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Jake's View
Thursday, 11 October, 2012, 3:03am
Abnormal interest in home affordability
Understanding the effects of unusually low mortgage rates is the key to calculating the real price of a home in Hong Kong’s property market
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Hong Kong home prices are continuing to break records, while rents are rising at a slower pace and even dropping in some sectors, according to the latest figures. The difference in the trends of prices and rents might be a sign that demand for homes is decreasing …
SCMP, October 10
No, a slower pace in rents is not a sign that the pressure on home prices may soon ease. It is only a sign that the property market is driven by abnormally low interest rates.
I grant you it is counter-intuitive. How could low interest rates alone drive home prices to such ridiculous heights? Surely there must also be a shortage of housing to cause it.
But, no, there is no shortage of housing. In fact, official figures show that more than 250,000 flats, more than 10 per cent of our housing stock, lie vacant. Building more homes will not bring prices down. It will only create more opportunities for mainland speculators.
Here is the critical concept to understand: the real price of a home is not the list price in the developer's brochure.
It is rather the monthly mortgage payment to which you pledge yourself when you borrow money from the bank to make the purchase.
And the critical period of that mortgage is its first few years. This is when you have yet to build up residual equity in your home and before rising skill in your career rewards you with higher income.
This period is the hurdle you know you must jump when you ask for a mortgage.
Examine your mortgage over that period more closely and you will find that by far the bulk of the payments you make goes to paying off interest on the principal you have borrowed. Only towards the end of the mortgage do you pay off more principal than interest.
Thus tweaking those mortgage interest rates only slightly is enough to make an enormous difference to your ability to afford your home. It is by far the biggest variable in the housing affordability equation.
And interest rates haven't been tweaked just slightly. For the last four years they have been wrenched out of normality, with borrowing rates forced to the very low single-digit levels.
It would never happen under normal conditions. A thriving economy with an overheated property market would normally see interest rates rising to cool things down again.
But our conditions are not entirely normal. The HK dollar is pegged to the US dollar and US monetary policy at present calls for economic stimulus through ultralow interest rates. We're out of kilter with the US economy. It can happen occasionally and now is one of those times.
Low interest rates explain the first chart. Home prices now exceed their 1997 highs by more than 20 per cent but Centaline's affordability index suggests that mortgage payments for a new private flat still absorb only 44 per cent of average family income, compared with 112 per cent in 1997.
Low interest rates also explain why home prices outpace home rents. Whether you take annual rent as a percentage of price or annual interest as a percentage of a sum of money, it's all yield and interest yields (interest rates) have pulled down property yields, as the second chart shows.
This article first appeared in the South China Morning Post print edition on Oct 11, 2012 as Abnormal interest in home affordability
After reading this article, people also read
tamarichard Oct 17th 2012
3:12pm
3:12pm
It's more than just the persistently low artificial rates that are masking genuine affordability.... look at the HKMA monthly residential mortgage survey data to see what I mean.... in January 2007 the average newly originated mortgage tenor in Hong Kong was 19.92 years.... today, it is 25.5 years...(in 2000 in was 15.5 years!!)... basically buyers are maintaining affordability by extending their loan duration.... which as anyone will tell you, will drastically increase one's sensitivity to interest rate rises. The government has recognised this and capped mortgages at 30 years now.
Whilst some would argue that this cannot possibly be a bubble due to the relatively low level of gearing (on average Loan-to-Values are now 55.90% vs 59.10% in Jan 2007), the fact is that if you assume rates do eventually revert to some kind of mean in the next few years, and if they move quickly, you would see a very very fast deterioration in Hong Kong households ability to service their mortgages (let alone put food on the table).... and perhaps the very fact that you have a fair amount of equity available in your property would induce you to take the money off the table (ie. sell) rather than wait for further rate increases and further price declines (thereby exacerbating overall selling pressure).
Whilst some would argue that this cannot possibly be a bubble due to the relatively low level of gearing (on average Loan-to-Values are now 55.90% vs 59.10% in Jan 2007), the fact is that if you assume rates do eventually revert to some kind of mean in the next few years, and if they move quickly, you would see a very very fast deterioration in Hong Kong households ability to service their mortgages (let alone put food on the table).... and perhaps the very fact that you have a fair amount of equity available in your property would induce you to take the money off the table (ie. sell) rather than wait for further rate increases and further price declines (thereby exacerbating overall selling pressure).
cc88 Oct 14th 2012
4:20pm
4:20pm
Jake - no where in your article do you give the data on how many property transactions are using mortgages to buy. 60% of HK homeowners are mortgage free already, and I suspect that the number of buyers using mortgages is far lower than in almost any other economy. Until you examine this data and include it in your analysis this article is unfortunately a little meaningless
keresearch Oct 16th 2012
10:22am
10:22am
Having lived here himself for other thirty years and having owned his property for 25 I am sure he is aware of these facts. The problem is that the HKMA has stopped giving out data on actual number of residential mortgages. So if you have the actual data please pass it on,.
SpeakFreely Oct 11th 2012
4:56pm
4:56pm
I would say yes or no. In 1997 the interest rate was quite high. Also before USA house market busted the interest rate was quite high too. Also, by theory now the interest rate is rock bottomed and it can only going up in the future, then based on expectation, house price should peak too, right?
The rent is slowing as this is tied to affordability as wages is not going fast enough.
The rent is slowing as this is tied to affordability as wages is not going fast enough.
ktownlover Oct 11th 2012
3:15pm
3:15pm
Jake is right - there are more than 250,000 vacant properties: it is a matter of official record. But he is also wrong - it not "only" a sign of abnormally low interest rates. It is a sign of accumulated wealth - homeowners with enough money not to worry about holding empty properties, and blinded by greed that convinces them they will always be worth more tomorrow. The same underlying factor keeps the rental market from falling as far as it should. Demand there is diminishing, particularly at the high end as banks cut or reduce accomodation alowances.taihang is right with his earlier comment - the rental market is flooded with vacant properties, and at absurd asking prices. The owners are locked to the aritificial market, and the estate agents are complicit in the racket. True, low interest rates allow this to continue, but they are not the "only" factor. Accumulated wealth counts more. This needs the introduction of a property holding tax.
taihang Oct 11th 2012
4:10pm
4:10pm
ktownlover, the low interest rate is the very reason that many of those with accumulated wealth speculate in property, instead of investments that - in normal times - would yield interest or profit.
Conversely, those without accumulated wealth borrow cheaply and help prices upward. In the end prices take on their own momentum, and no one is too worried about rent any more.
What's more, actually renting out a property (rather than advertising a high but theoretical asking rent) means the true earning potential of the property is known, and that knocks a big amount off the (ficticious) value. Not to dissimilar from the model based pricing of credit derivatives that had never actually been traded, in the final years before the crisis.
Conversely, those without accumulated wealth borrow cheaply and help prices upward. In the end prices take on their own momentum, and no one is too worried about rent any more.
What's more, actually renting out a property (rather than advertising a high but theoretical asking rent) means the true earning potential of the property is known, and that knocks a big amount off the (ficticious) value. Not to dissimilar from the model based pricing of credit derivatives that had never actually been traded, in the final years before the crisis.
ktownlover Oct 11th 2012
7:11pm
7:11pm
I have to agree - spot on - especially your point about owners not letting for fear of identifying true value. I fully accept the fundamental role of low interest rates in locking money into property. Again, this needs a holding tax on vacant property to kick the market towards supply-demand synch. But this is Hong Kong: that ain't gonna happen.
whymak Oct 11th 2012
12:54pm
12:54pm
Everyone knows it's mainlanders who are driving up our housing prices. How much did the Chinese pay you, Mr. van der Kamp, to write this contrarian claptrap? You are lucky that we don't have lynch mobs in this civilized city. I have registered my complaint about your economics lies with the SCMP editor and the young Scholarism heroes.
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