SCMP Wednesday, January 10, 2001

Crumbling foundations


If one phrase captured the pre-1997 boom in SAR property prices, it was perhaps that "people in Hong Kong don't buy property for the rental yield". It barely bore up to scrutiny but seemed highly descriptive of the times. Thousands of would-be home owners agreed and threw in their lot with a rising market.
Yet the biggest punter of all had barely set up shop by the time rational economics reasserted itself. In launching a greatly expanded subsidised-flats-for-sale programme in 1997, Chief Executive Tung Chee-hwa took a huge gamble. He bet that in a rising market, he could sell a huge number of subsidised flats, jack up home-ownership levels and make himself really popular.
It didn't work, and 3.5 years later, the property market remains hamstrung by that big, bad policy. Despite a slowly recovering economy, improving employment data and falling interest rates, the Home Ownership Scheme (HOS) could yet prove Mr Tung's political nemesis.
The Chief Executive inherited the HOS from a colonial regime that had twisted free-market principles by building and allocating housing. Yet, by expanding the HOS even as the property bubble burst and by attaching such political baggage to its success, he forgot the most basic of investment principles.
For much of the early to mid-1990s, Hong Kong had negative "real" interest rates. Inflation exceeded nominal rates, which were low due to the lacklustre economy in the United States. It made no sense to lose money in the bank, so people put their funds into property instead. The Government reacted with "anti-speculation" restrictions on pre-sales that knocked all but the biggest developers out of the game. The resultant lack of supply from 1994 onwards laid the ground for the pre-handover price blowout.
By the summer of 1997, you could expect to earn a two per cent return on the average unit by renting it out. Bull-market analysts justified this piffling payback by saying SAR residents bought for capital appreciation rather than rental yield and that Hong Kong was different, due to its lack of land. Mr Tung bought into this sophistry, or figured he could sell enough HOS units before economic reality reasserted itself.
The HOS was introduced in the early 1980s and a decade later began to be used to migrate better-off public-housing tenants to the home-owning sector. As the owner of all land, the Government transferred sites to the Housing Authority (HA) at nominal cost, a system that allowed the HA to fund its building programme for public rental flats from profits made by selling HOS units.
This seemed a typical Hong Kong solution that solved the endemic housing problem by mixing free markets and socially engineered government solutions. The trouble was that what worked as a small programme in a rising market was disastrous as a large programme in a falling market.
Three years of rising interest rates radically altered the financial quotient underpinning the boom of the 1990s. Today, property prices have fallen by 40-50 per cent, and residential rental yields have risen to about five per cent. Arguably, that return is still too low, and prices must fall further to "clear" the market. Maybe. But with interest rates declining, the SAR is at least moving towards a balance between investment return and the "cost" of money.
The spanner in the works remains the HOS. This week, developers, led by Sun Hung Kai Properties, have again complained that sales of subsidised units - priced at half the level of their competing units - are killing the market. HOS units have become the benchmark price dictating all other property prices. When the prices of HOS units were rising, none of this mattered much. Most people preferred private units, which have the advantage of no on-sale restrictions and so are more valuable and liquid investments. So long as that situation remained intact, Mr Tung seemed to figure he could build like crazy and engineer his chosen 70 per cent home-ownership target.
In reverse, the effect was to create a market that fell sharply with few transactions. This partly reflects the success of the HA, which, piling scandals aside, is producing projects that compete on quality with private-sector flats yet are priced at huge discounts and allow owners to sell units back to the authority within two years.
Moreover, with the Government cranking up its tenants-purchase scheme with generous financing terms for renters of public housing, an entirely different group of people from those originally planned are now lining up to buy HOS flats. The last release in December was 30 times over-subscribed, with 90 per cent of applicants coming from among renters of non-public housing.
So who are these people? A recent Equal Opportunities Commission ruling dictated that no applicants for public housing should be ruled against on the grounds of gender or family status. Anecdotal evidence suggests the majority are young graduates with good life-time-earnings expectations who, for now, fall within the maximum monthly income band of $32,000 and have a net worth of less than $700,000.
This is precisely the group private-sector developers would expect to migrate on to the housing ladder in non-core districts, such as Tseung Kwan O. As such, we now have the ridiculous situation in which subsidised housing - costing as little as $500,000 a unit - is provided to people with a net worth that might exceed the purchase price.
In his pre-Christmas clarification speech on housing policy, Financial Secretary Donald Tsang Yam-kuen sought to clarify matters by saying that a maximum 20,000 HOS units would be sold each year for the next four years and that a consistent supply of land would be made available to developers.
Unfortunately, the same dynamics that, in a rising market, saw thousands queue for ballot entries to private-sector pre-sales is, with expectations reversed, unfolding in public-sector sales. The on-sale restrictions that seemed a hindrance before constitute a bonus today due to the price discount and the option to sell a unit back to the authority, thereby negating any investment risk.
Given the chance, the Government would like to jettison the HOS misadventure, but that is not possible with so many projects in the production pipe line. The battleground now is whether the units should be cannibalised into the public rental sector, where the waiting list remains above 100,000.
That seems politically untenable, given Mr Tung's ownership targets. Can he really be the chief executive who engineered a massive decline in home ownership? Mr Tsang would have vetoed such calls from the developers, since it would entail a massive recapitalisation of the HA, which depends on revenue from HOS sales to fund its public-housing programme.
So what is the end game? With interest rates falling, it is possible to see before the end of the year a situation in which the cost of mortgage financing dips to 6.5 per cent and deposit rates slip to less than four per cent. In a normal market, the risk-reward trade-off between leaving money in the bank and buying property would suggest a bottom.
The full deregulation of bank-deposit rates in July means property might never again have such an outright advantage over cash in the bank. But with rental yields rising to sensible levels, property should have gained a relative edge.
Mr Tung will be hoping that falling rates are enough to reverse sentiment. If that happens, the private sector could yet win back pricing power, and he might be able to sell HOS stock into a slowly rising market. But it will have been a close-run thing. Hopefully, all involved now realise the folly of trying to become the market.
Simon Pritchard ( ) is a staff writer on the Post's business desk.