Property 101: Misguided policies push up home prices

It’s a well-known fact that Hong Kong housing keeps scaling new heights. Just how this phenomenon is felt by the people can be quantified by looking at terms such as “Expensive Flats” in Google Trends, which indicates that home prices are at their highest since 2011. While everyone blames this on low interest rate and low supply, this article highlights another more significant yet overlooked factor – the dysfunctional structure of Hong Kong’s housing supply.

Lost opportunity in housing reform – policy intervention even worse now

One of the main reasons that the last Chief Executive undertook reforms in public housing infrastructure was that the government had no duty to subsidize property investing. It is a shame that the government perpetuated the high land price policy after the abolition of Home Ownership Scheme (HOS), preventing developers from speedy replenishment of their landbanks at reasonable prices; this led to a shortage of private sector supply to relieve the high home prices we see today. It was also a gross oversight that the previous government failed to set an upper limit for public housing (just like the Financial Secretary targeting public spending at below 20% of GDP) to prevent welfare housing sector from expanding endlessly. These two policy mistakes are fatal errors in the reform of housing policies, we may be decades away before a similar opportunity presents itself again.

The combination of its planned economy philosophy and huge political pressure emanating from the high home prices has led the current government to aggressively grab land that would otherwise be building private sector housing. Meanwhile, the ever lengthening Public Rental Housing (PRH) waiting list and massive over-subscription in HOS sales reinforced in the minds of the administrators the justification of ever deepening government intervention in the housing market. As of now, private housing supply barely exceeds public housing supply by 10,000 units over the next five years [Figure 1], but will likely be significantly overwhelmed by public supply in the not too distant future. Amongst global housing markets, Hong Kong must rank high in terms of the degree of government intervention and participation in housing supply.

Figure 1: A possible completion pipeline in the next five years

Government exit needed to restore supply balance

At the top of the housing cycle, when the government diverts tax payers’ money to subsidise public housing, the well-ordered equilibrium of the market is broken – when faced with shortage of private land on the one hand, and irrational, price insensitive competition of low end government housing (HOS competes in the sales market while PRH competes in the rental market) on the other, developers have no choice but to focus on the luxury segment. This polarisation of the market (public housing flooding the low end coupled with private housing migrating to the super high-end) seriously damages the structure of the market, turning a smooth housing ladder into fragmented and disjoint segments with administratively imposed high barriers to overcome between each micro segment. The biggest victim of this tragedy is none other than the middle class, who can neither qualify for the welfare paid by their tax money, nor afford the private housing whose prices the policy helped elevate.

In light of this, the government should suspend any further public housing plans and sell all public lands into the private market. When there is adequate private land supply, developers would certainly sell earlier and build faster, thereby bringing the whole housing supply chain forward. In so doing, a more competitive private market emerges, relieving upward pressure on home prices [Figure 2].

Figure 2: By combining all public land into private market, private housing supply rises by 112%

Economics 101: more supply leads to lower prices

What the housing mandarins fail to realise is that the “home price” people refer to is private housing prices, because the public housing sector lacks a mature, open, and liquid system to reflect the balance between supply and demand. As long as there is sufficient supply in the private market, there is no need for a visible hand to set artificial prices or otherwise interfere in market behaviour.

In addition, the pool of capital that can address private home prices and consequently influence the public’s perception towards housing market has never been natural end-users of public housing. Therefore, basing public housing policy on private housing levels is strangely, barking up the wrong tree – the objective outcome of the current housing policies is one of grabbing private land, reducing private housing supply, and pushing up private home prices.

When public housing has reduced private supply, the same pool of capital is now forced to compete on a reduced allocation – how could each private unit not see higher prices as a result? To give a simple example, starting with a total 100 home buying dollars and total supply of ten units, then government reduces private sector to only four units (government policy targets 60% market share), higher home prices ($25/unit) inevitably result [Figure 3].

Figure 3: Public housing takes away private supply, thereby lifting average price in the market

On the contrary, if all public land is returned to private housing, the number of private units will increase by 1.5 times, while average home price would fall by 60% to $10 a unit [Figure 4]. This way, not only private home prices become much more affordable, the political pressure due to high home prices also disappears.

Figure 4: When left to market, private housing supply rises and prices must fall

It is obvious that by stepping back from interventionism, the market will function as intended, and home prices will be much more affordable. What is more, the people of Hong Kong will be able to buy the right product that meets their needs, at prices they can afford. This is a far more humane psychological condition than the current lottery mentality, dreaming of receiving government handouts, and in many cases trying to hide assets/income or giving up well-paid and promising careers to qualify for housing welfare. This vastly opposite mentality between masters of own destiny and low-esteem welfare recipient is what determines the future of Hong Kong.

Rear-view mirror policy making is counterproductive

The public housing machinery that the former Chief Executive failed to finish overhauling is characterised by a minority of officials determining the fate of a massive asset class, while these bureaucrats lack market experience, and have difficulty responding to market signals in a rational way. This situation is made worse by welfare politicians high jacking housing policy to extract maximum electoral benefits instead of serving the needs of the people. It is unsurprising that the sphere of housing policy has become a playground for vested interest groups.

What this set up leads to is that public housing supply is ramped up the most when the ducks quack the loudest, usually at the top of cycles. The government policies at these cycle peaks also inevitably attract home buyers/renters which are most lacking in analytical abilities, least able to afford, and most unequipped to fend off the risks of a subsequent price collapse. Thanks to the most ill-timed government subsidies, these people always buy homes at the highest prices with the highest leverage.

Once the property market has corrected, the peak of public housing completion arrives on cue to worsen market vacancies when it is already at its worst [Figure 5]. In other words, government behaviour not only increase home price volatility, it leads to higher construction costs, and lures the greedy seeking advantages into welfare traps, if not worse – negative equity.

Figure 5: Public housing policy lags behind markets, raises price and supply volatilities

Abandon intervention and return free markets

At the opposite end of the spectrum, private developers must meet market demands at every turn in order to maximize profits. They will always increase supply when price rises, even adding supply at a faster pace than the change in price (because they are flexible in advancing or delaying presales). When the market corrects, developers readily cuts prices and reduce supply, because they do not have administrative inertia or procedures to deal with. This results in lower price fluctuations [Figure 6: Blue line move faster than red line, thereby reduces the steepness in the slope of red line] and fewer slogan chanting, ambulance chasing welfare politicians.

 

Figure 6: Private market adjusts supply and prices rapidly, avoids uncertainties of policy interventions

The naked and large scale government meddling in housing supply not only contradicts basic economic principles, it also creates unfairness and wastes limited public resources. The above analysis shows clearly the contrast between private oriented and planned economy approaches to housing administration. We leave you with a final chart of actual completion data – almost every time home prices reaches a peak, the proportion of public housing completion surges [Chart 1], proving beyond doubt that our highly paid mandarins make the same mistakes at the same points in every property cycle. The sad truth remains, that we will be sure to witness another public housing tragedy in Hong Kong over the next 4 years.

Knowing that history repeats itself, the only and the right thing the civil servants should do is to humbly acknowledge that the market knows far more than any small group of smart individuals. Rather than arbitrarily thrust administrative coercion to achieve exactly the opposite, why not just step aside and let the people exercise their inborn economic liberties, thus reducing harm brought to the people and their wellbeing.

Chart 1: Public housing supply peaks 4 years following every property cycle peak – demonstrating that the road to hell is paved with good intentions

This article was researched and written with significant input from Mr Tom NG Chun Wai, whose contribution is greatly appreciated.