Joshua Han Miller is the Chief Executive Officer and Board Director at OKAY.com with close to 20 years’ experience in finance, leadership and Hong Kong property. Before moving into the real estate industry, Joshua was a Vice President with Morgan Stanley, working in the Global Capital Markets and Investment Banking divisions in Hong Kong and New York.  Born in the U.S. (Hawaii) and raised in Hong Kong, Joshua obtained his MBA at the MIT Sloan School of Management, and his BA at Dartmouth College.

 

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14 October 2016 - We have had several questions from our clients about the recent news of a “red hot” property market being fueled by financing firms Convoy Global and ETC Finance.  These firms are offering 80-90% financing on property purchases, well beyond what is allowed of banks governed by the Hong Kong Monetary Authority, since some financing firms are not subject to the HKMA’s regulations.  

It is somewhat concerning to see these finance firms’ formally partnering with large property agencies.  Although not uncommon in real estate, when real estate agents aggressively push additional lending upon the unsuspecting marginal borrower, it can be problematic down the road when interest rates do rise.

 

If it’s widespread, the re-emergence of secondary property lending facilities is a dangerous game. SCMP cites that financing companies are offering loans 1-2.5% below prime which itself isn’t dangerous until interest rates increase to at least 7%, potentially leading to foreclosures 3 years from now. This is only the case for those who have heavily leveraged their property purchases without the financial strength to afford interest payments 2-4 times what they are today.

 

These loans aren’t universally used by purchasers, and the recent “wave” represents a relatively small proportion of purchasers over the last 5 years. There aren’t any readily-available statistics on this specifically, but loan growth by Hong Kong banks has been declining over the last 3 years, despite deposits increasing approx. 6-10% per year over the same period. Combine this with the low property sales transaction volumes during this period (still below SARS levels), and one can infer that aggregate market leverage remains below “bubble” risk levels.

 

Anecdotally, these additional financing sources are used for smaller first-hand purchases more often than for the secondary market or larger purchases. Most purchasers of property in the last several years have generally limited their borrowing to the HKMA limits (maximum of 60% loan-to-value ratio).  At OKAY.com we’ve continued to see a reasonable proportion of cash purchasers as well.  So the macro risk of a bubble from a debt perspective remains low for now in my opinion. 

 

Of course, we could see more borrowers turning to alternative lenders, incrementally increasing the amount of real estate leverage over time.  If this does in fact occur, it will be interesting to observe Hong Kong Government’s reaction.  After all, these finance companies are regulated by the Money Lenders Ordinance, which is controlled by the Commissioner of Police, which is also controlled by the Hong Kong Government.  A cynic could say that, by not imposing the same limits on alternative lenders, the government is trying to encourage more real estate purchases to ensure the market doesn’t fall too far.  It’s possible, but I doubt it.  If overall leverage starts to approach the high levels seen in the 80’s when 95% mortgages were commonplace, I suspect we’ll see tightening on that front as well.

 

Hong Kong is also often compared to other global markets as being one of the most expensive – both on a price per square foot basis, and on an affordability basis.  A recent UBS Real Estate Bubble Index report cited Hong Kong purchases as representing approx. 18 years’ of income, compared to similarly-sized flats in London (16 years), Singapore (12 years), New York (11 years) and Boston (4 years)(1).

 

What bubble articles generally don’t mention is that comparing stats across markets is not a reliable approach to determine a bubble.  Real estate isn’t fungible across countries, naturally.  So relative behavior of what price is acceptable varies by country.  Hong Kong property has always had higher pricing and lower affordability (i.e. representing more years of income) than other countries, yet with lower overall leverage levels.  In some markets people are simply willing to spend a higher percentage of their income on rent or to purchase – it depends on your expectations and other costs.  

 

It also depends heavily on tax rates, which in many countries consume a much higher proportion of income than in Hong Kong.   

 

So bubbles are very much relative to each city’s historical levels.  It’s true Hong Kong property prices, even after the recent ~12 % correction, are at historical highs.  But there are also lower debt levels in the market than in the last real crash of 1997 – which was driven by the Asian currency crisis and was not purely a bubble in the standalone HK real estate market.  Perhaps a better measure, but also hard to calculate is historical price & leverage vs. total wealth in Hong Kong, or some measure of median wealth per capita.  

 

All in all, if the definition of a bubble is something that bursts and leads to a large crash as opposed to a cyclical pullback, especially one the government has been trying to catalyze for years, then we’re not on the verge of a property bubble in Hong Kong.  We’re in a grey zone where short-term confidence is returning, interest rates are low and significantly higher rates aren’t an immediate threat.  However, income and GDP growth are both marginal, new supply is increasing, and the retail inflows from China have significantly abated.  I think the market will be relatively stable for the time being and falling gradually as sales volumes increase (still well below historical averages), to the point of a turnaround.  

 

And if prices fall dramatically, it’ll be due to exogenous factors – the outcome of the U.S. elections, if Brexit does lead to a toppling of European confidence, heightened military conflict in the region, and any other events that are difficult to predict.

 

Do you think there will be a Hong Kong property market bubble? Share your thoughts in the comments below.

 

 

Footnotes:

(1) UBS Global Real Estate Bubble Index report (Sept. 2016), referring to the cost of purchasing a 60m2 apartment in various global markets.