The link between H-share IPOs and Hong Kong property prices
If you want to know what's going to happen to Hong Kong property prices in 2011, keep a close eye on how much money mainland companies raise in initial public offerings on the city's stock exchange.
That might sound screwy at first. After all everyone knows why Hong Kong property prices are ending 2010 up 20 per cent on the year (please see the first chart below).
And it's got nothing to do with how mainland shares have performed on the local stock market. At yesterday's close the H-share index was down by a lamentable 3.8 per cent since the beginning of the year.
No, as anyone can tell you, Hong Kong property prices have risen so steeply for a straightforward combination of reasons.
First of all, new flats are in short supply. That's partly because the government has drip-fed the market with limited lots of building land over recent years in order to keep prices up.
Officials like high prices because they bump up the government's revenues from stamp duty on secondary market transactions, and because they enable it to subsidise the development of new rail lines by doling out development land to the MTRC.
But supplies of new housing are also short because the city's developers have hardly rushed to bring new flats to the market. From their point of view, a trickle of new homes keeps their margins at 30 per cent or more while supporting the value of their land banks.
As a result, the number of new flats completed over the last three years has averaged between 7,000 and 8,000 a year, or just over half the government's estimates of the city's demand.
Coupled with short supply, we have rock-bottom mortgage rates. Thanks to our currency peg and the Federal Reserve's ultra-low interest rate policy, mortgages can be had in Hong Kong for as little as 2 to 2.5 per cent a year.
With deposit rates now negative in real, inflation-adjusted terms, that makes property investment a highly attractive alternative to leaving your money in the bank.
What's more, despite recent price increases, Hong Kong property remains affordable by historical standards. Although people who are inclined to see bubbles like to point out that the average home price is now more than 12 times the city's median household income - roughly the same as at the height of the 1997 property boom - they are looking at the wrong indicator.
What they should be looking at is the ratio of monthly mortgage payments to household income, which currently stands at 40 per cent, below its long term average of 49 per cent and well below the levels of 100 per cent or more reached at the height of the 1997 boom.
So with housing supply short, mortgage rates at next to nothing, and buying a home relatively cheap by Hong Kong standards, perhaps the only surprising thing about 2010's run-up in property prices was that it wasn't even greater. Certainly there is no need to invoke any link with mainland share issues on the stock market to explain the gains.
Yet according to Charles Leung Ka-yui and Edward Tang Chi-ho of the City University of Hong Kong there is a link. They have crunched the numbers and concluded that H-share IPO activity is partially responsible for driving Hong Kong's residential property prices (though IPO activity by Hong Kong companies has no effect).
Certainly there does appear to be a correlation between overall IPO funds raised and the performance of the Hong Kong property prices (see the second chart). But as Leung and Tang admit, the exact nature of the relationship between H-share IPOs and Hong Kong flat prices is 'puzzling'.
They suggest the link is the result of 'animal spirits'. The volume of mainland IPOs coming to the Hong Kong market is a broad indicator of the mainland's economic vigour.
As a result, the more H-share IPOs there are, the more confident Hong Kong's homebuyers will feel, and the more eager they will be to jump into the market.
Monitor could suggest a more direct reason: that mainland company bosses siphon off a portion of the funds raised by their H-share IPOs straight into the Hong Kong property market as an enticing alternative to repatriating the money to invest in their core business at home.
Either way, with analysts forecasting another record-breaking year for Hong Kong IPOs, property prices look set for more gains in 2011.