The Hong Kong Monetary Authority (HKMA) has announced that the Financial Secretary, the Hon. Donald Tsang, has earlier today (Saturday) signed a Memorandum of Agreement with the vendor for the purchase of permanent office accommodation for the HKMA. As required by the relevant land lease, the agreement is subject to the consent of the Director of Lands.
The subject properties are Levels 55 and 56 and Levels 77 to 88 inclusive of the office building to be erected on Site R of Inland Lot No. 8898 (i.e. Two International Finance Centre). The money for the purchase will come out of the Exchange Fund.
The cost of the purchase is HK$3.699 billion. The HKMA's projections on the cost savings considerations behind the purchase are at Annex. Further details of the purchase will be disclosed in due course according to normal commercial practice.
For further enquiries, please contact:
Thomas Chan, Senior Manager (Press), at 2878 1480
Jasmin Fung, Manager (Press), at 2878 8246
Caitlin Wong, Manager (Press), at 2878 1687
Hong Kong Monetary Authority
28 April 2001
Annex
Memorandum of Agreement for the Acquisition of Permanent
Office Accommodation for the Hong Kong Monetary Authority
Financial Analysis
In considering whether to purchase permanent office accommodation, the Hong Kong Monetary Authority (HKMA) has conducted the following commonly used analyses to evaluate the investment:
(1) Payback period
- This is a simple benchmark return, which measures the number of years required to recoup the cash invested from rental saved each year. This is an easily understood analysis, but it does not take account of the time value of money.
- On the basis of an offer extended by the developer, the annual rental payable for the same amount of space in IFC II, at current levels, is about HK$222.4 million per annum.
- The agreed purchase price is HK$3.699 billion.
- Payback period (purchase price/rental savings per annum) is about 16.6 years. That is, the cost of purchase from rental savings will be recouped in about 16.6 years, ignoring the time value of money.
(2) Internal Rate of Return (IRR)
- The internal rate of return is the discount rate at which the present value of all future cash flows less investment equals zero. If we take a holding period of 30 years, the rental savings over these 30 years and the terminal market value of the office at the end of the holding period will be the future cash flows generated by the current investment. The return calculated on the basis of these future cash flows will be the IRR of the investment.
- There are two main input variables in calculating the IRR. The first is the assumed rental levels over the next 30 years. We have based our assumption on historical trends over the past 20 years, and have used this number as the assumed growth rate in rentals during the future holding period. (The historical trend is calculated by consecutive 10-year periods over the past 20 years, comparing the rental levels at the beginning and end of each period, and deriving the annualised growth rate during that period. A simple average of the data points obtained this way is then taken as the assumed growth rate).
- The second is the assumed market value of the office 30 years later. Again, we have based our assumption on historical trends of capital appreciation over the past 20 years (using a methodology similar to that for rentals). Nevertheless, to lean on the conservative side in view of the booming property market in Hong Kong in the mid-1990s, we have shaved off a third of the historical average annual appreciation and used this adjusted number to arrive at the terminal market value.
- Under these assumptions, the IRR in our baseline case is 13.47%. If we use the yield of the 10-year Exchange Fund bonds as a proxy of our cost of capital, this IRR is well above this hurdle rate.
Sensitivity test :
- If we assume rentals to remain unchanged, while capital appreciation will follow historical trends as adjusted above, the IRR will be 10.63%.
- If we assume the market value of the office to remain unchanged, while rentals will follow historical trends, the IRR will be 11.46%.
- If we assume both the rental and the market value of the office to remain unchanged over the holding period, then the IRR will decline to 5.61%.
(3) Net Present Value (NPV) Analysis
- The NPV of an investment is calculated by discounting back a stream of future cash flows generated by the investment at a predetermined discount rate, totalling them, and then subtracting that from the investment amount. In this case, using a holding period of 30 years, the cash flows of rental savings over the 30 years and the terminal market value of the office at the end of 30 years are discounted back to arrive at a sum of all future cash flows at current prices. This sum is then compared with the purchase price. If it is higher (i.e. a positive NPV), then the property is worth buying. If it is lower (i.e. a negative NPV), then it is worth leasing.
- There are three input variables in the analysis. The first two are the rental levels and the terminal market value of the office, and the same assumptions as in the IRR analysis are used.
- The third variable is the discount rate. There are different ways of choosing the discount rate, and it is not uncommon to use the investor's cost of capital for a project of this type. In our baseline case, we have adopted the yield of the 10-year Exchange Fund Bonds as a proxy of our cost of capital and hence the discount rate.
- Using these input variables, the NPV of our baseline case is HK$10.96 billion. That is, it is better value to buy.
Sensitivity test
- if we assume rentals to remain unchanged, while capital appreciation will follow historical trends as adjusted above, the NPV will be HK$5.99 billion.
- if we assume the market value of the office to remain unchanged, while rentals will follow historical trends, the NPV will be HK$4.75 billion.
- if we assume both rentals and the market value of the office to remain unchanged over the holding period, then the NPV will decline to
HK$-0.22 billion.
- if we assume both rentals and the market value of the office to remain unchanged, and the yield of the 10-year Exchange Fund Notes to rise to a high level of 9.91% as briefly experienced during the peak of the Asian crisis in 1998, the NPV will decline further to HK$-1.57 billion.
Hong Kong Monetary Authority
April 2001
