Analysis | Hong Kong’s property developers will struggle to service their bulging debts as interest rates soar, analysts warn
- Home builders are likely to have a hard time turning a profit as the interest payments on their debt mountains get bigger
- They are likely to be less aggressive bidding for land, and are coming under pressure to offload assets at lower prices
Raymond Cheng, managing director of CGS-CIMB Securities, has a sense of déja vu.
The same was true in the years just before Cheng became an analyst in 2003.
Home builders’ gearing ratios – a measure of how much of their operations are funded by debt – at that time were particularly high, at 60 to 70 per cent, Cheng said. Many of them had been aggressive in their land acquisitions, their appetite for risk fuelled by the many opportunities in the market in the 1990s.
During the deep correction between 1997 and 2003, when home prices nosedived some 60 per cent, they suddenly found themselves losing money on property sales.
The painful experience of those troubled times was enough to make many of them more financially prudent. Over the next few years, gearing levels fell to about 10 to 20 per cent as the developers reined in their expansion and allocated more of their money to investment properties.
But the low interest rate environment that’s dominated economics since the financial crash of 2008 has fuelled a resurgence of debt.
“It might have made developers feel the cost [of borrowing] was low,” said Cheng. Certain developers seized the opportunity to expand in mainland China, pushing up their gearing ratios once more.
Now, with borrowing costs at a 14-year high and certain to rise further, this could be problematic.
Home prices declined by 8.1 per cent in the first nine months of the year, reflecting the impact of higher interest rates and the lingering effects of coronavirus restrictions.
The average net gearing, or net debt to equity ratio, of developers and landlords has risen from about 15 per cent five to 10 years ago to 22 per cent now, said Cheng.
Link Reit, Hang Lung Properties and Hysan Development also saw their gearing ratios increase in recent years, as they stepped up their capital expenditure and acquisition plans, according to Jefferies.
Henderson, known for frequently taking advantage of compulsory sales, has made at least 13 acquisitions worth HK$70 billion since 2020, according to Colliers’ figures. It has 27 newly-acquired urban redevelopment projects, enjoying 80 per cent to full ownership, according to its interim results.
Despite its higher gearing, New World Development ranked fourth in terms of acquisitions, at HK$11.4 billion. For instance, in May it filed an application to buy the 10 to 20 per cent it does not own of three buildings near Times Square in Causeway Bay through compulsory auction, according to Lands Tribunal documents.
The cost of servicing debt is likely to hurt developers in the second half of 2022 and beyond as interest rates continue their upward trajectory, Morgan Stanley said in a report on September 19.
Henderson, Hysan and Link Reit’s interest expenses rose by 25 to 29 per cent from a year earlier after new acquisitions added to their debt piles, according to Morgan Stanley.
For New World Development, with floating debt of HK$123 billion, every 100 basis points rise in interest rate pushes up its cash interest expenses by HK$1.2 billion, the American investment bank estimated in another report on October 6.
Developers contacted by the Post sought to play down market concerns about their debt repayments.
“To say that the group’s gearing remains at a high level would be a faulty generalisation,” Henderson’s spokeswoman said.
“Over the past two years, the group’s net gearing has been managed prudently and conservatively at a moderate level of mid-20s in percentage terms.”
A significant portion of Henderson’s debt is in fixed-rate notes and bonds, and the group has arranged interest rate swaps to guard against risks related to the its borrowing, she added.
“Hang Lung will continue to adopt prudent financial discipline,” she added.
New World Development said it has been taking measures to remain “resilient”.
“We have and will continue to proactively manage our net gearing ratio,” said a spokesperson for the company.
“Since FY21, we have successfully controlled capex [capital expenditure] to below our original budget. We will continue to meticulously examine every land acquisition initiative and capex item.”
Indeed, Hong Kong’s developers are unlikely to face the crisis their mainland peers are going through, because they have a higher proportion of rental income, which is less prone to risk.
“Mainland developers’ rental income from investment properties occupies less than 10 per cent, maybe just 5 per cent, of their profit on average,” said Cheng. “The investment property rental income of Hong Kong developers makes up 40 to 50 per cent of profit on average.”
Still, their profitability will undoubtedly be hurt.
Morgan Stanley said it cut its estimates for New World’s earnings per share by 35 per cent and 47 per cent for the financial years of 2023 and 2024, respectively. This mainly reflected higher interest costs, lower development property bookings and a fall in investment property profit, it said in the October 6 report.
Landlords with major development plans or acquisitions may see their profitability squeezed by higher rates, according to Jefferies’ report.
Increases in borrowing costs have an effect on land prices. Expectations of interest rate rises tend to make developers less aggressive at auction.
The Urban Renewal Authority in late October awarded a redevelopment project in To Kwa Wan to Sino Land Company and China Merchants Land for HK$2.39 billion. The price per square foot at HK$8,571 was 9.8 per cent lower than the bottom end of market estimates compiled by Vincent Cheung, managing director of Vincorn Consulting and Appraisal.
The interest rate upcycle has prompted some developers to sell assets. For example, New World Development and Swire Properties have got rid of non-core assets such as car parks.
New World expects to sell around HK$10 billion of non-core assets in the next financial year.
“We will continue to dispose of our non-core assets to retain capital,” said the developer’s spokesperson.
“We’ll have over HK$8 billion of income booked from development properties in FY23. Together with an increase in our recurring income, it’ll more than offset the additional interest expense.”
Disposing of non-core assets is a part of Swire Properties’ strategy to ensure long-term growth, a spokeswoman said in a statement.
“This strategy has put us in a strong position to fuel our HK$100 billion investment plan over the next decade,” she said.
She said 72 per cent of Swire Properties’ borrowings are on a fixed-rate basis, which helps mitigate the impact of the rising interest rates.
The general offloading of assets is a good opportunity for buyers to negotiate lower prices, said Ingrid Cheh, head of Hong Kong real estate at Schroders Capital. Landlords are likely to be more open to price cuts.
During past rate hike cycles, the impact on house prices was not as pronounced because the magnitude and pace of the increases were smaller, while a supply shortfall acted as a counterbalance.
This time, the upcycle has coincided with a downturn in the property market.
DBS expects Hong Kong home prices to fall 5 per cent next year. Goldman Sachs, Morgan Stanley, HSBC, JLL and Colliers have all predicted a decline too.
Goldman’s predictions have been the direst. It expects home prices to plummet by 30 per cent by the end of 2023, as sharply increasing interest rates continue to pressure affordability and repel investors from the market.
The government has taken steps to try to buoy the market.
It was met with some scepticism from property analysts, however, who said refunding the cash at a later date would not make homes any more affordable.
The outlook remains uncertain, according to Kathy Lee, head of research at Colliers.
“There are still a lot of external uncertainties including interest rate hikes and China’s economic growth,” said Lee.