Hong Kong Property: Sometimes, Rising Rent Does Not Mean Much21 June, 2011, 18:57. Posted by Zarathustra
Tags: Bubble, Hong Kong, Property, Real Estate
Property prices in Hong Kong have been moving sideway at best for some months. With falling transaction volume, home owners wanting to sell their properties are no doubt getting more desperate. So desperate that even a wild speculation of resuming Home Ownership Scheme (HOS) can trigger some prices cuttings as we can see in the recent transactions.
Of course, those who are really desperate to sell may be minority. For many Hong Kong property bulls, they are still very optimistic. The prospect of hard landing in China does not exist for them, and the fact that the Chinese government is tightening policy and its impact on Hong Kong has gone off their radar screen. The prospect for another round of quantitative easing is also slim for the moment. With rising macro risks, there are less and less reasons to feel bullish as time goes by, except a blind faith that perhaps the Chinese economy will be all right and continue to grow strongly for the next 10 years, an argument that does not appeal to me.
With low interest rates environment at its end and growing uncertainties on global macroeconomic outlook, there is still one bullish argument that I have yet to rebuke: rising rents.
I have rarely touched on rents in my own forecast for various reasons. The biggest reason, however, is that rent is a coincident indicator at best, and a lagging indicator at worst. The reason for that is rather obvious: property prices (or capital value) are based on market’s expectation of the future income generated by the properties. Rising property prices, in some way, can be thought of (roughly) as the market expectation of rising income generated by the properties relative to the required rate of return (cost of capital).
This is almost like a human nature that most people based their future expectation on what is happening right now. The good example of such backward looking “forecast” is the expectation that real interest rate will remain negative. As I have pointed out, real interest rate is a lagging indicator for property market in Hong Kong. However, many people are still sticking with the notion Hong Kong property prices can’t correct as real interest rate will remain negative, and the reason for that is that inflation is rising now in Hong Kong.
Similarly, rents are of similar nature. At best, the turning point of rents coincide perfectly with property prices. At worst, it lags for a few months.
The following chart shows the monthly price and rent indices compiled by the Rating and Valuation Department of the Hong Kong government.
Although they move quite synchronously over the long-term, careful inspection shows that property prices often peaked and bottomed out earlier than rents.
1994 peak and 1995 bottom
2008 top and 2009 bottom
Similar things happen for office properties:
And to a much lesser extent, retail properties (in this case, it appears more like a coincident indicator rather than a lagging indicator):
Source: Rating and Valuation Department
This is the main reason why I have rarely touched on rents, except noting that rental yields are hovering around the historical lowest level, indicating the property prices are overvalued. Of course, being overvalued does not mean that prices will fall tomorrow: it require some more fundamental change in those factors which fuel this bubble. Unfortunately, I have seen this change coming as monetary tightening from China is spilling over to Hong Kong, increasing interest rates in Hong Kong, while increasing macro uncertainties in the global economy will be a concern.
Once again, I am looking for 0-10% rise in home prices for the full year of 2011, with higher probability of reaching the lower bound of the base-case forecast, implying 10% or more correction from this point in the next 6-12 months. If the macroeconomic environment continues to deteriorate, I will be lowering my forecast even further for 2011 and 2012.
Hong Kong Property 2011 Forecast 10 Jan 2011
Hong Kong Property: Looking Downward 4 April 2011