HK: still high rise?

While the recent rise in interest rates has hardly dulled optimism about Hong Kong’s property market, some of the initial buying frenzy back in the spring has gone. Alexandra Harney reports

In February, Franklin Lam stood before a packed crowd in Hong Kong’s tallest office building and made a startling prediction. The city’s residential property prices would rise 45% over the next year, said the head of UBS’ Hong Kong equities business, leading to a 90% rise between 2004 and 2006. Prices for office space in the Central business district would soar 85% by next year.

Within a couple months, thousands of people a day were touring a swanky showroom for a luxury waterfront property development known as The Arch. One British-Chinese businessman set a new Hong Kong record by paying HK$168m, or HK$31,300 a square foot, for a seven-bedroom, 5,300 sq ft penthouse in the project owned by local developer Sun Hung Kai.

Hong Kong, a city addicted to shopping for assets of all kinds, was back in its groove. Many agreed with Lam’s view that the 35% increase in prices in 2004 was only the beginning of a robust recovery in property values. Speculative investors began pouring in from around the world.

But it was not to last. On 18 May, the Hong Kong Monetary Authority (HKMA) surprised investors by introducing a ceiling on the amount the Hong Kong dollar could rise to discourage speculators who were using its currency as a proxy for the renminbi. (The Hong Kong dollar has been pegged to the US dollar since 1983.) Investors’ expectations of a revaluation of the Chinese currency were rising, and Hong Kong dollar-denominated assets were benefiting as a result.

Joseph Yam, chief executive of the HKMA, had had enough. “You don't need to make use of the Hong Kong dollar as a speculative tool for betting” on appreciation of the renminbi, he told reporters that evening.

Hong Kong banks responded by lifting interest rates. The effective mortgage rate is now about 4.75%, up from as little as 2.2% earlier this year, according to Buggle Lau, chief analyst at Midland Realty in Hong Kong.

Slowdown

Daunted by the higher lending rates, some buyers pulled back. The number of transactions in the secondary market (pre-owned homes, which comprise most of the market) slowed from 13,300 in March to 6,450 in June. The gap between the prices of primary and secondary properties narrowed as well, from about 40% to 25%-30%, Lau says.

“Although the market has gone relatively quiet due to the interest rate issue since April, and that overall mass residential price movement as seen from the index seems to be flat over the period from April to July, there were in fact some properties of better quality still seeing upward price movement, while prices for some relatively lower quality properties had downward pressure,” says Kenneth Tsang, head of research for Greater China at Jones Lang LaSalle. He estimates that property prices rose 14% over the first seven months of this year.

Midland’s Lau and others attribute the price increases over the past two years to a shortage of supply. Developers, facing the prospect of a shortage of land, have been pacing their release of new properties to the public. “We do not see how property prices can replicate the increase of last year and we don’t think that’s what the Government wants,” says Lau.

The Hong Kong Government confirms this. Henry Tang, the financial secretary, pointed out in an interview: “Asset prices are 45% below peak, but rental [prices are] only 38% below peak in 1997.”

“We want to keep a very close watch on it to ensure that the bubble is not growing unreasonably and housing continues to be affordable,” he said, adding that he was not “unduly worried” that prices were rising uncontrollably.

Hong Kong knows a few things about property bubbles. Property prices skyrocketed as the city approached the 1997 handover from British to Chinese sovereignty. Housewives spent their weekends touring property developments the way women elsewhere did their grocery shopping. Investors “flipped” properties - sold them immediately after purchase. Mortgage rates leapt as high as 8%.

The Asian financial crisis of 1997-98 changed all that. Prices fell some 70% from their 1997 peak during the 2003 outbreak of severe acute respiratory syndrome (SARS).

The property market’s decline took a heavy toll on the city’s economy and self confidence. Many Hong Kong families put their wealth into their homes and, for the first time, many had negative equity - when the mortgage exceeds the value of the property itself. The Hong Kong Government, which shuns high taxes in favour of releasing pieces of land to developers to raise cash, faced a fiscal deficit after years of surplus.

Sustainable growth

However, analysts are confident that the market’s steady growth this year is sustainable. An influx of Mainland Chinese tourists has propped up consumer confidence, prices and wages are increasing. Unemployment fell to 5.7% between May and July.

As inflation continues to rise, Hong Kong’s real interest rates will remain relatively low. At the same time, the city’s closely-watched affordability ratio was about 41% as of the end of July, well below the 90% recorded in 1997, according to Tsang. Both Lau and Tsang expect prices to rise another 5% by the end of this year.

Others believe there is more room for growth next year. Amar Gill, head of Hong Kong research at CLSA, the brokerage, believes a shortage of supply of new units will keep upward pressure on prices.

Traditionally, the Hong Kong property market can absorb about 30,000 new units a year, according to Gill. But with only 20,000-22,000 units expected to come onto the market in 2005-06, and 15,000 units expected to be completed in 2007-08, “there is a serious supply crunch”, he says.

“Wages are rising, employment is rising, real interest rates are going down. We have to still be very positive on the property sector.” Gill foresees a 20%-25% rise in prices this year, followed by a 10%-15% increase in 2006.

Analysts and property owners will be watching the Government’s planned 27 September auction of three pieces of land carefully for signs of developers’ confidence in the market.

Developers, who need to replenish their reserve of land for future projects, are expected to bid high. The Government, which should profit handsomely from the auction, will need to continue to release land to the developers to prevent the shortage of supply pushing prices too high for ordinary people to afford.

In the meantime, there are ample reminders that Hong Kong property developers and agents are optimistic about future demand. Adverts for One Silver Sea, a new luxury development, line the walls of the city’s Central subway station. On the weekends, property agents line up outside large developments beneath colourful umbrellas offering tours of flats for sale.

That is good news for Hong Kong’s economy. The HKMA estimates that a 10% increase in property prices lifts annual growth in consumption by 1%.

Alexandra Harney is the South China correspondent for the Financial Times in Hong Kong.