Sleepless in Hong Kong: CY Leung’s property headache

Why is the Hong Kong property market important to Leung Chun-ying, who took office as the third chief executive of Hong Kong on July 1? It is because the government is the biggest landowner in Hong Kong. It gets 25% to 30% of its budget from land and land-related revenues, including stamp duties. If you were being cheeky, you would call the Hong Kong government Asia’s biggest property company.

Hong Kong property has been on an upward trend for the past eight years (since the Sars epidemic in 2003). Prices have risen at a 14% annual rate, greater than the 5% return from the Hang Seng Index.

Given that property is a major store of wealth for Hong Kongers, what Leung thinks about property may affect their net worth. As for those who don’t own property, rent is the biggest monthly expense for most. Again, what the chief executive thinks and (more important) does, with regard to property, matters.

So, what is the status of the property market that he has inherited? In a nutshell, the local market is still blown about by both external and internal macro factors, with a war of attrition as positive and negative sentiments clash.

Low interest rates make buying flats affordable for many. And earlier this year, Hong Kong tipped to a buyer’s market in certain neighbourhoods and price ranges. That was thanks to negative perceptions ranging from reduced transaction levels, weaker global economic activity and declining liquidity flows from China as the country undergoes a period of relative economic weakness. Plus, the prospect of future mortgage rate rises as interest rates ultimately move upwards, which the Federal Reserve has targeted tentatively for 2014, prompted people to want to buy now.

“Hong Kong is still driven by the peg,” Peter Churchouse of Portwood Capital said. “There’s a conflict where there is a total freedom of capital flows and a free economy, but a currency and interest rate environment that is pegged. Hong Kong is at the mercy of the peg. We have seen lots of mismatches in the past 25 years.”

The point he is making is that Hong Kong should be tightening its interest rates given the economic environment, but because of the monetary regime, it can’t do so. When the US picks up and increases interest rates, Hong Kong property may take a nosedive, and it won’t be able to do anything about it through interest rates, however inopportune the Fed’s timing is.

The master plan
Hong Kong’s former chief executive Donald Tsang, in his final policy address late last year, set a long-term target of 40,000 residential units per year. That number includes 20,000 private properties, plus 15,000 public rental houses and 5,000 units under the Home Ownership Scheme. In recent years the average has been about 13,000 new flats per year, compared to 24,000 a year during the nineties.

There have been government measures to curb speculation, such as a maximum loan-to-value ratio of 50% for flats sold for more than HK$10 million ($1.3 million), which did have a dampening effect, with luxury home prices falling 2.1% during the first quarter, and there have been administrative rules on stamp duty and re-selling. All of these measures may (and probably will) be reversed one day, which should serve to mitigate the effect of rising interest rates.

Combined with global economic uncertainty, these factors conspired to tilt the Hong Kong residential property market in favour of the buyer. However, that has since changed, thanks to the stimulus pumped into the system from the European Central Bank, the effects of which found its way to Asia.

That is because Hong Kong is addicted to the fumes from Western spending as much as Europe and the US. Since then, the residential market has been resilient and prices have remained strong.

What might Leung think about all this? He has gone on the record as saying that, while recognising the affordability gap, government policies should not strive to bring down or destabilise prices, but rather to provide homes for sale at subsidised prices to middle- and low-income earners — and he has reiterated his promise to build more subsidised flats since taking office. (Let’s not forget that Leung devised a plan to build 85,000 public housing units a year during Tung Chee-hwa’s tenure.)

He has also said that Hong Kong is not short of land, but lacks the proper planning to use it correctly. Before the election, he suggested setting up a strategic development committee to coordinate land development strategies to ensure a steady supply. He has said that land with supporting infrastructure, such as vacant government sites and in industrial areas, is ready for short-term development.

Furthermore, he wants to set up an arbitration system to resolve differences regarding land-use modifications. That would mean that privately owned land could be readied for redevelopment more quickly. And he wants to restart land reclamation plans for northern Lantau and the Tsuen Wan area.

Seeking to burnish his populist credentials, Leung has mostly commented on residential property. However, parallel drivers and striking supply-demand mismatches also apply in other sectors.

Colliers International’s Retail Market Research and Forecast Report finds that the average ground-floor retail property rent increased 5.3% quarter-on quarter in the first quarter of 2012 in Hong Kong’s key shopping districts of Central, Causeway Bay, Tsim Sha Tsui and Mong Kok.

Keep in mind that the 5.3% rent hike is an increase from a 3.7% rise in the previous quarter. The increase was down to the fact that newcomers outbid either one another or existing tenants in order to secure the best spaces in prime locations. In turn, local retailers have been compelled to find space in second-tier retail streets, putting upward price pressure on that real estate as well.

During the next 12 months, Colliers projects that retail rents will increase by another 12%.

Retail therapy
“Prime ground-floor retail units are extremely limited in supply while popular shopping malls are at 100% occupancy,” said Helen Mak, director of retail services at Colliers International Hong Kong, “After hitting multiple dead ends, some retailers start to lose patience when they realise their plans aren’t materialising even after waiting for one or two years. Some individual retailers, who originally planned to first establish their base in Hong Kong, have instead skipped the territory and opened their first flagship stores in China.”

The Hong Kong Tourism Board projects a 5.5% increase in tourists this year to 44 million. That might be a modest projection given there was a 21% increase in incoming Chinese tourists alone in the first quarter of 2012 to 8.2 million visitors.

“Tourism to Hong Kong has doubled in recent years, but there is not much new retail supply. Take for example shopping malls. There have been no new ones built in Hong Kong in recent years. What shopping malls there are have been refitted,” said George Hongchoy, the executive director and chief executive officer of Link Management, which manages the Link Real Estate Investment Trust.

That said, projects such as the Link Reit’s Stanley Plaza renovation have revitalised neighbourhoods, undoubtedly pushing up property prices in Stanley.

Scandalous
It is almost impossible to underestimate the extent of the relationship between real estate and government in Hong Kong. Government officials’ connections to property scandals are fairly frequent, as when Thomas and Raymond Kwok of Sun Hung Kai Properties were detained along with Rafael Hui, ex-head of Hong Kong’s civil service, in one of Hong Kong’s most startling stories for many years.

Leung has also had his flirtation with political property scandal — he was the former managing director of property services firm DTZ, which was an adviser to an entrant in a contest to design the West Kowloon Arts Project a decade ago.

This was a major project (though it remains unresolved and unbuilt). Leung was a judge in the contest and failed to declare the conflict of interest, claiming that he was unaware of DTZ’s involvement in the bidding process. He received criticism for this omission — but still won the election handily.

However, he may still find that Hong Kong’s property market is a cause of sleepless nights during his time in government house.

This article first appeared in the July issue of FinanceAsia magazine.