One horse town

As anyone who lives and works here knows, Hong Kong is a singular location with a singular economy. It’s based on four so-called key industries, namely financial services, tourism, trading and logistics and professional and producer services, and combined in 2017 they employed almost 1.8 million Hongkongers—nearly half the city’s labour force. Nonetheless, an inordinate amount of Hong Kong’s economic activity and its public revenues come from real estate—either land sales, property taxes or stamp duties. Notably, the economic value of property isn’t included in the Census and Statistics Department’s economic data, but that doesn’t mean it lessens its importance. So with all the chatter of rising interest rates, falling housing prices, office supply crunches and softening retail rents, what is it exactly that makes property so critical to Hong Kong’s overall health?

The Public Good

First and foremost, Hong Kong flirts with single-industry status. As much as we poke fun at Macau for its reliance on gambling revenues to power the city (approximately 50% by some accounts), Hong Kong isn’t that far behind. As of September 2018, the value of government land sales for the year totalled nearly HK$51 billion—a drop in the bucket of the SAR’s 2018 to 2019 HK$600 billion budget (and 2018’s sales will go to another budget). However, land premiums and stamp duties alone account for 36.5% of that total, which is an increase from 26% in the early 1990s. “That’s always been one of the issues people point to as putting the government in a compromising position,” says Denis Ma, head of research for JLL in Hong Kong. “They have no incentive to make land cheap, and it’s [a policy] that might need to be addressed in future. We still have half the population living in public housing, which gives no return.”

“Hong Kong is a very low tax [location] but the government needs to secure revenue to pay for infrastructure and support welfare programmes,” echoes Colliers’ international director of research, Daniel Shih. “I wouldn’t say it’s to offset tax issues, but it’s a way for the government to maintain a healthy position. So land sales are important—and high land costs support high property prices.” Lower prices for sales means less stamp duty income, and lower values mean lower rates revenue. Hong Kong’s fiscal budget lost as much as 3% of its value following the 1997 Asian Financial Crisis, when no land premiums were collected and when they accounted for just 15% of the budget. It’s possible any difference could be made up in volume, but with transaction numbers flagging, that remains to be seen.

Property is perhaps the most sentiment-driven of Hong Kong’s key industries, and sentiment directly affects consumption—a pillar of almost any economy. In 2019, interest rate increases could mean higher mortgage loan payments. The Hong Kong Monetary Authority (HKMA) ensured anyone currently with a mortgage was carrying an affordable one by implementing lower LTV ratios over the past five years—with the exception of primary sales purchases financed by developers. Higher loan instalments mean less cash in hand, and so less disposable income and frivolous spending: fewer dinners out, fewer trips to the movies and one more season with those Nikes. For those saving for a massive down payment, rising prices mean a longer saving period and less average spending. Consumption spending relies on “households’ lifetime financial resources, and housing wealth is an important part of those resources, changes in the property price can be expected to influence consumption,” wrote the HKMA in 2001 in an attempt to explain the connection between property and macroeconomics. In the wake of the Asian Financial Crisis, between 1997 and 2000, prices plunged as much as 50% and private wealth suffered. That’s referred to as the wealth effect, and it can fluctuate along with the property market—and with the stock market.

The Long Run

Furthermore, a Hang Seng Index that’s been wobbly since autumn 2018 doesn’t help, and any downturn in property makes banks, which are exposed to the property markets via financing—institutional and individual—get anxious. Non-performing loans can influence how, and how much, banks will lend. The HKMA has already done its part to ensure the health of the banks, but lending affects even cash-rich developers—the same developers who build office towers, which Hong Kong is currently facing a shortage of. With a dearth of office space on the horizon, Hong Kong’s regional business competitiveness could be affected, bringing property’s importance full circle. No new business means a negative impact on those 1.8 million workers.

But there’s more to property than price, rental yields, office occupier stats and retail rents as an indicator of retail sales. Hong Kong’s “free market first,” low tax environment means things like fees at public schools, administration fees at public hospitals, fees at public sport facilities—and a lack of any kind of pension scheme, no matter how hard the MPF tried. Given banks’ general stinginess on interest bearing accounts, for many residents, property is their primary source of retirement savings, either to ensure someplace to live or to sell as a means to retire someplace with a lower cost of living. “Housing is the most important form of savings for many households,” concurred the HKMA.

Ma agrees as well. Of the general focus on property, “the first thing I would say is if you look at Hong Kong property over the long term is it’s a good store of wealth. It’s something like 7% compound average over 30 years,” he notes. “The other thing is the volatility of the market makes it trade like a stock, and that compounds the issue. For a lot of Hong Kong people there’s no social security in Hong Kong, so ideally by the time you retire, if you have an income source from a rental property, maybe two, that’s considerable. You can go to, say, Malaysia with $15,000 or $20,000 per month and that’s a good living.”

There’s also a more intangible aspect to the SAR’s reliance on real estate that may never change. “Hongkongers have always been very active in the market. It’s not just a shelter for families. It’s an investment vehicle. It’s for the children,” finishes Shih. “Culturally, the Chinese like to own a piece of real estate, so it’s not just Hong Kong. It’s an important part of building assets.”