Why property is Hong Kong's national sport

Bernie Lo | @cnbcbernie | http://www.cnbc.com/id/101928585

"14 Years To Buy a Flat!" the newspaper headline screamed after the Chinese University of Hong Kong's housing affordability index hit an all-time low. In 2002, a household would need 5 years' savings to buy a modest 40 square meter flat, the survey showed; today they would need 14 years' savings. Hong Kong consistently ranks among the world's most expensive property markets. A series of policy decisions since the 1980s illustrates why Hong Kong was headed down this path from the start.

Pegged for trouble

The modern functioning real estate market only dates back to 1983, when the Government pressured banks into introducing long-term mortgage financing instruments. Before that no true mortgages existed, only short-term funding of 3-5 years. 1983 was also the year the Hong Kong dollar came under tremendous speculative attack and the administration opted to peg it to the U.S. dollar. The peg, which still exists, contributed to massive volatility over that period.

The peg has meant that Hong Kong has no independent monetary policy. It is hostage to the U.S. Federal Reserve; the Hong Kong Monetary Authority (HKMA) has no control over interest rates. At many times, the prevailing rates here have been at great odds with what is needed. For instance, while the U.S. economy may be soft and need low rates, Hong Kong could be bursting with economic activity and because of the peg, experiencing an inordinately low rate environment.

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In 1990 the U.S. entered a recession and interest rates were cut; this conversely boosted asset prices in Hong Kong whose economy was fine, and property prices began a multi-year climb. By the mid-90's, to make sure confidence was high ahead of the 1997 handover, money poured in from China and much of it found its way into real estate. By the time the handover arrived, Hong Kong's property market had skyrocketed; an average 115 percent of household income was paying for housing, clearly an unsustainable situation.

Then Thailand devalued its currency and the Asian Financial Crisis raged – currencies crashed, markets careened. Other countries could adjust and cut rates as needed, but Hong Kong, tethered by the peg, was choked. Interest rates could not be adjusted downward. Within a year and a half, property prices had crashed by 45 percent. Subsequent years brought some relief, but then SARS turned Hong Kong into a ghost town in 2003, and prices resumed their descent, now down 60 percent from their all-time highs in 1997.

Easy money boost

What goes down will come up though, and later, U.S. Fed Chairman Ben Bernanke's free and easy money policy was a booster injection for property. Mortgage rates hit lows well below 1 percent during the quantitative easing (QE) process, and even now are only at around 2.5 percent. Many blamed an influx of Chinese money for pumping up prices, but Chinese buyers have never accounted for more than around a tenth of total sales. Furthermore, they focused on the extreme luxury segment of the market.

The government, sensing creeping public outrage, resorted to draconian measures a couple years ago, including doubling the stamp duty (property transaction tax) on many buyers, mainly non-Permanent residents, in order to cool the market, and raised the down payment requirements, in some cases to 60 percent of the sales price. Transaction volumes fell by two-thirds. But prices have only eased about 5 percent.

Activity in recent months has picked up again, as developers learned that by discounting prices in order to compensate for higher down payments and stamp duties, there was plenty of pent-up demand. You now regularly see surveys and studies showing the property market frothier than it ever was even in the go-go days of the late 90's.

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There are many unknowns: when will the Fed actually begin raising rates again after shutting QE, and how will an expected slowdown in the Chinese economy impact HK?

There's also one overhang that cannot be overlooked that dates from the Shek Kip Mei fire of 1953 which destroyed massive shantytowns of mostly Chinese immigrants. The British governor at the time decided to embark on a massive construction program to rehouse those left homeless and marked the beginning of Hong Kong's public housing experiment. Since that time, government-provided rental and subsidized purchase property has come to comprise nearly 50 percent of total housing stock, meaning the government is landlord to half of Hong Kong, leaving the other half to fight it out in the private market. Simple economics tells you that a synthetically shrunken supply will only lead to higher prices.

Hong Kong Popping Housing Bubbles London Can’t Handle

http://www.bloomberg.com/news/2014-07-29/singapore-popping-housing-bubbles-london-can-t-handle.html

Take a look at the world’s dizzying surges in the price of housing for 12 months at the end of June: London, up 20 percent. Manhattan, 18 percent. Sydney, 15.4 percent.

Then there are Singapore and Hong Kong: down 3.7 percent and 0.6 percent.

Prompted by concerns over potential property bubbles and affordability for the middle class, the governments of the two Asian cities have been reining in home prices by imposing measures including mortgage caps, taxes on property flippers, and levies on foreign buyers as high as 15 percent.

“Hong Kong has successfully cooled down the market in terms of transactions and turnover,” said Raymond Yeung, senior economist at Australia & New Zealand Banking Group Ltd. in Hong Kong. “Singapore has been more effective.”

So could New York, London and other global cities facing soaring housing prices pull off the same act?

Not really. Hong Kong and Singapore’s island geographies, preponderance of public housing resulting in two-tier housing markets and citizens willing to tolerate government directives make the cities unique, according to academics and researchers. London and New York have nowhere near the same level of control over their economies and the behavior of their residents.

Having Clout

Singapore and Hong Kong, as a special administrative region of China, have governments with policy-making power over their entire geographic areas, where they are relatively free of political opposition from neighborhood groups or borough councils that stymie directives or mitigate their effectiveness. The Asian cities control the land supply and are the biggest landlords.

That allows them to implement decisive policy measures. For example, in January 2013, the Monetary Authority of Singapore, effectively the central bank and chief regulator, cut the mortgage ratio allowable on purchases of second homes while more than doubling minimum down payments from 10 percent to 25 percent. The banks had no choice but to follow.

“Imagine doing something like this in the U.S. where there are 7,000 banks and many regulators,” said Sumit Agarwal, a professor in economics, finance and real estate at the National University of Singapore. “It’s a nightmare from the policy point of view and would be impossible.”

Hong Kong and Singapore haven’t shied away from using taxes to discriminate against foreign buyers -- something other locales with surging prices have yet to do. Non-permanent residents in both cities are subject to an additional 15 percent tax when they buy property, except in Singapore where Americans are exempted by treaty.

Free-Market

While such actions may seem contradictory to the cities’ stated free-market principles, “affordable housing is part of the legitimacy of any government, and government has a role to play in intervening in the market in periods where there are extreme circumstances,” said Michael Klibaner, who heads Greater China research at real estate firm Jones Lang LaSalle Inc. in Hong Kong.

The U.K. government has tried some measures. After it increased the stamp duty to 7 percent on high-value properties in March 2012, price increases for homes valued from 5 million pounds to 10 million pounds ($8.5 million to $17 million) slowed from 9.7 percent to 5.8 percent in the subsequent year, according to broker Knight Frank LLP.

Bank of England Governor Mark Carney announced another set of measures last month, citing concerns over household indebtedness and the threat of a property bubble. They limit mortgages to less than 4.5 times a borrowers’ annual income and require banks to refuse loans to those failing to prove they could afford a 3 percentage-point rise in interest rates.

Stagnant Prices

They may be working. Prices in the capital stagnated in July, the first month with no growth since December 2012.

Meanwhile, the opposition Labour Party has backed away from a call for a flat tax on properties worth more than 2 million pounds, instead suggesting taxes that rise the more expensive a property is, if they win next year’s U.K. national election.

Labour’s Treasury spokesman, Ed Balls, writing in the London Evening Standard newspaper, suggested a lower band for homes valued at between 2 million pounds and 5 million pounds. Further bands would go up to 10 million pounds and 20 million pounds, with the top rate levied on properties above 20 million pounds. The thresholds would increase in line with average house prices.

Least likely to be deterred are well-heeled buyers from Russia, the Middle East and Asia looking to park their money in tony London neighborhoods, the ones who have helped drive up the prices, said Matthew Pointon, a property economist at Capital Economics Ltd. in London.

“Wealthy people who buy these houses just pay it,” said Pointon, adding that the government isn’t interested in discouraging the influx of money. “The government is always very keen to portray London as open for business to the world.”

Preferential Treatment

Foreigners in Britain enjoy preferential tax treatment over locals, as they are currently exempt from paying capital gains. This benefit will cease when new legislation takes effect in April bringing the U.K. into line with the U.S. and Australia which charge capital gains on non-residents. (Hong Kong has no capital gains tax while Singapore taxes non- residents.)

In Australia, foreigners bought a record 14 percent of new properties in the first three months of the year, based on a survey of property professionals by National Australia Bank Ltd.

In New York, there’s not much likelihood of foreign buyers facing additional costs, said Jones Lang LaSalle’s Klibaner, a native New Yorker.

“If you live in Manhattan, you aren’t going to blame the government for bad policies or become a xenophobe because too many rich Chinese and Russians are buying apartments on Central Park,” he said. “When you want to get on the property ladder, you start in Queens or Brooklyn or New Jersey.”

Election Issue

Still, affordability is very much on middle-class voters’ minds. New York Mayor Bill de Blasio, a self-described progressive who took office in January on a promise of creating more homes New Yorkers can afford, unveiled a plan in May to try to do it.

“This is the first local election in a long time where housing affordability came to the forefront,” said Christopher Mayer, Paul Milstein Professor of Real Estate, Finance and Economics at New York’s Columbia Business School. “This is going to happen in more places.”

The dominance of the private sector in the housing markets of New York and London also leaves them with less leverage than their counterparts in Asia. More than 80 percent of Singapore residents live in government-built flats, according to the website of the city’s Housing & Development Board.

Of those living in Singapore’s public housing, more than 90 percent own their apartments, the result of government policy promoting home ownership through a combination of cheap loans, housing grants and a program that allows buyers to use accumulated government pension contributions for purchases.

Public housing doesn’t carry a stigma in Singapore, where most is located in master-planned towns, with schools, sports and medical facilities in landscaped surroundings.

Laissez-Faire

While Hong Kong may rank No. 1 on the Cato Institute’s global ranking of free economies, its housing policy is anything but laissez-faire. The government auctions its land to developers to trickle out new housing stock when it wants to increase supply. It also owns 76 percent of MTR Corp. (66), the subway operator that is one of the city’s biggest property developers.

“Supply is so limited in both cities, the government is all powerful when it comes to land issues,” said Eddie Hui, a real estate professor at Hong Kong Polytechnic University. “They can be more heavy-handed.”

Foreign Suburbs

Singapore is about two-thirds the size of New York City, and Hong Kong is about 30 percent bigger. Unlike Manhattan, where residents can move to cheaper boroughs or nearby states, the far-flung suburbs of Singapore and Hong Kong are in other countries beyond their borders. (Some Singaporeans have bought homes in neighboring Malaysia, which requires a passport-control stop and a two-hour drive when traffic is heavy to reach the business district.)

“In Hong Kong and Singapore there’s nowhere else to go, so regulation is almost essential if you have a fixed supply of land,” said Columbia’s Mayer.

Singapore began introducing curbs in 2009 after home prices climbed 25 percent in two years through 2008. It stepped up with stricter measures in 2013, including a cap on mortgage payments at 60 percent of a borrower’s monthly income, higher stamp duties and an increase in real estate taxes.

In 2009, when property prices were plunging across the U.S., Hong Kong’s housing market was going into overdrive. A combination of record-low interest rates, a lack of alternative desirable investments due to a lackluster stock market and a flood of mainland buyers plunking down cash for properties sent prices soaring.

Chinese Buyers

Hong Kong began introducing a string of progressively stronger measures starting in November 2010, including a flip tax of 15 percent on properties resold within six months, and a doubling of stamp duties to 8.5 percent on properties worth HK$20 million ($2.6 million) or more.

It also slapped a 15 percent tax on purchases of homes by non-local buyers and companies, a policy aimed to deter mainland Chinese buyers whom many Hong Kong residents blamed for soaring prices.

After climbing 115 percent since January 2008, prices started dropping in the second quarter of 2013. The share of mainland buyers of luxury properties, defined as homes worth more than HK$12 million, fell from 34 percent in the third quarter of 2012 to 13 percent a year later, according to research by Centaline Property Agency in Hong Kong.

Least Affordable

Still, prices on Hong Kong island, roughly the size of Manhattan where about 1.2 million people live, are the third-most expensive in the world after Monaco and London, at $1,920 per square foot, according to the Global Property Guide website. While housing costs about half as much in the northernmost New Territories, where more than half of Hong Kong’s 7.2 million residents live, prices there rose 140 percent from 2008 through 2012.

For all Hong Kong’s successes, it remains the world’s most-unaffordable housing market, with a median home price 14.9 times gross annual median household income, according to a survey released in January by Demographia, a consulting firm in Belleville, Illinois. Singapore was given the survey’s highest rank, “severely unaffordable,” while Knight Frank’s annual wealth report placed it as No. 2 most-unaffordable in the world.

Singapore’s correction looks set to continue. After prices slid for a third consecutive quarter to June, Finance Minister Tharman Shanmugaratnam this month predicted further declines.

Less Bearish

In Hong Kong, analysts are revising previously bearish forecasts. JPMorgan & Chase Co. in a June 4 report predicts a further 5 percent drop in secondary home prices this year compared with an earlier forecast of a 20 percent decline. Citigroup Inc. said June 3 it expects prices of mass-market homes to stay flat.

Things may be picking up. Prices have climbed about 4 percent in the seven weeks since the beginning of June, according to Centaline.

The slump in Hong Kong housing prices may be illusory because transactions have all but dried up as buyers wait on the sidelines for recovery, says ANZ’s Yeung.

“It looks effective on the surface, but this is only depressed demand,” he said.

Meanwhile, the government is taking measures to increase supply. In January, it announced a policy target of 470,000 additional housing units over 10 years for both public and private housing.

Hong Kong isn’t entirely without resistance. In June, an angry mob forced its way into the Legislative Council to protest a plan to relocate villages to make way for high rises.

“Governments in Hong Kong or the U.K. or China all have the same dilemma,” said Hui, the Hong Kong Polytechnic professor. “Home prices are high, and we all know we have to do something. But when they announce measures against our interests we tell them to do it in someone else’s backyard.”

Ultimately, markets may play a greater role in solving the problem of rising prices once global interest rates start rising. At that time, said ANZ’s Yeung, “the global housing bubble, or boom, will come to an end.”