US interest rates, capital inflows from China and attempts to cool residential markets are all weighing on Hong Kong’s markets. Tsering Namgyal reports

Hong Kong’s property market will remain challenging in the near term due to a number of factors. One of these is the impending hike in US interest rates, which would finally put an end to cheap money.

According to Peter Churchouse, former Morgan Stanley analyst and a leading authority on Hong Kong, a rate hike “will come later than sooner”. This is good news, he says, because it might finally bring down Hong Kong’s famously high real estate prices, which have been propped up by years of quantitative easing and capital from mainland China.

Analysts say this is positive because the rising property prices in Hong Kong have been forcing the government to announce measures to curb the rise. This has had the unintended effect of actually squeezing the middle-class and lower-income workers.

Some economists have also attributed last year’s historic Occupy Central protests to Hong Kong’s exorbitant property prices. 

Record high prices, very low yields, and the expected rise in interest rates do not augur well for the near-term outlook for Hong Kong’s real estate market, according to JLL. “That is, however, not to say that there aren’t opportunities in the market,” says Dennis Ma, head of research in Hong Kong.

Investors eyeing long-term opportunities, for instance, are poised to benefit from the government’s focus on developing new commercial and residential clusters beyond the city’s traditional core markets through the release of land.

In the office market, locations such as Wong Chuk Hang and Kowloon East, which is set to become the city’s second central business district, have attracted strong investor interest. As for retail properties, whipping up investor interest are areas in the New Territories such as Yuen Long and Tseung Kwan O.

Marcos Chan, head of research for Hong Kong, Macau and Taiwan at CBRE, has a slightly more optimistic view. He thinks the real estate market will be supported by affordable interest rates, although he expects them to rise in the next 12 months. “Reasonably strong end-user demands for both residential and office markets and rental increment, as well as low vacancy and limited supply for both residential and office markets,” will drive the Hong Kong property market, he says.

Last year, the government introduced ‘double stamp duty’ on residential property in a bid to cool the market. Analysts concur that double stamp duty has affected investment volumes but left prices broadly stable.

Ma believes that the new taxes means increased interest in “indirect acquisitions via equity transfers, which are not subject to the new taxes”. He adds: “These transactions, however, require the property to be already held under a company structure and often will lengthen the acquisition process owing to the greater amount of due diligence involved.” 

Chinese influence
One of the biggest factors driving the Hong Kong market is the influx of capital from China. For instance, Chinese banks have become increasingly active in the government residential land sales market over the past few years, analysts say.

“Look across the office and residential market and you will usually find that it is [Chinese] buyers that lead the way in setting new market benchmarks, in terms of pricing,” says Ma.

According to CBRE, more Chinese firms are looking for offices, in terms of both leasing and sales, while increasingly Chinese developers are getting involved in the land-sale market. It reckons, however, that the introduction of double stamp duty has led to a slight weakening of demand. 

The near-zero interest rate policy set by the US Federal Reserve in the wake of the global financial crisis has caused Hong Kong asset prices to reach record levels. However, Ma believes higher future interest rates “will force investors to re-evaluate their investment decisions”.

Rental growth in some segments of the market, such as office and residential, might help sustain prices in the near term, although that may be challenged as interest rates rise in the medium to long term.

CBRE believes that transaction volumes are likely to fall at the outset of interest rate rises.

Analysts say that property prices will continue to hold steady across most segments of the market in 2015, with the exception of high-street shops, where slowing retail sales and very tight yields are likely to lead to a modest correction. 

“Although the initial rise in interest rates is likely to dampen market sentiment, we believe that there will still be enough rental growth in the market to keep property prices at current levels for this year,” says JLL. However, as interest rates steadily rise, the pressure on property prices will start to increase. 

Policy measures
Analysts believe that policy risk is the main source of uncertainty when investing in the Hong Kong property market. 

“The government has continually indicated that it will keep a close eye on the residential property market and is willing to introduce more control measures – such as the lowering of loan-to-value ratios in February 2015 – to keep prices in check,” says Ma.

Still, analysts such as Chan believe Hong Kong property prices are not likely to fall in the next two years. The reasons are positive rental reversion, very low vacancy and limited short-term supply.

Meanwhile, Chan believes that with so many restrictive measures in place, vendors will find it difficult to buy back after the sales, and, importantly, the labour market remains strong as the level at which employers are planning to make new hires is at a three-year high. 

Adding to the euphoria is last November’s implementation of Shanghai-Hong Kong Stock Connect, a pilot programme connecting the two stock exchanges that has pushed Hong Kong equities to record levels. More Chinese firms are expected to pile in to Hong Kong property later this year, when the programme is expected to be extended to link with the Shenzhen Stock Exchange.

On the whole, the outlook remains positive in the long term as the Hong Kong economy remains healthy and the job market is sound. This means the risk of a property market crash is minimal.

“An interest rate hike, nevertheless, is still a factor in determining market directions –  it will affect affordability and hence property prices,” Chan says.

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