HONG KONG - Hong Kong’s office towers, among the most expensive commercial real estate in the world, have never been this empty.

Billionaire Li Ka Shing’s trophy asset, Cheung Kong Centre, is about 25 per cent vacant, while his latest project under way across the street with sweeping views of Victoria Harbour has signed up one tenant. Fellow tycoon Lee Shau Kee’s curved glass The Henderson building under construction nearby is just 30 per cent leased. Rents and sale prices are cratering.

While commercial real estate is struggling from New York to Sydney as more people work from home, Hong Kong faces a unique set of challenges that may lead to a prolonged slump in a market once coveted by global investors and local tycoons alike.

Western banks have been cutting space as deal-making slows and China tightens its grip on the financial hub. Chinese businesses, which were expected to pick up the slack, are not gobbling up as much space as expected as their own economy struggles. A spate of new buildings will add to the glut.

“We just don’t see any positive drivers in the near future,” said Mr Eddie Kwok of CBRE Group. “Price declines may slow, but it’s difficult for a rebound.”

The office slump stands out in a city that has finally found its footing after years of Covid-19 pandemic clampdowns and strict security measures from Beijing that sparked an exodus of families. Retail sales are picking up, restaurants are packed and punters are jamming the Happy Valley Racecourse once again.

Yet a record 13 million sq ft of office space sits empty.

The overall Grade A vacancy rate was almost 15 per cent in April, data from Colliers International Group shows. That is more than three times higher than in 2019, and tops Manhattan’s rate of 12.5 per cent, and the 4.6 per cent level in the rival Asian hub of Singapore.

Unlike in New York or London, Hong Kong’s landlords cannot point to the work from home movement to explain much of the decline.

Given the city’s highly efficient subway system and tiny apartments, Hong Kongers are less inclined to fire up their laptops at home. The city is back to work, with subway ridership surpassing 2019 levels in March, while in New York it is still at 65 per cent of pre-pandemic numbers.

Instead, Hong Kong landlords are starting to lose their best customers.

As the business climate deteriorates in China amid rising tensions with the United States, Wall Street banks are scaling back expansion plans. Hong Kong, where many China-focused bankers operate, is paying the price, as the finance industry takes up almost 30 per cent of the office space.

Morgan Stanley is considering cutting 7 per cent of its Asia-Pacific investment banking workforce after axing about 50 jobs in 2022, Bloomberg reported. JP Morgan has let go about 30 investment bankers in Asia, including those based in Hong Kong. Firms such as Deutsche Bank, Standard Chartered Bank and BNP Paribas have either relinquished space or moved away from the core to trim costs. FedEx is moving its Asia-Pacific headquarters to Singapore.

As global banks pull back, mainland companies are not filling the void fast enough even after border restrictions were removed.

While Chinese companies such as ByteDance and PetroChina are taking up space, they accounted for just 11 per cent of new leases in the first quarter, compared with an average of 15 per cent between 2017 and 2019, according to CBRE. They also made up just 8 per cent of commercial property purchases in the period, down from 19 per cent before the pandemic.

Meanwhile, developers such as CK Asset Holdings and Henderson Land Development keep building more skyscrapers. There will be at least 7 million sq ft of Grade A space coming on the market in the next three years, CBRE estimated. The annual absorption rate before Covid-19 was just 1.8 million sq ft, so it will take years to fill the new space, Mr Kwok said.

The office downturn is putting a damper on deals and rents. The number of office transactions nearly halved in the first quarter from the five-year average, a bigger drop than in the US, according to MSCI Real Assets.

Prices for premium offices, meanwhile, dropped 26 per cent in March from their peak in 2018, and rents are off 29 per cent from four years ago. While that is good news for tenants in a market that still has the highest occupancy costs in the world, it is a blow to landlords, many of whom paid top dollar to build projects that are coming on stream now.

In a sign of the times, Pamfleet, a Hong Kong-based private equity firm now owned by Schroders, sold a commercial building in Kowloon for HK$350 million (S$60.3 million) in February, about as much as it paid in 2015, and a deep discount to the HK$600 million asking price.

The biggest losers in the downturn are Chinese developers such as China Evergrande Group and Cheung Kei Group that splurged on trophy properties just a few years ago. As the property crisis in China shows few signs of abating, these developers could either refinance or dispose of their properties at a loss to meet funding needs.

The weak commercial market is taking its toll on real estate stocks and investment trusts. CK Asset Holdings and Henderson Land Development are among developers whose shares have dropped more than 8 per cent in 2023, double the decline in the main Hong Kong equity gauge.

Tycoons such as Mr Li and the Kwok family at Sun Hung Kai Properties should be able to weather the downturn with their ample cash and other sources of income from residential properties and shopping malls. Office real estate accounts for less than 10 per cent of profits for these companies, said Mr Mark Leung, an analyst at UBS Group.

Even with the price declines, global investors have few reasons to jump into the market given the sluggish outlook and low yields, said an executive at a foreign private equity firm who declined to be identified. The changing face of Hong Kong, with many expats leaving, makes it hard to reignite much interest, the person added.

“There won’t be many Western institutional investors in Hong Kong” with all the geopolitical tensions, said Mr Neil Brookes, global head of capital markets at Knight Frank. BLOOMBERG