Housing prices are dropping, but a nosedive is unlikely

Hong Kong banks are finally raising interest rates for the first time in 12 years, marking the start of the new rate hike cycle. Large commercial banks, led by HSBC, have raised their prime rate by 12.5 basis points. In the case of a second-hand home bought at HK$7 million with the loan-to-value ratio set at 0.6, if the HK$4.2 million mortgage has a repayment period of 25 years, then the monthly mortgage payment will only increase by HK$260. Judging from this figure, the rate hike’s effect seems small but let’s not forget that HIBOR-based mortgage rates, which had been standing at just above 1% from the beginning of 2018, are now mostly at 2.15% to 2.25%, approaching the rate cap, thanks to the HIBOR increase. Mortgage owners are starting to feel the pressure.

Due to a combination of factors—including the US-China trade war, economic instabilities, stock market downturn, the new vacancy tax, increased discount in the Home Ownership Scheme and lower selling prices set by Chinese developers for new projects—housing prices in Hong Kong will experience a decline this year. The extent of the decline will depend on the moving trajectory of interest rates.

US interest rates have risen by 2% since 2015, through a total of eight rate hikes. The US Federal Reserve estimated one additional rate hike in 2018, three in 2019, and another one in 2020. The five upcoming rate increases are collectively expected to raise interest rates by another 1.25%. It would take a staggering 3% increase if Hong Kong were to catch up with the US rates, which would be bad news for the city’s housing market. However, despite the interest arbitrage activities, the Hong Kong market is still well funded. Some think that most of the funds that have stayed in Hong Kong are from mainland China, and the flow of these type of funds is dictated largely by mainland policies rather than arbitrage strategies. With Hong Kong a major destination for outflowing mainland funds, it has become the norm for such funds to stay in Hong Kong for the long term. In addition, as the current Hong Kong rate hike is far below the 25-basis-point increase of its US counterpart, optimists tend to believe that Hong Kong interest rates will stay below the States’ instead of trying to keep up.

On the other hand, it’s unclear if the US Fed will actually fulfill its rate hike plans in the coming years, and the development of the US-China trade war is a huge contributor to this uncertainty. If the trade war continues to escalate, its impact on the American economy and commodity prices will probably be felt starting next year. In the case of an economic downturn, the roadmap for the Fed’s current rate hike will surely change course.

Optimistically, I believe that the increase of Hong Kong’s interest rates will not surpass 1% in the following year. As for the housing market, while a 10 to 15% downward adjustment is inevitable, a steep plunge in home prices will be very unlikely.