Fundamentals, not bubble, driving HK's property prices
It's almost two years now since the International Monetary Fund warned that a bubble was about to develop in the Hong Kong property market.
'Strong capital inflows and the resultant large liquidity overhang in the financial system could potentially lead to rapid credit growth, fuelling asset markets and creating macroeconomic volatility,' the fund warned back in 2009.
Yesterday, with transaction volumes down over recent months, the Fund's resident representative in the city retracted the warning. Although home prices are still up, their elevated level 'may not necessarily reflect a bubble', Sean Craig admitted.
No doubt Hong Kong's authorities now think they deserve a pat on the back for successfully preventing a repeat of the city's 1997 property boom and bust.
In the months following the IMF's initial warning, the government and the Hong Kong Monetary Authority introduced a series of administrative restrictions designed to take some of the steam out of the property market.
The HKMA repeatedly raised the down payments required of buyers at the top end of the market, while twisting bankers' arms to be more circumspect in their mortgage lending.
At the same time, the government imposed a punitive stamp duty on anyone flipping newly bought properties back to the market, and promised to increase the supply of building land. Yet even though the IMF may now have changed its tune, it is far from clear that the Hong Kong government and the HKMA can claim the credit for averting a bubble.
As Craig and his IMF colleague Hua Changchun pointed out at an HKMA seminar yesterday, official attempts to cool the market have had a dubious impact.
The government's most Draconian restrictions were announced last November. The HKMA increased the minimum downpayment to 50 per cent on flats worth more than HK$12 million and on all commercially owned or buy-to-rent properties. At the same time, to discourage speculation the government slapped an additional 15 per cent special stamp duty on properties re-sold within six months of their purchase.
In the month immediately following the introduction of these measures transaction volumes declined and prices did fall, as the first chart below illustrates.
But that's hardly surprising. Property market activity usually slows in December, only to rebound in the new year when bonuses are paid. And that's what happened in January and February 2011. After a brief slowdown, both volumes and prices rebounded vigorously, implying that the government's measures had little impact.
This unexpected resilience has raised some eyebrows in the Hong Kong office of the IMF, where staff set out to build a model of the forces driving Hong Kong property prices.
Their results probably won't surprise seasoned observers of the local market, but they do serve to illustrate the limits of the sort of macroprudential measures the government and HKMA have employed.
The IMF found that the government's special stamp duty had done nothing to restrain prices. It may even have added to recent gains as owners added the extra cost into their selling price.
Meanwhile, increasing minimum down payments on flats has had only a limited effect. That should not come as a shock in a market where many buyers - especially those from the mainland - pay in cash, and where average mortgage loan to value ratios tend to be low anyway.
As a result, all that raising down payments has achieved is to slow the increase in prices by forcing buyers who do need to borrow to delay their purchases until they can scrape together the necessary downpayment.
What really drives the local property market, the IMF concluded, is a combination of the limited supply of building land, together with local liquidity conditions. As you would expect, the IMF found an increase in the supply of land leads to a decline in property prices several years later as new flats reach the market.
But the most powerful driver of the recent surge in prices is Hong Kong's plentiful liquidity coupled with the decline in real interest rates.
That shouldn't be surprising either.
As the second chart shows, when real interest rates - that is interest rates adjusted for inflation - fall, savers take their money out of the bank and invest it in property.
As Craig said yesterday, the city's property market wasn't in a bubble. 'The rapid rise in prices we've seen reflects Hong Kong's very favourable economic fundamentals.'