MAGAZINE 45 EXPERT OPINION

The US economy is in some serious trouble; problems that started in the housing market are spreading like mildew. So just how far (and how soon) will this affect the Hong Kong property market? Alex Frew McMillan reports
 

Though the full figures aren't out yet for the holiday season, it looks like consumer spending - which accounts for fully 70 percent of the US economy and which has for years propped it up when things go bad - is on track to drop for the first time since 1991. Retail sales were down 0.4 percent for December, an unexpected drop.

If the notoriously spendthrift Joe and Jane Public have started to horde their cash, prospects stateside look bleak indeed. Can a recession be far away? And what does that mean for the property market in Hong Kong?

It has been a while since the "R" word reared its ugly head. The last US recession, in 2001, was short-lived. But it was exported to Asia about nine months after it started in the United States. In Hong Kong, the downturn was more severe in the end, exacerbated by Sars in early 2003.

The property market suffered more than most. Mass-market residential property prices dropped 12 percent in 2000, 9.7 percent in 2001 and 9.6 percent in 2002. Luxury properties didn't fall quite as far but were also down in all three years, rubbing salt into the wound of the huge drops in prices seen in 1998, when the property bubble burst. Only in late 2003 did the market start coming back.

"There is going to be a ripple effect in Asia [from subprime problems]," Rob Blain, the chairman and chief executive officer of CB Richard Ellis Asia Pacific, said at the MIPIM conference in November. "It would be naïve to suggest that won't happen."

But Blain's remark was a preface to a generally bullish outlook on the region. As the year starts, many market watchers are upbeat on Asian property in general and particularly bullish about Hong Kong.

UBS is predicting a 50 percent increase in Hong Kong home prices between now and next year. Bear Stearns foresees a rise of 40 percent this year and 20 percent next year. Merrill Lynch anticipates a jump of 50 percent by the end of 2009.

However, these rosy forecasts from the start of the year are receiving a little revision. The US stock market has had its worst start to the year since 1978, with the S&P 500 down 2.5 percent in the first 10 days of trading. Hong Kong stocks are following that downward path, off 23 percent from their highs of last year as the Hang Seng fell below 25,000 on January 16.

The stock market is normally an early indicator of broader problems. So experts are watching to see if the other shoe drops.

But property owners shouldn't panic yet. Xavier Wong, the head of research for Knight Frank Hong Kong, notes that the weak dollar should be helping US exporters, and boosting gains that US multinationals make overseas and then send back home.

"Even if the slowdown in the US is more marked than previously thought, the residential market in Hong Kong should be highly resilient," Wong said.

Judy Chai, executive director at Hong Kong brokerage Sallmanns Residential, even says the setback on Wall Street and at Exchange Square might, perversely, be good news for Hong Kong property.

"The real-estate market will get stronger when the stock market goes down," she predicts. "People will cash out and put it into real estate."

A home is the biggest purchase many people make in their lives. So it stands to reason that when the value of that purchase starts to fall, they feel it keenly. Even though most homeowners can sit tight and aren't forced to sell, the paper losses hurt psychologically.

Ben Bernanke, the chairman of the US Federal Reserve Bank, certainly seems aware of the danger. He is hustling to cut interest rates as quickly as possible in a bid to boost confidence, and ease the pain of homeowners who are struggling with mortgage payments. There's a half-point cut on the horizon and factored in by the markets already, and some pundits are predicting the US Federal Reserve Bank will cut rates to as low as 3 percent, from 4.25 percent now.

Technically, economists count a recession as two downward quarters in a row for the economy. Few people see that on the cards here, even if growth does slow a little.

"I do not foresee a recession in Hong Kong's economy," Wong said. But the United States might be a different matter. "The probability is getting higher."

The housing pains have hit home, literally, and left Americans feeling a lot less flush for cash. Consumer confidence is as low as it has been since 1995, and that sometimes becomes a self-fulfilling prophesy - if people believe the economy is going badly, they stop spending, which only makes the economy worse.

That's where the US Federal Reserve Bank may come in. If they can convince Wall Street and Joe Blow that they're taking rapid action, maybe they can turn that vicious confidence cycle into reverse.

There's little worrying Hong Kong consumers, and property buyers, at the moment. The strong gains of the stock market last year are still contributing to a wealth effect in the city, and many people are enjoying wage gains and expecting future raises, too.

This has been driving the property market forward. The wealth effect caused a spurt in interest in property during the last quarter of last year, a momentum that has been maintained so far in 2008.

Luxury residential prices climbed 9.4 percent in the fourth quarter, double the 4.8 percent growth of the previous three months, according to Colliers. It is predicting an increase of 25 percent for luxury residential capital values this year - which seems conservative compared to some other forecasts -- and a 15 percent climb in rents.

"In anticipation of further interest rate cuts and limited new supply in traditional luxury districts, quality residential properties will continue to be sought after in the market," Ricky Poon, the company's director of residential sales, said in his forecast for the year.

The US economy's problems have of course been, perversely, good news for Hong Kong's property market. Interest rates dropped significantly last year, and look set to continue falling, encouraging Hong Kong buyers to step in.

The Hong Kong property market has changed in one way since the last recession. There was too much real estate on the market in Hong Kong after the handover, when the government pledged to bring 85,000 new apartment units onto the market each year. Now the opposite is true.

"Between 1998 and 2003, there was an oversupply of residential units, but that is not the case at the moment," Wong said.

According to Knight Frank, there were only around 5,000 new residential units for sale at the end of November, down 50 percent from June. The situation is not expected to change for the next few years, with little new development coming on the market.

"In no rush to release their full inventory to the market, developers have been aggressive in setting asking prices," Knight Frank's December report noted. "The prices of some primary residential units are now 40 percent to 50 percent higher than their secondary market comparables."

Chai says the supply of property is much lower than the demand, particularly at the high end. She also says she doesn't see any of the speculation that characterised the last bubble, with most sales now going to people who actually live in the unit or hold at most one or two properties for investment.

"I don't see any effect on luxury property. The supply and demand is so severe, and investment bankers still want a place to live," Chai said. "Most people who are buying property now have very deep pockets, so they have holding power."

Chai - who thinks the short dip in stocks could be good for property - concedes that a long-term drop in the stock market would hurt in the end. But she doesn't see it happening in the first half of the year, and she suggests a breather could be a good thing later in 2008.

"I think in time we will be affected, but not in the next six months," she said. "I hope we are, because it is very difficult right now. I just lost two deals because the owners want to hold on to it and flip the property for a higher price."

It is a good question whether American problems will continue to be good news for long. Although Hong Kong is now much more intertwined with China's booming economy, still posting double-digit growth, China is making a lot of that money off exports to the United States. So Hong Kong's big brother may not escape the pain, and Hong Kong may turn out to be more linked to the United States than many now seem to think.

Princeton University economist Burton Malkiel predicts the United States will be flat and see basically no growth in the first half of this year. China will slow from 11 percent last year to around 7 percent this year, he predicts; a sizeable drop.