TOP SAIL INTERNATIONAL LTD v. WONG LAI WEI

LDCS 19000 of 2010

IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

LAND COMPULSORY SALE APPLICATION NO.19000 OF 2010

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BETWEEN

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J U D G M E N T

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1.  This is an application made under the Land (Compulsory Sale for Redevelopment) Ordinance, Cap. 545 (“the Ordinance”) for an order of compulsory sale of all the undivided shares in Aberdeen Inland Lot No. 271 (No. 5 Tang Fung Street) and Aberdeen Inland Lot No. 272 (No. 7 Tang Fung Street) (collectively referred to as “the Lots”).

2.  The existing building (“the Building”) on the Lots is a composite building consisting of 6 levels, namely the ground floor and the 1st to 5th floor, abutting on the northern side of Tang Fung Street which is a cul-de-sac to the southeast of and branching off to Tin Wan Street in Aberdeen.  According to the Occupation Permit, the Building was completed on 31 March 1958.  The Building is in fact located in the middle of a row of 6 contiguous building lots forming a rectangular-shaped site on No. 1-11 of Tang Fung Street, with No. 1-3 on the left of No. 5 and No. 9-11 on the right of No. 7.

3.  The ground floor level of the Building is for non-domestic use whilst the upper floors are residential units.  There are 2 units at each level, one unit at No. 5 and the other at No. 7 of Tang Fung Street.  There are 12 undivided shares in the Lots, with 1 share for each unit. 

4.  The Applicant had acquired all the units of the Lots except the unit on 1/F No. 7 Tang Fung Street which is registered in the sole name of the Respondent (“the Respondent’s Unit”).  Thus, the percentage of the undivided shares owned by the Applicant in the Lots is 91.67%.

5.  The Applicant commenced the present proceedings on 14 December 2010.  There is no dispute that the Applicant is the majority owner of the Lots and is entitled to make the application under Section 3(2)(b) of the Ordinance.

6.  In the Amended Notice of Opposition filed by the Respondent on 18 July 2011, the Respondent opposed the application on the ground that the value of the Respondent’s Unit offered by the Applicant does not reflect the fair and reasonable market value under the Ordinance and the Applicant had neither taken reasonable steps to acquire nor offered reasonable terms for all the undivided share in the Lots.

7.  At trial, Counsel for the Respondent confirmed that the Respondent does not oppose to the order for compulsory sale being made and had also agreed that the apportionment ratio attributable to the Respondent’s Unit based on the existing use value (“EUV”) should be 7.8485%.  The sole issue still in dispute is what should be the redevelopment value (“RDV”) of the Lots, and hence what should be the reserve price set for the auction.

8.  The Applicant has called 1 factual witness and 3 experts in support of the application and the Respondent has called 1 factual witness and 1 expert at trial.

Ratio for the apportionment of expenses and proceeds under section 10 of the Ordinance

9.  Under section 3 of the Ordinance, the Applicant may make an application accompanied by a valuation report as specified in Part 1 of Schedule 1, prepared not earlier than 3 months before the date of the Application, containing the assessments of the EUV of all units in the Building on the Lots.  Under section 4(1)(a), if there is a dispute between the parties on the EUV of the units in the Building on the Lots, the Tribunal has to determine the values.

10.  The Applicant has filed a valuation report of the Building dated 7 December 2010 (“Application Report”) prepared by Mr. Alnwick Chan (“Mr. A. Chan”) giving a total EUV of $38,283,418 and the EUV of the Respondent’s Property at $3,017,747, as at the valuation date of 1 October 2010.  The Respondent has only filed a valuation report concerning the RDV of the Lots.

11.  However, the parties agreed at the beginning of the hearing that there is no longer any issue on the ratio for apportionment of expenses and proceeds.  It is agreed that the apportionment ratio, based on the EUV of the Respondent’s Unit and the total EUV of the building on the Lots to be 7.8485%.  

Justification for Redevelopment

12.  The second determination under Section 4(1)(b) of the Ordinance is whether the order for compulsory sale should be made.  According to Section 4(2) of the Ordinance, this would involve 2 statutory requirements, namely :-

(a)   is the redevelopment justified due to the age or state of repair of the Building; and

(b)   has the Applicant taken reasonable steps to acquire all the undivided shares in the Lots?

13.  Even though the Respondent had consented to a sale order, the Applicant still has to satisfy this Tribunal that the above statutory requirements are met, otherwise, an order of compulsory sale ought not be granted. 

14.  As for the requirement under (a) above, the Tribunal has taken into consideration the expert opinion of Mr. Raymond Chan (“Mr. R. Chan), the Building Surveyor and Dr. James Lau (“Dr. Lau”), the structural engineer.

15.  Dr. Lau had conducted a structural assessment of the Building and prepared a report dated 25 May 2011.  He concluded that the Building is in very poor conditions and worse than a building of similar age.  These conditions are caused by years of neglect and poor maintenance.  Many slabs, beams and columns have deep cracks and spalling.  In some important structural elements, the cracks had cut into the concrete cores.  The reinforcing steels likewise showed an advanced stage of corrosion with the diameters of the steel bars being reduced significantly. The reduced concrete sections and steel diameters had reduced the strengths of the structural elements.  The corrosion had cut into the moment joints and reduced the strengths of the columns, the beams and the joints.  There is a danger inherent in the Building and contingency measure with temporary steel struts should be put up to give support to the Building.  The Building has to be repaired immediately and the estimated costs is at HK$11.82 millions and it is more cost effective to demolish and rebuild the Building.

16.  Mr. R. Chan, in his Condition Survey Report dated 25 May 2011 stated that the Building is generally in a dilapidated and potentially dangerous condition.  Some of the building components and finishes are at the end of their effective life span.  Without substantial repairs, the Building is not up to tenantable standard.  The structural stability of the Building is affected by existing defects and unauthorised building works.  He found the following defects and opined that the only sensible solution is to rebuild the same :

(a)   The waterproofing system of the main roof and upper roof failed to function and further weakened due to the fact that there are unauthorised structures on the roof. 

(b)   Water seepage, mould growth, loose plaster, cracks and concrete spalling were commonly observed. 

(c)   External walls and light well serving as an external envelope for weather protection was defective. 

(d)   A lot of unauthorised drying racks, supporting racks/frames at various residential flats remained at the external wells. 

(e)   Bolts/nails of these metal frames were rusted which might expand and slowly push off the concrete cover and resulted in more serious concrete defects. 

(f)   The rusted drainage pipes along the external wall were in a very poor condition which might fall down and hurt passer-by. 

(g)   The unauthorised opening to the light well might affect the structural stability of the Building. 

(h)   The unauthorised building works are not safe by themselves which affect the structural stability and accelerate the deterioration of the Building. 

(i)   The corrugated canopies/sheets located at the external walls, the yards and the chimney in kitchens were suspected to contain asbestos.

(j)   The staircase does not meet the current required standard, imposing danger in case of fire.

17.  This Tribunal accepts the evidence Dr. Lau and Mr. R. Chan which are sound and supported by facts.  Having considered the opinion of the experts, this Tribunal accepts that the condition of the Building is not up to tenantable standard and is substantially below the usual standard for human habitation. Without extensive repair at unreasonable high costs, the Building is unfit for habitation.  This Tribunal is satisfied that the redevelopment of the Lots is justified due to the state of repair of the Building.

18.  As for the requirement of “the age” of the Building, this Tribunal agreed with the observation by Judge Wong in the case of Top Sail International Limited V Cheng Kai Ming, executor of the estate of Chan Hue also know as Chan Sum Hiu, deceased (LDCS 18000/2010) that “we should not restrict our consideration to just the physical age of the Buildings… we are of the view that the absence of a specific physical age in the Ordinance indicates that the Tribunal has discretion to determine at what stage a building should be redeveloped after considering all the relevant factors concerning the age of the building in question” (at paragraph 23).

19.  Given the fact that the Building is 53 years old with obsolete design and in a very poor and even dangerous physical condition (as particularised in paragraph 15-16 above), coupled with the fact that very substantial costs is required to repair and maintain the Building, this Tribunal is satisfied that an order for sale is justified on the ground of age as well.

Reasonable Steps to Acquire All the Undivided Shares in the Lots

20.  The Applicant is under an obligation to negotiate for the purchase of the Respondent’s Unit in terms that are fair and reasonable under Section 4(2)(b) of the Ordinance.

21.  It is not in dispute that prior to the commencement of this proceedings, the Applicant had made the following offers to the Respondent :-

(a)   an offer of HK$3,500,000 on 14 October 2010;

(b)   an offer of HK$3,550,000 on 5 November 2010;

(c)   an offer of HK$3,600,000 on 23 November 2010.

22.  Adopting the test formulated in Capital Well Ltd v Bond Star Development Ltd [2005] 4 HKLRD 363, this Tribunal is not required to conduct a valuation exercise in assessing whether the offer is reasonable.  This Tribunal merely needs to be satisfied that the offer falls within the range of what may broadly be regarded as fair and reasonable.

23.  The present application was filed on 14 December 2010.  The Application Report assessed the EUV of the Building as of 1 October 2010 to be HK$38,283,418.  In the Applicant’s RDV Report, Mr. A. Chan found the RDV of the Building as of 1 October 2010 to be HK$41,180,000.  Applying the agreed apportionment ratio of 7.8485%, the pro-rata share of RDV of the Respondent’s Unit should be HK$3,232,012 (i.e. $41,180,000 x 7.8485%).

24.  When compared this figure with the offers made by the Applicant, it is apparent that all offers made are above the value of the Respondent’s Unit.  This Tribunal is satisfied that the offers made by the Applicant falls within the range of what may broadly be regarded as fair and reasonable and hence, the conclusion that the Applicant has taken reasonable steps to acquire all the undivided shares in the Lots.

25.  Before leaving this issue, this Tribunal will also deal with the Respondent’s allegation that the Applicant had been unconscionable in making its offer.  We found this allegation to be unsubstantiated given our ruling in the previous paragraph.  Madam Chow testified for the Respondent saying that before the Applicant was involved, there were other developers who had in fact offered to purchase the Respondent’s Unit for redevelopment purpose since March 2006. This Tribunal found that the offers made by the other developers other than the Applicant are irrelevant in considering the question of fair and reasonable offer.  It is also Madam Chow’s evidence that the offer made by the Applicant is not sufficient to purchase another property of similar size in the vicinity.  Again, this Tribunal found this is irrelevant in our consideration of the question of fair and reasonable offer.

Reserve Price

Stance taken by the parties on the RDV of the Lots

26.  The Applicant relied on the following reports prepared by Mr. A. Chan :

(i)  A valuation report dated 7 December 2010 (“Applicant’s RDV Report”) (Exhibit A3);

(ii)  A valuation report dated 22 September 2011 (“Applicant’s Rebuttal Report”) (Exhibit A4);

(iii)  A valuation report dated 18 October 2011 (“Applicant’s Supplementary Report”) (Exhibit A5);

27.  The Respondent relied on the following reports prepared by Mr. Wong Yung Shing (“Mr. Wong”) :

(i)  A valuation report dated 7 September 2011 (“Respondent’s RDV Report”) (Exhibit R1);

(ii)  A valuation report by way of letter dated 21 October 2011 (“Respondent’s Supplementary Report”) (Exhibit R2);

(iii)  A valuation report by way of letter dated 24 October 2011 (Respondent’s Reply Report”) (Exhibit R3).

28.  In the Applicant’s RDV Report, Mr. A. Chan has assessed the RDV of the Lots at $41,180,000 as at 1 October 2010.  In the Applicant’s Supplementary Report, Mr. A. Chan has up-dated the RDV in the sum of $48,800,000 as at 11 October 2011.  The Applicant submits that the Reserve Price for the proposed auction of the Lots, based on Mr. A. Chan’s up-dated assessment, is $48,800,000.

29.  The Respondent disputes Mr. A. Chan’s assessed RDV and reserve price of the Lots.  In the Respondent’s Supplementary Report, Mr. Wong had valued the gross development value (“GDV”) and the RDV of the Lots, on the basis of part of a much larger “merged site” of No. 1-11 Tang Fung Street, at $1,669,924,600 and $1,153,888,000 respectively.  Since the Lots represent 1/3 of the merged site of No. 1-11 Tang Fung Street in terms of site area, Mr. Wong opined that the GDV and RDV of the Lots should equal to 1/3 of $1,669,924,600 (or $556,641,533) and 1/3 of $1,153,888,000 (or $384,629,333) respectively.  Mr. Wong said that he had followed the Land’s Department’s existing policy of land auction under the “regime of List of Application” and applied a 20% discount to the RDV figure (which he rounded to $384,629,000) giving a sum of $307,703,200.  The Respondent submits that this figure of $307,703,200 should be taken as the reserve price for the proposed auction of the Lots.

30.  In addition, Mr. Wong has prepared the Respondent’s Reply Report in response to the Applicant’s Supplementary Report.  Although Mr. Wong commented that Mr. A. Chan was wrong in principle, he expressed for the first time that his revised valuation of the RDV of the Lots was based on the scenario of hotel development but otherwise following the same residual valuation of Mr. A. Chan.  Mr. Wong also restricted the area of the site in this revised residual valuation solely to the area of the Lots.  The valuation schedule is marked as Appendix 2 in the Respondent’s Reply Report (page 162 of Bundle F).  In this revised valuation, Mr. Wong estimated the RDV of the Lots at $116,010,000.

31.  However, the Tribunal has in an earlier decision ruled against the Respondent (which is the subject matter of another written judgment handed down on 25 November 2011) and has ordered that parts of Mr. Wong’s valuation reports be inadmissible in this Application.  These include his evidence on both of the “merged site” approach and the “premium ratio” approach.  Hence, the Respondent in the final submission submits that a reasonable reserve price for the auction of the Lots should be based on either :

(i) the latest RDV valuation of the Lots by Mr. Wong, for the development and use as “a hotel, a service apartment or the like” in the sum of $116 million, or

(ii) alternatively, at least in the sum of $56.5 million, being the summation of (a) the total historical acquisition costs of all the other units in the Building apart from the Respondent’s Unit in the sum of $52.5 million and (b) the value attributable to the Respondent’s Unit in the sum of $4 million based on the last offer made by the Applicant. 

In any event, the Respondent submits that the Reserve Price should not be the RDV as assessed by Mr. A. Chan.

Consideration in Fixing the Reserve Price

32.  Under section 5 of the Ordinance, sub-section (1) provides that “Where an order for sale is granted and the trustees under the order have complied with section 7(1) in respect of the lot the subject of the order- (a) subject to paragraph (b), the lot shall be sold by public auction in accordance with the conditions specified in Schedule 2;…”  Under Schedule 2 (Conditions in accordance with which lot shall be sold by auction) to the Ordinance, Para. 2 provides that, “The lot the subject of the auction shall be subject to a reserve price- (a) which takes into account the redevelopment potential of the lot on its own (or, where 2 or more lots are the subject of the auction, on their own), and (b) approved by the Tribunal.”

33.  Therefore, it is plain reading of the relevant sections of the Ordinance that the proposed auction of the Lots shall be subject to a reserve price which takes into account the redevelopment potential of the Lots on their own.  We decide to adopt the RDV of the Lots as the reserve price for the Lots in this Application, this being the norm in all previous cases where the Tribunal has been asked to approve the reserve price for auction under the Ordinance.  We do not agree to use 80% of the RDV of the Lots as the reserve price and we are rather surprised that Mr. Wong has at some stage in his valuation suggested that percentage.  We find that adopting the RDV of the Lots as the reserve price renders a better protection for the outstanding minority owner’s interest.

34.  Following the provisions of the Ordinance on the reserve price, we do not agree that we have, in the alternative, also to look into the historical acquisitions costs of the majority owner as well as the value of the minority owner’s interest, as suggested by the Respondent.  This alternative basically rests on the proposition that the reserve price for the auction of the Lots must be equal to if not higher than the historical costs including the value of the outstanding minority owner’s interest.  That simply is not the Ordinance’s statutory basis for assessing the reserve price.  Therefore, leaving aside this alternative basis which we do not accept, the dispute between the parties now is either :

 (i) the RDV of $48.80 million as assessed by Mr. A. Chan; or

(ii) the RDV of $116.01 million as recently assessed by Mr. Wong.  Of course, if we are not satisfied entirely with the valuation of either party, we shall vary their RDV assessments, for the purpose of approving the reserved price for the proposed auction of the Lots.

Comparison of Mr. Chan and Mr. Wong’s residual valuation for the RDV of the Lots

35.  Both experts agreed that there was no suitable site sale comparable for direct comparison purpose, and both instead agreed to resort to the residual method of valuation.  Simply put, the method is the assessment of the land value by deducting the development costs from the potential sales revenue, i.e. the gross sale price, of the proposed development upon completion.  It is based on the redevelopment of the Lots in accordance with the terms of the Government lease taking into account the current statutory planning control and the development control under the Buildings Ordinance (Cap. 123).  

36.  It is well understood throughout the valuation profession that in carrying out a residual valuation, it is essential that one has to state at the outset the details of the proposed optimal development, based on what is permitted by the physical site constraints, the lease condition, the planning control and the market.  In case that the development proposal is not permitted by either the lease conditions, planning or development control, the burden of proof is on the maker of the valuation report that the hope value due to this proposal is embedded in the assessed market value.  These have been set out, for example, in the publication HKIS Hong Kong Valuation Standards on Properties 1st ed. (2005) by the Hong Kong Institute of Surveyors :

“8. Market Value will include elements of value, usually known as “hope value”, which refers to the situation that one has an expectation that the circumstances affecting the Property may have a positive change in the future. Examples include:

- the prospect of having re-development opportunity where in fact there is no current permission of re-development granted for that Property.

- the realization of ‘marriage value’ arising from merger with another Property or interests within the same Property.

9.However, the amount of hope value must be limited to the extent that it would be reflected in offers made by prospective purchasers in the general market.” (at page 25)

37.  It is also stated in the abovementioned publication that:

“In arriving at ‘Market Value’ (as defined in the Standards), the Valuer has to take into account the Assumptions which the market would generally make under the particular circumstances. An Assumption is a supposition that it is taken to be true. It involves facts, conditions or situations affecting the subject of, or approach to, a Valuation that it has been agreed but need not be verified by the Valuer as part of the Valuation process. Assumptions are made where it is reasonable for the Valuer to accept that something is true without the need of carrying out specific investigation.” (at page 51)

38.  Mr. A. Chan, in the Applicant’s Supplementary Report (page 594 of Bundle C2) has adopted the following usual steps :

(i) He first identified what he regarded as the optimum development for the Lots (i.e. as a composite development with shops on the G/F, club house on the 1/F and domestic flats from 2/F to 23/F).

(ii) He then identified and analysed the retail and domestic comparables, applying relevant adjustments as appropriate.

(iii) He finally adopted the following average unit rates for assessing the GDV: ground Floor shops at $154,200 per sq. m; open set back area in front of ground floor shops at $15,420 per sq. m. and domestic flats at $96,000 per sq. m., all on saleable area basis.

39.  Mr. A. Chan has not been cross-examined on the Applicant’s Supplementary Report in which the RDV has been adjusted due to:-

(i)  the relocation of the transformer room to the proposed development at 1/F so as to maximize the non-domestic gross area of G/F;

(ii)  time adjustments, revised quantum adjustment and adjustment for privacy; and

(iii)   the coming into force of the “Sustainable Building Design Guidelines of Building Department”, providing for a set-back area of 1.5 m. from the lot boundary up to above 15 m. of the building measured from the main street level.

40.  In the Respondent’s Reply Report, putting aside the sections on “merged site” approach (which has been ruled out by this Tribunal), Mr. Wong has assumed the same optimum development proposal as Mr. A. Chan including the design, the number of floors, the saleable floor areas and used all of Mr. A. Chan’s valuation inputs in his own revised valuation, except for the adoption of a different unit rate for the assessment of the “domestic” GDV (for the hotel accommodation portion).  In his report, Mr. Wong has not explained why he held the view that section 16’s approval under the Planning Ordinance for the use of the Lots as a hotel would be granted by the Town Planning Board.

41.  For ease of comparison, we set out below the residual valuation of the two experts giving evidence in this case:

	Mr. Chan’s valuation (Bundle C2/594)		Mr. Yung’s valuation (Bundle F/162)
GDV	$102,169,352		$194,900,708
PV 2.55 years @ 5%	X 0.8960		X 0.8960
Discounted value of GDV		$90,628,302		$172,891,120
Less- development cost
Total cost	$35,239,519		$35,239,519
PV 1.375 years @ 5%	X 0.9351		X 0.9351
Discounted value of cost		$32,952,474		$32,952,474
Less- demolition cost
Total cost	$1,384,700		$1,384,700
PV 0.375 year @ 5%	X 0.9818		X 0.9818
Discounted value of demolition cost		$1,556,017		$1,556,017
Land value + profit		$56,119,811		$138,382,629
Less- Profit @ 15%		/ 1.15		/1.15
Land value		$48,799,836 Rounded to $48,800,000		$120,332,721
PV 0.75% @ 5% (for getting planning approval)				X 0.9641
Land value				$116,029,021 Rounded to $116,010,000

42.  On a closer look of the experts’ valuation schedules (Mr. A. Chan’s at page 594 of Bundle C2 and Mr. Wong’s at page 162 of Bundle F), the numerical input differences are two only: (1) the differences in the GDV of the optimum development, due to the differences in the “domestic” component of the GDV and (2) a further discount of the land value as given by Mr. Wong at the end reflecting the time of 0.75 year required to obtain the planning approval for the proposed development of the Lots for hotel use.  The difference in the “domestic” component of the GDV is that whilst Mr. A. Chan adopts an average unit rate of $96,000 per sq. m., Mr. Wong adopts an average unit rate of $201,707 per sq. m.

43.  The underlying differences between the two expert’s valuations are firstly, whether it is a reasonable assumption in the residual valuation that the Lots could be developed for hotel use and secondly, whether the estimates by either expert of the “domestic component” of the GDV as well as the total GDV of the optimum development proposed for the Lots are supported by market evidence and can be accepted as fair and reasonable by this Tribunal?  The answers to these two fundamental questions will tell us whether the RDV arrived at by either one of the two valuations better reflects the market value of the Lots, taking into account the maximum permissible redevelopment potential of the Lots within the physical limits of the site, lease conditions, planning and market constraints. 

Could the Lots be redeveloped for hotel use?

44.  We will now deal with the question as to whether it is a reasonable assumption in Mr. Wong’s residual valuation that the Lots could be developed for hotel use.  We have to bear in mind the extracts on the HKIS’s Valuation Standards we quoted at paragraph 36 and 37  above.

45.  It is common ground that the Lots, a rectangular site of about 174.2 sq. m. in net site area, is bounded by similar older buildings on both sides and located at the dead end street of Tang Fung Street in Tin Wan, Aberdeen, Hong Kong.  The Lots are held under unrestricted lease apart from the usual “offensive trade clause”.  They have the zoning of “Residential (Group A)” (“R(A)”) under the Draft Aberdeen & Ap Lei Chau Outline Zoning plan No. s/H15/26 (“OZP”) for the area exhibited on 16 July 2010, with hotel use under Column 2 of the R(A) zoning of the OZP so that section 16’s approval under the Planning Ordinance is required if the owner is desirous of developing the Lots or changing the existing or new building on the Lots for hotel use.  Mr. A. Chan and Mr. Wong are on the opposite sides of the table when the issue of whether section 16’s approval for hotel use of the Lots could be justified and obtained.

46.  Mr. A. Chan has stated in the Applicant’s Rebuttal Report (page 500-501 of Bundle C2) that hotel development for the Lots could not be justified on the following grounds:

(i) The small sized lot is located on a dead-end street with poor pedestrian flow.

(ii) The existing immediate environment of Tang Fung Street cannot support or justify a hotel development.

(iii) The lease of the lot contains an “offensive trade clause” that prohibits hotel development unless License is granted by the Government.

47.  Mr. A. Chan produced the Practice Note App-40 on “Hotel Development issued by the Buildings Department for Authorized Person and Structural Engineers” (Exhibit A6).  It states that “Building (Planning) Regulations 23A (“BPR 23A”), which came into operation on 1 November 2000, provides the Building Authority (“BA”) with a discretionary power to treat a hotel building or the hotel part of a building as a non-domestic building for site coverage as well as plot ratio purposes and to disregard certain supporting facilities together with the setting down and picking up areas for hotel users from gross floor area calculations.”  The Practice Note also set down the criteria that the BA will consider before exercising its discretionary power under the said BPR 23A.  And when considering whether a site is suitable for hotel development, the BA will take into account, inter alia, the following aspect: “(a) the predominant nature and character of the surrounding land uses…; (b) whether the scale of a hotel development is compatible with the surrounding developments…; (c) whether an adequate number and width of streets are available to serve the proposed hotel and to cope with the additional vehicular and pedestrian traffic generated; and (d) whether any necessary transport, parking, loading and unloading facilities for hotel use would be provided..” Mr. A. Chan in giving evidence opined that in light of the physical characteristics of the Lots and the immediate environment, it would be unlikely that the Lots met with those criteria.  This was disagreed by Mr. Wong.

48.  Mr. Wong has assumed in his valuation that a period of 9 months only is needed to obtain the necessary planning approval so that he discounts the residual land value for the period at a discounting rate of 5%.  Although he is completely silent as to whether section 16’s approval will be a matter that can be considered as of right, it is apparent from his valuation that he has not allowed anything for the risk of not getting the requisite approval from the Town Planning Board.

49.  When giving evidence, Mr. Wong said that he had come across even smaller sites that had obtained similar section 16’s approvals but he did not provide any details of such success cases.  Mr. Wong did not elaborate if he had ever enquired with the Government’s Town Planning Department and whether the department supported the proposed section 16’s application for the Lots.  Also, he did not elaborate if he had ever enquired with the Town Planning Board on the statistics of success or failure rates of similar applications.  In this respect, since we know that some basic information of previous planning applications are available to the general public from the web site of the Town Planning Board, we do not understand why Mr. Wong did not bother even to adduce such information to the Tribunal, if it is his case that section 16’s applications and approvals for hotel use for sites similar to the Lots will support his assumption that approval for the Lots can be obtained in 9 months.

50.  Mr. Wong gave oral evidence that the Caritas had run a hotel a short distance to the northwest of the Lots.  The hotel is Caritas Oswald Cheung International House (“Caritas hotel”), south of the Caritas Social Centre – Aberdeen. Unfortunately, we do not have the benefit of other evidence from Mr. Wong. However, we note from the location plan attached to Mr. A. Chan’s valuation reports that it is fronting Tin Wan Road, a two-way thoroughfare in the Tin Wan area of Aberdeen and the size of the land over which the hotel is located is more than twice of the Lots.  Nevertheless, we find that it is not reasonable to assert that because a hotel is located nearby, it is natural and definite that the Lots could be put to similar use without regard to the exact location and the other characteristics of the Lots.

51.  In our opinion, we agree with the reasons cited by Mr. A. Chan and find that based on the evidence adduced in this case, it is more likely than not that section 16’s approval for hotel use could not be obtained at the time of valuation of the RDV of the Lots, or in the immediate future.

52.  Even though Mr. Wong agrees with Mr. A. Chan that the lease of the Lots contains an “offensive trade clause” that requires a technical modification of the lease, for which the payment of a premium is needed, he has not allowed for, in his valuation, the amount of premium or the time taken for effecting the modification.

53.  We note that Mr. Wong not only assumed section 16’s approval for hotel use would be granted to the owner of the Lots within 9 months, he also assumed that the approval would be granted without any condition.  We find that Mr. Wong should have spelt out very clearly at the outset that his residual valuation would be contingent on getting the necessary planning approval and lease modification within 9 months, both at no extra cost to the owner.  He should have considered the possibility of not getting the said approvals and opined whether and how his assessment of the RDV of the Lots on the basis of hotel use would be affected under such circumstances.  Realistically, this assumption must be an essential element of his valuation in this case.  Although there is a possibility that planning approval may be obtained, in the event that section 16’s approval could not be obtained, the value of the Lots assessed as a hotel site (at $116,010,000 by Mr. Wong) would be reduced drastically to $48,800,000 (as a composite development site, per Mr. A. Chan as Mr. Wong has not carried out any valuation on that basis). 

54.  To conclude, this Tribunal finds that although the definition of market value, apart from valuation in the resumption context (which in general excludes hope value per section 21C of the Lands Resumption Ordinance, Cap. 124) embodies the element of redevelopment value, the latter must be assessed within the constraints of the physical limits of the site, the lease conditions, the planning and market conditions.  The assumption that certain planning approval could be obtained must be spelt out at the outset, could be supported by market evidence and must be agreed with the client who gives instruction for the valuation assignment (see the HKIS Valuation Standards quoted above).  Any expert could not simply assert that since market value could include redevelopment value, one could assume the redevelopment value on the basis of any higher order use, in terms of value, in the absence of planning approval and/or disregarding the likelihood of getting such approval.

Estimation of GDV by Mr. Chan and Mr. Wong

55.  We have earlier set out in a table the different inputs adopted by the experts.  We now show below the details in their assessments of the “domestic” GDV and the total GDV, as follows:

	Mr. Chan’s  proposal (saleable areas)	Mr. Chan’s adopted unit rates / value	Mr. Wong’s  adopted unit rate / GDV
Domestic	877.25 sq. m.	$96,000 per sq. m. / $84,216,000	$201,707 / $176,947,356
Open set back at G/F	9.29 sq. m.	$15,420 per sq. m. / $143,252	$15,420 per sq. m. / $143,252
G/F shops	115.50 sq. m.	$154,200 per sq.m. / $17,810,000	$154,200 per sq m. / $17,810,100
Total GDV		$102,169,352	$194,900,708

Estimation of GDV by Mr. Wong

56.  The analysis and estimate of the average unit rate of $201,707 per sq. m. for the “domestic” component of the GDV is found in the valuation schedule prepared by Mr. Wong (page 162 of Bundle F). Mr. Wong clarified in the hearing that this was in fact all he has assumed and calculated in what he described, under “the scenario of hotel development” (page 161 of Bundle F).  Hence, assuming the following averages:

(i) Size of one guest room at 250.00 sq. ft. (Net area of 1 room);

(ii) Rental per night per room at $800;

(iii) Yield adopted for the hotel at 5.0%; and

(iv) Occupancy rate over the year at 80%”,

he arrived at the Unit rate of $18,799.20 per sq. ft.( Net), or $201,706.87 per sq. m. (Net) for which he rounded to $201,707 per sq. m. (Net). 

Estimation of income for the hotel guest room

57.  Mr. Wong explained that based on what he enquired in person over the counter of the Caritas hotel nearby in July 2011, he estimated the average rental per night per room to be $800, for an average sized room of 250 sq. ft.  The Applicant challenged Mr. Wong’s evidence and submitted that even the booking form obtained by the Applicant over the internet (Exhibit A8) did not support Mr. Wong’s figure.  The form actually show that for the period enquired (26 to 27 October 2011), the reservation room rates ranged from $520 for a standard single room to $690 for Deluxe Twin/Double Room. Similarly, the Applicant submitted that according to a pamphlet on Ovolo (Exhibit A9), a service apartment building located at Shek Pai Wan Road (which has also been mentioned by Mr. Wong during the hearing), the room charge on monthly basis only gave rise to a daily rate of $383, much lower than Mr. Wong’s adopted daily rate of $800.  We agree with the Applicant that Mr. Wong’s method of estimating the expected net receipt from the hotel rooms is not acceptable. Common sense tells that every hotel generally charges a much higher rate to impromptu guest coming to the counter without booking as it usually gives a substantial discount to travel agencies and long time customers, and lesser but still a considerable discount to customer who booked in advance.

58.  So, whilst it is true that, as the Respondent argued, the room rates may differ from season to season, it is sheer common sense that in valuing hotels, one could not just use the orally enquired room rate over the counter on a certain date in the summer season as the basis for estimating the average room rate for the hotel for the whole year, as Mr. Wong has done in his valuation.  We also agree with the Applicant’s submission that the Caritas hotel, situated nearby but of a different class, is not a good comparable and should not be adopted as the only comparable for assessing the tariff for the proposed hotel on the Lots.  We agree with the Applicant that Mr. Wong’s assessment of the average daily room rate of $800 for the proposed hotel under the scenario of hotel development is not reliable and cannot be accepted in his valuation.

Should the net or the gross income from the guest room be used in estimating the GDV?

59.  Mr. Wong reiterated at the hearing that it would not be necessary to compute the net receipt from the hotel as the hotel could be run by a separate operator / hotel management company.  We find that either he was not addressing the right question or he was wrong under the principle in investment valuation of property.  In estimating the average unit rate for computing the GDV of the “domestic” portion of the proposed development at $201,707 per sq. m., Mr. Wong had in fact divided his adopted average daily room rate of $800 by what he adopted as the investment yield of 5%.  So, Mr. Wong should have, in the computation, used the net receipt from the guest rooms with the adopted investment yield of 5%, presumable a net yield.  It has nothing to do with whether the hotel is directly run by the owner or by any other operator.

60.  This leads to the fundamental principle in valuation of property by investment method, whether the property in question is a shop premises, a domestic flat, an industrial unit, or in this case, a hotel property.  For example, if one values a shop receiving a net rent, one could of course compute the capital value of the shop by dividing the yearly net rent with the net investment yield.  However, if the rent received is inclusive of utilities and other outgoings, what one should not endeavour to do is to divide the gross rental income by the net investment yield.  Otherwise, the capital value estimate so arrived will be inflated.  This is valuation ABC and the same principle should apply to any other type of property, more particularly so for a hotel property as the latter has a much lower net rent to gross rent ratio than virtually any other type of property.  The above principle is consistent with the definition of yield adopted in elementary valuation textbook like The Valuation of Property Investments by Nigel Enever and David Issac published by Estates Gazette (2002 edition), where the author said at page 6 that “The initial yield on an investment is the current net income (our emphasis) expressed as a percentage of the capital value… The current income is normally known or can be estimated, and therefore capital value of the investment depends upon the yield which investors are prepared to accept.”

61.  Mr. Wong also did not elaborate further in the hearing as to why he adopted the other averages including the average size of guest room, the expected yield for the hotel, or the expected occupancy rate over the year.  Yet he still insisted that his method was correct under cross-examination.

62.  Mr. Wong’s answer that the gross instead of the net income should be capitalised in an attempt to estimate the GDV of the “domestic” portion of the proposed development (i.e. the market value of the hotel accommodation upon completion) lead us to come to our view that he did not seem to have any experience in valuing a hotel before.  Otherwise, he should not have tackled the estimates of the net or gross receipts and the GDV of the proposed hotel in such an incomprehensible and unreasonable manner.  His method as far as we understand is not supported by any authority of precedent valuation or textbook reference.

63.  In the English book of Valuation: Principles into Practice- A handbook for advanced students and practitioners 5^th Edition”, edited by W H Rees & R E H Hayward and published by Estates Gazettes, it is stated that “hotel investment valuation will follow normal valuation principles, i.e. capitalisation of the rental income.  It can be seen above that the net free cash flow (our emphasis) comprises the two elements of rent and residual profits.” (at page 598)  And according to the American book of Hotels and Motels, A Guide to Market Analysis, Investment Analysis, and Valuation (1997 edition) by Stephen Rushmore, MAI and published by the Appraisal Institute, “In appraising the market value of real estate, the appraiser considers three approaches: 1. The cost approach,... 2. The sales comparison approach… and 3. The income capitalization approach, which is sometimes referred as the income approach.” (at pages 207-208) and  “The income capitalization approach is applied in three steps :

(1). Forecast net income (our emphasis) for a specified number of years.

(2). Select an appropriate discount factor or capitalization rate.

(3). Apply the proper discount and / or capitalization procedure.” (at page 214)

64.  It is clear from the above quotations of the two different textbooks that when investment approach is used in the valuation of hotel, it is always the net income that has to be forecasted, not the gross income Mr. Wong has sought to adopt in his valuation!

Mr. Wong’s adopted yield for the hotel

65.  Mr. Wong has not adduced any information in support of his adopted yield of 5% for the hotel accommodation.  Since he did not state whether the said yield is a net yield, we have considered the possibility that the yield adopted by him might be estimated on a gross basis, same as the rental income of $800 per room per day, in his attempt to estimate the “domestic” GDV.  However, this argument does not assist Mr. Wong’s case because it does not seem to us to be correct that the gross yield for hotel accommodation could be as low as 5% bearing in mind that (1) compared with other types of investment properties, the gross to net ratio in hotel room income is very high, and (2) the current best lending rate of the major banks in Hong Kong such as HSBC is 5%.  More importantly, it is simply not the common practice to appraise hotel using gross yield and gross rent.

66.  Unlike other forms of properties such as domestic flats, offices and retail shops, hotels seldom change hands in the market.  And even if they are sold and purchased, it is not easy for the general public or even valuation professionals without given any details of the hotel to analyse the transaction price for the purpose of estimating the yield.  So we have ruled out the possibility that Mr. Wong could have the knowledge that the yield for a certain type of hotel such as that proposed on the Lots should fetch a yield of 5%, unless he has carried out very thorough research.  However, if Mr. Wong has done such a research, why did he not provide that in his valuation reports, or clarified that in the course of the hearing. The only reasonable conclusion is that the adopted yield of 5% suggested by Mr. Wong was simply what he thought to be a suitable figure to be used in the valuation and there is no basis whatsoever to support such a figure.  Bearing in mind that this will have a significant effect on the outcome of the valuation, we cannot accept this type of “spot” valuation, particularly because we are of the view that, as we have said before, Mr. Wong might not even have any recent experience of valuing a hotel in Hong Kong before handling this valuation assignment.  He cannot just get a figure out of his mind and expect this Tribunal to accept the same.

Estimation of the number of guest rooms and GDV in the proposed development

67.  On being asked whether he had calculated the total number of rooms in the proposed hotel, Mr. Wong replied that the number was not important, so long as the average unit rate of GDV was arrived at in the manner described in his valuation report.  This really is a big surprise to the Tribunal because even to any layman, the number of guest rooms in any hotel must be one of the most important parameters in the design and the value of any hotel. 

68.  Although Mr. Wong did not explicitly stated in his valuation the number of rooms or his estimate of market capital value per room, he clarified at the hearing on 26 October 2011 that the market value of one guest room can be computed using the following formula: gross receipt of $800 per room per day x 30.5 days x 12 months x 80% occupancy rate x 20 (1/ adopted investment yield of 5%), or $4,684,800.

69.  Also, although he had at one stage answered that the number of rooms in the proposed hotel was not that important, he confirmed to the Tribunal on the same date of the hearing that as he was still adopting Mr. A. Chan’s composite development design (comprising ground floor shops, club house and transformer room on 1/F and 23 storeys of domestic units from 2/F to 24/F), there would be in the proposed hotel the same net saleable areas on each floor as stated in Mr. A. Chan’s proposal giving a total of 23 rooms. 

70.  Using the above data of a proposal of 23 rooms and the estimated market value per room of $4,684,800, the total market value of the hotel accommodation, apart from the G/F shops (i.e. the “domestic” GDV in the valuation at Bundle F/162) amounts to $4,684,800 x 23, or $107,750,400.  This contrasts with the figure of $176,947,356 arrived at in Mr. Wong’s estimates of the GDV.

71.  However, Mr. Wong did not see it necessary to clarify the reason for the difference.  He answered that it would not be necessary to know the number of rooms because the figures he adopted, the average daily room rate of $800 and the average size of guest room at 250 sq. ft. (equivalent to 23.22 sq. m.) are mere averages.  However, using his estimated “domestic GDV” of about $177 Million, we find that he was actually proposing a total number of 38 guest rooms, not 23, in the proposed hotel. (The computation is: total saleable area of 877.25 sq. m. / average size of guest room at 23.22 sq m. = 37.78.  As a check, applying a unit market value of $4,684,800 per guest room to this number of 37.78 gives a figure of $17,699,744 rounded to $177 Million.)  So we conclude that although Mr. Wong has on the one hand stated in the Respondent’s Reply Report (page 169 of Bundle F) and reiterated orally in the hearing that he has adopted Mr. A. Chan’s assumptions on the proposed development, he was on the other hand valuing the accommodation at $177 Million, based on a totally different number of rooms and hence an entirely different design.

Is a hotel proposal still compatible with Mr. A. Chan’s design in the proposed development for the Lots?

72.  Notwithstanding that he revised his valuation based on the scenario of hotel development, Mr. Wong opined that it was compatible with the design of Mr. A. Chan’s development on the G/F and 1/F so that he saw fit not to change Mr. A. Chan’s adopted GDV figures for the G/F and used it in his valuation.  He insisted nothing had to be changed or ought to have been changed.  We disagree with this view.  We all know by common sense that even ignoring the lay-bys (if any) for the guest coaches, cars and delivery vans, a hotel design has to incorporate a certain area for counter, waiting area, office, store rooms for linen, washrooms, etc. so that the resulting design on the G/F and 1/F could never be the same as in the composite development proposed by Mr. A. Chan.  Mr. Wong argued that these areas could be located on a floor other than the G/F; however, he forgot that all the upper floor design and saleable area in his proposal were supposed to be the same as in Mr. A. Chan’s original proposal.  In the circumstances, how and where would these areas be relocated?

Could the Lots be developed for service apartment use?

73.  The Respondent, in its final submission, submitted that the site could be put to better use, as a hotel or as a service apartment building.  However, although Mr. Wong advanced his hotel development model at a fairly late stage, he has not given any evidence, either in writing or orally, on the valuation of the Lots as a service apartment building.  Neither has Mr. A. Chan given evidence in this aspect since he has stated throughout his written valuation reports and confirmed in re-examination that he would stick to his design of a composite building.  However, Counsel for the Respondent in his closing submission raised the issue that the valuation by Mr. Wong of the RDV of the Lots at $116,010,000 is not unreasonable, if the Lots are used for the building of service apartments.  This Tribunal does not accept that the Respondent can adopt such an argument without any evidence in support.

74.  Even though we accept Mr. A. Chan’s unchallenged oral evidence that as the Lots are zoned R(A), no planning approval is required if the owner of the Lots wishes to use the proposed building for service apartment use, however, we do not agree that the proposal to redevelop the Lots into a service apartment building will necessarily fetch a higher residual land value.  Otherwise, all proposed composite building developments will be replaced by service apartments.  This is beyond common sense.  Also, we agree with the Applicant that a service apartment building has differences in various aspects of design, accommodation and areas when compared with a composite building.  However, since no evidence has been adduced by either expert in these aspects, we shall not consider this option any further.  We cannot agree with the Respondent’s final submission that Mr. Wong’s valuation of the RDV of the Lots at $116.010 Million is also applicable to the development of a service apartment building since Mr. Wong’s valuation schedule is not a valuation based on the development of a service apartment.

Summary of our findings on residual valuation

75.  We find the residual valuation of Mr. A. Chan as appeared in the Applicant’s Supplementary Report to be fair and reasonable.  We are satisfied on the following: (1) his assumptions as to the most optimum development for the Lots; (2) his valuation of the GDV for the proposed composite development including the areas of different types of accommodation and the adopted average unit rates for the different areas, (3) the construction costs, and (4) the discounting rates and periods used in the residual valuation

76.  We agree with the Applicant that Mr. Wong’s valuation was completely wrong on the following grounds: (1) Mr. Wong’s estimate of an average daily rent of $800 per guest room is unreliable and cannot be accepted for the purpose of estimating the GDV; (2) the method of using the gross income from the guest rooms divided by the net yield for the hotel is wrong and cannot be accepted; (ii) there is no evidence at all in support of his adopted yield and occupancy rate for the hotel; and (iv) it is absurd that even if Mr. Wong has satisfied himself that a hotel could be redeveloped on the Lots, he could still adopt all the design and area assumptions behind Mr. A. Chan’s residual valuation (at Bundle C2/594) for a composite / primarily residential development.

77.  In particular, Mr. Wong opined that based on the daily room rate of $800, the average unit rate for the “domestic GDV” of the proposed hotel on the Lots would be $201,707 per sq. m.  The Applicant submits that this computation is entirely wrong.  We agree with this submission.  We would like to reiterate that it is not prudent at all, to say the least, for any professional valuation surveyor to use Mr. Wong’s method of converting the daily gross room rate into an average unit sale price for hotel (on sq. m. basis) as the daily gross room rate can only be used in the calculation of the gross receipt of the hotel but not the net rental income of the hotel, or the net sale price of the hotel accommodation. 

78.  We do not understand why Mr. Wong failed to prepare his entire valuation with proper development assumptions as to the type and design of the optimum development (i.e. as a hotel).  If he cared to start from the first principle, based on the physical parameters of the site (which are agreed), the lease and planning constraints (even assuming section 16’s approval would be obtained, which is a separate issue), and the fundamentals of the Buildings (Planning) Regulations, and with reference to standard text book in the estimate of GDV of a hotel, he would have been able to complete his residual valuation in the more proper and reasonable manner.  However, it should not be the one as appeared in his valuation schedule (page 162 of Bundle F).

Conclusion of our findings on Mr. Wong’s valuation evidence

79.  To summarise, we reject Mr. Wong’s opinion as expressed in the Respondent’s Reply Report in its entirety.  Not only that we do not agree with Mr. Wong’s assumption of obtaining the section 16’s approval in 9 months’ time without accounting at all for the very high risk of not getting the said approval, he had carried out his residual valuation with unsupported inputs and unrealistic assumptions as to the optimum development of the Lots.  He adopted most of the inputs in the investment method of valuation for estimating the GDV for the proposed hotel accommodation without justification and adequate support.  He was wrong in dividing the gross income by the yield in his attempt to estimate the unit rate of the GDV of the hotel accommodation which method is against the basic principle of investment method of valuation.

RDV of the Lots and the reserve price for the proposed auction of the Lots

80.  We are still left with the task of determining the RDV of the Lots for the purpose of approving the reserve price for the proposed auction of the Lots.  At paragraph 75 above, we find Mr. A. Chan’s residual valuation as contained in the Applicant’s Supplementary Report to be fair and reasonable.  We therefore decide that based on Mr. A. Chan’s valuation, the RDV of the Lots as at 11 October 2011 reflecting redevelopment on their own is $48.80 Million.  This should be adopted as the reserve price for the proposed auction of the Lots.

Conclusion

81.  Having considered the above, this Tribunal is satisfied that the requirements and conditions as laid down in the Ordinance have been met and an order for compulsory sale sought by the Applicant should be granted.

82.  It is suggested by Mr. Mak that this Tribunal should consider making directions for the Lots in this case to be sold together with No. 1-3 and No. 9-11 of Tang Fung Street, in which the Applicant is also the majority owner and the subject of compulsory sale application.  An order for sale had already been made as far as No. 1-3 is concerned whilst the application concerning No. 9-11 will only be heard in early 2012.  Without a sale order for the latter, this Tribunal cannot see how Mr. Mak’s suggestion can be carried out.  By acceding to Mr. Mak’s request is to pre-empt the result in the application concerning No. 9-11.  This is utterly wrong.

Order

83.  This Tribunal make the following orders :

1. This Tribunal is satisfied that the value of the Respondent’s Unit as assessed in this Application is fair and reasonable; and is fair and reasonable when compared with the values of the Applicant’s units;

2. This Tribunal is satisfied that the redevelopment of the Lots is justified due to the age or state of repair of the Building, and that the Applicant has taken reasonable steps to acquire all the undivided shares in the Lots including that of the Respondent;

3. All the undivided shares in the Lots, the subject of the Application, be sold by way of public auction for the purposes of redevelopment of the Lots;

4. Mr. Lung Siu Wing and Mr. Luk Kam Chung Richard, nominated by the Applicant, be appointed trustees (“the Trustees”) to discharge the duties imposed on trustee under the Ordinance in relation to the Lots and the Trustees be authorized to charge such remuneration for their services in accordance with the terms set out in the letter from Messrs. So, Lung & Associates, Solicitors dated 18 October 2011;

5. For the purposes of the sale of the Lots by public auction :-

(i)  The sale of the Lots be on the particulars and conditions of sale substantially the same as those in the draft Particulars and Conditions of Sale ( as set out in page 41-64 of Bundle E) initialed and approved by the Tribunal;

(ii)  The reserve price be set at $48,800,000;

(iii)  Subject to further extensions that the Tribunal may subsequently allow upon the application of the purchaser of the Lots or its successor in title, the redevelopment of the Lots and the Building shall be completed and made fit for occupation within a period of 6 years after the date on which the purchaser of the Lots becomes the owner of the Lots; and

6.  Liberty to the Applicant, the Respondent and the Trustees to apply to the Tribunal for further directions.

Costs

84.   Costs order nisi that the Respondent do pay the costs of this case to the Applicant with certificate for counsel, to be taxed if not agreed on party and party basis at High Court Scale.  Unless any of the parties apply by summons to vary it, the costs order nisi shall be made absolute upon expiry of 14 days.