Hong Kong property: time to buy or bail?

Like so many things in Hong Kong, be it the stock market or the dating scene, the city’s property market has a speculative feel to it, seemingly dominated by players who are out for a quick punt rather than with the intention to buy-and-hold. And, for those who live in Hong Kong, expensive rents and spiralling property prices are simply a part of life in the city, much like the smog.

But with job prospects within the financial industry looking gloomy (the best gauge of this being the growing number of bankers that have decided to “retire”) and growth in Asia slowing down, one would expect property prices to start falling. However, contrary to expectations, they have only been heading north.

The Centa-City Leading Index, which tracks home prices in Hong Kong, hit a record high of 106.5 at the end of July. Property prices have already surpassed the peak of 1997 and the market has touched new heights. Will investors get burnt? Is now the time to bail? Some say it could be, or at least that those who are looking to buy should tread carefully.

“We are cautious on the market,” said Christopher Lee, managing director of corporate ratings at Standard & Poor’s. “We have seen property prices rise 100% in the last two to three years and have surpassed the 1997 peak. Affordability is low.”

Amid a low rate environment, investors are scouring the market for places to park their money to beat the miserly deposit rates. Many are turning to the property market, which has traditionally been viewed as a hedge against inflation. But that cycle could turn.

“Low interest rates are supporting property demand,” said Lee. “Also, Hong Kong is an open economy and has good rule of law, and property is seen as a safe harbour, so we are seeing capital searching for real assets and parking their money here. Such money is fickle and could leave very quickly.”

Lee adds that the property market is divided into two segments: luxury and mass market. Foreign buyers provide most of the demand for luxury properties, which means that price movements are largely unrelated to the local Hong Kong economy. In the mass market, however, local household incomes have not kept pace with the steep rise in property prices.

He warns that this segment is most vulnerable to a sharp correction in property prices, particularly since the affordability of homes in Hong Kong is so low. “The cost of a typical home is 20 times the median household income in Hong Kong, compared to less than 10 times in other developed markets,” said Lee. “If there is a major market correction, the mass market has less ability to absorb [it].”

Year-to-date, home prices have risen by some 11.6%, to the surprise of many analysts. However, Paul Louie, Nomura’s regional head of property research for Asia outside Japan, argues that Hong Kong is not in the midst of a property bubble and that the recent gains are not driven by irrational exuberance.

“We think the year-to-date gains are fairly healthy for two reasons: It has been driven by underlying rental growth. Centaline housing rentals have gone up by 8.5% so far this year,” said Louie.

“When rentals keep up with the rise in property prices, it is a healthy signal,” he added. “You don’t want to see rents stagnate while property prices move upwards. Also, the gains have been driven by local end users. Foreign or mainland buyers have not been as active.”

Louie is projecting more moderate property price gains of 5% to 6% during the coming 18 months.

In his view, prices have risen due to a lack of supply. Since prices bottomed out in 2003, the supply of new homes has simply not kept up with demand and prices have spiked as a result. And, while job cuts have hit the city’s financial industry, many laid-off workers are still choosing to stay in Hong Kong — presumably because the prospects are even bleaker in the US or Europe.

“Although the job market may not be good, people still need a place to live,” said Louie. “While the challenges for the financial sector are real, the high-income earners are still choosing to remain in Hong Kong. As a result, we have seen softness at the top end, but as demand cascades downwards, this has increased prices in the middle segment.”

Recent government policy measures have also had unintended consequences. For instance, the special stamp duty tax that was introduced in November 2010 — intended to curb speculators — resulted in a 30% fall in property transaction volume, and also reduced liquidity in the market.

“The stamp duty helped to curb speculation but there were also fewer properties available for sale, as many were in the hands of end users that are not willing to sell,” Louie added.

He maintains the view that Hong Kong’s property is not in the midst of a bubble. “Back in the 1990s, people were taking on a mortgage and paying 9% for an asset that was yielding 4.5%-5%. That was not rational. In the current situation, people are taking on a 2% mortgage for an asset that is yielding 3.5%. As with most cycles, they do go into a bubble at some point, but I think for now, most people are behaving rationally and not using excess leverage.”

Still, buyer beware. Nothing good or bad lasts for very long. Interest rates won’t stay low indefinitely, stocks won’t keep rising forever and neither will property prices. As with dating and the stock market, timing, as they say, is everything.