Hong Kong developers' profit margins squeezed

Profit margins of property developers could be slashed in half this year as falling home prices and soaring construction costs and land premiums bite into performance.

Nicole Wong, CLSA's regional head of property research, said margins could dive to 20 per cent from the 40 per cent seen in 2009 and 2010 - the year when many developers aggressively bid up prices for prime residential sites as demand for luxury flats was fuelled by cashed-up mainlanders.

In March that year, Sun Hung Kai Properties paid HK$10.9 billion for a plot in Ho Man Tin, the second-highest price ever for a development site. It translated to a land cost of HK$12,540 per buildable square foot.

A month later, Wharf and Nan Fung Development paid HK$10.4 billion, or HK$32,014 per buildable square foot, for a site on Mount Nicholson Road on the Peak, the third-highest price ever paid for a plot.

The most expensive site on record was a plot in Siu Sai Wan, bought by Sino Land in 1997 for HK$11.82 billion, on which it built Island Resort.

SHKP said last week the Ho Man Tin project would be released for sale this year.

Alfred Lau, a property analyst at Bocom International, said home prices at that project would be about HK$17,000 per square foot, after taking into account construction costs of between HK$4,000 and HK$5,000 per square foot, excluding interest expenses.

Compare that with the HK$21,000 per square foot at Dunbar Place, the most recent development in Ho Man Tin that was launched in April last year, SHKP's project clearly shows the already striking effects of the market downturn. But that correction pales in comparison to the 118 per cent rally in property prices from December 2008 to March last year, when prices began their decline shortly after the government imposed extra stamp duties on the market in an attempt to deflate the housing bubble.

Home prices have cooled about 5 per cent on since, but land prices are proving resilient.

Paul Louie, the head of regional property research at Barclays, said land prices in Kau To Shan, a luxury residential area in Sha Tin, sold at government auctions almost doubled to HK$10,551 per square foot between August 2011 and May 2012 and had climbed to HK$10,885 by March last year.

"For land bought in 2011, the 24 per cent home price appreciation since then has boosted margins to 35 per cent, while for land bought in 2012, the average margin would be 30 per cent," Louie said. "For land bought in 2013, the margin will only be 20 per cent."

Adding to developers' downside, more than 13,000 flats - 30 per cent more than last year - are scheduled to be launched for presale this year. The increased supply is forcing developers to offer deep discounts and stamp duty subsidies to offload their projects.

SHKP generated a strong response at the latest release of units at its Riva development in Yuen Long, but only after it slashed prices by as much as 45 per cent compared with the first units sold a year ago.

Wong said the pressure on Hong Kong developers - spoiled by regular returns of 30 to 40 per cent - was likely to intensify as mainland developers were quite happy with 20 per cent margins.

That increased competition will also push mainland developers to replenish their land reserves, which Wong said could keep land prices elevated.

"We will see more mainland developers participating in Hong Kong land sales," she said.

Last week, a unit of mainland-backed Poly Property paid HK$3.92 billion, or HK$6,530 per square foot, for the biggest site in Kai Tak, where new flats will be sold only to permanent residents.

That was 26 per cent more than China Overseas Land & Investment paid for a nearby site in June last year.

Faced with the significant risk of growing pressure on margins, SHKP, the city's second-largest developer by market capitalisation, has said it will opt for volume to make up the shortfall.

"SHKP will increase building new flats to 4,000 to 5,000 a year, from the present 2,000 to 3,000, to generate higher sales volume to offset the lower profit," Thomas Kwok Ping-kwong, the company's co-chairman and managing director, said at its earnings announcement last week.

Many analysts say such battles for market share to bulk up profits often turn out to be painful.