Hong Kong property prices at all time high

Prices of residential property on Hong Kong Island have passed their previous peak set in 1997 according to an index compiled by Centaline (of Hong Kong's leading real estate agents).


Fourteen years is a long time to wait to recover to previous highs. A very long time. Of course, a person who had purchased at the time of the 1997 peak and held would have also received rental yield (or imputed yield in the case of an owner occupied home). Assuming a net yield of 4% during that time, the break even point for an ungeared buyer would probably have been reached some time in late 2006 (depending on how you do the numbers). Even so, that is still a long time to wait to "get your money back".


A couple of observations.


The first is that a property in 2011 is not the same property it was in 1997. Even if there have been no changes in its surroundings, at the very least it will have aged by 14 years - while it is very difficult to assess, depreciation is very real. That said, it also has to be asked whether the HKD is worth as much today as it was in 1997. The answer appears to be "not much different". The composite CPI stood at 113.0 at the end of 1997 and at 115.1 at the end of January 2011. This is not quite an apples-to-apples comparison (the peak of the property index was a few months before the end of 1997 CPI number and the January 2011 CPI number is a month behind the property market peak reached this month. None the less, there has clearly been at least some decline in the real value of the HKD during this time to partially offset the depreciation effect of time on the properties themselves.


The second issue is that property is not homogeneous. The number cited is an index for Hong Kong Island. Luxury properties have long since surpassed previous highs, indicating that at the other end of the market, there is still some catching up to do. Also, other parts of Hong Kong (most noticeably, the north west part of the New Territories) are still lower than in 1997 . This can crudely be attributed to supply (more new units being built off Hong Kong Island) and demand (more demand in the luxury and upper middle class segments of the market). The latter is also at least a partial reflection of the uneven distribution of the benefits of the economic recovery (boom!) subsequent to the Asian crisis and SARS in both Hong Kong and the rest of the PRC.

What does this tell us about future Hong Kong property prices? Not much. Properties may be expensive in absolute terms, but still remain affordable in relative terms if (and it is a big if) you have a deposit. However the relative affordability is largely due to the low interest rates applicable to mortgage finance.

While predicting the future direction of Hong Kong property prices is, at best, an exercise in uncertainty, given where prices have got to, the positive circumstances which have driven the increase in values since 2003 and the policy stance of the Hong Kong government, it would require a considerable degree of optimism to believe that prices will continue rising at the same pace. In contrast, it is much easier to envisage either stagnating or falling prices in the short to medium term future - rising interest rates, termination of US quantitative easing, increased supply and other factors all have the ability to adversely affect the market. The greater uncertainties are the issues of when it will happen and how substantial the decline will be. I have no views on either issue. However, the longer we continue to experience negative real interest rates and more than nominal inflation the better from my perspective.

Keeping the mortgages

Several banks have started talking up the rates they are offering on mortgages. The latest being Bank of China (Hong Kong) Limited which has raised the spread on its HIBOR linked mortgage product to HIBOR + 0.9 - 1.2%. At current interest rates that works out at 1.1- 1.4% pa and compares with the old rates of HIBOR + 0.8% (1.0% pa). While still extremely cheap, its another sign that the banks are trying to exert some upward pressure on rates and expand their NIM (net interest margin). The new rates apply to new mortgages and do not affect existing mortgages.

While I can understand the banks' motivation, given that the demand for mortgage loans has fallen due to higher deposit requirements and a fall in transaction volumes (courtesy of the HK government's punitive stamp duty on short term resales), it seems unrealistic for a supplier of a good (mortgage loans) to increase price (interest rates) while experiencing falling demand (less money being borrowed). As far as I am aware the supply of money (deposits) has not dried up and Hong Kong banks still have very healthy loan to deposit ratios. Also, there has been no noticeable increase in either deposit rates or bond yields. I have to wonder what I am missing here?

As far as my own position is concerned, the case for not making early repayments has got even stronger in recent months:

1. all my mortgages currently cost less than 1% pa;

2. CPI measured inflation is currently running at 3.6% pa (for the year to January 2011);

3. yields on equities and real estate are well above the cost of funds;

4. there is no risk of being called (absent default);

5. based on current bank valuations, my weighted average gearing on the Hong Kong properties is less than 31% (range 7-45%);

6. historically, banks have not called mortgages unless there is an actual failure to make payments due;

7. I will make either a full or a partial repayment of the mortgage on our home when I retire and get back my capital contribution (and, yes, I feel like a complete wimp for doing this).

In effect, my position is that negative real interest rates and low nominal rates mean that keeping the mortgages for as long as possible is a meaningful way of adding value to the portfolio through generation of positive carry (yield differential) and inflationary erosion of principal.

The major risk is that the floating interest rates (HIBOR) move above the yields on investments and/or that we revert to an deflationary environment. While I do expect interest rates to move up at some stage (but can only guess and when this will happen and by how much), I consider the downside to be limited (especially compared to the risk of holding volatile assets like equities and real estate). Given that I will cease working in the near future, this is an important point because I will have to service the loans from rental income without the security blanket of job related income.

I also have to accept that rising interest rates have the potential to cause property prices to fall. This is a very real and not immaterial risk to my portfolio. Given my gearing and cash flow position I have a high degree of confidence that I can ride out any downturn. Hopefully this will not turn out to be a case of famous last words.

HK Budget revisited

Prior to heading off to New York last week, I (along with a lot of other people) expressed my disappointment with the tepid and ill-directed budget. One of my specific gripes was the daft proposal to benefit the fund management industry by paying $6,000 per eligible recipient into MPF plans. The Financial Secretary subsequently caved into pressure, cancelling the gift to the fund management industry and substituting a cash payment to every Hong Kong permanent resident.

While it would have been more equitable and "fairer" for the excess taxation to be returned to the people who gave the money to the government in the first place (i.e. the taxpayers), in many respects I don't mind a near-universal cash distribution. It's a definite improvement over the previous MPF related proposal and reduces the excessive build of "reserves" held by the government (HK$1.3 trillion + at the last count). Also, given the rise of inflation some of the lower income groups could use some financial assistance.