substantiate the use of the best lending rate in lieu of the generally accepted property yield based capitalization rate.

23. I agree with the reasoning of Mr. Lee that in practice, the market will not give allowance to the existence of the 1 month tenancy in a Property as both the vendor and the purchaser understand that vacant possession could be obtained after giving 1 month’s notice to the sitting tenant; but that the sale and purchase of the property would be completed in at least 1 month’s time in order to allow for, for instance, the arrangement of finance, the requisition of title and all other matters in connection with conveyancing.  As to the valuation of the reversion, I agree in principle with the Respondent in the use of the property yield based capitalization rate, in the traditional valuation method of valuing the term and the reversion for a retail property such as Shop 239.

Deduction for conversion costs and waiting period

24. It was not disputed by the parties that: -

(a)	The occupation permit of the Properties permitted the use of the premises for domestic purpose only; and
(b)	A reasonable purchaser of the Properties would take into account the fact that our application would have to be made under section 25 of the Buildings Ordinance (“the BO”), Cap. 123 for change of use from domestic to shop.

25. However, the parties could not agree as to whether there should be the need for any deduction to be made for the conversion costs and the waiting time.  The Applicants submitted that under section 25 of the BO, all that was required for the change of use would simply be the filing of a standard pro-forma notice (a copy of which was produced as Exhibit A4) to the Building Authority.  This was not agreed by the Respondent.  The Tribunal was reminded that the approval by the Building Authority would not be automatic and the Building Authority could actually require the owners to carry out certain works before granting the approval.  More importantly, the Respondent submitted that any reasonable purchaser would take this fact into account in arriving at the Open Market Value of the Properties.  As a result, appropriate deductions should be made for the conversion costs and the waiting time.

26. Section 25 of the BO reads,

“	(1)	One month's notice in the specified form shall be given to the Building Authority of any intended material change in the use of a building by the person intending to carry out or authorizing the carrying out of such change.
	(2)	Where in the opinion of the Building Authority any building is not suitable by reason of its construction for its present or intended use, he may by order in writing served on the owner or occupier-
		(a)	within 1 month of the receipt of a notice under subsection (1) prohibit such intended use; or
		(b)	require the owner or occupier to discontinue such present use of the building within 1 month from the service of the order:
	Provided that the Building Authority may permit by notice in writing such building works as he deems necessary for the purpose of rendering the building suitable for its present or intended use.”

27. Mr. Lai provided in his valuation reports his estimates of the deductions, including the estimated conversion costs and the estimated time of the conversion works for the purpose of discounting the estimated open market value of the Properties.  During the hearing, Mr. Lee also provided calculations at Exhibit A5 as his fallback position. 

28. I decide that as the parties had agreed that the occupation permit of the Properties only permitted their use for domestic purpose, it is reasonable to conclude that prospective purchasers would all make allowance to ensure that the Properties, upon completion of the transactions, would comply with the BO.  As such, it is more reasonable to accept the Respondent’s position than the Applicants’ so that appropriate deductions would have to be made accordingly for the estimated costs of conversion for compliance with the BO as well as the time for such works.

29. Having considered the evidence of Mr. Lee and Mr. Lai, I assess the conversion costs in the lump sum of $50,000 and the time for such alteration at three and a half months.  As to the discounting rate to be applied to the estimated Open Market Value of the Properties (on vacant possession basis), I accept the usual traditional approach of using the capitalization rate of 7% as adopted by Mr. Lai (as agreed by the experts to be the capitalization rate based on the property yield for the Properties) instead of 6% based on the best lending rate as adopted by Mr. Lee.

30. Using the above adopted inputs, I value the Properties as follows: -

Orders

31. Accordingly, I order that the Respondent do pay the Applicants of LDLR 5 of 2006 (Shop 239) and LDLR 10 of 2006 (Shop 237) compensation for the resumed Properties in the sums of $7,209,000 and $6,915,000 respectively.  The matters of professional fees, interest and costs shall be adjourned to a date to be fixed by the Registrar, with liberty to apply for any other ancillary and consequential matters.