“Peter, is there going to be another property crash in Hong Kong?”
I get asked this question often. It’s understandable. Many people are worried the residential property market in Hong Kong is overheating. And it has certainly gone up. It saw a compound annual growth rate of 7.4 percent from 1981 to the end 2016.
So is the Hong Kong residential property market a true bubble? Will current conditions lead to a crash in the housing market? And is there real systemic risk to the banking system?
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The answer to all three questions is NO – not at this stage…
Why the property market isn’t a risk to the banking system
Property bubbles and the systemic risk they bring are usually created by excessive debt being piled into real estate, both by developers and property companies and also end users.
So let’s first take the residential property developer community in Hong Kong.
The Hong Kong housing market is dominated by about eight or nine major developers of private housing. These companies do not carry a lot of debt. They are not Chinese companies or U.S., UK, Australian or Canadian developers that typically have net debt to equity ratios of around 50 percent or more.
No, the average net debt to equity ratio for the major listed developers in Hong Kong is typically in the 15 percent to 20 percent range, with many well below this level. The real estate developer sector in Hong Kong is by far the most lowly geared of any country around the developed world.
They have learned the lessons the hard way, from bitter experience back in the 1980s. At that time, Hong Kong developers had splurged on debt and a massive building boom. Prices went up approximately 100 percent per annum for the three years leading into 1981. That was a real estate bubble of epic proportions. At the time, I predicted to my clients that I thought Hong Kong would experience a correction of at least 10 percent in its bloated housing market. I was way wrong. The “correction” was more like 70 percent over three years. That was a time when I watched these companies hanging on by their fingernails – and the good graces of HSBC and other local banks.
Since that near-death experience, these companies have shunned debt. For example, one of the larger-listed companies whose board I sit on routinely runs a balance sheet which has a net debt to equity ratio between 3 percent and 5 percent. That is miniscule!
So there is no real systemic risk to the financial system from the big players in the real estate development game in Hong Kong.
But what about consumers? Well, unlike many other developed countries, Hong Kong folks don’t carry a lot of credit card debt. They are not big users of hire purchase loans and loans to finance buying household goods and the like. They do not have a system of college education debt – a problem that is engulfing families in the U.S. They also do not carry a lot of auto loans.
The biggest debt for most Hong Kong consumers is likely to be a mortgage on an apartment.
Today, the average new mortgage loan granted is for 51 percent of the value of the property, down from 64 percent back in 2009, when the market first started to recover from the global financial crisis.
That low LTV (loan to value ratio) gives banks a very sizable equity cushion.
This means that anyone taking out a mortgage from a bank today would need to see the value of their home fall by 49 percent before they got into a negative equity position. That is, their outstanding mortgage debt would be more than the value of the property.
And delinquent mortgage loans in Hong Kong represent just 0.04 percent of all mortgage loans. That is less than one tenth of one percent. That’s about as close to zero as one can get.
Now, we have seen big falls in Hong Kong residential property in the past. For example, when residential property fell by around 60 percent following the Asian financial crisis in 1997.
By September 2003, the Hong Kong Monetary Authority estimated that 99,805 residential mortgages were in negative equity. This represented 20 percent of all residential mortgages outstanding. Given that prices had fallen some 60 percent by that time, I was surprised that the figure was not higher.
And did people default on mortgages? Very little. Delinquent mortgages (the proportion of residential loans overdue by three months or more) peaked in June 2003 at a very small 1.12 percent. That was hardly likely to blow the banks apart. So if history is any guide, any property market downturn today would probably not result in a big default rate.
In short, it seems there is little systemic financial risk to the banking system in Hong Kong coming from either the developer community or the end users in the mortgage markets.
Now to the bubble question
So why don’t I think the Hong Kong property market is a bubble that will burst with terrible consequences?
A bubble occurs when activity and pricing in a particular asset class (stocks, bonds, real estate, art) becomes manic and soars beyond long-term average levels and rates. I am referring to two variables here. Volumes of transactions/activity and prices of the assets in question.
The China stock market, for example, was very clearly in a bubble in its huge run up in 2014/2015. Both pricing of the market and trading activity soared way beyond longer-term averages. The Shanghai market, for example, rose 153 percent from the end of May 2014 to its peak in the second week of June 2015. Stocks were trading at valuations way in excess of “normal” levels. Stocks that normally might trade at a price-to-earnings ratio of 15 to 20 were then trading at 50 times earnings. And daily volumes of share trading soared by many multiples of “normal” levels.
So let’s take a look at the Hong Kong residential property market. Our chart below shows the long-term volume of property transactions (the number of residential sales and purchase agreements) in Hong Kong.
The average monthly trading volume is in the range of 6,000 to 8,000 per month. A sustained volume of transactions above 10,000 per month is usually a sign of bubble conditions. Levels consistently below 5,000 are signs of a bear market.
Early 2016 was an extremely bearish time, according to this indicator. Transactions volume fell to record low levels of less than 3,000. Volumes picked up, but were at very low levels again as recently as January 2017. For the first eleven months of 2017 the average monthly residential transactions volume in the primary and secondary markets was 7,049, well within the “normal” range.
So there is no manic bubble being reflected in the volume of transactions.
Now let’s look at pricing
Hong Kong’s housing market is probably the most volatile in the world… certainly amongst developed markets.
Since 1997, the Hong Kong residential property market has had five meaningful corrections (or pullbacks). There was a period in 2005/2006 where the market flat-lined. But the biggest tumble was a jaw dropping 60 percent fall during the Asian financial crisis between 1997 and mid-2003.
The most recent correction was in Q4 2015 to the end of Q1 2016. Prices fell about 13 percent. But the market was quick to recover, and by the end of 2016, it had recovered all its losses from that correction. The residential property price index now stands about 7 percent higher than it did at its previous peak in Q3 2015.
At the current “run rate”, Hong Kong’s housing prices were set to produce a gain of around 15 to 17 percent last year.
Following it’s decline in 2015/2016, a price increase of this level is certainly substantial, but it does not qualify as a manic boom.
There simply is not the mania that normally accompanies bubbles that burst. It’s not there in buying activity and transactions volumes. It is certainly a buoyant market, especially in the primary market where developers are offering buyers top up financing over and above what the banks are providing. That is stimulating the primary market. That kind of financing is not available in the secondary market, so there is reduced activity in this part of the market. Buyers can typically obtain only a 50 percent mortgage.
And there is not a debt-infused bomb that is about to go off in Hong Kong, either with banks, developers, or households.
There is also no massive supply bubble that is going to hit the market and force prices down. In fact, supply coming on line over the coming three years or so will be about 20 percent to 35 percent lower than the average supply in the 30 years leading up to 2003. Supply is modest, but rising slowly.
Finally, there is not an inflation bubble on the immediate horizon in the U.S., which would signal a big rise in interest rates in Hong Kong. Yes, interest rates are set to rise, but will still be much lower than longer term averages.
In short, I just do not see conditions that would produce the sort of huge 60 percent down side that followed the 1997 Asian financial crisis.
To sum up, I don’t see any systemic risk to the banking system or any signs of a residential real estate bubble in Hong Kong.