Supply Squeeze

March 15, 2006

The Rating and Valuation Department recently released its preliminary findings of property market in 2005. In particular, the forecast supply of private domestic units in 2006 and 2007 is most alarming.

Chart I The Department forecast that in 2006 and 2007, Hong Kong will have supply of private domestic units of 17,200 and 16,400 respectively, compared to an annual average of 24.853 in 1996-2005. The last time Hong Kong had seen such a low level of supply was in 1976, when there were 15,425 units (the Department had included village houses in their supply count before 2002, so 1997 may be another year in the last 30 years that had recorded similarly low figure). Nevertheless, 17,200 or less per annum is more than obvious an undersupply by any standard. Moreover, the declining trend is alarming - 31,052 units in 2002, 26,397 in 2003, 26,040 in 2004 and 17,320 in 2005. Chart I shows the supply curve since 1976.

The supply crunch was brought about by the suspension of government land sales from late 2002 to early 2004; and when it resumed in 2004 there were only a handful of lots sold so far. It is made even worse that in the last 6 months there were no successful applications of land auction under the current application system. We have reasons to believe the actual supply in 2006 and 2007 may be lower than government's forecast. If one compares the Department's forecast and actual supply figures in 1995-2005, one will note that the Department over-estimated the supply in 9 out of 11 years by an average of 9.5% (ranging from 2% to 18%) and under-estimated in 2 of those years by 2% and 4%. Chart II shows the forecast supply and actual supply from 1995 to 2005. The pink line shows the forecast supply and the blue line the actual supply. For most of the time. the blue line (actual) is below the pink line (forecast).

Chart II

On the demand side of the balance. there are a growing number of new families since 2000 and annual marriages reached a 21-year high in 2005. New family formation had been one of the main driving forces in the surging demand in 1980's and 1990's. This time there will be no exception.

Strong local economic growth since 2003 has paved way for escalating demand for domestic units, as evidenced by the growing number of sales in both primary and secondary markets since then. With the general public upbeat about the outlook, one can only forecast a higher take-up rate of flats in 2006 than last year's 17,450 units. Property consultants have generally estimated this at 20,000 to 25,000 units.

Banks have been well known for their conservative lending during economic down turn and aggressiveness during the boom years. Mortgage leverage has always played a pivotal role in Hong Kong's property market, and the "make or break" of property market depends to a great extent on banks' lending attitude. Today, the banks are head locked in mortgage wars that have seen "prime lending rate" becoming history, with all mortgage rates priced at sub-prime, Hibor-linked rates are the talk of the day. With the encouragement of Hong Kong Mortgage Corporation, 90% lending or more are just common-place. All these will only serve to further boost demand, especially at a time when interest rate escalation is easing off.

So it's almost guaranteed that the market will see price hike at an alarming speed this year, and next. It is the government's responsibility to try and avoid the coming bubble, as the government is the only land supplier and has control over when and how the land is released to the market. While we uphold the current application system of land sales as it leaves to the market to decide when and how much land is supplied, we must caution that the government should be more flexible in setting the price threshold that triggers the sale. The application system can be flawed seriously if the government controls the amount of land released by unrealistically setting a higher-than-market price threshold. The fact that there is no successful application in the last six months is a strong indication that government's price tag is too high.

Having learnt the hard way that substantial price decline can be disastrous, the government seems to have resumed high land price policy. If this persists, it will not before long that we will see a bigger bubble taking shape, and the outcome can be equally disastrous especially when this is happening during a time of full-throttle economic growth.

More private land can be released to the market if the government does not ask for excessive premium for land use change, as many developers have huge land banks that need user modification before residential development can be started. In recent years, land premium has been a major contention between government and developers that has delayed supply of land. The time taken to process a land modification is also unnecessarily protracted. The situation has not improved that surveyors engaged in land use modifications have recently formed a working group to press the government for an imminent solution.

To quench the expected thirst for more flats in 2006 and 2007, knowing that land sold this year will not produce flats until 2009-2010, the government should consider releasing the Home Ownership Scheme (HOS) flats, although it had vowed not to do so before 2007 in its "9-point measures" in 2002 to rescue the market. The sheer number at 16,000 units if released in phases will serve to deflate the bubble and will be welcomed by the market as these units cater for mainly first time buyers, which is growing fast in number as a result of more marriages and economic growth.

By K.S. Koh