Why Hong Kong is the world’s most expensive property market
Another day, another survey showing that Hong Kong is one of the most expensive cities in the world to live. The Economist Intelligence Unit’s Worldwide Cost> READ MORE
Another day, another survey showing that Hong Kong is one of the most expensive cities in the world to live. The Economist Intelligence Unit’s Worldwide Cost> READ MORE
Today I’m sharing an article written by my friend, Peter Churchouse, who with his son Tama runs Churchouse Publishing in Hong Kong. Peter spent decades as the> READ MORE
In many parts of the world – depending on the period and place – buying a house or flat has the reputation of being a one-way ticket to wealth. Buy, hold, and> READ MORE
In an investment world suffering from thirst because of zero interest rates, real estate is cool water. As we’ve written recently, government bond yields in many> READ MORE
Another day, another survey showing that Hong Kong is one of the most expensive cities in the world to live.
The Economist Intelligence Unit’s Worldwide Cost of Living Survey released recently showed Singapore as the most expensive city to live in, with Hong Kong second.
When it comes to the cost of real estate, Hong Kong prices are at the top of the list. Buying a no-frills one-bedroom apartment near Hong Kong’s central business district will set you back around US$1 million.
Just take a look at Hong Kong’s residential prices since 2008 versus the U.S. and U.K. Prices are up more than 100 percent!
Why is Hong Kong property in such a massive bull market?
Over the past few weeks, I’ve been asked about this numerous times. The week before it was Bloomberg’s Rishaad Salamat doing the asking (click here watch the interview.)
And then last week I spoke about Hong Kong’s property market at Morgan Stanley’s 7th Annual Hong Kong Investor Summit.
A lot of people think that buyers from mainland China are pushing up prices in Hong Kong. (Remember, Hong Kong is politically separate from China, but it’s under Chinese control.)
Over the past few years, we’ve seen the story of “Hot Mainland China Money” playing out across real estate markets all over the world.
There’s a lot of mainland Chinese cash looking for a home outside of China, for diversification reasons and because wealthy folks simply want to move their money outside of China’s borders.
Their number one investment target is offshore real estate in markets like London, Los Angeles, New York, Vancouver, Sydney and Auckland, to name some prominent examples.
This “hot” mainland China money has also gotten a lot of the blame for property price increases in Hong Kong.
But I want to show you some data on why that conclusion is wrong for Hong Kong.
Here’s why Hong Kong is different
You see, back in 2012, the Hong Kong government introduced a new stamp duty aimed at cooling Hong Kong’s red-hot property market.
This additional Buyers Stamp Duty (BSD) added a whopping 15 percent to the purchase price of residential property for certain buyers. Any buyer who is not a permanent resident of Hong Kong is subject to this stamp duty, along with corporate buyers acquiring a property in the name of a company.
So for that $1 million small apartment, you now have to pay an additional BSD of US$150,000… and this is before we get to other stamp duties or costs payable.
This BSD, therefore, captures individual mainland Chinese buyers, along with anyone who is looking to buy residential property in the name of a company and not themselves.
But in each of the past two years (2015 and 2016), less than 5 percent of the total residential sales transactions have been subjected to this additional BSD.
So even if ALL of the BSD taxpayers were mainland Chinese (unlikely given that people living in Hong Kong and elsewhere continue to use companies to buy Hong Kong property), it’s obvious that mainland Chinese money cannot be blamed for driving prices up.
Mainland buyers are a fraction of the total. We cannot blame them for Hong Kong’s high apartment prices.
So, if not mainland buyers, who is to blame? The Federal Reserve for keeping interest rates so low for so long? Perhaps, but the real culprit is much closer to home.
The Hong Kong government
All land in Hong Kong is owned and sold by the government. Public housing is provided by the government and either sold or rented. This housing, which accounts for about 56 percent of the total residential housing stock, is provided for lower income families who would normally find private housing unaffordable. These families don’t usually buy in the private real estate market.
On the private side, land parcels are auctioned by the government to local (and increasingly mainland Chinese) developers.
Those residential units are built and sold into the market.
Take a look at the chart below. It shows the number of both public and private residential units completed each year. This is Hong Kong’s total annual housing supply.
Between 1984 and 2005, total annual housing production was around 67,000 units per year.
But between 2006 and 2015, that number dropped to just 24,000… that’s 65 percent below the long-term annual average!
Hong Kong’s population has continued to grow, along with a need for more housing.
Government land policies have cut back the supply of housing to meet those demands, in both private and public sectors.
The government’s own forecasts of future private housing supply in the coming few years still fall well short of long-term average production.
And even their forecasts are often very optimistic. Our research has shown that over some 30 years, the government overestimated future housing supply by an average of 23 percent!
So what does this mean?
Well, from a supply point of view, Economics 101 will tell you that lots of demand without supply will lead to high prices.
And it means that when a government holds so much control over a scarce asset (in this case land) then it commands a huge influence on pricing.
We should use that to our advantage. Hong Kong has some of the largest and most profitable real estate developer companies in the world. Several are trading at very attractive valuations compared to their longer-term averages.
As for the folks trying to get on the world’s most unaffordable property ladder who keep asking me, “Pete, when’s it going to end?”, I’m afraid that the base case scenario is that prices don’t meaningfully correct any time soon.
You might not be able to buy an apartment, but you can still participate in Hong Kong’s property market with the right real estate stocks.
I’ve been covering Hong Kong property stocks for nearly 30 years, and I tend to focus the majority of my recommendations on a handful of top quality companies. (But in the interests of being fair to subscribers of The Churchouse Letter, I won’t include those here.)
Alternatively, you can take a look at the Guggenheim China Real Estate ETF (New York Stock Exchange; ticker: TAO). This gives you a basket of Hong Kong and Mainland Chinese real estate developer stocks and REITs. Around 80 percent of the ETF is in Hong Kong real estate stocks, with mainland China taking up the other 20 percent.
If you’re looking for a Hong Kong property ETF then this is OK. Although jumbling up Hong Kong and mainland China stocks in a single ETF isn’t ideal. These are completely different markets and should be treated as such.
Just yesterday, mainland Chinese developer stocks fell between 3-5 percent in a single day due to real estate tightening curbs announced over the weekend. Hong Kong property stocks were more or less flat!
Today I’m sharing an article written by my friend, Peter Churchouse, who with his son Tama runs Churchouse Publishing in Hong Kong. Peter spent decades as the Head of Asia Research and Regional Strategist at Morgan Stanley in Hong Kong, and is a fantastic source of stories and insight on investing in Asia. Peter specialises in real estate. He ran the real estate equity research team at Morgan Stanley, ran an hedge fund specialising in Asian real estate, sits on the boards of major listed Hong Kong and mainland China property companies, and has put together an incredible track record of global real estate transactions over the past four decades.
Peter and Tama write The Churchouse Letter, a monthly publication about investing in Asia, along with a free email called Peter’s Perspective, which you can sign up for here.
Below, Peter recaps a famous deal that changed the course of history – and highlights timeless lessons for investing in real estate.
By Peter Churchouse
The “mighty” Mississippi River is born a mere trickle in Lake Itasca, some 1,500 feet above sea level in the northern U.S. state of Minnesota.
From there it meanders its way south, gathering volume as the increasing flow from tributaries swell it into the fifteenth largest river in the world (and fourth-longest, at 2,320 miles, or 3,733 kilometers).
The river creates some of the most fertile agricultural terrain in America, along with navigable rivers, forests, prairies, and mineral riches.
These bounties led France throughout the 17th century to explore the Mississippi River valley creating settlements across the region.
By the middle of the 18th century, the French held sway a length of terrain from New Orleans in the south, to Montana in the north.
This “Louisiana Territory” was enormous, covering some 828,000 square miles (over 2 million square kilometers).
That’s nearly three and a half times the size of France today – or the size of Cambodia, Vietnam, Myanmar, Laos, and Thailand combined.
The territory becomes a bargaining chip
The territory came to be, as historian George Herring puts it, a “pawn on the chessboard of European politics”.
France ceded control to the Spanish at the culmination of the Seven Years’ War in 1762 under the Treaty of Paris. But Napoleon Bonaparte regained ownership from Spain in 1800 under the secret “Third Treaty of San Ildefonso” between the French and Spanish.
Around the same time, U.S. President Thomas Jefferson demonstrated foresight and smart thinking by agreeing to increase American presence in what was a politically unstable area of North America.
However, he was concerned that political instability in the area could undermine efforts to occupy these lands and lead to further conflict with the American state.
Word filtered that France had entered into a secret agreement with the Spanish to take back control of the Louisiana Territory.
Soon thereafter, Napoleon’s France was facing revolutions across its colonies, most notably Haiti and Hispaniola, where French forces suffered thousands of casualties from war and yellow fever.
Napoleon’s visions for the French colonies in the western Atlantic were in tatters.
His plans to use the Mississippi basin as a base for food production and trading activities to support French colonies in the region now made little sense.
The colonies were breaking, and French forces would be inadequate to protect the Louisiana Territory.
Moreover, plans were afoot for conquests closer to home in Europe. But he needed money to fund those military adventures.
America’s big deal
Jefferson offered to purchase some of the territory from Napoleon. Specifically, the Americans said they were prepared to pay up to US$9.375 million for New Orleans its surroundings.
Napoleon countered, offering Jefferson a deal of incalculable value…
He proposed the sale of the vast Louisiana territory for US$15 million. That’s equivalent to roughly US$250 million today.
The Americans couldn’t believe their luck. The offer was completely unexpected. They were stunned.
In a single stroke, the newly emerging America could almost double its total land area, at a cost of less than 3 cents per acre.
Signed in Paris on April 30, 1803, and aptly announced to the American public on July 4, this deal became known as the Louisiana Purchase.
America went on to become the most powerful and wealthy nation on earth.
Four lessons in deal making from the Louisiana Purchase
In my decades in finance and real estate, one thing I’ve learned is this: the core underlying principals of investing rarely change.
You see, the fundamentals aren’t new. Technology, computing, speed of information dissemination and transparency – sure, these have all helped change the game.
But throughout the span of recorded human history, the same lessons are there in plain sight, again and again. They’re timeless.
The Louisiana Purchase was more a political deal than an outright real estate one.
But there are some major lessons that still ring true today.
Firstly, motivated sellers offer value.
If you’re a buyer, the best sellers of real estate are ones who need to get out, and fast.
Distress equals opportunity
There are hundreds of reasons why an individual might need to sell: Maybe they need cash to bail out their business, maybe they’re leaving the country, it could be a divorce, it could be a case of over-leverage… who knows?
Regardless, a motivated seller usually gives you (as the buyer) negotiating power – in other words, the opportunity for a lower price.
And hopefully, you can pounce, which brings me on to the next lesson: The ability to act quickly can be critical.
Take the Louisiana Purchase. The deal was completed on the April 30. Napoleon’s offer of the entire territory was only made NINETEEN days prior to that!
Had the Americans not acted so quickly, who knows what could have happened.
We do know that Napoleon’s two brothers were trying to talk him out of the sale.
Some of the best real estate buys I’ve made have been done quickly – sometimes on the spot.
Combining a speedy transaction with a motivated seller will give you a better price. Period.
But critically, you have to know your market inside out.
A seller looking to offload quickly often wants to sell you more than just his property. He wants to dump you with the problems that come with it.
Maybe there are structural issues, a leaky roof, asbestos, or a new sewage plant to be installed close by. You get the picture…
The final lesson from the Louisiana Purchase is this: Don’t sell real core assets to fund spending.
It’s one thing to sell assets and reinvest, it’s quite another to do what Napoleon did.
He frittered the entire proceeds on senseless wars and military incursions, squandering one of France’s greatest financial and economic assets.
Some time later Napoleon was reported to have said, “America is a fortunate country. She grows rich by the follies of our European nations.”
I couldn’t agree more!
In many parts of the world – depending on the period and place – buying a house or flat has the reputation of being a one-way ticket to wealth. Buy, hold, and be rich.
That’s worked for some generations, in some countries – including in much of Asia. But residential real estate’s reputation in many parts of the world as the ultimate wealth creator is often just wrong. In many markets, stocks do a lot better.
There are plenty of good reasons to own residential real estate. You need someplace to live, and you get tired of paying rent. You can borrow money for almost nothing. You can use your retirement money for a down payment. You saw your parents and grandparents grow rich by buying real estate when they were young. You like the tax advantages (in some countries) of owning real estate. You like cashing the checks that your tenants send you.
But owning a house or apartment, or several of them, often generates returns that are lower than those of the stock market. The chart below shows the long-term returns for the Singapore, Hong Kong and U.S. housing and stock markets. (Stock market results do not include dividends, and housing prices are nominal returns.)
Stock Market vs. Real Estate (R.E.) Performance
The U.S. and Hong Kong stock markets win hands down when compared to house prices over time. It’s only in Singapore where owning a house instead of stocks has made more money.
The U.S. stock market rules
For the U.S. market, the results aren’t even close. The S&P 500 has averaged an 8 percent annual return since 1975. U.S. house prices have earned just 4.8 percent a year since 1975. In fact, over nearly every decade, the S&P 500 does better than housing.
The only decade when housing did better encompassed the recent housing bubble, from 2000 to 2010. Even accounting for the sharp decline in the last two years of that period, U.S. housing prices still outperformed the S&P 500 for the decade.
So far this decade, the U.S. stock market is ahead once again. And for the past 40 years, it would have earned you almost 4 times as much as U.S. residential real estate.
Hong Kong – stocks win again
Hong Kong house prices have done much better than U.S. housing prices (Hong Kong house price data since 1980). But since 1980, Hong Kong real estate (up about 1,500 percent over the period) has trailed Hong Kong’s Hang Seng stock index (up nearly 2,700 percent).
And only since 2000 have Hong Kong house prices started to catch up to stock market performance. During the 1980s and 1990s the stock market was unbeatable. Since 2000, Hong Kong housing has performed much better.
But residential real estate has beaten stocks in Singapore
Since 1980, Singapore real estate has generated better returns than Singapore-listed stocks. It’s the exception in the three markets we looked at.
Singapore house prices have averaged 6 percent annual returns since 1980; stocks have only returned 5 percent a year (based on data from Datastream and the Straits Times Index). But stocks did better than housing in the 1980s and the 2000s. It was Singapore’s hot property market in the 1990s that made the difference. But so far this decade, neither house prices nor stock prices have done well.
Real estate should be part of a well-diversified portfolio. But not at the cost of investing in shares.
In an investment world suffering from thirst because of zero interest rates, real estate is cool water.
As we’ve written recently, government bond yields in many markets are negative, or at historically low levels. This is due in part to quantitative easing efforts by central banks, and a “flight to safety” by investors eager for certainty – even if the “certainty” is that they’ll lose money in government bonds.
As a result, the yield on a ten-year U.S. Treasury bond is now at 1.48 percent. For Japan and Germany, 10-year bonds now have negative yields. And in Switzerland, all government bonds that mature within the next 30 years pay negative interest.
Singapore and Hong Kong bonds aren’t much better
Singapore’s government bonds are not in the negative yield club yet. But they are at historic lows. Right now on a 10-year government bond, Singaporeans will earn just 1.75 percent a year for the next ten years. Hong Kong’s bond yields are at historic lows, too. A ten-year sovereign bond is paying just 0.85 percent.
Extremely low bond yields are a problem for investors searching for income. They don’t want to earn (literally) less than nothing owning government bonds. Real estate is one answer.
Real estate vs. bond yields
In a recent study, commercial real estate giant Colliers International suggested that the Asia Pacific real estate market may benefit from Brexit. This is in part because Great Britain’s exit from the EU may result in more market uncertainty and a “flight to safety” by investors, and thus lower bond yields.
This may push some investors to look more closely at real estate as an investment option for yield. (Also, of course, lower interest rates make borrowing cheaper – which helps boost real estate returns.)
Lower government bond yields make the yield on rental properties that much more attractive by comparison. The table below shows the spread, or difference, between 10-year sovereign bond yields and the yield earned on real estate investment trusts, or REITs.
REIT and Bond Yield Spreads
A REIT is a publicly traded company that owns a collection of properties that produce rental income. Most of this rental income is then paid out to REIT shareholders in the form of a dividend. You can buy and sell REITs like a stock, paying just the brokerage transaction fees.
The income earned on a basket of investment properties – as reflected in the Hang Seng REIT Index – yields 4.9 percentage points more than a 10-year Hong Kong government bond. For Singapore, it’s a difference of 3.9 percentage points.
Lower for longer
Thanks to Brexit, interest rates will probably stay low for longer than many investors anticipated. The U.S. Federal Reserve, America’s central bank, will likely delay its next interest rate hike in part because of the economic uncertainty that came with the Brexit vote.
Because Hong Kong’s dollar is pegged to the U.S. dollar, Hong Kong’s interest rate policy follows what the U.S. does. That will keep lending rates down, real interest rates negative, and property prices high.
The Singapore dollar is not pegged to the U.S. dollar, and its central bank doesn’t adjust interest rates as part of its monetary policy. But, rates in Singapore generally mirror what’s happening in the U.S. So, as long as U.S. rates stay low, Singapore rates will stay low as well.
The REIT way to buy real estate
REITs are a low-priced and convenient way to buy real estate, and earn a far higher yield than government bonds, or many other yield-generating assets. But a REIT carries a lot more risk than owning a government bond. U.S. Treasuries, or government bonds, are viewed as “risk-free” – there’s virtually no chance of default.
REITs, though, trade like a stock and their prices fluctuate – and they could cut their dividends. And any increase in interest rates could hurt the dividend – and share price.
There are a number of REITs listed in Singapore and Hong Kong, but no good way to buy a basket of them. Besides the FTSE Straits Times REIT Index (noted in table above), the Singapore Stock Exchange (SGX) has a REIT index. It tracks 34 REITs that own everything from shopping malls to office buildings to residential properties. It has a yield of 5.8 percent, but is not available as an ETF. (The full list of the REITs that make up the index can be found on the SGX website.)
The Hong Kong Exchange has 11 listed REITs, 5 of which deal exclusively with mainland China property. The full list of Hong Kong-listed REITs can be found on the Hong Kong Exchange website.
If you would rather own a basket of REITs, instead of just picking one or two to invest in, you can try a U.S. REIT ETF. The yields on U.S. REITs are a little lower, but it will still give you some exposure to the real estate sector – and a higher yield than government bonds. One of the most popular is the iShares U.S. Real Estate ETF (New York Stock Exchange; ticker: IYR). It currently yields 3.6 percent and tracks a basket of U.S. REITs.
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