Monday, November 07, 2011

Hong Kong property - random musings

Hong Kong property is a subject that produces a very wide range of views, currently ranging from the cautiously confident to the extremely bearish.

The cautiously confident camp largely rest their case on:

(i) continued demand from mainland investors;

(ii) sell side structural issues which act as an impediment to selling or trading up - specifically the difficulty in replacing existing low cost mortgage financing, tighter lending criteria and the punitive stamp duty regime adopted to curb speculation;

(iii) the likelihood of continued inflation as central banks continue to try and inflate their way out of what may or may not be a double dip recession.

The bearish camp typically put forward a number of reasons why the property market will decline including:

(i) rising interest rate costs for new borrowers. While old HIBOR loans are still costing less than 1% pa, new loans typically cost around 2.5% (+/- a bit depending on bank and borrower). This is enough to make borrowing more expensive by a meaningful margin;

(ii) tighter lending criteria. Loan to value and payment to income thresholds being tighter than during the bull market. Funding pressures on banks are contributing to the tighter lending conditions;

(iii) reduced future demand from mainland buyers;

(iv) increased supply as the government releases more land for development and developers rush projects to market before sale prices start falling (this is already happening);

(v) property prices are high by historical standards, high in absolute terms and high in relative terms.

Predictions for the size of the expected decline range from a relatively mild 10% to a very damaging 50%.

Both the optimists and the bears count among their numbers rather shrill "perma" members who occasionally appear quite emotional on the subject.

It seems beyond debate that, at least in the short term, prices are headed lower. In fact they already have in both the secondary and the primary markets although it is unclear by how much. FWIW, my view is that there is far more downside risk that upside risk at the moment. I expect property prices to fall further, largely due to further increases in supply and the continued effects the tight market for property finance. That said, while we have experienced greater than 50% falls in the past, given the very high levels of equity in the market, it would take a significant further deterioration in market fundamentals (e.g. a very large increase in HIBOR etc) to produce a 50% fall. This doesn't mean in can't happen, only that I consider a much smaller decline to be more likely - possibly something in the order of 20% (although that is a complete guess). I also expect rents to level off or even soften a bit as more owners put their units out for lease and/or the banking sector sheds jobs.

If prices do fall significantly, I will probably buy again. Realistically, given the impact of the 1997-2003 bear market, I would expect the Hong Kong government to reverse some or all of the cooling measures long before we got to that stage.


Bill said...

"If prices do fall significantly, I will probably buy again"

But would you be able to? (especially if not working). You have already said that your main lender won't lend you any more and with reduced assets and (almost) unchanged borrowings surely that would not change. Also if prices decline then rents would probably follow (with a time lag) reducing your cash flow.

Also do you ever worry about being undiversified? I realise that you have multiple stocks and multiple properties so as a fund manager would see it you are diversified in the sense that an individual bad investment would not be a major problem. BUT you do have the great bulk of your assets in one basket (Greater China) which seems a little bit risky to me.

traineeinvestor said...

Hi Bill

Good questions. By the time the market is attractive enough to want to buy again, the lack of steady employment income may well make it impossible to get enough debt financing. The likely result is that I would have to look at something quite small or wait until 2013 when one of the mortgages is fully repaid and I can offer an additional property as security.

Falling rents? Quite possibly. I've been there before and its not pretty but I'd rather cut rents than have a lenghty vacancy.

In terms of diversification, yes I do worry about it. The high concentration in Hong Kong property and China generally is a cause of concern, but if I put money outside of HK, I have to confident that either I am investing in a country with a strong currency and/or that the HKD/USD peg will not go. Either I take the currency risk or I take the asset concentration risk.