Dark clouds over Hong Kong's property market as 'perfect storm' looms

Real estate prices and sales have fallen following last year's government measures to cool the sector, and analysts are expecting more gloom

PUBLISHED : Monday, 10 March, 2014, 6:10am
UPDATED : Monday, 10 March, 2014, 10:23am

Hong Kong's housing market faces being caught in the middle of a perfect storm, with government curbs having crimped demand at a time of increasing supply and an imminent interest rate rise threatening to set off a severe price correction.

Home prices in the second-hand market peaked at 18 per cent above the previous 1997 high in March last year after doubling since 2008, but have since fallen 5 per cent in a sign the government's tough stance on reining in an overheated market is having the effect desired by Chief Executive Leung Chun-ying.

A collapse in demand that saw overall property sales plunge to a 23-year low of 70,501 deals last year has fuelled fears of a repetition of major downward trends of the past.

Amid the continuing slide, which began when the government imposed a hefty increase in stamp duty in February last year, gloom-and-doom forecasts of prices plunging as much as 35 per cent in two years have emerged.

"There are strong similarities with the 1997 bubble, but the exceptionally low level of interest rates has encouraged homebuyers to borrow more in this cycle than in 1997. So the market is far more dependent on inter-generational transfer of equity, low supply and low interest rates," said Andrew Lawrence, the managing director of real estate equities research at Malaysian investment bank CIMB Securities.

Before 2009, about 75 per cent of property transactions required a mortgage, Lawrence said, but following a drop in mortgage rates, now at a historical low of about 2.2 per cent, nearly every property transaction had been mortgage-funded.

One of the most bearish property analysts in the city, Lawrence said home values could fall more than 50 per cent in a worst-case scenario if the government did not relax the higher stamp duties.

"The first stage is a function of the cumulative impact of government measures: dampening demand and increasing supply," he said. "The second stage is the result of a rise in interest rates due to the normalisation of United States monetary policy.

"The return of property prices to their long-term trend would likely require both of these factors to weigh on prices, but a correction to long-term trend currently implies a 54 per cent correction. However, we are not expecting an immediate crash."

Lawrence said a 35 per cent correction over the next two years was more likely, with most of that driven by increased supply.

Leung has pledged to supply 20,000 new flats a year - just 14,100 started construction last year - as part of a plan to tackle soaring housing inflation that has pushed home ownership ever further out of the reach of ordinary people, fuelling social discontent.

Lawrence said he expected interest rates and the exit of liquidity from the banking system would start to weigh on market sentiment in the months ahead.

"In addition, given the change in the duration of the special stamp duty, we expect the second half of this year and the first half of next year to be hit by even lower demand levels," he said.

The special stamp duty imposes a levy of up to 20 per cent on those who resell their flats within three years, compared with the previous 15 per cent levy on sales within two years.

Forecasts by developers, whose revenues ride on property prices, are more positive.

This is the first time the market is undergoing consolidation because of austerity measures
Joseph Tsang, Jones Lang LaSalle

"It will only fall 5 to 10 per cent," said Stewart Leung Chi-kin, the chairman of Wheelock Properties, a subsidiary of Wheelock and Co.

"How can home prices fall, taking into account rising construction costs? Developers will not sell homes at below cost as they have strong staying power.

"They can sit on their projects and wait for the market's recovery. Developers can compensate for their shortfall in property sales through selling other assets and rental income."

Leung's view was echoed by Li Ka-shing, the head of Cheung Kong (Holdings), the city's biggest developer by market capitalisation. Li said developers which had gone through the 1997 crisis were now "financial healthy with low gearing", implying they would be in no rush to sell properties at below cost.

Despite the upbeat talk, there has been evidence of a downward trend, with a number of developers selling new homes at prices below those in the secondary market.

In one example, Sun Hung Kai Properties last month sold flats at its Riva development in Yuen Long at HK$7,600 to HK$12,400 per square foot (on a net basis) - up to 45 per cent below list prices when the project was first launched in March last year and also 15 per cent below second-hand home prices in the area.

Analysts expect developers will continue to cut prices when they launch new projects.

But while they expect new supply and higher borrowing costs will exert pressure on prices, they rule out a return to the dark days of 1997, when prices plunged by as much as 70 per cent when a sharp rise in interest rates sowed panic among distressed homeowners with extremely high leverage levels.

CLSA's regional head of property research, Nicole Wong, said a repeat of that crisis was unlikely.

"The current price correction is policy-driven," Wong said. "Whenever there is a policy-driven correction, there is likely a floor because measures can be tweaked or even reversed if the correction goes too far."

But the collapse in 1997 had no floor because it was driven by economic contraction, which created a downward spiral.

Joseph Tsang, the managing director and head of capital markets at Jones Lang LaSalle, shared Wong's view, saying the average loan-value ratio was 70 per cent in 1997, compared with 50 per cent now, and there had been a regional economic meltdown at the same time.

"This is the first time in history the property market is undergoing consolidation because of austerity measures," Tsang said.

Paul Louie, the head of regional property research at Barclays, said in a report he believed the government would roll back the various stamp duties and other cooling measures if home prices fell 15 to 20 per cent.

"But will this help support the market and stabilise home prices? The experience from the 1998 Asian crisis and the recent tightening clearly show that the various tightening or easing measures only have a fleeting impact, and it took a long time to reverse the overall trend," Louie said.

In the 1997-98 crisis, the government rolled back restrictive measures within nine months, with home prices finding a temporary bottom in October 1998 and then rebounding 9.4 per cent by December, before dropping 25 per cent from 1999 to 2000.

The first of the latest round of austerity measures were announced in 2009, but it took four years for their effects to be felt.

"Our concern is that if the various property measures have not worked on the way up, why would they work in reverse to support home prices as they come down?" Louie said.