Is the big rush into Japanese property justified? 20240529

We have heard nothing other than 'we are buying Niseko ski flat' or 'our fund is adding Tokyo hotel' for the past few months, as if the rest of the world is all in the dog house...

Clients familiar with our arguments will know we have been negative for at least 2 years on the Japanese market, so this email seeks to give a more rounded exposition on why.

When crowds scramble one way, we go the other

The recent scramble for adding Japanese exposure (see Article 1) is in line with the concurrent rise in the Topix, but in property land there is even more momentum, especially amongst funds:

Granted, funds have been sitting on their hands in the past 2 years as interest rates globally spiked, and their IRR calculations were thrown into disarray. So the wishful hope that Fed rate cuts will be implemented (now proven wrong), plus a reversal of Japanese asset depreciation has sparked a sudden fad into pumping money into the land of the rising (may be now setting) sun...

We are very wary of the much more significant risk of Yen devaluation against whatever puny asset appreciation in the currency in the coming years however, and would prefer other jurisdictions where BOTH currency and asset prices will rise (regular readers will know where that is!).

FX should be central in investment decisions

The point of making price gains but adding translation losses is best illustrated with a view to history:

As shown above, during the haydays of Japanese industrial and cultural ascent, both asset prices in local currency (LC) and exchange rates were on the rise - see left green arrow. The combined effect for foreign investors is even stronger returns in USD terms (red line) than locals (blue line), shown by the purple enlarging triangle.

In the subsequent lost 2 decades, Yen basically went sideways (2nd green arrow), with price drops very comparable in LC and USD (purple parallelogram).

We are now probably into the next leg of Yen derating (see 3rd green arrow) thanks to shrinking population - see Article 3 - and the resurgent commodities complex when all input materials see price spirals. Unsurprisingly, since 2010, despite LC price gains, USD denominated values fell (purple trapezium).

We expect the next (final) down leg in Yen (4th green arrow) to unfold in the next 3 years or so, which can also destroy value for overseas investors (ie down red arrow despite up blue arrow).

To put it in numbers terms, below is a table showing the impact of Yen weakness (red shades) vs USD denominated Tokyo home prices:

Of course, the 2025-29 projections above are purely based on the arrows in chart above and may not play out the way we projected, but the risk that you get negative USD returns (2nd column from right) is very real indeed.

Macro picture for Japan: far from rosy

By the combined will to reintroduce inflation and to inflate away the mountains of govt debt (highest in OECD), the Japanese work force has been earning negative real income for the past two years:

In the meantime, the cost of living crisis left private consumption down for 4 quarters in a row, with little help to exports (net exports were increasingly negative in recent quarters) to contribute to GDP growth:

In the meantime, the geopolitical tensions between China and US is causing the rate environment to surge further, due to:

1) loss of demand for US debts by big traditional owners like China (fr 8.9% to 2.2% in 13 yrs) and HK, in fact Japan has also been falling in total proportion of US treasury holdings (fr 9.5% to 3.4% now):

2) Ukraine/Middle East conflicts likely to trigger more input price inflation, eg oil prices - and as a resource poor but manufacturing intensive economy, higher oil prices (blue line, down is higher prices) will tend to trigger economic contractions (red area). The green line is merely projecting prices returning to $150/barrel, which can easily be exceeded should international wars flare up again:

The result would be grim for Japanese economy. If wars spread to the APAC region, there is an added strong chance of capital flight from Japan given its recent militarisation movements might scare foreign investors away:

3) bond rout will impact Japan more than US - as US fiscal profligacy continues (yes, by adding $3.5tr debt in one year), long bond yields have nowhere to go but up (orange line), this will drag JGBs up with it (green line). Assuming totally benign geopolitical/sovereign debt calm conditions, the laughable 0.87% JGB yield will still nearly triple to 2.5%, and this 'benign' expansion of US-JP yield spread may trigger further capital outflows as money seeks higher returns in the US:

The result? Yen could drop another 25% to the 200 mark.

If this Yen drop becomes disorderly, it could result in JGBs trading at premium to TBs, leading to the much more nightmarish outcome of 10.5% JGBs vs say 8.5% TBs:

Such an outcome would mean Yen has to return to 270+ levels, much against the wishful sub-150 levels the 'anchoring biased' talking heads out there could imagine... or a 45%+ drop from current levels.

Real yields also too low to be attractive

Back to our usual real property yield table - Sydney/Singapore/Tokyo are some of the lowest returning markets on inflation adjusted basis (3rd column from right), compared to Phnom Penh/Athens which are our preferred investment destinations:

In a bond rout outcome, both European and Japanese markets will suddenly look much worse as US becomes the safe haven, thereby helping HK/NYC (2nd column from right).

Based on these various factors, we will only touch Japan if: a) long term fixed rate borrowing can be locked in; b) Yen leverage and/or hedge are put in place. But how many even the big institutions are taking these precautionary measures? We doubt many. On this note it is interesting to demonstrate how institutions are mere humans, however smart they otherwise appear: see Article 2.

==================Article 1==================

Interest in Japanese real estate grows despite rate rise prospects

Mar 8, 2024

Institutions and family offices are backing real estate for another strong year, despite the prospect of the country’s first interest rate rise since 2007.

​https://www.asianinvestor.net/article/interest-in-japanese-real-estate-grows-despite-rate-rise-prospects/494795​

==================Article 2==================

Hidden billions in Tokyo real estate lure activist hedge funds

Apr 16, 2024

The long-concealed market value of Tokyo’s largest skyscrapers is being unveiled by activist investors.

​https://www.japantimes.co.jp/business/2024/04/16/companies/headge-funds-urge-japan-real-estate-sales/​

==================Article 3==================

Japan’s Population Declines Again: Seniors 75 and Over Top 20 Million for First Time

Apr 24, 2024

An estimate published by Japan’s Ministry of Internal Affairs and Communications shows that the total population as of October 1, 2023, was 124,352,000. This was a drop of 595,000 (0.48%) from the previous year. It is the thirteenth consecutive year that the population decreased. The population of Japanese citizens was 121,193,000, for a record year-on-year decrease of 837,000, or 0.69%.

​https://www.nippon.com/en/japan-data/h01967/

Bloomberg Talk - How Rate Hikes & Inflation Could Impact the Property Market in 2023

I would like to thank Bloomberg for the invitation to be on the panel on November 8, 2022. At the event, I highlighted the impact of rate hikes & inflation on global housing markets and discussed the opportunities that may lie ahead.

Below is a short extract of some salient points in the presentation.

Event overview:

Aggressive interest-rate hikes could worsen the outlook for global housing markets, particularly Hong Kong, which might continue to follow the U.S. in lifting mortgage rates aggressively until mid-2023. The Hong Kong housing market 2023 outlook versus other major markets like the UK and Singapore will be discussed, and explore if commercial and industrial properties could be an inflation hedge and outperform home prices in Hong Kong.

Is bear market confirmed for HK? 20221031

The observation that HK housing is in a downcycle has become consensus of late, after the CCL reaches a new low last week from the triple top dating as far back as 2019 (see green line in Chart 1). Cumulatively the index is now down 12% from the Aug 2021 high:

Chart 1: Home prices denominated in various currencies

But across the world, investors will always think about returns in their own currencies, and therefore, an 'objective consensus' of a true bear market in any asset price is only formed when the bulk of observers around the world see the same down trend that the base currency investors also sees.

So in order to find out whether the HK home prices are truly in a bear market by consensus (Chart 1 does not seem to suggest that is the case), let's take a look at the index as denominated in a few main jurisdictions:

a) the collective non-USD community (as proxied by DXY);

b) the EU community (as proxied by Euro);

c) the Brits (as proxied by GBP); and

d) gold bugs (as proxied by the price of gold).

HK still in bull market to world at large

From the point of view of the developed world population (as the USD index is represented by six liquid currencies, see Chart 3), however, the drop in HKD (blue line in Chart 2) terms is not corroborated by the price as measured by DXY the USD index:

Chart 2: Home price in non-USD terms still trending up

In fact, the non-USD price index is still very much heading up, from the longer term view (green dotted lines) to medium term view (red dotted lines), to even the shorter term time horizon (blue dotted lines)! What this suggests is that for the average OECD investor, HK property is still a rising asset.

Chart 3: make up of the DXY - 6 currencies

Home prices even more bullish for Europeans

For the average person based in Euro, the upward momentum seems even stronger compared to DXY, and HK prices, thanks to the collapse in Euros in the last few months, seem to be accelerating upwards within the red channel:

Chart 4: Euro investors may see HK prices accelerating upwards

Brits also feel the upturn?

Similarly, with the recent precipitous drop in the value of the Pound, the HK home price index will appear to the average Blighty investor to be positively surging even, after HK first started pulling away from a very correlated pairing between the HKD and GBP denominated indices which pretty much shadowed each other since our data started in 1981:

Chart 5: HK prices look strong to the British Pound investor

The much weaker pound post Boris's premiership (botched Brexit plus zealous lockdowns?) ensures that the weak pound has provided a strong platform for HK assets to appear to go from strength to strength.

Gold the only currency beating HK property?

For those who believe in gold, there is good news - In Gold terms, the 1997 peak remains the unsurprised top for HK home prices, meaning that we may still be in a bear market when measured from the perspective of the precious metal:

Chart 6: Gold strong vs HK, but mini breakout underway?

Even though the price index has broken above a near term trading channel, as indicated by the red arrow in Chart 6, if war does flare up more next year, we think gold might reassert its dominance and the break up could reverse. Time will tell.

Strong currency imports deflation, which is not a bad thing now!

In normal disinflationary times such as most of the past 40+ years, being pegged to the USD is good for HK assets during times of weak USD, as Chart 7 illustrates - weakening or weak USD is generally accompanied by bouts of strong home price increases, and the reverse held true (mostly in the mid/late 90s):

Chart 7: weak USD good for home prices, and vice versa - will it be different this time?

However, could we be in a period similar to the early 70s or early 80s, when strong USD will suck liquidity away from HK and produce deflation? How does this contrast the current super high inflationary environment? Is the strong USD a blessing as it reduces the 'cost of living' crisis that would otherwise hit these shores?

A very interesting dynamic, not seen before in our brief monetary history for sure... The above study shows that, whilst we remain somewhat bearish on the outlook of the HK market, more needs to happen in the global currency markets before it is a true foregone conclusion...

The author would like to thank Lee Man Hin Carson from The University of Hong Kong majoring in Accounting and Finance for assisting in data collection, analysis, and drafting of this article.

2022 HK policy address speech - Pro property and pro industrial 20221019

Key points of the policy speech are as follows:

a) all out attracting talent to HK - a must do given the loss of 140k population in the past 2-3 years, this is contained in divider a) below;

b) more drive for family office hub as well as other small measures of business support see divider b);

c) housing bad policy continues - i) plundering private market share with every rising PRH/HOS supply, resulting in every higher private home prices and ever more public housing slaves - what a missed opportunity! ii) displacing brownfields into new built industrial - likely insufficient vs demand; iii) private supply low, but development process shortening. see divider c);

d) major speeding up of infrastructure build out - mostly roads and rails, very positive and lots of opportunities opening up for the smart property investor see divider d).

In summary - talent will not come unless we lift the lockdowns, but otherwise by and large a pro property speech with lots of bright spots, but sadly will not help affordability of housing, which is unsurprising given how entrenched the public-housing vested interest groups is!

below are extracts of the speech, emphasis are mine, with odd comments thrown in:

-----------------------------------------------------a) Talent------------------------------------------------------------

Attract Enterprises, Investment and Talents to Enhance Competitiveness

26. …new institutional setups and implement an array of new initiatives targeted at attracting enterprises, investment and talents:

establish the Office for Attracting Strategic Enterprises (OASES), led by the Financial Secretary, for attracting strategic enterprises …offering them special facilitation measures and one-stop services;

establish the Talents Service Unit, led by the Chief Secretary…formulating strategies to recruit talents;

set up Dedicated Teams for Attracting Businesses and Talents …reach out to target enterprises and talents and persuade them to pursue development in Hong Kong;

set aside $30 billion from the Future Fund to establish the Co-Investment Fund for attracting enterprises to set up operations in Hong Kong and investing in their business;

launch the Top Talent Pass Scheme;

enhance existing talent admission schemes; and

upon becoming permanent residents, apply for a refund of the extra stamp duty paid for purchasing residential property in Hong Kong.

27. The OASES will:

1. draw up a list of target enterprises …to reach out to and carry out negotiations with the enterprises;

2. measures covering aspects such as land, tax and financing that are applicable exclusively to target enterprises, and …tailor-made plans to facilitate the setting up in Hong Kong; and

3. provide the employees …one-stop facilitation services in areas such as visa application and education arrangement for their children.

Trawl for Talents

29. Over the past two years, the local workforce shrank by about 140 000. … We will:

1. launch the Top Talent Pass Scheme for a period of two years. Eligible talents will include individuals whose annual salary reached HK$2.5 million or above in the past year, and individuals graduated from the world's top 100 universities with at least three years of work experience over the past five years. …two-year pass …not subject to any quota. Individuals who graduated from the world's top 100 universities in the past five years and have yet to fulfil the work experience requirement will also be eligible, subject to an annual quota of 10 000;

2. streamline the General Employment Policy (GEP) and the Admission Scheme for Mainland Talents and Professionals (ASMTP), vacancies under the 13 professions in the Talent List with annual salary of HK$2 million or above, employers are not required to provide proof to substantiate their difficulties in local recruitment;

3. suspend the annual quota under the Quality Migrant Admission Scheme (QMAS) for a period of two years;

4. relax the Immigration Arrangements for Non-local Graduates (IANG) by extending the limit of stay from one year to two years …expand to cover the GBA campus of a Hong Kong university on a pilot basis for a period of two years.

5. enhance the Technology Talent Admission Scheme (TechTAS) by lifting the requirement for technology firms to employ additional local employees;

6. extend the limit of stay of employment visas … will be valid for a maximum period of three years; and

7. refund the extra stamp duty …become a permanent resident …can apply for a refund of the Buyer's Stamp Duty and the New Residential Stamp Duty paid for the first residential property purchased which they still own, while the Ad Valorem Stamp Duty at Scale 2 rates is still payable such that the overall stamp duty charged will be on par with that charged on first-time home buyers who are ordinary permanent residents.

30. waive the requirement of applying for an employment visa for more visitors participating in short-term activities in Hong Kong. …will expanding to more categories.

---------------------------------------------------b) Business Freebies--------------------------------------------

International Financial Centre

37. …strengthen asset and risk management – …to offer tax concession for eligible family offices. The target is attracting no less than 200 family offices to establish or expand their operations in Hong Kong by end-2025.

45. support the convention and exhibition (C&E) industry …new $1.4 billion scheme …to subsidise more than 200 exhibitions to be staged in Hong Kong over three years.

46. To provide further support for SMEs, we will:

extend concessions of government fees and charges –reduce 75% of water and sewage charges for non-domestic accounts for eight months from 1 December 2022 to 31 July 2023, subject to a monthly ceiling of $20,000 and $12,500 respectively per household. …provide 75% rental or fee concessions …tenants of government premises and eligible short-term tenancies and waivers under the Lands Department for six months from 1 January 2023 to 30 June 2023.

----------------------------------------c) Housing Madness Continues-----------------------------------------

63. The Steering Committee on Land and Housing Supply and the Task Force on Public Housing Projects …submitted …reports. set the following key strategies and targets:

1. introduce the new Light Public Housing (LPH), with about 30 000 units to be built in the coming five years; [ed: only bureaucrats know how to create more complex structures over already bewildering complicated infrastructure]

2. increase public housing production by about 50% in the coming five years (from 2023-24 to 2027-28);

3. cap the waiting time for PRH immediately. …6 years and shorten it to about 4.5 years in four years' time (i.e. in 2026-27);

4. saleable area of all subsidised sale flats completed from 2026-27 onward will be no less than 26 square metres [ed: public housing becoming ever more luxurious and ever larger – no longer a safety net];

Private Housing Supply

66. …the demand for private housing in the next 10 years will be 129 000 units. …providing no less than 72 000 residential units in the next five years. [ed: private ownership is now an after thought in the bureaucratic housing steam roller]

69. …plan to make available land in Yuen Long and Hung Shui Kiu for development of multi-storey industrial buildings from next year, with lease conditions requiring a certain portion of floor area to be set aside for leasing to the affected brownfield operators below market rent.[ed: supply will be much less than displaced brown field site GFA by far, good for industrial property]

70. Tseung Kwan O (TKO) Area …provide 50 000 residential units with the first population intake in 2030 at the earliest. [ed: not a pleasant district – ultra high density dormitory town]

71. To substantially compress the time required for land production, we will:

1. streamline statutory procedures – …bill to amend the Town Planning Ordinance, the Land Resumption Ordinance, the Foreshore and Sea-bed (Reclamations) Ordinance, the Roads (Works, Use and Compensation) Ordinance and the Railways Ordinance, as well as amendment to the Schedules to the EIA Ordinance …the time required …reduced from at least 6 years to 4 years, …large-scale projects from 13 years to 7 years, of which the time for the EIA process will be compressed to within 18 to 24 months;

2. …charging land premium at standard rates for redevelopment of industrial buildings. …extend this approach, [from] only industrial buildings and in-situ land exchange applications in NDAs, to cover agricultural land in the New Territories located outside NDAs to compress relevant workflow; [ed: will speed up industrial revitalisation speed]

3. …lowering the compulsory sale application thresholds for private buildings aged 50 or above but below 70 from 80% to 70% of ownership, and further to 60% for those aged 70 or above. For industrial buildings in non-industrial zoning, the threshold will be lowered to 70% of ownership for those aged 30 years or above; [ed: great for industrial, bad for minority private ownership rights]

----------------------------------------------------d) Infra Galore-----------------------------------------------------

Drive Development by Transport Infrastructure

76. The six major transport infrastructure projects are:

1. Northern Metropolis Highway – It will facilitate east-west connectivity in the New Territories North between Tin Shui Wai in the west and Kwu Tung North in the east via San Tin;

2. Shatin Bypass – connecting Tai Po and Kowloon West …relieve traffic pressure on Tolo Highway;

3. TKO-Yau Tong Tunnel – …third road tunnel at TKO [for] TKO Area 137;

4. Hong Kong-Shenzhen Western Rail Link – Hung Shui Kiu with Qianhai [ed: long shelved but now back on track];

5. Central Rail Link – …12th railway line will connect Kam Tin in Yuen Long with Kowloon Tong via Kwai Chung, alleviating pressure on the carrying capacity of the Tuen Ma Line; and

6. TKO Line Southern Extension –TKO Line southwards to TKO Area 137,.

77. …Kwu Tung Station of the Northern Link will be commissioned in 2027, …the Tung Chung Line Extension, Oyster Bay Station and Tuen Mun South Extension commencing next year.

78. …projects under planning, including Route 11, Tsing Yi-Lantau Link and Tuen Mun Bypass, as well as improvements to Lion Rock Tunnel. 

Radical reforms needed to end the 'Rising PRH waiting time' myth 20220520

Radical reforms needed to end the 'Rising PRH waiting time' myth

After the Hong Kong Housing Authority (HKHA) announced the latest Public Rental Housing (PRH) statistics, showing that the 'average waiting time' has risen to a new high of 6.1 years, cliché-ridden editorials predictably rattled the same plattitudes about the 'need to increase supply for PRH' to address the problem, such as:

SCMP: Average waiting time for public housing flat in Hong Kong rises to 6.1 years, highest in more than 2 decades

The Standard: Waiting time for public housing rises to 6.1 years, hits 23-year high

The truth of the matter is not what it seems as claimed the housing bureaucracy (which is primarily responsible for the crisis), and the uncritical media. We have addressed this fallacy in extensive detail in the following article:

"HK’s Ever Ballooning Public Housing Addiction Cycle 05/2021" 

1. Lowering thresholds leads to perpetual shortage in housing welfare
2. Drastic cure: cut income limits, halt all public housing building
3. Wanton lifting of welfare thresholds crowds out private market

as well as some earlier writings (in Chinese only):

《公屋改革面面觀─結構性自我膨脹  2014年9月》English translation

《公屋改革面面觀─公屋「豪宅化」2014年10月》English translation

In essence, the long 'waiting time' phenomenon is a self staged smoke and mirrors game, which resulted solely from the ever rising income ceiling for public housing applicants, which significantly outpaces the increase in median household income for the population at large.

As a result, ever large swathes of the population fall into the eligibility net, thereby lengthening the waiting time unnecessarily. Coupled with this, the constant growth in average size of flats occupied by PRH occupants, the pursuit for luxurious standard for what should be a welfare product, have attracted even more applicants seeking this freebie.

The resultant rent seeking free-for-all only punished the tax payers and the genuine hard up applicants who are edged out of the housing market while the bureaucrats and rent seeking committees/advisors build their empires. In the meantime, the cancerous growth in public housing removes our ability to buy our own homes in the private market, thus becoming permanent slaves to the bureaucracy... a sad outcome indeed unless the reforms we outlined time and again are implemented.

HK’s Ever Ballooning Public Housing Addiction Cycle 20211113

 ​This article is also published on StandNews here: https://www.thestandnews.com/society/hks-ever-ballooning-public-housing-addiction-cycle

HK’s Ever Ballooning Public Housing Addiction Cycle

In 2018, the HKSAR government announced six new initiatives on housing aimed at ‘rebuilding the housing ladder’. But with the introduction of the “Starter Homes (SH)” pilot project, the already bulging number of steps on the ladder increased to five. Not only this, the qualifying income limits for various housing welfare strata continued to be increased, for example, the income threshold for Public Rental Housing (PRH) with a 3-member household has crept from HK$22k to HK$24k.

With the ever widening net trapping more potential customers, is it any wonder that sensationalist headlines like “waiting time for public housing …the longest ever”, “waiting time …almost double the Housing Authority’s three-year service pledge” are everywhere in the media, and that the public has now been conditioned to equate “severe shortage in public housing supply” whenever housing policy is being mentioned?

The truth of the matter, sadly, is not what it seems as claimed by all the proponents of more public housing provision. In this article, we explore the real causes of the housing problems, contrary to the widespread misunderstanding permeating policy debate on this subject…

Lowering thresholds leads to perpetual shortage in housing welfare

The reality has been that the government has been constantly enlarging the pie for welfare housing, by repeatedly raising income and asset thresholds towards the upper echelons of the society, resulting well paid and asset rich citizens inadvertently sucked into the catchment of housing welfare trap. As shown in Chart 1, each of the main public housing ladders have income thresholds that are massively higher than the median income of the target population: PRH threshold is 36% higher (red arrow), Home Ownership Scheme (HOS) thresholds are a jaw dropping premium of 154% above the median income of its target population (orange arrow), and the newly launched SH scheme has an astronomically vast premium in its income threshold above even median private housing resident incomes (green arrow)!

Chart 1：Cumulative household numbers by income strata – current thresholds (Q2 21 data)

In essense, the larger the catchment of housing welfare (ie the higher the income thresholds), the more entitled applicants there will be who do not need such welfare. We should not be surprised to see therefore that the whole society is turned into lottery buying hopefuls when state freebies are so freely available to so many – and highly paid rent seekers crowding out the genuine low income needy applicants! This mentality will cut an otherwise naturally upward flowing trade-up ladder by diverting all demand into the benefits strata, destroying an otherwise free and dynamic private market.

Drastic cure: cut income limits, halt all public housing building

The only way to reverse the vicious cycle of ever rising income/asset thresholds creating ever more demand, which feeds in ever grander public housing construction programmes, is to set the income thresholds by reference to certain percentages of the population, instead of allowing that percentage to permanently march towards 100%.

One easy way to achieve such manageable entitlement limits is by reference to median household incomes in each of the housing stratum, such as:

1) PRH income threshold @ median PRH household income, or HK$17,900 (red dotted line);

2) HOS income threshold @ median HOS household income, or HK$26,000 (orange dotted line);

3) SH income threshold @ median private residential household income, or HK$36,500 (green dotted line).

Chart 2：Cumulative household numbers by income strata – proposed thresholds

This approach can also introduce huge administrative flexibility, allowing the government to set the thresholds at any percentiles (median being 50 percentile) of various housing strata, and progressively reduce chronic dependence on welfare housing, while freeing up more land for the private market. As more land is sold on the private market, supply there will increase, thereby lowering the market price which will reverse the pressure for the government to interfere. As the private market becomes the dominant segment liquidity and efficiency of the entire housing market is improved. (For more discussion on these aspects please see your author’s other pieces: 公屋改革面面觀─公屋「豪宅化」(Chinese only) and “Property 101: Misguided policies push up home prices”).

Wanton lifting of welfare thresholds crowds out private market

There are currently 0.84m PRH units, which already take up over a third of all households in the city, and should be absolutely sufficient to cater to the low end of the housing ladder. By the same token, HOS (0.43m units) and SH building should also terminate, so as to unleash on the private market sufficient supply both to provide choice to those who can afford private housing already, and more importantly, to restrain, if not reverse the rising private home prices.

But just how can we prove that the lengthening waiting list is a game of smoke and mirrors, scripted, directed, and played by the government for show? Here are three clues:

1) HOS income threshold (green line in Chart 3) has majorly exceeded since 2015 the 75 percentile income in all of HK, thus becoming the main competitor of luxury housing markets! During the 90s the HOS threshold was largely tracking the 75th percentile, but all pretences were shed after the resumption of HOS sale from 2013 onwards, with the magnitude of premium over 75 percentile enlarging every year – if this is not aiding and abetting the rich to buy what should be welfare housing, what else can qualify as such?

Chart 3：comparing public housing income threshold & median income bands

2) PRH income threshold (red line) used to closely hug the overall median income levels, but has now also abandoned any façade of being a form of low-end welfare, and is fiercely competing with the private sector for high income customers!

3) The well intended policies yet again pave the roads to hell – by increasing the income thresholds more near peaks (1997, 2019) while reducing the thresholds more at market bottoms (2003) – this is procyclical, meaning more people are made eligible for public welfare at the peak (so buyers end up buying at top and lose more money), while fewer are being let in at the bottom (when they should be given the chance to purchase cheaper)… perfect irony of how ivory tower originated administrative policies always backfire!

Pro-cyclical policies amplify market risks

We now look at this phenomenon of pushing the population to buy at market tops and then shutting them out at the troughs. The premium of income thresholds over median incomes set by the mandarins always increases as prices reach peaks – eg surging from 60% in 2012 to 154% in 2020 (red arrows on right side of Chart 4) just when prices start to fall in 2019/20 (green arrows in right side). Proof again that government policies are encouraging home buyers most when prices are just about to fall.

Similar idiotic policies were also practised in the 90s – eg the mad prices rises of the early 90s (green arrows on left side) coincided precisely with the big increases in income threshold premium above median household incomes (red arrows on right side). Yet, when the prices collapsed after the Asian Crisis (green arrow in middle left), the government also shrunk the income threshold premium to a discount (red arrow in middle left).

Chart 4：Income threshold premium vs home price cycles

On a longer time perspective, the inertial encroachment into the private housing market is independent of cycles – be it income threshold for HOS or PRH, the premium over overall income has been steadily rising (as demonstrated by the red and blue dotted lines above). This is why HK’s housing market is so sickly, and the government coffers much less abundant than it could have been (or our tax rates lower than they are now).

The only quarters that have benefited from this nationalisation of what is essentially a private asset class, has been the various vested interest groups – from bureaucrats running the housing policy, to monopolistic quangos carrying out various aspects of this unhealthy policy, to even academics or welfare groups which live off this ecosystem. Not the people of Hong Kong.

Major paradigm shift needed

All the foregoing discussion amply illustrate how the current system is creating unfairness, while distorting the free market. Your author suggested a framework above (referring to Chart 2) setting eligibility thresholds with reference to median household income percentiles. This has the advantages of:

1) Removing well to do applicants from the eligibility queue, and catering truly to only those most in need of such welfare;

2) Give people the ability to look after themselves – allowing the people of HK to decide themselves whether, or where to buy or rent their homes, rather than having to defer to the arbitrary decisions of gatekeeping bureaucrats, who’s scope and magnitude of power over people’s housing decisions seem to be increasing by the day;

3) Liberate the vitality of the private market, which is far more capable of providing what people need, when they need it, and lifting general living standards (eg ease of moving close to where work/family are located, vastly cutting commuting time); and

4) Majorly boost government coffer intakes – not only will there be no more emergency fundings needed to keep ailing quangos on lifelines, there will be significantly more stamp duty / profit tax, and land sale revenues for deploying in other more worthy public services.

By adopting the framework outlined in Chart 2 in setting the eligibility of public housing, we could save as many as 0.92million units of potential demand for HOS units (green highlight in Chart 5), while eliminating the need to build another 0.3million HOS units in the coming years (Chart 6). In fact, if the govt has lowered from 1998 the PRH eligibility to the same level as PRH median household income, almost all applicants over the past 20 years would have been allocated their homes (ie red line in Chart 6 being mostly under zero), and there would not have even been a ‘housing crisis’.

Chart 5：Eligible households who have not been awarded HOS

Chart 6：Eligible households who have not been awarded PRH

Such a beneficial operating model may of course undermine a few vested interest groups, but under the current executively dominant new governance environment, we are facing a golden opportunity to fully and properly cure the disease that is HK housing policy.

The author would like to thank Andy LO Tuen Yin of The Chinese University of HK and John Poon of The University of Hong Kong for assisting in data collection, analysis, and drafting of this article.

Is it time to buy HK retail property yet? 20210921

 

Stand news 20210917

In the past two years, the retail market has been decimated by first the domestic protests and then by the global lockdowns.

One of the prime victims of this combination of circumstances has been retail properties of Hong Kong, where rents have fallen some 14% from the 2019 peak, and is still down 8.9% even now (blue line in Chart 1). The drop in retail property prices were even more pronounced, down 17% peak to trough and now standing at 13% off the 2019 highs (red line in Chart 1).

Anecdotal reports of drops of 70-80% in prime street shop rents have also been common, indicating that formerly tourist hotspots have been far worse hit than the overall indices suggest.

Chart 1: Retail rents up 4x vs price surging 29x since 1984

Looking further back in time, however, both rents and prices have risen by multiples over recent decades, so the question remains – are these mere single-digit drops, which take us back to levels 7-8 years ago, enough of a correction for the current downturn?

 

Consumption drives rents, but interest rates hold sway of prices

To explain the rise in retail property prices, we plotted on the same chart the various components that contribute to prices: a) retail sales (very dark area, Chart 2); b) domestic consumption beyond pure retail (dark area); c) change in property yields (light area); and finally d) financing costs as represented by mortgage rates (very light area):

Chart 2: bulk of price increase driven by yield compression   Chart 3: PRC shoppers drove 03-12 run up in retail, which reversed big time after 2019

It is clear from Chart 2 that the bulk of the contribution to retail price increases were yield compression, 4.2x the magnitude contributed by domestic consumption, but yields did not follow mortgage rate’s falls which would otherwise have doubled again the net impact on retail property prices. To view the various value drivers in a logarithmic view (all exponentially rising value series are best viewed this way ), the yield compression component remains highly significant (see Chart 3).

What Chart 3 also makes clear is how retail sales as a top line driver was boosted by opening of the PRC independent travel market in 2003, which propelled retail sales to almost equal total domestic consumption by 2012. However, this factor fell away rapidly after the 2019 protests and then the lockdowns in 2020. The changed retail habits in the lockdown era also decimated retail and pushed a lot of shopping activity online, which explains the widening gap between consumption and retail in the chart.

Rental underperformance compensated by drastic yield compression

In Chart 2 above, the difference between price (red line) and the yield compression implied price (top of light area) must be explained by rental not keeping up with increases in top line consumption takes. This kind of makes sense, as not all domestic consumption activities take place in retail premises – eg services, as well as online sales, take place in office or industrial space, or increasingly nowadays, in data centres, which are calculated under office/industrial rents but not retail rents.

Another way to illustrate this divergence is shown below:

Chart 4: retail rent tracks retail sales, but not consumption

Here the rent index (purple line) tracks retail sales (blue line) very closely, proving that retail rent does indeed shadow retail specific activities and very little else – the fact they almost entirely overlap for almost all of the past three decades is impressive, and echoes our analysis above that rent has underperformed consumption (here represented by orange line) at large.

 

Retail property price – bit more rebound, then another leg down?

In our assessment, the current favourable tailwind of low interest rates and rental rebound from deep lockdown lows may peter out by late Q4 21 or early Q1 22, resulting in a topping out of retail property price growth by then:

Chart 5: Retail price likely to grow into end-21 before declining again as interest rates are likely to spike into 2023

Retail a safer bet than HK resi?

Despite possible bearish outcomes, retail property prices may still be in safer territory than HK residential for these reasons:

a) the lifting of lockdowns brings back PRC visitors, which will benefit foot traffic and retail rents more than residential rents;

b) the ability by PRC buyers to purchase HK flats has not evaporated as severely as retail spending in the past two years, thus will see less rebound post reopening;

c) HK’s high finance sector salaries that has sustained high residential rents may not see as much upside going forward (eg when interest rates rise and negatively impacting finance related incomes); and

d) residential yields are at historic lows and could expand even more than retail yields (blue area in Chart 6). These factors combine to provide more safety margin for retail property prices than residential prices, ie retail prices will likely outperform in the next year or two (red arrow in Chart 6):

Chart 6: Investing in retail properties seem to be a better decision than residential properties.

The ultra low yields in HK will be a big headwind to strong price appreciations ahead, especially in view of the lowest interest rates in all human history, coupled with a worldwide inflationary wave. Even so, retail property does not seem the worse amongst the various subsectors in HK property, given its recent corrections.

 

 

 

The author would like to thank Samson Leung of Hong Kong Baptist University and Jacky Chau of The Chinese University of Hong Kong for assisting in data collection, analysis, and drafting this article.