All clear on HK bubble risk, but mainland faces slump

PUBLISHED : Friday, 09 July, 2010, 12:00am
UPDATED : Friday, 09 July, 2010, 12:00am

Last November, the International Monetary Fund warned that Hong Kong was in grave danger. 'A credit-asset price cycle could take hold, leading to a sharp run-up in prices for certain real and financial assets,' the fund's analysts wrote in their annual health check on the city's economy.

In plain language, they were worried that a bubble was developing in the property market.

With liquidity flooding into Hong Kong's financial system thanks to ultra-low interest rates in developed markets, the IMF feared that the easy availability of cheap credit would push up property prices. In turn, the run-up in prices would then prompt more and more people to take out mortgages and jump on the real estate band wagon in what the fund believed could soon become a runaway momentum-driven repeat of the city's 1997 property market frenzy.

A month later, the IMF repeated its warning, calling on Hong Kong's government to adopt 'countercyclical regulatory action to mitigate the asset price cycle'. In other words, it thought the government should try and pop the perceived bubble.

Today, eight months after it first sounded the alarm, the IMF is no longer concerned that a bubble is inflating in Hong Kong.

That might seem a little strange considering that residential property prices have climbed by 10 per cent in the meantime to hit their highest level since December 1997.

But at the release in Hong Kong yesterday of the IMF's Global Financial Stability Report, its financial counsellor, Jose Vinals, played down the risk of a local real estate bubble, saying: 'There has been a cooling off of tensions in the property market.'

There are three possible reasons for this change of heart. No doubt the Hong Kong government would like to claim the credit for successfully preventing a bubble, after it raised the required downpayments for mortgages on expensive flats and announced it would increase the supply of building land.

In reality, however, the government's measures had little direct effect on prices. The run-up in prices at the top end of the market was driven largely by cashed-up mainland investors with no need for local mortgages, so the government's increase in required downpayments had little impact. Meanwhile, its moves to increase land supply would have taken years to affect the supply of new flats reaching the market.

The second reason for an easing of property price pressures - a decrease in excess liquidity because of tighter credit supervision on the mainland coupled with a drop in risk appetite following Europe's debt crisis - makes more sense. With less easy money around, and with more uncertainty in the financial markets, potential buyers have taken a wait-and-see attitude and held back from taking the plunge.

But perhaps the most likely reason of all for the IMF's change of stance is that there never was all that much risk of a dangerous 1997-style credit-fuelled property bubble in Hong Kong in the first place.

Contrary to common belief, local homebuyers tend to be a cautious lot, sensibly wary of excessive leverage. Even before the government raised the required downpayments on top-end flats, average loan to value ratios were just 64 per cent, well below the permitted maximum. Hong Kong banks are pretty risk averse too these days, with low loan-to-deposit ratios and mortgage credit procedures that are considered tight by international standards.

As a result there never were any signs of a credit-powered speculative property buying binge. Transaction volumes stayed modest, housing affordability remained low by historical standards despite the rise in prices, and the number of home buyers flipping their properties back to the market for a quick profit was negligible.

So if the IMF is now downplaying the threat posed by a property bubble, it might just be that the danger was never really there.

Concern about a bubble in Hong Kong's property market may be abating, but fears of a bust in mainland house prices continue to run high.

How much prices could fall following recent government tightening measures is anyone's guess. But if you want a guide, Spanish bank BBVA, in conjunction with Citic Bank, has attempted to work out just how overpriced home prices have got on the mainland.

Using a model based on factors including the existing housing stock, population density, growth in incomes, interest rates and construction costs, BBVA analysts have calculated theoretical equilibrium prices for housing in different cities.

They conclude that the most overpriced city is Shanghai, where prices have overshot their equilibrium level by more than 30 per cent. Tianjin and Beijing are close behind (see the first chart), while home prices in Guangzhou are pretty much spot on fair value.

Reverting to equilibrium value would mean an average fall in prices of 21.5 per cent or, alternatively, six years of stagnation to allow the equilibrium price to catch up with the market. BBVA admits there are flaws in its model, which doesn't allow for expectations of future gains. Even so, the outlook for investors is daunting.