Look before you leap
Alex Frew McMillan
Professional property investor Danny Lim isn't sure how much further Hong Kong's property rally has to go. Forecasters have been ripping up their predictions for the year ahead because the market keeps getting ahead of them, and all signs point to continued gains for the rest of this year.
But Lim is sure of one thing. 'We're nearer the top of the market than the bottom,' the founder of the property-fund manager The Creations Group, says. 'There are risks going forward.'
Ask any market watcher where Hong Kong property is heading, and you'll get replies that are remarkably similar. Up - for the foreseeable future. Demand is very strong thanks to low interest rates, rising wages and an economy forecast to grow at 4.7 per cent this year. Borrowing costs are the lowest on record. And supply is set to stay below average for the next couple of years.
But no game goes on forever. And the time to be suspicious is just when everyone seems to agree it's so fun to play. What happens when the music stops? And how can Hong Kongers protect themselves against the inevitable?
Homes in Hong Kong are more overvalued than anywhere else on earth, bar Australia, according to the latest house-price index from The Economist. Thanks to a 20 per cent gain last year, Hong Kong properties are now overvalued by 53 per cent, based on the ratio of prices to average rents. They're still rising rapidly in Hong Kong, too, suggesting the city may soon surpass the Wide Brown Land. Australia's property prices gained a less frenzied 5.8 per cent last year, and are overpriced by 56.4 per cent when compared with rents.
'I do think it is getting a bit toppy,' Tim Murphy, the managing director of the property-investment advisory company IP Global, says of Hong Kong. 'Unless you can find a deal in the New Territories or Kowloon, I would be very careful.'
Knowing that the Hong Kong market is nearer a peak in its property cycle than the low is all well and good. But how do you use the information?
After all, property looked expensive after strong run-ups in 2003 and 2009, after the end of Sars and the global financial crisis, respectively. But anyone who sold at the end of those years would have missed out on gains of more than 20 per cent in the following year as well.
While it's tempting to sell all of your property holdings and wait for a drop in the market, that's a dangerous game to play. Trying to time the market is beyond many property professionals, and probably isn't a good idea - for anyone. Even if you sell near a peak, there's no guarantee the market will drop significantly or within the time frame you need to reinvest. Rents are also currently expected to rise faster than home values.
'I think the risks are too great,' Lim says. 'The lay person is not in the field of buying or selling, so you most likely are going to make a mistake. And if prices continue to go up, you might be priced out of the market and not be able to buy what you sold in the first place.'
Murphy agrees that the 'horse trading' of apartments in Hong Kong is tempting, but a hard strategy to execute. Not only is the timing hard to pull off but there are costs involved.
'It's a bit of a myth really, that you jump out and jump back in later,' he says. 'By the time you pay all the fees, it's not worth it really.'
The rule of thumb is that owners need to hold a property for five years to be reasonably sure of making back transactional costs such as stamp duty, legal fees and the brokerage commission. Most owners may be sitting on decent gains now, given the rapid advances in the past two years, but it's questionable whether there will be a drop significant enough to cover the cost of re-buying.
'Unless you're making 20 per cent to 25 per cent on the property value, it's a false economy,' Murphy says. 'The only reason to do it is if you believe there's a big crash coming. But I just don't see it crashing by that amount.'
Unless you need the money, then, market watchers say there's little point to the idea of selling the home in which you live. Still, home owners are going to start feeling a bit of a pinch when interest rates begin to rise.
According to mortgage broker mReferral, the affordability ratio - the amount of their average monthly income that each household needs to spend every month to cover their mortgage payment - is currently running at 39.3 per cent in Hong Kong. That's a far cry from the peak of the property bubble in 1997, when virtually all of the average Hong Konger's income - 93% - was going to pay off property loans. But the affordability ratio is only so reasonable because interest rates are at record lows. The mortgage rate stood at just 0.89 per cent at the start of the year, a far cry from the 12.25 per cent mortgage holders were paying back in 1997.
'If you look at the existing ratio, you can tell it's not unhealthy at the moment - it's not a bubble,' Sharmaine Lau Yuen-yuen, mReferral's chief economic analyst, says. 'But the signs are more clear. We have to be more cautious that interest rates can go up this year.'
For Hong Kong, mortgage rates have averaged three to five per cent over the past decade or so, and it's reasonable to expect they'll soon revert to that mean. That would boost the interest portion of a mortgage repayment significantly - on a prime-based mortgage, an increase from the current 2.2 per cent effective rate to 3 per cent would boost the payment 7.6 per cent, or 17.6 per cent if rates rise to four per cent.
'What we suggest is that people should do a pressure test for themselves,' Lau says. 'They should evaluate what if the interest rate goes up two percentage points or even three,' using a mortgage calculator such as the one on mReferral's Web page (http://www.mreferral.com/english/calculator_main.html).
Lau says a debt-to-income ratio of 50 per cent or lower should be fine. Anything between 50 and 60 per cent is what she calls 'marginal,' and home owners should worry if their debt repayments account for more than 60 per cent of their income.
The affordability ratio could rise rapidly if interest rates increase at the same time home prices are also advancing. Buggle Lau, the chief economist analyst at the property brokerage Midland Realty, has run some numbers suggesting some alarming trends. Though the affordability ratio does stand at 39.3 per cent now, apartments are older, on average, in 2011 than they were in 1997, when the average Hong Kong home was 10.8 years old. The figure is 19.8 years today.
Comparing like with like pushes the affordability ratio closer to 60 per cent. Factor in an increase of three percentage points in interest rates and another 20 per cent increase in prices, and the affordability ratio would climb as high as 92.2 per cent.
Though Midland isn't saying prices are set to stall, the brokerage does worry that home buyers are being spoiled by such a sustained low interest rate. 'People have been enjoying this one to two per cent mortgage rate for too long,' Lau at Midland says. 'They don't have a sense of how it would impact on their monthly payment.'
Midland had been predicting an 11 per cent rise in property prices this year. But Lau says the brokerage withdrew the forecast because, after prices advanced five to six per cent in the first two months of this year alone, they were getting 'irrational.' Even if affordability shoots up, 'prices could go up because of panic buying,' Lau explains. 'With irrational exuberance, people ignore the fundamentals and prices go up.'
The government has also pledged to increase supply of new units to 30,000 to 40,000 units a year, including public housing. That's above the average absorption rate of the past 20 years of around 26,000 units.
Such a pledge could change the economic landscape significantly when the new supply starts to appear in three to four years - and harks back to the government's pledge in 1997 to bring 85,000 units onto the market each year, a promise that ended up crashing the market.
'We are worrying, 'What if the government does too much rather than too little?'' Lau notes. 'One should never underestimate the government's determination.'
Simon Lo Wing-fai, the head of research and advisory services at the brokerage Colliers International, agrees the new supply is a threat. The fortunes of the property market appear governed by interest rates for the next year or so, and unlike some who predict higher US rates this year, he doesn't see that happening until 2012.
Colliers also had to retract its initial forecast of around 10 per cent growth for this year, and Lo now says a more realistic number is 15 per cent to 20 per cent growth for 2011.
'It is very much dependent on the interest rate cycle,' Lo says. If the government's plan 'really happens, and the supply cycle coincides with a contraction in the global or local economy, then it will be a bad thing for the real estate market in Hong Kong.'
To Murphy, it's simple. Since rental yields are very low in Hong Kong, at three or four per cent, he would keep any properties that are easily servicing their debt. But he would also think about selling part of a portfolio to diversify overseas.
'Protecting yourself is not about overexposing yourself to any one property market,' he cautions. 'If you are holding a lot of assets here it wouldn't be a bad idea to liquidate some of them.'
Likewise, Lim is encouraged to diversify by the strong gains in Hong Kong. Though he doesn't recommend anyone selling their own home, he does advocate taking a little bit of property money off the table in Hong Kong.
'The best way to reduce your risk is to sell down some of your assets, and diversify out into other economies,' he says. His family has put property on the market in Hong Kong and Australia, where they're likely to yield strong currency gains, and is focusing on distressed first-world markets like the US.
Then again, the US levies long-term capital gains of 15 per cent - and short-term charges of 35 per cent for property sold within a year. Contrast that with capital-gains-free Hong Kong, and it probably only makes sense if you're able to identify properties as a long-term play, that also pay decent rental yields.
The problem of selling property at the peak of the market is that you may make out well - but you've then got to put the money to use. That's particularly true in today's low-interest and inflation-threatened times, when money in the bank just keeps getting eroded.
'People could consider putting a small amount, 10 per cent, 20 per cent, [of their portfolio] outside Hong Kong,' Lim says. 'But it is a difficult one. There's not a clear-cut solution.'