Forecast of 30 per cent slump in home prices is about right
Barclays may have jumped the gun earlier, but its researchers point to burden of mortgage servicing when rates rise amid abundant supply
Two years ago, at the beginning of November 2011, Barclays Bank published a research report forecasting that Hong Kong home prices would fall 30 per cent over the following two years.
Two years on, and local housing prices have actually climbed 24 per cent.
Barclays is undismayed. Yesterday, the bank published a new report predicting that by the end of 2015, in two years' time, Hong Kong home prices will have fallen by … 30 per cent (see the first chart).
To be fair, yesterday's report was written by a new team of analysts, not the same pair who wrote the 2011 paper.
And while Monitor was sceptical about the earlier forecast, writing in November 2011 that "supply is short and mortgage rates are low by historical standards - both of which should help support prices", this time Barclays makes an arresting case.
Although the US Federal Reserve is now unlikely to begin raising interest rates until 2015, most analysts accept that when it does, and Hong Kong mortgage rates increase in parallel, local home prices will weaken.
But Paul Louie and Zita Qin at Barclays believe that consensus expectations for a correction of about 15 per cent understate the magnitude of the likely fall.
They argue the 15 per cent figure is based on projections of how rate increases will affect the cost of servicing a mortgage.
At the moment, paying off a home loan on a HK$4.8 million, 718 square foot flat costs the typical Hong Kong household 57 per cent of its monthly income, which is line with the long-term average (see the second chart).
If mortgage rates were to go up by 2 percentage points to 4.2 per cent, the increase would push mortgage service costs up to a punishing 69 per cent of monthly income. As a result, property prices would have to fall by 16 per cent to bring housing affordability back into line with the long-term average.
That line of reasoning is fine as far as it goes, but as Louie and Qin point out, it doesn't go nearly far enough.
If prices were to fall 16 per cent, it doesn't follow that buyers would flock back to the market. Speculative buyers have already been deterred by the government's special stamp duty. And with little prospect of capital gains in sight, potential owner-occupiers would reassess the attractiveness of buying compared with renting.
With the minimum down payment on a new home still cripplingly high, and Hong Kong incomes now static, many would conclude that in a falling market, renting makes more sense.
According to Louie and Qin, it would take a price drop of at least 30 per cent to entice them back into the market.
Of course, despite official denials, it is likely the Hong Kong government would reverse its efforts to cool the market. But just as its measures failed to bring down prices when they were rising, so their reversal would fail to provide much support in a falling market.
Part of the problem is likely to be an abundance of supply. Prices have been sticky in recent months because investors have little incentive to sell.
But once prices begin to weaken, the owners of investment properties - who the Barclays analysts believe are typically sitting on unrealised capital gains of nearly 100 per cent - will rush to take profits, putting further downward pressure on the market.
At the same time, developers, who Louie and Qin say are now encumbered with 12 years' worth of inventory, would have no choice but to cut their prices in pursuit of demand, adding to the downward momentum.
The result, they argue, is that Hong Kong home prices are set "to drop by at least 30 per cent by the end of 2015".
That timetable may be a little hurried. If the Fed holds back, the fall will take longer. But the magnitude of the likely slump looks entirely reasonable.
We have been warned.