Saturday, December 29, 2012

Hong Kong Revisited -- Risks Presented by Low Cap Rates

View of Hong Kong Central from Kowloon, November 2012

Returning to Hong Kong 18 months after my previous post, I found residential prices had increased 23% this year alone as of October, and 87% since 2007, causing the Hong Kong Monetary Authority (Hong Kong's central bank) to worry that “the disconnect between property prices and economic fundamentals” presents “macro-financial risks” to the Hong Kong economy. has reported rental property capitalization rates in Hong Kong have declined to a range between 2.2 and 3.6%, and as low as 2.13% in The Peak neighborhood, and The Economist has reported an estimate that Hong Kong homes are 69% overvalued when compared to the rental income that they can produce.

Ultra-low real estate capitalization rates in Asia, such as in Hong Kong, present a bubble that lasts only until interest rates return to normal levels. Hong Kong already has a history of these bursting bubbles, such as the office market in 2004, declining 30% the following year, or the residential market in the Asian Contagion of 1997, when average prices declined 63% from peak to trough.

The Hong Kong government has already taken measures to discourage speculation, such as lowering loan-to-value ratios on mortgages and imposing stamp duty taxes of 15% on home flippers and foreign buyers, but such measures also send signals that housing prices are still headed upwards.

A Barclay’s report this year shed some light, though, on the gain in housing prices, reporting that the proportion of investor-buyers increasing to 70% and that 60% of homeowners have no mortgage. This points the reason for the price gain in the direction of foreign buyers, particularly the Chinese mainland, who often do not occupy their Hong Kong homes but treat them as “safe haven” assets.

With home affordability in Hong Kong at historic lows, any events that call in to question Hong Kong’s “safe haven” status, such as an interest rate shock, could cause it to suffer the fate of most of the second home markets the world over, although there is always a need for a safe haven somewhere. London, New York and Dubai have been recent popular destinations for foreign buyers with this aim in mind.

Hong Kong benchmark interest rate history -- HK Monetary Authority
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