Housing bubble in Hong Kong? External events can trigger collapse in the real estate sector

Cusson Leung is head of Asia (ex-Japan) property and conglomerates research, and head of Hong Kong research at investment bank JPMorgan. He examines scenarios that could lead to a property bubble in Hong Kong.

Is the housing market in Hong Kong overpriced? Are we heading towards a property bubble?

One way to look at whether the housing market is overpriced is to look at the price-to-earnings, or price-to-rent, ratios, just like the way we look at the relative valuation of equities. As gross rental yields generated by residential homes have fallen to below 3 per cent per annum, and as low as 2 per cent per cent annually for luxury homes, I believe the housing market is grossly overpriced, especially as we are in the early stage of a rising interest-rate cycle. It will be more obvious when Hong Kong banks eventually follow the Federal Reserve to raise home-loan rates. To see if a housing bubble exists, there are plenty of clues. Over the past few years, home-price growth has outpaced GDP growth, and if we look at home price-to-income ratios, with an average flat price at 15 to 18 times the gross annual median income of Hongkongers, there is no question that properties are out of reach of many, and that the market is frothy. Having said that, even if we know a bubble does exist, it doesn’t necessarily burst unless otherwise triggered by external events. In a frenzied market, most people rarely believe there is a bubble, nor do they care about such warnings. It is sad but true that a bubble is often realised in hindsight. Taking into account the prevailing market conditions and prospects, I don’t see immediate factors that will cause it to pop. As if you’re sitting on an inflating balloon, nobody can tell if it will pop the next minute, or next year. I know there are more downside risks than upside [ones] at this point in the market cycle.

How do local interest rates and capital inflow factors influence the Hong Kong housing market?

Between 2009 and early this year, Hong Kong’s monetary base has expanded from about HK$540 billion to about HK$1.65 trillion. It is a result of strong liquidity inflow from all over the world, including the mainland. Ever since the global financial crisis in 2008, central banks around the world have resorted to quantitative easing to stimulate their economies. Hong Kong, as a free, open market, has attracted a lot of [this capital]. Even as the Fed [is raising] rates, local banks still have the buffer not to follow suit as [their] liquidity remains ample. Yet, if the Fed begins monetary tightening, some capital in Hong Kong will retreat and go back to the Fed. When it is in action, Hong Kong liquidity will be reduced, exerting stronger upward pressure on local rates.

Is there a possibility of negative equity affecting Hong Kong real estate, like during Sars in 2003?

I [don’t] think it’s [going to happen], thanks to the stringent risk management measures and lending criteria imposed on banks by the Hong Kong Monetary Authority. Average loan-to-value ratios of newly approved mortgage loans are slightly above 50 per cent. Unless there is a market slump, in which prices plunge by more than 40 per cent, the number of negative equity cases will not shoot up that easily. However, we can’t rule out such a possibility. Shortly after the Asian financial crisis in 1997, the price correction wasn’t that steep. Until 2003, overall prices declined by as much as 68 per cent from the [highs] of 1997. Amid a prolonged, deep market slump, foreclosed homes by banks and steep price cuts by some sellers would dampen market sentiment. Potential homebuyers would stay on the sidelines to wait for more bargains, causing sales to contract and consequently a vicious downward spiral of prices. No one expected there would be that many negative equity cases after 2003, but things just happen.