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Luxury sector looks good - further on

A little cycle-of-life reasoning will reveal Hong Kong's luxury property sector as one of the better investment themes for those with a medium to long-term outlook.

The Hong Kong economy is in its worst state in decades, prices are falling to alarming levels, and stories of expatriates and tycoons bailing out in favour of Shanghai and other big cities abound. The mood in Hong Kong has never been more sobering.

But, as many point out, Hong Kong's prospects are anything but gloomy, thanks to China's fast growth. Factor in record low mortgage rates, decent rental yields and changes to the government's immigration policy, and the picture begins to look much brighter.

Insignia Brooke consultant Nicholas Brooke has given a thumbs-up to the luxury sector, saying recent price behaviour and transaction volumes suggest the market is within 15 to 20 per cent of a cyclical bottom.

He predicted a shift in demand for luxury property over the next 12 to 18 months, and advised buyers to position themselves now.

'It is a buyer's market,' Mr Brooke said. 'Business is being done, but at levels set by the buyer, not the vendor. There is still a big gap between the vendors and what the purchasers are willing to pay.'

He advised buyers to bargain hard, stick to their positions, and be prepared to walk away until vendors lowered their expectations.

Timing a market bottom could be challenging, 'and we may not be there yet', Mr Brooke said. But it was a good idea to research what was available because building quality and the range of amenities could vary widely at the top end, he added.

The luxury residential market is defined as properties of 1,600 square feet or more, with average prices beginning at HK$5,000 per square foot. Prices in this property range typically start at HK$7.5 million.

Recent transaction volumes in the luxury sector have hit a much lower average than in the mass residential market. The low turnover is another good sign, because it signals the asset class is unloved, a trend that normally occurs at market bottoms and leads to undervaluation.

One good shopping rule is to have a target price in mind.

'If you buy at HK$5,000 per square foot, investment yields make more sense,' Mr Brooke says. 'People can rationalise it from a professional perspective.'

Many sellers are looking for HK$7,000 per square foot, but fair value is, in fact, about HK$5,000 to HK$5,500 per square foot. At these levels, Hong Kong's luxury property would trade at a reasonable discount to London, where luxury prices trade at HK$10,000 to $12,500 per square foot.

Hong Kong's luxury sector has proved a dud investment in recent years, with prices falling 60 per cent since the market peak in 1997.

With hindsight, investors would have been better off riding the London or Sydney property markets over the past five years, but with valuations in both these markets looking stretched, better deals might lie closer to home, Mr Brooke said.

The price collapse in Hong Kong was due in part to a deflating property bubble, which popped in 1997, and a cyclical downturn in the regional economies that began the same year.

Looking ahead, Mr Brooke was reluctant to predict too much for the short term, except to say that conditions should firm up markedly next year.

'The property market tends to mirror the economy. When the economy recovers, the property market will follow,' Mr Brooke said. 'We will be looking for sustained upward movement in gross domestic product and all the economic numbers before we see any price increase that is sustainable.

'During the next two or three years, virtually all the markets in the region will hit bottom and then start to bounce back. It will be a question of how to position yourself to take advantage of the bounce.'

Mr Brooke took a bearish stance in 1997, but his outlook was generally soft. He predicted price declines of 20 per cent.

Investors looking for a return to previous price levels would do well to recall that property premiums in the 1990s were due in part to Hong Kong's unique position as a doorway to China's restricted markets.

As mainland economic reforms continue, cities such as Shanghai, Beijing and Guangzhou, each with new airports, modernised transport links and telecommunications, are emerging as reasonable alternatives for direct trade. The trend could prolong Hong Kong's marginalisation and result in a move towards price parity with other mainland cities.

Investment adviser Marc Faber believes Hong Kong's prosperity in the past half century was largely a historical accident caused by the rise of communism on the mainland in the 1950s. In the long run, he believes, Hong Kong will wane in prosperity, and even lag behind mainland cities in economic significance. However, it would be wrong to be over-pessimistic about Hong Kong's near-term fortunes, he said.

Mr Faber predicted that growing mainland prosperity would favour Hong Kong, with some of the good fortune flowing into the city.

One positive factor on the horizon is the number of mainland professionals and wealthy entrepreneurs seeking to move to Hong Kong. But Mr Brooke pointed out that the benefits might be delayed as it would take time, possibly even years, before changes to the immigration law were enacted.

'The reality is the process will not be in place till the end of the year at best,' he said. 'Then you have to do your marketing. This is something that could help boost the market next year and beyond.'

Another positive is record-low mortgage rates, with financial institutions offering up to five-year fixed rates at 3.5 per cent.

'I recommend property near public transport,' Mr Faber said. 'I am a great believer in buying above or close to the MTR. Convenience is a big factor in people's lives today. We can already track value corridors around and above stations, and along the railway lines.'

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