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The Property Market in Hong Kong

With acknowledgements to Dr.Vincent Mok

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The Property Sector in HK : Theory & PracticeThe Property Sector in HK : Theory & Practice

General concepts of property & property market

Characteristics of property:-

•durability

•depreciation: a flow of housing services

•a productive asset: combine with capital & labor, for ultimate satisfaction

•Property is a real asset: a purchase of a property is not a consumption, it is an investment.

Property is a heterogeneous asset with many attributes:-

Size, location, quality, neighborhood quality, accessibility.

27 Jan 2003

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Property & rental market

rental income is a flow while an asset is a stock.

Rents --> asset price (ceteris paribus)

rental

investor return

end-user cost

For an investorexpected rate of return against risk

annual rental revenuerate of rental revenue, R/H = -----------------------------------

market value of property

e.g. SCMP today asking price $6.7m, monthly rental =$32,000.

R/H = (32,000 x 12)/6.7m = 5.7%

In principle, R/H => asset value.higher higher

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An important factor is interest rate (i.e. the mortgage rate, i)

Basic principle for property investment:

where E(h) is the expected rate of asset appreciation

e.g. In March 2003, i (prime rate)=_5%, R/H =5.7%,

to induce an investor to enter the property market =>

the expected rate of asset appreciation has to be > - 0.7 %

R/H > i - E(h)

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Equilibrium condition: R/H = i - E(h)

If R/H < i - E(h), capital will flow out from property market and vice versa (accounting for risk & liquidity premium of different types of investment)

In a dynamic situation, both i & expectation are not fixed.

Interest rate

If i increases to i1,

=> the market mechanism adjusts the property prices downward relative to the rental incomes to restore an equilibrium.

Market sentiment

Both ________and _________market sentiment always exist simultaneously in the market, usually with different strength.

R/H < i - E(h)

capital flows out from the property market,

bearish bullish

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E.g. In July 1991, the announcement of the Memorandum of Understanding between the UK and China on the New Airport triggered a bullish market sentiment in the property market.

R/H > i - E(h)

E(h) => attractiveness in property investment

=> property value => R/H until equilibrium is restored.

---------------------------------------------------------

To cater for an inflation ( ), i has to be adjusted to i*

where i* = i-

e.g., in Jan 2003,

=> i* = i -

= -3.5%, i=5%

= 5-(-3.5) = 8.5%

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Today’s Example

If the rental asked is market value – allow about 5% for bargaining - $30,000

What is expected asset appreciation at the moment? -10%?

In that case : 360,000/ H = 5 –(-10%) = 15% Equilibrium H = $2.4m not the $6.7m asked

Don’t panic! That assumes the asset depreciation is forever

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Same Example

But we can make it worse! The interest rate should be adjusted for the

general rate of inflation/deflation Real interest rates are currently about 8.5% In that case :

360,000/ H = 8.5 –(-10%) = 18.5% Equilibrium H = $1.94m

Don’t panic! That still assumes the asset depreciation is forever

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Same Example

Some more realistic scenarios Asset depreciation of zero long term In that case :

360,000/ H = 8.5% Equilibrium H = $4.2m

Asset appreciation of 2% long term 360,000/H = 8.5% - 2% = 6.5% Equilibrium H = $5.5m

Asset appreciation of 5% long term Equilibrium H = $7.2m

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Population

Income

Demand for accommodation

Stock of housing

Supply of housing

Rents

Expected inflation

Interest rate

Other factors

R/H

Rate of return

Demand for property

Propertyprices

The Working Mechanism of Property Market

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Significance of the property market in Hong Kong“Property market is the pillar of the Hong Kong economy.”

OR IS IT? IT CONTRIBUTES TO NATIONAL INCOME THROUGH THE OUTPUT OF THE CONSTRUCTION SECTOR AND THE VALUE OF ACCOMMODATION SERVICESource of government revenueLand sales: 15% (23% in 1997-98)Stamp duty: 5% (11% in 1997-98)

Around 40% of the total loans of the banking sector were lent to the property sector

Hong Kong Property Market : Issues and ProspectsHong Kong Property Market : Issues and Prospects

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Major factors affecting the Hong Kong Housing Market:Major factors affecting the Hong Kong Housing Market:

(1) Economic factor

(A) Interest rate:

• During Asian Financial Crisis: 9.5% in October 1997 to 12% in late 1998.

• Current prime rate: 5% in Jan 2003

•Interest rate : still has long term effect to the housing market, especially to the affordability of the home-buyers

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Interest Rate, Inflation Rate and Housing Price (1985 - 2001)

1985 19871986 19891988 19901991 199419931992 19951996199719980

2

4

6

8

10

12

14

% Price (HK$/per sq. ft)

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

Year

Best Lending Rate (%)

Inflation Rate (%) Housing Price (HK$/ per sq. ft)

2001

34005.5

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(1) Economic factor(B) IncomeAffordability ratio

monthly mortgage payment= ----------------------------------------------

median family income

•small size flats (e.q. 400 sq. ft.)

•70% mortgage

•repayment period = 15 years

Defects of the ratio:•salary does not always represent the total incomes of a family (incomes from investment)

•the possession of a property is an investment; part of the mortgage payment is for the principle => a form of saving

•the ratio reflects the domestic purchasing power; overseas buyers with large capital are neglected.

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Affordability Ratio

Jan

- 9

3M

ay -

93

Sep

- 9

3Ja

n -

94

May

- 9

4S

ep -

94

Jan

- 9

5M

ay -

95

Sep

- 9

5Ja

n -

96

May

- 9

6S

ep -

96

Jan

- 9

7M

ay -

97

Sep

- 9

7Ja

n -

98

May

- 9

8S

ep -

98

Jan

- 9

9M

ay -

99

Sep

- 9

9Ja

n -

00

30

50

60

80

70

40

AR at 60

AR at 45

Price

mid

- 0

1

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(1) Economic factor

(C) Mortgage Lending Policies

• Since Nov 91, banks: limit the lending ceiling to 70% of property value

• Banks control the mortgage repayment to household income ratio (usually 50%) to minimize their risk

Behaviour of banks

Banks: do not play the role in stabilizing the property market nor in combating speculative activities.

•Actually, loan default/delinquency rate was very low (1-2%) in HK compared with US (2.84-3.46%).

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(2) Government Policies

(A) Background (before 1997)

• The Shek Kip Mei fires of 1953 led to a massive public housing programme.

•Public housing policies: approximately 52% of population in public housing, and 48% in private housing. HK Housing Authority is the largest developer in HK.

•Sino-British Joint Declaration: before 1997, not more than 50 hectares per annum to be supplied.

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(2) Government Policies

( (B) After 1997

The government first set the annual target of 85,000 flats, claiming that this would not have an effect on ‘other parts of the housing market’

Then the policy was dropped (without announcement).

Population growth seriously over-estimated

Now determined to restrict the supply and tried not to enter into direct competition in the market.

Housing Authority future in doubt.

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Future Prospects:Future Prospects:

SUPPLY:

• In the 90s: average private housing supply = 25,000 - 30,000 units of flats.

• Recent supply: new units plus unsold units = about 50,000 units.

•A significant ‘over-hang’ in the market, creating expectations of further decline

•Border opening may reduce prices further, especially in Northern NT.

DEMAND:

• Population Growth : annual growth = 1.77%, 110,000 people per year.

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Home buyers characteristics:

a) first-time buyers

b) Healthy affordability: around 40%

c) Speculation activities are negligible

d) Investors: consider rate of rental revenue.

However, the upward filtering activities are currently declining. The reasons are:

Negative equity problem remains serious (about 10% of privately-owned units) --> upgrading demand in housing market is greatly reduced.

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Comparison of Economic and Market Factors Between 2Q/97 and 3Q/01

Comparison of Economic and Market Factors Between 2Q/97 and 3Q/01

2Q/97 3Q/98 3Q/01

Mass Residential price (HK$/sq.ft.) 8,200 4,600 3,400

Affordability ratio 76% 50% 40%

Prime lending rate 9.50% 9.75% 5.5%annualised inflation 5.60% 2.50% -4%

annualised GDP Growth 6.9% -5.2% 0%

unemployment rate 2.20% 5% 4.9%

unemployment rate trend declining rising rising

interest rate trend rising stable/declining

declining

residential supply vs historical average(average: 25,800)

below(18,200)

below(24,790)

above(26,100)

typical flat-buyers speculators end-users end-users

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Current Economic Condition:Current Economic Condition:

•high unemployment rate ( ____ in late 2002)

• slight economic growth

• reduction in household income

• high real lending rates (in Jan 2003)

= lending rate - inflation rate

= 5-(-3.5) = 8.5%

•Limited number of buyers

•No sign of the return of bull market (like the year of 1997) mostly due to the sluggish economic environment.

7.2%

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Changes in property price affect two major parts of an economyPrivate consumptionPrivate investmentVia wealth and balance sheet effects

[I] Property price and consumption

(A) Wealth effect

Reasons: consumption depends on households’ lifetime financial resources

Hence: PP drops - -> lifetime financial resources drop - -> so does consumption

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Furthermore: consider the behavior of future home buyers and home owners(1) PP increases a –ve effect on consumption by future home buyersReason: they need to save more to meet an increase in down-payment(2) PP increases an increase in wealthCondition: depends on convertibility of housing wealth into consumptionRealize K gains by trading down & exiting home-owner sector depends on how mature is the secondary mktVia secondary mortgage depends on how mature is the financial sector.

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(B) Balance sheet effect

Two important implications:

(1) For strong balance sheets, i.e. low leverage and strong cash flows less influence by decline in asset prices

(2) Magnification effects through the function of financial intermediaries

Assets price drops -ve effects on households and banks’ balance sheets credit crunch

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Case of HK:(1) Home owner ratio = 35-40% in HK and 70% in the US & the UK Implication: effects of PP change are less

volatile in HK than in the US & the UK

(2) More mature secondary property market and financial market in HK

(3) Widespread use of property as collaterals in HK

(4) After 1998: -ve equity homeowners respond to it by increasing their savings (consumption drops) to help repair their balance sheets

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HK: Period under investigation, 1984-2000PCE = 0.015 +0.598GDP +0.024RHSI + 0.1RPP – 0.657NQ

PCE=% change in private consumptionGDP= “ “ real GDPRHSI= “ “ real stock market priceRPP= “ “ real property pricesNQ= “ “ share of total household facing

-ve equityResults:(1) Changes in PP have large effects on consumption when

compared with changes in stock pricesOther evidence: US (1982-1999) and a group of 14

developed economies (1975-1999) (Ref: Case et al (2001))

(2) A 10% drop in property prices would decrease consumption by 1% when compared with about 1/4% for the same extent in stock price

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[II] Property price and investmentChanges in PP can influence investment mainly via two

channels(1) PP increase lowers the cost of new construction

relative to acquisition of existing buildings(2) PP increase improves balance sheets of firms

and banks encourages banks to increase creditsExperience of other countries: PP have a more

significant effects on investment in Europe and Japan than in the US & UK partly because of the more widespread use of property collateral against loan

HK exp: a fall in PP by 1% will reduce property-related private investment by almost 0.4%

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References:(1) Hong Kong Monetary Authority (2001) “The

Property Market and The Macro-Economy”, Quarterly Bulletin, May, pp.40-49.

(2) Case, K., Quigley, J. and Shiller, R. (2001) “Comparing Wealth Effects: The Stock Market Versus the Housing Market”, National Bureau of Economic Research Working Paper Series, Working Paper 8606.

(www.nber.org/papers/w8606)

Note: You do not have to care for the econometric models in the papers. Instead, you have to make yourselves clear about the theory and the results of the empirical studies.