• Tue
  • Sep 2, 2014
  • Updated: 12:39pm

Developers' profit warning shot down

PUBLISHED : Wednesday, 25 July, 2012, 12:00am
UPDATED : Wednesday, 25 July, 2012, 12:00am

Property tycoon Lee Shau-kee last week raised a red flag over concerns that the profit margins of Hong Kong property developers were being threatened by rising construction costs and increased land supply.

But analysts, who say that developers have enjoyed soaring revenues and returns of up to 40 per cent over the past five years, see rises in property prices continuing to outstrip construction costs.

Lee, who is the chairman of Henderson Land Development, warned last week that construction costs were becoming so high that developers would find it increasingly difficult to sustain their profit results.

Data compiled by Centaline Property Agency shows that total sales value in the secondary property market surged to HK$1.59 trillion in the five years to June 30 this year. That was 120 per cent higher than the previous five years, and 130 per cent higher than that registered in the first five years following the city's return to China.

A survey by property consultants Jones Lang LaSalle showed that prices in the mass property market rose by 9.3 per cent in the first half of the year, while a report by surveying firm Davis Langdon & Seah showed that construction costs were up by 7.7 per cent on a year ago (see sidebar) - which suggests that so far developers have been able to maintain their margins, as prices have grown faster than construction costs.

Nicole Wong, regional head of property research at CLSA Asia-Pacific Markets, said that if it was true that developers couldn't make a profit, they wouldn't acquire sites.

'When the property market is booming, developers are able to raise their selling prices sufficiently to cover increased construction costs,' she said. 'If the market is poor, they have to cut their prices.'

Based on existing property prices, developers could still generate profit margins of about 25 per cent from new sites, Wong said, but they were targeting margins of as high as 35 per cent to factor in increased economic and policy risks.

Eva Lee, head of Hong Kong and China property research for Swiss investment bank UBS, said Chief Executive Leung Chun-ying would not tolerate 'drastic' rises in flat prices, but this would likely serve only to reduce developer profit margins to 'normal' levels from the returns of up to 40 per cent at which some were previously operating.

Not only construction costs, but land price, interest rates and selling price determine profit margins, said Paul Louie, at Nomura Equity Research. So when construction costs rise, developers could maintain their profit margins by, for example, lowering their land costs. This is shown by the less aggressive bids from developers in recent land sales, he said.

'Unless a developer is very bearish about the market, it will not depart away from their target to achieve a profit margin of about 20 per cent,' Louie said.

Joyce Kwock, an analyst at Swiss investment bank Credit Suisse, said that if apartment prices in the project to be built on the former North Point Estate site were pitched at HK$16,000 per square foot, a 10 per cent premium on prices in nearby residential estates, this would cover construction costs of about HK$2,500 per sq ft and generate a profit margin of 26 per cent.

But Eric Yuen Chi-fung, head of research at brokerage house GuocoCapital, said Lee's remarks implied that he did not see room for home prices to rise significantly in the near future. Developer margins were highly related to flat prices, he said, and margins generated on new projects might become lower because home prices had been climbing for the last 10 years and could not keep rising significantly forever.

But even were margins to fall, overall profits for developers could be maintained because they could increase the number of flats they sold, he said. Also, up to one half of developers' incomes came from rental properties, which were a stable source of revenue.

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