Hong Kong Property: How much higher can Real Estate prices go?

YOHO MIDTOWN by Sun Hung Kai Properties (16.HK)

Analysts, property brokers, pundits alike are forecasting how much higher home prices can go. Most, if not all, are predicting higher prices next year.

In my previous analysis of the factors which drive Hong Kong Property Prices, I pointed out the major factor in recent years which drives prices: money supply. In this analysis, I am going to analyse the relationship between money supply and property price.

The chart below depicts the relationship between the year-on-year change of M1 money supply (HKMA) and the year-on-year change of property prices (using Centa-City Index):

As I discussed previously, except the period of 2006-2007 when a lot of large IPO activities were happening, which distorted the money supply numbers, the rise in home prices are almost always preceded by a large increase of money supply, and this pattern is more obvious after 2003, after the government pledged to stay side-line in the real estate market.

I ran some linear regressions using the monthly home prices data from January of 2003. I found that the year-on-year change in home prices is best explained by the year-on-year change of M1 money supply of 5 months ago. The adjusted R-squared was 0.348. Yes, the explanatory power is not very high, but I wonder if I can get anything higher than that in other financial data time series, not to mention that I have not even attempted to remove the distortions in 2006-2007. Here’s the Scatter Plot, which nicely illustrates the relationship:

The resulting regression equation is:

Y = 0.020006 + 0.563059 X

The Alpha term is not significant, so I just drop it for now. In layman terms, this means that any 10% year-on-year change of M1 money supply will predict a 5.6306% year-on-year change in home prices five months later.

Of course we should not be fooled by the seemingly sophisticated statistics and believe that the above chart answers all the questions on how much property prices will rise. Because of the currency peg, when hot money flows into Hong Kong and drives up the currency, the Hong Kong Monetary Authority has to inject money into the system in order to stabilise the Hong Kong currency. This will mean an increase in money supply. So the analysis here tells us that in order to forecast Hong Kong property prices, the key variable to consider is money supply, which has become pretty much a function of money flow.

The problem of predicting home prices in Hong Kong is tricky as it becomes pretty much a monetary phenomenon. Money flow into and out of Hong Kong is not always predictable. As an open economy with free capital flow, money flowing into Hong Kong today does not mean that it will continue to flow in tomorrow. Sudden shock in the economy can easily reverse the flow (think of 1997).

So what drives money into Hong Kong? Here are some commonly cited reasons:

1. When Chinese Yuan appreciation will make property prices in Hong Kong cheaper relative to China

2. Quantitative Easing/low interest rates

They are valid arguments to support the thesis that money flow will continue to be favourable to Hong Kong property. But there are some limits, in my view, that these arguments can work. Chinese Yuan appreciation is essentially a tightening monetary policy from China’s perspective. Given the property bubble in China, I will not be surprised if, at some point, the property bubble burst in China after series of tightening. In the event of bubble bursting and recession, higher China Yuan valuation will most likely bring no benefit to Hong Kong property.

And it might be true that the United States might not be able to raise interest rate for another 1-2 years, but as interest rates are at record low now, so any surprise in interest rates can only be on the upside, and the recent rise in bond yields suggests that interest rates may actually rise sooner than previously assumed.

So how much higher can Hong Kong property go? For now, I am definitely on the cautious camp. I don’t mean that it will not go up for more: in fact I will not be surprised if it goes up for another 10-20% in 2011 if things continue to be favourable, but the more it goes up, the more dangerous it becomes.

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About Zarathustra

Zarathustra: Founder and Managing Editor of Also sprach Analyst. Once an analyst, now an investor and entrepreneur. Based in Hong Kong, but Londoner at heart.