Apartment bull market now over
Hong Kong’s three-year residential property bull market run is now officially over. Twelve months of price falls and stagnation have seen apartment prices drop by around 3% from April 2005 to 2006.
Small (less than 100 sq. m.) apartments (Class A, B and C,) suffered 3.3% price fall while Class D & E luxury apartments (100 sq. m. and above) held ground with a 3.6% price growth from April 2005 to 2006.
From late 2003 till July 2006 Hong Kong apartment prices rose around 85%. The revival was prompted not only by reviving GDP growth, but also by an unusual factor - the sharp drop in mortgage rates since mid 2001 (see below).
In late 2003 the interest rate on new apartment mortgages was 2.3% to 2.4%, while yields were at 4.7%-6.5%, so it is perhaps not surprising that property prices began to rise.
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Property cycle
The rather dramatic price-rises of the last two years must be put in their proper perspective: Hong Kong apartments are still 50% down on their pre-Asian crisis peak levels.
From the peak of Hong Kong’s spectacular pre-handover property boom in 1997 to the trough in 2003, Hong Kong residential property prices fell by no less than 66% in nominal terms.
Annual declines were:
- 1998 – 32% price decline
- 1999 – 8.5% price decline
- 2000 – 14.5% price decline
- 2001 – 10% price decline
- 2002 - 13% price decline
Large swathes of the population of Hong Kong have still not recovered from the burden of debt.
In July 2003, property prices fell by 17.6 over a year earlier. After which, the price index started inching upward. By December 2003, the property price index finally registered growth, a miniscule 1.9% rise. Then the impressive recovery happened in 2004 and continued to 2005. The average annual growth of property prices was 25%.
Rents and yields
Rents have also risen over the past three years, particularly in the upper market.
As a result of the market’s recovery yields on high end (“Grade A”) apartments have fallen from 6.5% in mid-1993, to 5.3% today. Yields on lower end (“Grade E”) properties have fallen from 5.5% in late 2002, to 3.2% today.
The Hong Kong residential market is somewhat unusual in that returns on higher-end (Grade A) residential properties are consistently better than those on lower-end properties (Grade A properties are also more volatile in price terms).
Average gross residential yields for the market as a whole are now around 4%.
Meanwhile even as yields have fallen, interest rates have moved up in line with US rates (which Hong Kong mirrors).
At these yields, we cannot be optimistic about apartment price growth – although Hong Kong has an endless capacity to surprise, and GDP growth is strong (see below).
Mortgage interest rates
Mortgage interest rates paid by Hong Kong borrowers have fallen from 11% in the post-crash environment of 1998, to under 3% at their lowest point. The fall in mortgage rates was significantly larger than that made possible by the fall in US rates.
In early 1998, the mortgage rate was priced at prime plus 1.25%. Now it is priced at around prime minus 2.5%. The mortgage rate is therefore 3.75% percentage points lower as a result of the change in the pricing practice of the banks.
The causes of the dramatic falll in mortgage interest rates were threefold:
- The elimination of the Interest Rate Rules of the Hong Kong Association of Banks (popularly known as the “banking cartel”);
- Measures taken by the Hong Kong Monetary Authority to relax market entry criteria; and
- The formation of the Hong Kong Mortgage Corporation (HKMC), which allowed banks to offload parts of their mortgage portfolio to the HKMC and securitize the rest.
Almost all Hong Kong mortgages (99% of the total US$67 billion mortgage pool) are on floating rate terms, so the decline in interest rates has had a marked effect on affordability.
Land sales
The British hand-over in 1997 has in theory lifted the annual supply constraint on new land sales (although in practice this was retained in response to the market crash).
This means that there will now be a potentially greater supply of new properties coming on stream.
In our view this somewhat limits the market’s upside. In fact we believe that Hong Kong is at present an unattractive destination for residential investment, for the following four reasons:
- Hong Kong’s per square meter apartment prices are among the highest in the world
- GDP growth is unlikely to resume at the high rates of the early 1990s
- Land supply is likely to be more liberal under the post-British era administration.
- Gross rental yields are relatively low.
However, Hong Kong retains an infinite capacity to surprise.
