Hong Kong’s New Vacancy Tax – Overview and Interpretation

Posted: Jul 6 2018Last Updated: Jul 6 2018
 
6 July 2018 - OKAY.com CEO Joshua Miller discusses what the new vacancy tax could mean for developers and consumers.
 
The Vacancy Tax - Structure
 
On June 30th, the government announced its new policy imposing a vacancy tax on developers regarding unsold first-hand private residential flats, constituting a tax amounting to 2 years’ of rental value for units that have not been occupied or rented out for more than 6 of the preceding 12 months.  The tax will be imposed each year that a property is considered vacant on this measure.  At current rental-to-sale values, this equates to a tax of approx. 4-5% of the property value each year.
 
How does the vacancy tax impact developers and first-hand (new) supply?
 
When developers introduce new supply to the market, the prices of these properties should be driven by market forces – i.e. supply and demand, paired with the developer’s cost of capital. So, for example, if a developer is focused on selling quickly, they are motivated to reduce the asking price of new properties (in addition to providing other incentives such as financing schemes). However, developers cannot always predict what the market’s reaction will be when they launch a new development.  If the units are not selling well, it is difficult to reduce prices as this upsets early purchasers who often perceive the developer has “reduced” the value of their property.  A good example is the riots that have occurred at developers’ offices in China when this has occurred in recent years.  Furthermore, if prospective buyers believe that prices may come down if they wait, this discourages homebuyers from buying units released earlier.  
 
The vacancy tax puts developers in a difficult position.  To ensure that all their units get sold or leased, they will be forced to launch new developments at lower prices.  How much lower depends on the developer’s assessment of the severity of the tax versus how their projection of demand at given prices. So it becomes somewhat of a guessing game.
 
Developers have voiced strong protest to the vacancy tax, claiming it is unfair since it does not apply to second hand owners who, in aggregate, hold most of the unsold units (approx. 43,000 units at the end of 2017, or about 80% of all unsold flats(1)).  
It is also especially awkward for developers who have existing have unsold inventory or are about to launch new projects, since they invested and built those projects without the tax (and lower prices) in mind.  
 
Lower prices (due to the vacancy tax) ultimately reduce the profitability of future development projects, creating a paradox:  if property development is less profitable, fewer new residential units will be built.  Developers may even shift their focus to office developments.  So a severe vacancy tax could end up reducing the new supply that Hong Kong’s housing market needs, hence why this vacancy tax was relatively mild.
 
 
Will this vacancy tax increase housing supply and reduce prices?
 
The immediate net impact on the total supply will be extremely small.  Even if all the developer-owned unsold units were sold (at lower prices), these only constitute approximately 0.8% of the total market – not enough to materially impact broader prices.  
Only by imposing a broader vacancy tax on all owners of vacant properties (such as announced in Vancouver) can the government materially increase supply.  But it’s difficult to see this happening given the negative public reaction and political repercussions it would cause.  The government’s other cooling measures have significantly reduced transaction volumes, increasing the length of time needed to sell.  Pinning homeowners between the contradicting forces created by a vacancy tax and the existing cooling measures isn’t fair either. This may explain why the announced vacancy tax is only targeting developers.
The bottom line is that this vacancy tax will have a minimal impact.  In theory it could be a precursor to broader vacancy tax measures over time, though whether or not the government would introduce such a tax is a longer discussion for another article.
 
Footnotes:
 

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