Can Hong Kong property somehow out run the aftermath of the U.S. credit crunch? The quick answer from the property pundits is that they aren’t sure, says Alex Frew McMillan

It has taken some time to settle in, but it’s clear the U.S. downturn is a very serious one. Financier George Soros figures it’s the biggest bust since the Great Depression – and, to be honest, that wasn’t that great.

There’s plenty of hemming and hawing about whether the United States is in recession – the textbook says that requires two consecutive quarters of negative growth, so you can only tell for sure in hindsight – but Wall Street has already rendered its opinion. They’re in big trouble.

The boys down in Exchange Square have picked up on the signals. The Hang Seng Index has suffered much more than the Dow Jones Industrial Average, giving back plenty of last year’s strong run. Meanwhile, the Hong Kong property market stays firm, but for how long exactly?

“It is a really, really tough call,” says Piers Brunner, the chief operating officer for Colliers International in Hong Kong. “When you look at the basics and fundamentals, we are looking at it as a positive market – with caution.”

Property consultants gave a bullish forecast as the year began, and they continued to maintain that stance as the first quarter ended. They anticipate that luxury residential real-estate values will rise 25 percent between now and February 2009, with luxury rents rising by 15 percent.

But market analysts are watching very, very carefully for any signs that the market might weaken. “It could be an overnight change in Hong Kong,” Brunner says. “It is almost week by week monitoring.”

Bad news in the stock market usually means bad news for the property market – but not always. Knight Frank data shows there were eight major downturns in the Hang Seng Index between 1980 and 2006, but only four major slumps in the property market during the same period. In the strangest situation, when the stock market crashed 53 percent in late December 1987, property prices actually rose by 1 percent.

When they come, though, the downturns in the property market are more serious. “Similar to other areas of the world, the duration of property market downturns in Hong Kong has been longer than that of the stock market, as it takes longer to adjust the imbalances in the real-estate market than the financial market,” the Knight Frank report states.

Xavier Wong, the Hong Kong head of research for Knight Frank, notes in the report that the residential market has only slumped before when prices become unaffordable, interest rates rise and supply is excessive.

None of those factors are true at the moment. International banks are still ramping up hiring in Hong Kong and can’t get enough office space in the city. Their employees drive up rents, especially at the high end of the market. But Wall Street has laid off around 30,000 workers as a result of the credit crunch and writedowns there. If that trend gets exported to Asia, it could have a dramatic effect.

“There is movement of money and staff into Hong Kong and Asia at the moment, so we’re positive,” Brunner says. “And yet we know the banks can change overnight in terms of both the hires or retrenchments and their whole strategy. And if that happens, the consequences can be huge.”

Economists still generally predict that even a U.S. recession would produce only a slowdown in growth, not a recession, in mainland China.
Simon Lo, the director of research at Colliers, predicts that China will see some consolidation of its rapid expansion. But he still expects the country to post growth of 9 percent in each of the next two years.
Hong Kong’s growth may slow to 5 percent or 6 percent, from 8 percent. But that is still higher than the average growth rate of the last 15 years, which is just 3.8 percent.
“The degree of adjustment may not be the same as in the West,” Lo insists.

There are some very strange things going on in the Hong Kong economy at the moment, most of them positive for the property market. Inflation is picking up, which normally drives people to buy real estate. Yet interest rates – which typically rise during times of inflation – are very, very low because Hong Kong takes its lead from the United States.

In fact, mortgage rates, based of course on interest rates, have fallen below the rate of inflation. The effective mortgage rate home borrowers are paying is around 3 percent, depending on their deal at the bank, while inflation is running at 6 percent. Such negative mortgage rates spur typically buoyant investment demand.

Economists call it the “golden cross”, a situation that last happened in Hong Kong in 1991. The property market then saw four consecutive years of very strong growth through 2004.

“That will drive massive amounts of investment money into the market,” Lo says.

Hong Kong’s currency is very weak, too, pegged as it is to the U.S. dollar, meaning Hong Kong property looks cheap to overseas investors.

“From a fiscal point of view, it’s not all matching,” Brunner says. “Weak currency, low interest rates and high inflation – it looks like it’s all back to front. Asset price inflation will kick in to the property market. So it’s not only the fundamentals of supply and demand and positive sentiment.”

These kind of economic trends are catching the eye of investors, both big and small. Antonio Wu, the director of Asian investment sales at Colliers, makes regular marketing trips to Europe. Last year, he found only five big institutional investors in Germany who wanted to talk about Asian real estate. This year, there were 12.

“Seven of them are actively studying Asia,” Wu says. “I think for the first investment, it would be in mature markets.” That means Hong Kong, Japan or Singapore. And the firms look to buy or build whole buildings.

On a smaller scale, one real estate agent said she recently fielded a call from an expatriate investment banker working in Seoul, who was interested in Hong Kong property purely as an investment play. She sold him an apartment in Academic Terrace, in Pokfulam, entirely over the phone – he never plans to set eyes on it. The rent the banker can command is likely to rise almost as rapidly as the value of the apartment. The strong demand for centrally located apartments, particularly on Hong Kong Island, is pushing those prices up, too.

Iain Chapman, head of the tenant representation group at Colliers, says there is a “healthy balance” between landlord and tenant for office space when the vacancy rate is around 5 percent. The rate in Central is 1 percent or lower – virtually no space is available and little new space is coming on the market. That space squeeze finds its way into the residential market because the people occupying all that space also need a place to sleep at night.

“When you are down to 1 percent [vacancies] in Central, you know there is only one way we’re going to go with rental adjustments,” Brunner says.

Does this mean we are set for another 1997-style bubble? That’s a very real possibility, experts say.

But at the moment, the percentage of speculators in the market isn’t anywhere near 1997 levels. Owner-occupiers accounted for 69 percent of all households in Hong Kong in 2006, the most recent figures.

Affordability is also much better. Based on a typical private home in Hong Kong of HK$3.9 million and an average household income of HK$24,500, a typical family would currently be paying around 43 percent of household income on their mortgage, compared with 110 percent in mid-1997 and more than 200 percent in late 1981, Knight Frank says.

At the moment, the focus is not on a bubble – it’s firmly on whether Hong Kong can escape the property woes that have already hit in the United States, the United Kingdom and Spain.

Both the media and the public seem almost eager for news of a slowdown or crash. Any signs of weakness in a particular estate or at a property sale claim big headlines.

“The volume of transactions has dropped,” Brunner says. “Some vendors are just sticking to their price, while some buyers are nervous about what is going on. So there’s a longer gestation period for deals to get done.”

Prices in Hong Kong stalled in March, the latest figures available, but they were up 10 percent already this year. The activity in January was breathtaking, real-estate professionals say.

Will prices turn in the other direction? Unlikely, the professionals say. But proceed with caution and watch this space.