The Big Question

May 12, 2011

The government put up three lots of residential land for public auction yesterday, and all three lots were sold for high prices. The most prominent one, the former Lingnan College site on Stubbs Road, Hong Kong Island, was auctioned for $4,490 million, which translates into $24,829 per square foot accommodation value (value of land per square foot of total developable floor space). The total cost of development, including construction and interest, will be more than $35,000 per square foot floor space. This prompted luxury property owners to raise selling prices amid a new round of bullish forecasts.

The law of gravity states that anything which rises will eventually fall. The cycle theory applies to everything on Planet Earth. The big question is: when? To answer this, we need to examine what contributed to the present price hike, which began in 2004 when the local economy began to recover from the SARS fallout, and has gathered speed since 2009.

The concerted efforts by major developed countries and China to jumpstart the global economy after the financial crash in late 2008 resulted in unprecedented high level of liquidity. Many of the economies are flush with cash. In Hong Kong, fearing that businesses would take longer time to recover, banks found a way out for their lending in the mortgage market. Effective interest rates are as low as one per cent when they are Hibor-linked or two per cent when they are prime rate-linked.

This has encouraged many people to buy properties; some of them otherwise could not afford to. It also lured investors into the property market, because the deposit rate is next to nothing. When a market is flooded with capital, price escalation is just a matter of how much.

Various sectors of the economy have recovered and demand for loans has increased. In the last year or so, this has picked up pace, as reflected in the significantly enhanced performances of banks. With the property price hike entering its eighth year without major correction, more and more people are concerned about when the trend will reverse. Banks have become cautious and want to reduce exposure on property, now that their capital has found its way into business lending.

Recently, major banks have increased mortgage rates and the forecast is this will continue. Globally, the conclusion of QE2 means the end of the era of excess liquidity. So the days of excess liquidity and loose lending is numbered.

Coming back to the big question – when will the property market experience a correction? While nobody has a crystal ball, it is certain that higher borrowing costs would serve to dampen mortgage demand. History has taught us that if the cost of fund equals or surpasses rental returns on property, it is about time the price was due for adjustment. Currently, effective mortgage rates are between 1.5 and 2.5 per cent, and rental yields are two per cent for luxury properties and three to four per cent on the mass residential properties. While there are also other factors at play, we are certain the correction is on the horizon.

By Koh Keng-shing