Around the World in a Dozen Properties – Part 3: How (and when!) to invest into the world’s frothiest property market – Hong Kong

It was Mark Twain who once said, “Buy land, they’re not making it anymore.” Indeed, had you done so in Hong Kong a few decades ago, you’d now be in a pretty good spot financially. That’s despite the fact that in Hong Kong, they ARE making more land.

Each time I visit the former British Crown Colony, the harbour line of the city has changed slightly. Hong Kong is a master at reclaiming land from the sea, having grown its useable land mass by more than 60 square kilometers. Its new airport and the Disney World Resort are entirely built on reclaimed land, and reclamation in its main harbour area has been so considerable that a discussion started about the risks to the city’s natural harbour and its use for transport of both cargo and people.

One of the most chronically overcrowded cities on the planet

Despite all these efforts, Hong Kong is a territory chronically short of land. Most of its 1,104 square kilometres are mountainous regions and can’t be developed at all. Also, business and finance is, of course, concentrated around the central areas of Hong Kong where space is chronically short. Due to the sky-high land prices, Hong Kong became one of the world’s most vertical cities, with sky-scraper squeezed next to sky-scraper. Population density is among the world’s highest.

It’s not just in terms of being built-up that Hong Kong is a city of superlatives. What was a sleepy backwater with just 400,000 residents in 1900 (when Greater London already counted 6.7m residents), has now become the world’s 3rd largest financial centre after New York and London. Hong Kong is not just a gateway to China; it is also one of the world’s major hubs for trading and financial transactions.

Hong Kong has one of the highest per capita incomes in the world; it has the greatest income inequality of all major cities on the planet; and it’s regularly named as the freest market economy by the Heritage Foundation Index of Economic Freedom. It recently ranked fourth in terms of the highest percentage of millionaire households, behind Switzerland, Qatar, and Singapore, with 8.5% of all households being worth at least one million dollars.

No wonder then that property prices have risen to stratospheric levels. In 2014, Hong Kong advertised the world’s most expensive home with a price tag of EUR17,000 per square foot. That means a 4,600 sq ft home sells for more than EUR70m! Even London and New York pale in comparison.

The increase in prices in Hong Kong during recent years has been staggering. Demand was strongest for small residential units, driven by the city’s growing army of well-heeled young professionals. Since 2003, prices for small residential units have risen five fold.

Even with land being scarce, there is no guarantee that prices rise in a straight line

Amazingly, Hong Kong wasn’t overly affected by the credit crunch. Shares listed in the territory did take a nose-dive in the 2008/09 crash, but property prices didn’t. Since 2009, prices in the residential market are up 109%.

Will it continue to rise? And how does one get in on the game without travelling to Hong Kong and putting a million dollars on the table for a small residential unit?

Anyone wanting to invest in Hong Kong property needs to be aware of a number of peculiar factors that are driving the market. Those can, at times, also lead to extreme swings in the opposite direction. Such was the case in the mid 1990s, when property prices fell by 65%. On my recent visit to Hong Kong, I found that prices in the residential sector had recently weakened a bit.

So where will prices be heading from here, and when is the best time for investors to get in?

Incredibly enough, whereas the local economy is a bulwark of unregulated capitalism, the property market of Hong Kong is actually one of the most government-controlled property markets in the world.

A small number of very large property development groups own vast landbanks. It’s the government that then determines how much of these land banks is released for development. The process to determine the policies can best be described as an old boys‘ network consisting of government officials and some of the richest families of the territory. Throw in a bit of corruption, and you basically have a cartel that determines to a large extent how much supply of new properties is being released into the market.

The Chinese being notorious gamblers and momentum investors, there is also a strong element of cyclicality added through both mentality and financial regulation. During downturns, the authorities and the local banking sector loosen lending rules. When the market shows signs of overheating, they are tightened. Nothing unusual per se, but the swings of the Hong Kong market are more extreme than in other localities.

Those with the right feeling for timing were able to repeatedly make a killing in the Hong Kong property market. It’s no surprise therefore that of the 20 richest people in Hong Kong, half have made their money in property (and the other half with virtually no exception has had some kind of involvement in the property market). Those who fared best historically were those who combined a vast land bank with a strong balance sheet. They were able to ride out and actively take advantage of weak periods, to expand rapidly during periods of rising prices.

This property company is the bellwether of the industry

Right among the leaders of this group are the Kwok brothers, Thomas and Raymond. Estimated to be worth $15 billion, they control Sung Hung Kai Properties (SHKP), one of the leading property development groups of Hong Kong.

The company was one of the many non-British owned companies that overtook the British trading companies that dominated the financial order of Hong Kong prior to 1997. It was founded in 1963 and listed on the local exchange in 1972. It specialises in premium-quality residential and commercial projects, with most of its existing rental portfolio focussed on Hong Kong, and only a smaller part of the portfolio now in China. At last count, 80% of its rental income was generated in Hong Kong.

Like virtually all other Hong Kong based property groups, SHKP has recenly been branching out to mainland China. In Hong Kong, it owns 28.7m sq ft of completed investment properties with a further 20.8m sq ft of properties under development. In China, it owns 10.3m sq ft of investment properties with a staggering 71.3m sq ft of additional space under development. Property in China is obviously less valuable per square foot than in Hong Kong, but it’s clear that the mainland will contribute significantly more to the group in the future. During the past five years, the group’s rental income in Hong Kong rose an average of 10% per year, whereas in mainland China it rose by an average of 37% per year.

What initially sounds like potential over-expansion on the mainland is actually built on an extremely solid financial footing. SHKP’s balance sheet is currently 85% equity and just 15% debt. The group has some of the highest credit ratings amongst Hong Kong developers – Moody’s gave SHKP an A1 rating and Standard & Poor’s gave the Group an A+ rating.

With such a strong financial foundation, SHKP should be in a good position to withstand any potential downturn. And such a downturn, it seems, is now likely on the cards. In March, property sales fell by 28%. The Hong Kong Monetary Authority passed the 7th round of market tightening measures, and there is a political movement to release more land for residential development so as to ensure that first-time buyers get a chance to get onto the property ladder. Right now, the city has the least affordable housing on the planet, with the median home price 17 times the average household income. From here on, it’ll probably be downwards – at least for a while.

The time to buy probably hasn’t come just yet

That leaves SHKP properties an investment that one mustn’t get excited about just yet. However, investors are always advised to do some long-term monitoring of quality investments, so that they are ready to invest when the right opportunity arises. In the case of SHKP, such an opportunity last arose in 2008/09, when as a consequence of the global share price rout the stock price temporarily tumbled by 70%, before rising 200% in the following five years.

It’s not clear yet if Hong Kong is indeed facing a “perfect storm”, as some predict. What is clear, however, is that a combination of new supply hitting the market, monetary cooling measures, and an impending interest rate rise are all in the making. None of this bodes well for the Hong Kong property market in the short term. SHKP, however, is likely going to weather the next storm, too.

For investors, the question will be at what point during the coming downturn will a buying opportunity arise. Master Investor magazine will be on the look-out for you, and get back to the subject when the froth has come off!