Real Estate and Capital Structure Decisions –
Jonathan Young, the CEO of Sunny Trading Company Limited (“STL”), faced a threat in October 2002 when the lease on his Wanchai office in Hong Kong was up for renewal, and the rent was set to increase by 10 per cent. Jonathan had long believed that leasing office space was the most practical and affordable option for his business in Hong Kong. When negotiations for a lower rent failed, however, he began to consider whether his firm would be better off owning or leasing office space. STL was a toy trading company with 20 full-time staff, so the type of office required was quite simple and straightforward. The existing Grade A office had a gross floor area of 250 m2, and was equipped with a conference room, a reception area, an open space with partitions for staff, a computer server room and a kitchen area.12 The current rental was HK$970,000 per annum. Office space with similar characteristics was widely available in the territory, although average rents varied from location to location. Central, Wanchai and Causeway Bay were the traditional homes of business on Hong Kong Island. In addition, a significant cluster of Grade A offices had been developed in North Point. For the same grade of office space, however, average rentals in Central were relatively expensive [see Exhibit 1 for Hong Kong’s office market geography and Exhibits 2 to 4 for a comparison of office rents and prices in various business districts]. Jonathan was a little perplexed about the decision facing him. Obviously, accepting the rental increase would cut his firm’s profit margins. Jonathan could look for another office, but he did not want his firm to be subject to the vagaries of the real estate market whenever the lease 1
Office buildings in Hong Kong were categorised into three classes: Grade A, Grade B and Grade C. Grade A: Modern with high-quality finishes, flexible layout, large floor plates, spacious lobbies and circulation areas, effective central air-conditioning, good lift services zoned for passengers and goods deliveries, good management, parking facilities normally available
Grade B: Ordinary design with good quality finishes, less flexible layout, average-sized floor plates, adequate lobbies, central or free standing air-conditioning, adequate lift services, average or above average management, parking facilities not essential.
Grade C: Plain design with basic features, restricted layout, small floor plates, basic lobbies, generally without air-conditioning, barely adequate or inadequate lift services, minimal to average management and no parking facilities.
One square metre is approximately equal to 10.763932 square feet.
Mary Ho prepared this case under the supervision of Dr. Frederik Pretorius for class discussion. The firms and the individuals in this case are fictional. This case is not intended to show effective or ineffective handling of decision or business processes.
© 2003 by The Centre for Asian Business Cases, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise (including the Internet) - without the permission of The University of Hong Kong. Ref. 03/158C
10 February, 2003
Real Estate and Capital Structure Decisions: Lease-Versus-Buy Analysis
terms expired. Owning an office, however, was more complicated than simply leasing. Hong Kong had a very active market in office condominium of all sizes, so liquidity did not pose as big a problem as buying a small office might in other economies. Jonathan needed to weigh a variety of factors before making a decision.
Lease Vs Buy Analysis
Buying an Office
A trading company that Jonathan knew had bought half a floor of office space in a small building in Wanchai in 1990. That company, known as Phoenix...
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