Railway Reform: Toolkit for Improving Rail Sector Performance Case Study: Hong Kong MTR Corporation

Case Study
Hong Kong Mass Transit Rail Corpora-
tion 220

1 Introduction
The Mass Transit Rail (MTR) Corporation was established in 1975 as a govern-
ment-owned enterprise to build, operate, and maintain a mass transit railway sys-
tem for Hong Kong’s public transport needs. In 2000, about 23 percent of its
shares were offered to private investors on the Hong Kong Stock Exchange.

Just like many other metro projects, MTR line construction in the 1970s and 1980s
was capital intensive and required substantial funding. With several lines under
construction/planning, MTR Corporation had accumulated substantial debt by
1985 (HK$18.7 billion, or US$2.4 billion 221). It was important for the government
to cover and even cut some of the company’s project costs without raising fares by
arranging government land grants for rail and property development.

Since it became publically traded, MTR Corporation has also needed to ensure it
undertakes only financially viable projects, as a profit oriented organization un-
dertaking non-government projects. The Rail + Property (R+P) program helps
MTR Corporation meet this objective.

This case study is relevant to railway companies and cities looking to generate cash
flow by developing land around rail stations.

2 MTR Corporation and the R+P Program

The portfolio of MTR Corporation is divided into four parts: 1) Hong Kong
Transport Operations; 2) Hong Kong Station Commercial Businesses; 3) Hong
Kong Property and other Businesses; and 4) Mainland of China and International
Business.

For Hong Kong Transport Operations, the merged 218.2-kilometer rail network
consists of nine railway lines with 84 stations serving Hong Kong Island, Kowloon,
and the New Territories, as well as a Light Rail network with 68 stops serving the
local communities of Tuen Mun and Yuen Long in the New Territories. The Cor-
poration also operates the Airport Express, a dedicated high-speed link connecting

220 This case study is largely based on Lawrence, Martha; Ollivier, Gerald. 2015. Attract-
ing Capital for Railway Development in China. World Bank, Washington, DC. © World
Bank. https://openknowledge.worldbank.org/handle/10986/23800 License: CC BY 3.0
IGO. URI: http://hdl.handle.net/10986/23800
221 When USD equivalent is shown for HK$ values, they are all converted by using the ex-

change rate of 1USD=7.75HK$ (as of 2015).

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Railway Reform: Toolkit for Improving Rail Sector Performance Case Study: Hong Kong MTR Corporation

Hong Kong International Airport and the city's major exhibition and conference
center, AsiaWorld-Expo. The rail system has an average weekday patronage of
nearly 5.3 million passengers.

With the R+P approach, MTR Corporation has been able to fund a large part of its
transport system development by: (i) creating land value through integrated urban
and transport planning; and (ii) capturing such value by receiving land develop-
ment rights from the government at “before rail” market prices and co-developing
such land with private developers at “after-rail” market prices (Figure 1).

The R+P approach went through different phases. Over the period of 1980 to 2005,
property development contributed substantially to expansions of the rail lines, in
particular during 1998 to 2005 (Figure 2).

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Railway Reform: Toolkit for Improving Rail Sector Performance Case Study: Hong Kong MTR Corporation

By end-2015, MTR Corporation completed developments at 33 MTR stations, gen-

erating some 100,000 housing units and more than 2 million square meters of
commercial space. The corporation is one of the largest property managers in
Hong Kong, managing over 96,000 units of residential flats, 13 shopping malls,
and five office buildings (764,003 square meters of commercial and office
space)222.

3 MTR Corporation’s R+P Approach

The R+P program has been implemented through public-private partnerships
(PPPs) and transactions. The following describes the approach to the R+P program
undertaken by the MTR Corporation.

Procedures of the R+P Program

The R+P program is considered on a line by line basis, considering market condi-
tions, financing gap for the line construction and future operation and government
requirements.

The Transport and Housing Bureau issues and updates on a regular basis a railway
development strategy, with the practical advice of MTR Corporation, and of the
Town Planning Board.

The Chief Executive in the Executive Council of the Hong Kong Special Adminis-
trative Region (HKSAR) then requests MTR Corporation to proceed with the pre-
liminary planning and design of the line. This includes negotiations on the detailed
scope, cost and implementation program for the line, and the identification of sites

222MTR Corporation, Business Overview 2015. https://www.mtr.com.hk/archive/corpo-

rate/en/publications/images/business_overview_e.pdf
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Railway Reform: Toolkit for Improving Rail Sector Performance Case Study: Hong Kong MTR Corporation

to be reserved for development, subject to rezoning approval. MTR Corporation

determines the financing gap for the line, and this gap is reviewed independently.

Once a decision is made to move forward with a specific line and R+P proposal,
and once all parties are in agreement, the government of Hong Kong grants MTR
Corporation exclusive development rights for specific sites, defining tower loca-
tions, permissible uses, and plot-ratio densities (i.e., floor space divided by land
area). This includes land above and around new stations and depots transferred at
the “before-rail” market price.

The Town Planning Department initially prepares a rough land use pattern asso-
ciated with the land grant. MTR Corporation then prepares a master layout of the
project, including the siting and massing of buildings, block designs, standards for
building quality, and locations of vehicle access points. It also obtains necessary
statutory planning approvals for the proposed development.

Next, MTR Corporation issues a tender among potential developers and selects a
partner based on the attractiveness of competing financial offers, experience, man-
agement capabilities, and other factors. Developers are given some flexibility to
recommend and negotiate site modifications to the R+P proposals. MTR Corpora-
tion uses its development rights to partner with developers (selected from a list of
qualified bidders) based on the “after-rail” market price. MTR Corporation does
not sell development rights to other private developers, but instead partners with
property developers. It remains in full control of the land and sells/leases the com-
pleted units.

Financial sustainability approach

As a profit-oriented organization, MTR Corporation needs to ensure that a suitable
rate of return can be achieved, prior to undertaking any investment.

Financial viability is estimated based on the 50-year net present value (NPV) for
the new construction, discounted with a weighted average cost of capital of MTR
plus 1 to 3 percent223, depending on the risk level.

The government discusses the appropriateness of providing capital grants or prop-

erty development rights to MTR Corporation based on the expected funding gap 224
of new rail construction (in the case of natural extensions) that could not be recov-
ered through future operating revenues. Such a gap is estimated by MTR Corpora-
tion and external assessors. Those assessors include consultants for independent

223 Cervero and Jin (2008) indicated that MTR Corporation aims to set returns for its in-
vestments based on the WACC – the weighted average cost of capital –set at 9.5% (re-
flecting the expected return in equity and interest from borrowing) plus a rent premium
of between 1.5% and 3% for equity shareholders, yielding a 11% to 12.5% return. The
WACC fluctuates based on loan rates charged by commercial banks. For riskier projects,
the WACC might be set at 10% plus a 3% premium, yielding a 13% net return. MTR Corpo-
ration will invest in railway projects if these net rates of return (11% to 13%, depending
on risks) are attained. This “WACC + premium” formula is used to guide not only railway
investment but also MTRC’s own real-estate investment, including shopping malls at-
tached to stations.
224 When a new rail project with property development rights is financially nonviable,

the government considers providing capital grants.

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Railway Reform: Toolkit for Improving Rail Sector Performance Case Study: Hong Kong MTR Corporation

checking, who review the cost and revenue of the proposed rail line, and surveying
firms which review property valuation for land development, based on Valuation
Standards on Properties published the Hong Kong Institute of Surveyors. 225

To safeguard the public interest from granting too much land, any excessive capital
grant will be reimbursed to the government with interest (claw-back mecha-
nism)226.

Market-driven approach
In the R+P model, MTR Corporation is the “master planner and designer” to align
the interests of multiple stakeholders in different project phases. It prepares a de-
velopment layout plan, resolves all interfaces with rail stations, takes care of ten-
dering land parcels, acts as a liaison between the government and developers,
monitors development quality and the sale or lease of completed properties, and
manages properties after completion.

Within MTR Corporation, managers weigh factors like the value of land, density
potential, and project size and scale in deciding whether to advance a specific R+P
proposal. The assembly of land to be developed around the station is largely deter-
mined by market demand, constrained by zoning regulations. Commercial prop-
erty development has occurred mostly at and near central city MTR stations while
residential projects have been built mainly in outlying areas and at terminal sta-
tions.

While many properties are high-rise towers above MTR station podiums, the R+P
model is not a “cookie-cutter” approach to making the cityscape transit supportive.
Indeed, the development parameters of R+P (such as area size, building densities,
floor uses, and site designs) vary from place to place, essentially depending on the
city’s urban planning and market demands. Floor Area Ratios (FARs) of at least
4.0 (as observed in recent MTR Corporation projects) are generally viewed as nec-
essary if R+P is to be financially viable; however, MTR Corporation’s actual site
coordination remains flexible by covering large R+P sites with the CDA zone.

The design principles of R+P have evolved over the past 35 years (Figure 3). Since
the late 1990s, development has integrated transit-oriented development design
concepts—high-density, mixed-use, and pedestrian-friendly—in a more physically
comprehensive manner than seen in the 1980s.

225 http://www.hkis.org.hk/en/
226 HKSAR legislative Council 2009.
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Risk management approach

MTR Corporation’s approach to property development is based on minimizing di-
rect risks in property development projects, reducing the company’s exposure to
the real estate market and its related risks. For their part, developers must cover
all development costs (such as Government land premiums based on post rail
value, construction and enabling work costs, marketing and sales expenses, pro-
fessional fees, finance charges, and others) and cope with all project risks. MTR
Corporation negotiates with developers to derive benefits from the property devel-
opments through sharing profits in agreed proportions from the sale or lease of the
properties (after deducting development costs), sharing assets in kind, or receiving
up-front payments from the developers, taken case by case227. The selection of one
of those three mechanisms is directly related to the evaluation of market conditions
and the considerations regarding the long-term value of a given development. For
private developers, the rules of the game are very clear at the outset, which eases
uncertainties.

One of the effective mechanisms MTR Corporation has used to both manage risks
and address diverse market needs is to engage several developers to each station
area (11 to 13 developers in recent cases).

227Studies show that R+P approach yields significant price premiums relative to fairly
comparable non-R+P housing projects, especially by reaping the accessibility gains
through the rail transit, which spur the developers to get involved. In Hong Kong, the
best locations for development near stations are usually made available through the R+P
program creating an incentive for developers to pay a premium.
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4 Results
The R+P approach has yielded financial and ridership benefits for MTR, as well as
contributed to sustainable community development.

Financial impact
Profits from property development and related business of MTR Corporation, in-
cluding HK station commercial business and HK property rental and management
business, have accounted for more than 50 percent of MTRC’s total profit between
2000 and 2015228. Profits from rail operations have also seen a fast increase due to
expanding the rail network with funding support from property development and
ridership increases brought by community development around the stations. The
profit contributions for MTR Corporation are shown in Figure 4.

The accumulated earnings and value brought by R+P model have increased MTR
Corporation’s return for shareholders, and the balance sheet value of equity at-
tributable to shareholders has been steadily increased during the last decade
(2004-2015) (Figure 5).

228We summarized the financial data about profit contributions from 2000 when MTR
Corporation got partially privatized on Hong Kong Stock Exchange.
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In addition, the corporation’s debt servicing capability has also been improved
with reduced debt ratio (Figure 6) over the same period.

Increased ridership
MTR Corporation has also seen higher passenger volume as a result of the high-
quality communities developed around the stations through the R+P program.
Growth of the total passenger number for the last decade (2004-2015) is shown in
Figure 7.229

229The sharp increase of passenger number in 2008 is due to the rail merger in Decem-
ber 2007.
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Stakeholder impacts
The Government of Hong Kong: The R+P model enabled the government of Hong
Kong to build a modern railway network with limited cash subsidy. Besides, the
financial benefits of R+P Program are distributed to the government through div-
idends and appreciation of the value of its shareholding. From 1980 to 2005, the
government received an estimated HK$140 billion (US$ 18 billion) in net financial
returns (nominal value). This is based on the difference between earned income
(HK$171.8 billion, or about US$22 billion, from land premiums, market capitali-
zation, shareholder cash dividends, and initial public offer proceeds) and the value
of injected equity capital (HK$32.2 billion, or US$4.2 billion).

Local communities: MTR Corporation also contributes to sustainable urban devel-

opment and economic development by providing efficient transit services with af-
fordable fares, high quality modern property development and quality retail busi-
ness and facilities close to the housing area.

5 Conclusion
The R+P program applied by the MTR Corporation in Hong Kong has been central
to the success of Hong Kong in developing its rail system. The R+P program ena-
bled MTR Corporation to capture real estate income to finance part of the capital
and running costs of new railway lines, and to increase transit patronage by facili-
tating the creation of high-quality, dense and walkable catchment areas around
stations.

The following three key concepts applied in the R+P program are essential to the
program success and can be adopted by other railways taking the transit-oriented
development mechanisms to help finance new rail lines:

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Railway Reform: Toolkit for Improving Rail Sector Performance Case Study: Hong Kong MTR Corporation

 Financial sustainability approach: The value for a rail company to only under-
take those rail investments that can achieve a targeted rate of return (after fac-
toring government support, in the form of land rights provided at before-rail
price, used in a R+P program, or cash subsidies) to be financially sustainable.

 Market-driven approach: The need to plan development along each rail line
comprehensively, with multiple stakeholders and partners, and to define the
scale and timing of such developments based on market demand, location
characteristics and institutional capacity.

 Risk management approach: The value for a railway company to bring in rele-
vant expertise and transfer a large part of commercial risks to private develop-
ers through PPPs and transactions with external partnerships.

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Railway Reform: Toolkit for Improving Rail Sector Performance Case Study: Hong Kong MTR Corporation

References
Lawrence, Martha; Ollivier, Gerald. 2015. Attracting Capital for Railway Devel-
opment in China. World Bank, Washington, DC. © World Bank.
https://openknowledge.worldbank.org/handle/10986/23800 License: CC BY 3.0
IGO. URI: http://hdl.handle.net/10986/23800

MTR Corporation. Business Overview 2015. https://www.mtr.com.hk/ar-

chive/corporate/en/publications/images/business_overview_e.pdf

MTR Corporation. Annual Reports (for the period of 2001 to 2015).

Rand, C., and Murakami, J. (2008). Rail + Property Development: A Model of

Sustainable Transit Finance and Urbanism. UC Berkeley Center for Future Ur-
ban Transport. http://www.its.berkeley.edu/publica-
tions/UCB/2008/VWP/UCB-ITS-VWP-2008-5.pdf

Suzuki, H., Murakami, J., Hong, Y., and Tamayose, B. (2015). Financing Transit-
Oriented Development with Land Values. Washington DC: World Bank Group.

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