TIN KUNG INVESTMENT LTD v. SECRETARY FOR TRANSPORT

LDRW 16/2001

IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

Railways Ordinance Application No. LDRW 16 of 2001

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J U D G M E N T

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1. This is an application from the Applicant, Tin Kung Investment Limited, for the determination of compensation in respect of the resumption by the Secretary for Transport, of two properties known as Unit A and Unit B on the Upper Ground floor, Block B of Wah Kai Industrial Centre in Tsuen Wan (known as "the Properties"). The Properties together with other units of Wah Kai Industrial Centre were all required to be taken down to make way for the construction of the Phase 1 West Rail between Tuen Mun and West Kowloon. The affected land and buildings were resumed in October 1999 under the Railway Ordinance, Chapter 519. The Applicant failed to reach agreement on the amount of compensation with the Secretary for Transport, the Respondent of the subject application, and hence the application to this Tribunal for a decision.

The Properties

2. The Properties were located on the upper ground floor of the industrial building with no direct frontage on any street. To reach the Properties, motor vehicles need to pass through the main gate pertaining to the industrial development, which was at street level and after that, negotiate one or two U bends of a sloping driveway within the industrial building. The industrial building was isolated from other buildings of the district. The Properties were said to be in one single unit when built, but partitioned as two units and sold subsequently. In 1993, when the Respondent bought the second unit, the Properties were then combined and used as one single unit by the removal of part of the partitioning made earlier.

The Concern

3. Before proceeding to tackle the core of the valuation, there are certain fundamental issues of our concern, which we have observed from the valuation reports. These are :-

(1) The Factors for Adjustment

The number of factors adopted by AW for adjustment is 11 and later reduced to 10 with some original factors taken out and substituted with others. The greatest amount of adjustment made for a single factor is 23% and the greatest in aggregate for a Comparable is 51.1%. The number of factors contained in RW's valuation reports is 9. The greatest amount of adjustment he has proposed for a single factor is 16% and the greatest amount in aggregate is 31.5%

Putting before anyone these statistics, there must be the concern whether the Comparables selected for valuation are indeed suitable for comparison. Making adjustment to compensate for the difference between two properties is not a perfect and effective valuation tool. What the experts have built in the valuation formula are largely subjective views (and such formula may be manipulated to arrive at an intended result). The subjective views tend to cause error, the risk of which goes in proportion to the quantum of adjustment made. Its application therefore is with limitation. It is suitable for use only if the two properties are in great similar but in minor place different. In the case where a large number of factors and amount of adjustment as the above are applied in the valuation, the risk of getting the valuation wrong is high. If this fundamental principle of application is not observed, the price of a commercial property in a central business area can be absurdly taken to find out the value of a piece of farmland in the green belt zone through adjustments. The great total number of factors/ amount of adjustment adopted is a sheer indication of the unsuitability of a property for use for comparison to the other. In this regard, the Respondent's counsel has rightly quoted HH Judge Cruden's view in his book entitled "Land Compensation and Valuation Law in Hong Kong".

(2) The Adjustment Quantum for Retail Potential

The range of adjustments given as revealed from the two experts' valuation reports is from 0% to -25%. This means that Comparables with retail potential are capable of fetching a value as much as 25% more than the Properties. Of course, some are much less than this. The method as to how this additional value is ascertained has not been displayed. The two experts do not seem to rely on any formula to work it out. It may just be an estimated figure out of the two experts' experience concerning the property market. It could also be just their sheer guess.

We are not clear about the basis how such additional sum can be calculated. In fact, we do not know whether in reality the buyers do pay a substantial sum for the so called retail potential since we were advised by the two experts that the Lands Department's approval in the form of a waiver letter is required before the owners can change the user stipulated in the land grant conditions. Accordingly, the Government levies a waiver fee equating to the difference in the full market value between the industrial/go-down user and non-industrial/non-go-down user, if the waiver is granted. In this context, we are puzzled on the need to pay the additional value. If the buyers do, they are paying more than what the properties are worth.

Alternatively, one might argue that the Lands Department charges the fee on the basis of the present value of the two users, whereas the buyers in anticipation of a promising future economics, work on the anticipated future value. These two different bases of calculation do leave the fee to be charged not up to its possible maximum level enabling the buyers to pay more for the properties (i.e. for the retail potential). This argument sounds logical but then this does not appear to be the economic situation in 1999 that supports the argument. The economic situation in 1999 was no good at all and there was no sign in 1999 that the good days were near at hand within a short time. Even if some buyers may have a different view, we should not forget that the Lands Department is not charging a once-off fee but a periodic fee varied in amount in different periods. The door for the owners to profiteer in this respect seemed to have been shut.

One may further argue that the special attributes associated with the Comparables that enable the Comparables to be converted to non-industrial or non-go-down users justify a value. Indeed, they do but such value does not appear to belong to the property owners. The grant conditions pertaining to the Properties and Comparables set the restriction on users and this is why the Lands Department charges as of right the full fee. If in the market, there are buyers who pay for such, it could be a wrong payment or otherwise, they might pay for something under the disguise of retail potential.

Having so explored, we have grave doubt that such a value exists, but nevertheless, the two experts do opine that the buyers pay an additional varying sum for it. They might not be wrong, as they might have observed that an extra payment was indeed given but what it was paid for is totally unclear to this Tribunal. Unless we are given to understand the rationale for such payment, we are unable to discern which of the two experts' views is the appropriate market price. If we must give a decision, the interest of the two parties is at stake. With this serious problem before us, we incline to discard those Comparables with such so-called retail potential for valuation.

4. Matters for Resolution

(1) Previous Lands Tribunal Decisions

During the course of hearings, both the Applicant and Respondent drew reference to the previous decisions of the Lands Tribunal on the three Wah Kay Industrial Centre cases, namely, the Secretary for Transport v. Poon Chi Man and Ho Sai Mui, LDMR 42 of 2000, the Secretary for Transport v. Wong Bun, LDRW 14 of 2001, and the Secretary for Transport v. Leung Ka Tong and Leung Pun Ching Hang Cindy, LDRW 13 of 2001. Suggestions were made to base on some of these previous decisions in arriving at the decision for the subject case. In the Applicant's final submission, the Applicant continued to pursue the same but in the Respondent's final submission, the Respondent seemed to have given up. Whilst we appreciate the merits and advantages for the Tribunal to refer back to the decisions of these previous cases, we find that it is not efficient to do so as the subject case is now before a panel in different composition. If the Tribunal consider the subject case only on the basis of the evidence given for the case without referring to the previous three cases, we do not find it unfair to either party.

(2) Scarce Demand

The Respondent opined that high headroom height/loading capacity factory units were special industrial properties. By virtue of their uniqueness, there was hardly any great demand in the market. If the Properties were to be divided into two units as the Applicant advised, there would not be likely to have two buyers available to take up the two units. We are surprised by this argument and do not accept the inference so made. To convince the Tribunal, the Respondent must adduce the necessary market evidence.

(3) Appropriate Use of the Properties

The Respondent held the view that the Properties were only suitable for industrial and go-down users, and without the so-called retail potential due to the isolated location and the access design. The Applicant of course held a different view. AW even considered that at one time, there was a prospective tenant intending to take up the Properties for car repairing purpose. This view (that the Properties were suitable for car repairing purpose) was later withdrawn upon RW's verification that the doorway was too narrow for motor vehicles to get through. We accept the Respondent's opinion.

(4) Retail Potential

The definition gave rise to serious dispute. There were controversies as to whether it should be defined on the basis of having street exposure or whether such service industry as car repairing should come within its literal meaning. These controversies do not seem to be that meaningful. How to label the potential does not seem to be the real concern. As to how the line to discern the relevant and irrelevant properties should be drawn, we are of the view that we should go back to the fundamentals, i.e. the practicable users of the Properties within the range of users permitted under the law. If the Properties can only be put to go-down and/or industrial users, any users other than such go-down or industrial users are irrelevant. In this premise, although car repairing or the like service industries may not be strictly retail in nature, properties with such potential should be treated as similar to properties with retail potential. Again, whether the properties are with street exposure is not so crucial but whether the properties with street exposure can be put to non-go-down or non-industrial users is relevant. We are of the view that we should try to confine the selection of Comparables to those without the so-called retail potential.

(5) Location

The transportation cost no doubt adds to the over-all production cost. This is why cement factories are located either near to conglomerates of civil engineering/building works or areas with an abundance of raw materials/power supply. In the context of Hong Kong, the farthest industrial district from any urban districts, the airport and the border with the Mainland is seldom more than an hour driving distance. The difference in transportation cost among industrial districts should be slight. Such difference among factory buildings within the same industrial area is even more negligible. We have reservation concerning the experts' award of -8% to +10% to reflect the location difference of factory buildings within the same Tsuen Wan district.

(6) Adjustment for Size

Both experts considered that industrial properties of different size would fetch different unit price. Generally, the unit rate falls as the size increases. This has been taken as a rule of thumb in adjusting the price for varying size in their valuations.

We accept that this might be true in some cases. It is true because on the production side, there are economies of scale; there are savings in such overheads as marketing and administration (and perhaps construction cost), and more importantly the short-term imbalance in the demand and supply after the factory building was built. However, in the context of economies of scale, reduction in cost of production does not seem to move forward as a matter of course in a straight line and in proportion of the production quantity. It very often occurs only when the production has reached a certain scale, as there is always a varying minimum size of the various production factors. Marketing and administration overheads are only a small fraction of the over-all costs. Notwithstanding the possible savings aforesaid, the short-term imbalance in demand and supply, if it moves in the opposite direction, can totally wipe these savings (in cost) out. Even holding the demand and supply in constant, a substantial reduction in cost as the size increases remains to be justified.

Back to the amount of adjustments made in the valuation reports, a -7% to +12.5 % were adopted for size differing from the Properties by roughly 50% (smaller) to 350% (greater). If these price differentials were to be true, the vendors would gain an extra sum of approximately $200,000 up to $1,500,000 in price by converting the large units into small ones (i.e. from approximately 313/322 sq. m. to 172 sq. m. and from 1040/1,122 sq. m. to 313/322 sq. m.), whereas the agreed cost of partitioning the Properties is only $12,000. The lucrative extra premium will within a short time induce the proliferation of supply by the conversion of large units to satisfy the demand since the conversion works are not complicated. The only hurdle that prevents the vendors from so converting the units is when the partitioning cost is equal to or greater than the additional price gained.

Their assumption that the price will go down as the size increases cannot hold true. We are not convinced that this quantum of adjustment reflected the real market phenomenon in 1999 without being provided with the sale evidence. We would only reluctantly agree that the extra payments if existed reflect the cost only, which, when compared with the Properties at a combined size of 635 sq. m., might in our view be in the range of 2 to 5% for exceptional large or small properties.

(7) Age

We do not agree that the building age should have a significant role-play in the valuation and therefore the adjustment to reflect it. We are of the view that the building condition should instead be counted. Well-maintained buildings senior in age could have a better condition than buildings less senior but lack of proper maintenance. In the event of a sound building condition, the subsequent high maintenance/repair outlay can be minimized or dispensed with. The savings in this respect could be high. From the photographs provided and from the impression gained during the inspection of the concerned factory buildings, we find that the condition of buildings concerned is more or less commensurate with the age. The two experts' adjustments are generally consistent except that their proposed amounts of adjustment differ.

(8) Floor

RW did not propose any adjustment for floor difference but AW did. Examining the properties for which AW gave adjustment, we find that in AW's view, G/F units were considered better than units above. In fact, the highest floor of the properties he adopted for valuation is 2/F. Apparently, the adjustment was given on account of the property being closer to the street. We do not find the adjustment on account of this appropriate as the benefits of being closer to the street, such as retail potential or near to loading and unloading areas, were each given separate adjustments. The grant of separate adjustments for floor difference is a duplication.

(9) Headroom Height/Loading Capacity

AW gave adjustments from +9% to -9% for loading capacities from 200 (150 below that of the Properties) to 500-lb./sq. ft. (150 above that of the Properties). RW gave +1% to -3% for 300 to 500-lb./sq. ft. In regard to Headroom Height, AW gave adjustments from +23% to -3% for 14 ft. 8 in. to 19 ft. 8 in. (the Properties at 19 ft.), whereas RW gave +16% to -6% for 14 ft. 9 in. to 21 ft. 10 in.

A higher headroom height allows for the accommodation of tall machine such as bottling plant and permits the stacking up of more goods within the same footage of floor area, in the case where the property is to be used for the purpose of warehouse. The tall machine and a greater volume of goods being stored require a corresponding increase in the loading capacity.

The two experts had not given the Tribunal a useful reasoning as to why their adjustments were justified. The adjustments were probably founded on their subjective general perception of the market rather than an analysis of the actual sale evidence. By comparing relevant sale evidence, the price differentials due to difference in loading capacity and headroom height can be established and hence, the adjustments. Such price differentials and hence the adjustments are not just reflecting the difference in the cost of producing the higher headroom height and stronger floor slab, but the subsequent change in demand and supply for properties of different headroom heights and loading capacities (as prices payable are not just for the cost of production but also an extra sum to reflect the condition of demand and supply). If the adjustments indeed originated from the latter i.e. by comparing sale evidence, this should have been spelled out during the hearings. The lack of reasoning does not assist the Tribunal in its judgement. To form the judgement, we have to look for assistance elsewhere.

By looking at the cost side, we do agree that the construction cost of the floor slab goes in direct proportion to the increase of the loading capacity, and likewise, the wall in relation to the increase in headroom height. Since the floor slab or the wall does not appear to each incur a respective cost of more than 10% and 30% of the over-all construction cost, the increase or decrease by 150 lb./sq. ft. gives a roughly 4% variation in the over-all cost. In the case of 4 ft. decrease in headroom height, the approximate reduction in the over-all cost is 6.7%.

RW's adjustments are closer to the figures derived from this analysis. We do acknowledge that considering only the cost side may not fully reflect the economic value of the increase in floor loading capacity and headroom height but there does not appear to be any alternative, as we cannot work in a vacuum in deciding the two experts' adjustments. In fact, in the absence of evidence to indicate that there was a short term inequilibrium in the demand and supply of properties of different headroom heights and loading capacities, we should not hold the assumption that the original cost pattern no longer serves as an indication.

(10) Container Vehicle Access

AW and RW held different view as to the amount of adjustment applicable. From drawings and photographs, we do not find that the access of the Properties was inferior in any significance to other Comparables except that the container vehicle parking spaces were not located together. There is also no reason that the sloping driveway with U bends should be an issue (in the case of Comparable S6, there is also a long and narrow lane between the public road and the factory building). If the condition of the driveway, which is part of the roads involved in the container vehicles' journeys, is an issue, we may need to take the trouble of examining the condition of all roads involved for all cases. Similarly, we share with RW that there is no need to allow adjustments for the "Access to the Loading/Unloading Platform" factor given the Comparables' slight difference to the Properties in this respect (therefore, the minimal effect on rent).

(11) Open Yard and Parking Space

RW reckoned the value of open yard as 1/8th of that of the saleable area. The Applicant who did not provide any sale evidence to the Tribunal challenged this. We observe that this reckoning is in line with the practice of past valuations brought before the Tribunal. We do not find it unreasonable. As to the value of car parking space, RW proposed $300,000 per space. This might be applicable in urban residential areas in 1999. In the context of industrial areas in Tsuen Wan, we would consider it appropriate at $150,000. Similarly, we would consider that the appropriate values for lorry and container parking space be respectively $350,000 and $550,000.

(12) Sale Brochures

Controversies also arise as to the appropriateness to make use of the sale brochures of Wah Kai Industrial Centre and some other factory buildings also in Tsuen Wan, which were built and sold ten to twenty years ago, to establish the relative prices of factory units on the lower few floors of the factory building to those on the upper floors. AW advocated such use for checking purpose but RW rejected it on the ground that the prices on the brochures were indicative. He remained opposed even after those prices provided by RW were confirmed to be the actual consideration paid to the vendors. The reason he gave the Tribunal was that the ratio so obtained might not represent the attitude of today's factory unit buyers towards the respective values of lower and upper floor factory units.

AW's proposal is not unacceptable in ascertaining the value of GF units or units on lower floors of factory buildings from the methodology view point. In deed, in the absence of comparable sales, it helps and works. Looking at the example of sea-view, one may find that AW's argument is not without support. Since long time ago (probably dated back to twenty years earlier), buyers began to treasure this attribute, particularly if it is connected with residential properties, and were willing to pay an extra premium for residential properties with such at a proportion of the total value paid for the gross floor area. Such attitude has hitherto remained unchanged. The same applies to the aspect of facing (or orientation) in the case of residential properties, and likewise, the floor level. By how much the extra premium should be paid in proportion to the total value paid to the gross floor area is a value judgement, very abstract, which may be changed or may not be changed over time (if there is evidence that it has not been changed, it is a good way to work out the unknown). Sometimes, an experienced property expert can grossly feel whether there has been a change in the buyers' such value judgement.

As distinct from these physical attributes associated with residential properties, the special characteristics associated with lower floor factory units have nothing to do with human beings' sensation. The value of such special characteristics as high headroom height and loading capacity is not determined in an abstract way. The value is affected by the additional productivity the special characteristics can yield in relation to the upper floor units, which do not possess such characteristics. Therefore, the ratio is measurable and changeable under different economics. Any expert is unable to simply advise the Tribunal out of intuition whether there is a change or not, or by how much the proportion has been changed. He/she must provide statistics on the productivity to prove indirectly that the relative ratio remains applicable, or otherwise, derive it directly from up-dated sale statistics.

5. Selection of Comparables

In view of the opinion as above, we do not find it appropriate to adopt those Comparables, which are being used or have the potential of being used for retail or service industries purposes. Going down the lists of Comparables provided by the two parties, we find that Nos. (2), (3) and (9) on RW's list (Page 436B of Exhibit AR1) and Nos 1(d) and S6 on AW's list (Pages 178 to 181 of Exhibit AR 1) are acceptable Comparables. We notice that in excluding Comparables with retail potential, the number of Comparable for valuation is reduced substantially down to only 5. We agree that this number is not ideal but compared with the risk of making adjustments to reflect the retail potential as mentioned above, we do not find it undesirable.

6. We dismiss AW's point that No. (3) should be excluded. We cannot accept the reason given that it should be excluded because of the pure subjective opinion that the price paid was too low. There is no evidence that the property was sold at below market value. The property agent from Centaline Property Limited did not give the useful evidence. We dismiss AW's view that No. (9) should be rejected. The mortgage sale should not be taken as a below market value sale. The mortgagee should have the onus to ensure that a price is obtained within the acceptable range (of market values) upon sale to avoid being sued for the under-sold portion. The illegal structure is neither an advantage nor disadvantage without having an in-depth investigation on its historical background. It could be an advantage in some cases but a disadvantage in the others. Finally, we also dismiss AW's view that No. (2) is inappropriate. The 6 months period is only a valuation practice widely followed by valuation experts. Its aim is to ensure that the most recent sales are taken for valuation to minimize the risk of error. It is not inflexible at all, particularly when confronted with only a handful of suitable Comparables. The short-coming of its being relatively remote from the relevant valuating date is remedied by making adjustment for the "Time" factor through the property indices.

7. Valuation

Following on from the above, we have drawn up a revised adjustment table as appended below: -

8. After adjustment, S6 remains deviated in value from the rest 4 Comparables by 64% to 141%. This deviation cannot be regarded as slight. Either the buyer paid wrongly in the price for S6 or the buyers paid wrongly for the rest four Comparables. Otherwise, there must be mistakes in the determination on the factors or amounts of adjustment. We suggest that the buyer of S6 rather than the buyers of the rest had paid wrongly needless of any analysis. In fact, we cannot expect that all transactions can be concluded at market value in view of the possibility of personal preference and the non-existence of a perfect market, which inter alias, requires a complete free circulation of market information.

9. It is also undesirable to average all five adjusted unit rates to obtain the compensation sum since S6 is outside the normal distribution created by the four. By averaging, the resultant unit rate is unnecessarily boosted. Therefore, it is only appropriate to average the four. The unit rate so obtained is $7376.5 per sq. m. and hence, the compensation amount of $4,682,602.2, or say, $$4,683,000.

10. We agree that there is no legal problem for the Applicant to sell in the open market the Properties in two separate units. There is no need to award an extra sum for this alternative. Unless the Applicant can justify, there is no evidence that small units were in acute demand in 1999 resulting in a price being paid more than just to cover the cost of converting the large unit into small one.

11. Orders

We hereby order that :-

(1) The Respondent do pay the Applicant a compensation in the sum of $4,683,000 for the resumption of the Properties; and

(2) The matters of professional fees, interest and costs be adjourned to a date to be fixed by the Assistant Registrar with liberty to apply for any other ancillary and consequential matters.