When Hong Kong came under the rule of the Chinese authorities there were many in the financial markets who expressed concern about the long-term prospects. There was focus on Chinese human rights issues, the closed shop approach to some parts of the economy and general concerns about how focused economic decisions would be on Hong Kong. Just a few months ago we started to see a reduction in economic growth across China, property prices began to stagnate and investors started to look elsewhere.
Over the last few weeks we have seen a significant reduction in demand for Hong Kong property with many putting this down to the domino effect from the Chinese economic downturn. Historically Hong Kong has been seen as a “premium real estate market” but this premium tag would seem to be in great danger in the short to medium term.
Forecast real estate performance
Some experts are predicting a fall of up to 40% in the value of Hong Kong property in the medium term. While this would seem to be rather excessive it is based on the so-called affordability factor which investors are starting to take notice of. An analyst at Deutsche bank has suggested that in order for the affordability ratio to return to the long-term sustainable level of 50% there would need to be reduction in residential property values in the region of 32%. What seems to make sense in theory does not always make sense in practice although it is certainly a different angle from that seen in the past!
It goes without saying that property developers do best when markets are buoyant, demand is high and prices are rising. This encourages forwardthinking by real estate developers and adds significant structure to markets. There are concerns that property developers with exposure to Hong Kong could see their annual earnings hit by anything up to 3% in the short to medium term. While this may not seem excessive let’s not forget that the Hong Kong real estate market has been fairly buoyant for some time. If the tide is turning and demand is falling this could be the start of a correction which would obviously impact the profitability of property developers with exposure to the area.
It is also estimated that investor funds could take a 4% hit from the Hong Kong real estate downturn which could again be the start of a difficult period. When you bear in mind that some investors look towards Hong Kong as something of a safe haven, as it was seen in years gone by, this potential 4% hit in short to medium term earnings will surprise many. There is also the danger that investors could start to panic and withdraw funds from real estate investment trusts.
While statistics are obviously important when valuing any investment market a major element which is often overlooked is investor sentiment.
In the good times property developers have no problem acquiring debt to finance their future developments. When there is significant demand it is fairly easy to project cash flow going forward which will cover interest and capital repayments on debt. Indeed, we have seen many developers creating much sought after real estate assets and selling them on for a significant return. However, many developers in the Hong Kong region have racked up large debts in recent times and there could be trouble brewing.
If worldwide interest rates begin to rise, real estate demand continues to fall then there will be a reduction in cash flow going forward and an increase in interest payments. Maybe not the doomsday scenario many are portraying but certainly challenging times for the Far East property market.