24 May 2017 - The Hong Kong property crash of 1997 is an often-cited example for the perils of property speculation and unsustainable pricing. The unprecedented financial boom years of the 90s culminated in a 70 per cent freefall of home prices in the Hong Kong market for 6 consecutive years, consigning homeowners to the adverse effects of negative equity. Looking to market conditions today, according to the 2016 UBS Global Real Estate report, Hong Kong’s housing market is the least affordable in the world and sits firmly within “bubble risk” territory.
With real estate prices in aggregate on a continued upward trajectory post 2003, is Hong Kong overdue for a sharp correction?
Referencing the “What Drives Property Prices in Hong Kong” research paper issued by the Hong Kong Monetary Authority, volatility in property prices and bubble risk are largely influenced by both demand and supply side factors which include the extent of government involvement, slow adjustment of housing stock to price movements, the degree of speculative demand (as demonstrated by affordability i.e. house price to income ratio) and interest rates. The 1990s were characterized as a period of loose monetary conditions with low and negative real interest rates which buoyed property demand. From 1995 to 1997, as adjusted for inflation, the Hong Kong housing market saw a real increase of 50 per cent in terms of prices whereas transaction volumes rose from 68,000 in 1995 to 172,000 in 1997.
As of now, despite recent and projected rate hikes by the Federal Reserve, interest rates and subsequent mortgage rate levels are at historic lows. The distinction however between now and 1997 is that the majority of property transactions are mortgage funded which means that homebuyers are encouraged to borrow more in our current cycle. That being said, this does not necessarily mean that buyers are overleveraged given the fact that loans are now subject to stricter loan-to-value (LTV) ratios of at most 60 per cent (whereas in the 90s it was 70 per cent) and that applicants for mortgages are subject to prudential measures.
Looking to the circumstances which burst the 1997 property bubble, it was an after effect of the Asian Financial Crisis whereby the devaluation of the Thai Baht spread financial contagion throughout the region as asset prices collapsed and overnight interest rates in Hong Kong soared by 280 per cent. Systemic and external in nature, though it is hard to envisage the exact sequence of triggers taking place, in our financialized and interconnected global economy, systemic threats abound.
More so, as with 1997, the Hong Kong government does not have the necessary financial flex to respond to system shocks which will adversely affect the property market given that the local currency is pegged to the U.S. dollar. In fact, in 1997, blame was also apportioned to the government for setting their 85,000 unit housing target which further depressed property prices during the slump. That being said, if you were to look at the impact on Hong Kong property prices wrought by the Global Financial Crisis of 2008, prices declined by 17 per cent only to swiftly recover - a noticeably subdued reaction when compared to 1997.
Though the government has enacted numerous cooling measures to rein in prices post 1997, a Barclay’s Capital property market report released in 2013 detailed that LTV caps only depress prices in the short term and do little to halt the rise of property prices in the long term. Further characterized as “economically unsustainable” by J.P Morgan’s Asia Pacific equity research unit, the fact that Hong Kong house prices amount to over 18.1 times gross annual median income , makes it tough to leave the “bubble risk” designation behind. Although Hong Kong home owners and buyers are in a financially ‘healthier’ position than they were in 1997 to weather risks, as with 1997, truly effective price control measures in the form of interest rates, remain beyond the control of the Hong Kong government.
In conclusion, there are some similarities between the situation in 1997 and the present, but there are also many differences that may delay and mitigate the effects of a burst property bubble. As always, this remains one of HK’s most talked about topics and unfortunately, one without a very clear answer.