Small but extremely densely populated Hong Kong is now the city most at risk of a property bubble, according to the Global Real Estate Bubble Index published by UBS in September. A spur of panic and fear spiraled in Hong Kong, and almost every publishing house in the universe had something to say about it. The term “bubble,” refers to the sustained and substantial mispricing of an asset, in this case, property. The tricky thing about bubbles is that there is no way of knowing that one exists, until it bursts. Fortunately, a bubble might not actually exist in Hong Kong.

According to UBS, Hong Kong residential prices have increased by more than 10 percent over the past four quarters, adjusted for inflation. The price-to-income multiple rose from 12 in 2008 to 22 today. This means residents essentially need to dole out 22 years of household income to afford a house in Hong Kong. The city remains chronically under-supplied with inadequate regulatory cooling measures.

However, this does not necessarily lead to a housing bubble. Firstly, a bubble is usually associated with excessive borrowing in the system. For example, a big fat property bubble burst in 2008, gifting the U.S. its worst financial crisis since the Great Depression because financial institutions allowed homeowners to take on debts that were only affordable in their dreams. In Hong Kong, regulation prevents this. Secondly, Hong Kong is small, mountainous, wealthy, and adjacent to a booming China – unaffordability did not just suddenly happen.

“The fundamentals aren’t there for a bubble to exist,” said Yu Wen Kwan, director of investments at GRP Limited, a Singapore based property developer with projects in China and Malaysia, that is looking to expand its portfolio into Hong Kong. “Homeowners and developers simply aren’t able to borrow excessively so they remain well capitalized and cash rich. While property prices are correcting, it’s just downward pressure because of the lack of affordability.”

The Hong Kong Monetary Authority places restrictions on the loan-to-value amounts for residential properties. For example, an applicant whose income is derived mainly in Hong Kong and who does not have an existing mortgage, who wishes to purchase a property with value exceeding HKD10 million (approximately $1.3 million), can only borrow up to 50 percent of the 10 million. If the applicant has an existing mortgage, they can only borrow up to 40 percent.

“I wouldn’t say it’s a bubble,” said Alexander Fu, vice chairman and CEO of Carlton Holdings International Corporation, a Hong Kong based property developer of commercial retail and boutique hotels. “We monitor the residential market closely, and I think it’s more of a correction. While residential developers will never want to tell you there’s a bubble, we have no bias regarding the loosening and tightening of regulation because we have no exposure to the market.”

According to Fu, even as less sophisticated investors are foreclosed on, the sophisticated cash-rich investors will buy these properties and the market will return to order.

From a macro perspective, Hong Kong’s total land area is 1,063 square miles, its population is 7.39 million – that’s a population density of about 7,000 people per square mile. For comparison, in the U.S., population density is 85 people per square mile. Moreover, less than 25 percent of Hong Kong’s land is developed: its topography is mountainous, and 40 percent of the land comprises parkland and nature reserves.

“Hong Kong apartments have always been small,” Kwan said. “It’s one of the wealthiest cities in the world. If there is inhabitable land, it’s already inhabited. You can’t expect developers to charge less than market price.”

More than 40 percent of government revenue derives from land premiums and stamp duties. This allows the government to keep income taxes low, and in some respects, guarantees high property prices. For residents, this means that housing has become increasingly unaffordable as land has become increasingly scarce – while this may have triggered a correction, it does not necessarily equate to a property bubble.

“The opportunity cost to buy a home here is too much,” said Barton Lui, a Hong Kong resident who works in asset management. “I earn well above the average income and I still can’t afford it. I’m not optimistic about the future. The government doesn’t do enough because it lacks incentive.”

Chief Executive of Hong Kong, Carrie Lam, has initiated the land reclamation of Lantau Island, the largest island in Hong Kong, to house 1.1 million people. Despite public skepticism over the project’s feasibility, Lam is bulldozing ahead. “She’s more willing to deal with the affordability crisis than past chiefs,” Fu said. “Residential markets should stabilize in the long-term.”

Hong Kong’s population is projected to increase to 8.22 million in mid-2043. Coupled with an increasing transfer of wealth from China, time will tell whether Lui and his neighbors start to receive some positive news. In the meantime, it’s best not to get unnecessarily hasty about a bubble in Hong Kong – residents have enough to worry about.

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