Negative equity is back (2)

Earlier this month I commented that negative equity situations had returned to the Hong Kong property market with an estimated 10,000 cases. That number was based on media reports which largely relied on comments from property agencies and other analysts.

On Friday the Hong Kong Monetary authority (which regulates banks in Hong Kong) announced that the number of negative equity cases in Hong Kong had risen to 2,568. This is roughly a quarter of the number reported earlier. Why such a big difference? The obvious reason is that the HKMA figure is as at the end of September. Property prices have fallen further in the month and a half - by 14.6% according to the Centa-City Index - which is likely to account for most of the difference.

The obvious question is how bad will the property and mortgage market get during this down part of the cycle? Some numbers to consider:

1. during the last low point (2nd quarter 2003), an estimate 106,000 homes were in negative equity (about 22% of all mortgaged homes);

2. residential property prices have fallen an estimated 20-30% off their peak earlier this year. During the last down turn prices fell by an estimated 60% over a six year period;

3. in May 2003 the total amount of outstanding mortgage loans was about HK$520 billion. It was just below HK$600 billion at the end of September. This probably represents a high water mark for the next few years at least. 14% growth over a five year period is quite low considering how far the property market advanced during that period. I take this as an indication that the average household inHong Kong is relatively lightly geared and has a healthy cash position (which is consistent with the low loan to deposit ratios at banks in Hong Kong);

4. banks have generally been conservative with their valuations. Even during the boom times they would only lend 70% loan to value and there was relatively little anecdotal evidence that valuations were inflated;

5. interest rates are very low (in both absolute and real terms) - certainly far lower than in 1997 when the market reached its previous peak.

While there is likely to be scope for further downside in the market in response to job losses, cuts in bonus levels, reduced willingness on the part of banks to lend money and general lack of confidence, it is hard to see property prices falling by 60% off their peak levels once again. It is too soon to be buying but the time will come. If I have learned two things from the experiences of previous economic cycles they are that assets acquired when times are seemingly bad will be better investments than assets acquired when times are good and that patience is one of the most important disciplines needed by an investor.