HK residential market soars; investors favour office in Q3 2010

14 September, 2010

International property adviser DTZ revealed today that the residential market was under the influence of the positive results of the five land auctions held this summer, leading to an upbeat development of transaction volume and price. While solid fundamentals supported the market outlook, the cooling measures were believed to have affected buyers’ decisions to a certain extent, resulting in a quieter sentiment in recent weeks. For the investment market, office properties have become increasingly the focus in this third quarter, and Mainland funding assumed a more significant profile.

The residential market kicked off Q3 2010 on a good note, with the number of Agreements for Sales and Purchase (S&Ps) for building units and land rising more than 32% from 11,407 in June to 15,104 in July, and reached this year’s peak at 17,157 in August. For the first half of 2010 the total transaction volume was 78,649 in terms of the number of S&Ps, which is the highest record for H1 since 1998.

Mr Alva To, DTZ’s Head of Consulting, Greater China, commented, “During Q2 2010, the government first announced measures to put a halt to the nascent speculative elements and help stablise the market. Despite this, the second quarter still recorded a total of 39,558 S&Ps which is the third highest Q2 record since 1998. This set the stage for a further growth in transaction in the first two months of Q3, as the solid fundamentals – a low unemployment rate, ample liquidity, low interest rates and tight supply – all supported the development of the market.

However, Mr To commented that although buyers are generally encouraged by the positive market outlook, they began to take a longer decision time as they looked on the government’s continuous monitoring of market trends, which might affect the transaction volume as Q3 entered its last month.

We expect the September figure will drop but still be maintained at 11,500, bringing the total transaction volume of Q3 to an estimated 43,761 in terms of the number of S&Ps, which will be the highest Q3 record since 1998. Such a number would also surpass the transaction volumes seen in Q1 and Q2, reflecting a solid demand for residential properties from the users’ end. Despite the government’s cooling measures which mainly target speculation, transaction volume depends more on economic fundamentals.

After the price correction in Q2, the price of mass residential resumed growth at a modest pace on the back of positive market factors. The average unit price of a Taikoo Shing flat rose 4.4% quarterly to HKD8,350 per sq ft. Mr To said, “The price of a Taikoo Shing flat has seen a jump of 9.9% in 2010 as of end of August, while the jump for the mass residential of Hong Kong in general was 11.6% at the same time. The recent land auctions of plots at prime areas in Kowloon encouraged some property owners to be more aggressive in asking price.

The price of luxury residential shared the uptrend with the mass residential. The average unit price of a flat at The Leighton Hill grew 1.4% quarterly to HKD21,800 per sq ft. Looking at the bigger picture, in 2010 alone the price at The Leighton Hill rose 14.7% while the overall luxury residential rose 13.9% this year. According to DTZ’s statistics, the price index of luxury residential as of August 2010 rose to 179.5, surpassing the historical peak of 178 in June 1997. “The price of luxury residential showed little sign of abating. Given the tight supply, a strong demand from investors and favourable results of land auctions, the price of luxury residential will likely be sustainable in the longer term, and the rise is likely to spread to other key mass residential estates,” commented Mr To.

Regarding the economic fundamentals, which are the main underlying factors for sustaining the development of the residential market, Mr To pointed out two factors that are encouraging to buyers. The first is that the good economic prospect of mainland China continues to benefit Hong Kong’s business market. The second is extremely low mortgage interest rates are not expected to rise soon, as America’s economy is still weak with dismal home sales figures and a high unemployment rate. “The second factor is especially important as it eases the burden of mortgage. Taking a 675 sq ft unit at Taikoo Shing as a reference point and based on the median household income of the month, the affordability ratio as of August 2010 is 99.9%, down from 104.2% in January 2010. The improvement was all the greater when compared with the ratio as of June 1997, which was more than 200%. Due to the effects of low interest rates, the ability to afford a residential property is seen as much greater today than in mid-1997,” said Mr To.

However, recent restrictions placed on home mortgages might have affected end-users as much as speculators. The Hong Kong Monetary Authority extended a rule capping home mortgages to 60% of the value of a property to apply to real estate worth HKD12 million or more, and the Hong Kong Mortgage Corporation Limited capped the amount for mortgage loans at a loan-to-value ratio of 90% (up to a maximum of HKD7.2 million), and the maximum debt-to-income ratio has been limited at 50% for all income groups. “Being part of the measures against the build-up of speculation activities, the new restrictions also raised the bar for end-users to own their properties, particularly for some first-time buyers, because of the smaller mortgage loan available to them. Transactions became quieter in recent weeks and we believe part of the purchasing power was affected by the new measures,” said Mr To.

Mr To believed the series of government measures – increasing supply of land, regulating sales of flats, deterring speculation and ensuring most buyers are financially sound end-users – will give a chance for the market to consolidate before continuing with the uptrend. “In particular, the increase of supply through the government-initiated land auctions should prove to be the most beneficial to the general buyers, as the increased supply should ease pressure of price surge due to tight supply,” he said.

The recent land auctions reflected that developers are confident of the market outlook, which is shown by the increasing price they were willing to pay for prime land sites. “The auction of the 1 Ede Road site on 31 August 2010 broke the record of price per sq ft for sites in Kowloon at HKD16,588 per sq ft. As prime sites in downtown areas are in such short supply, developers are willing to withstand the expensive cost in acquiring land sites as they are confident of the demand of the luxury residential market. The excitement from these land sales also gave momentum to push up prices of existing projects,” said Mr To.

While the greater restriction on mortgage loans may affect the purchasing power of some buyers, and thus cast a shadow on the sales volume in the near future, the residential market should be able to ride on the strong fundamentals and expect a further growth in prices before year end, from around 5% for mass residential and 10% for luxury residential,” said Mr To.

At the same time, the local property investment market had a steady performance as well. As of 7 September 2010, 47 major deals (each with a unit value of more than HK$100 million) were recorded, but for the entire Q3 2010 the number of major deals completed is expected to be about 60 to 70. This would be in line with the transaction volume of a year ago, and would be similar to the level of investment activities of the last quarter, when 65 major deals were recorded.

Mr Alvin Yip, DTZ’s Co-Head of Investment, China, said, “In 2009, we witnessed a V-shaped rebound in property investment transactions, when low interest rates and the expectation of capital growth prompted investors to hasten their moves before property prices rose too quickly, and so sales went up markedly along the quarters. In contrast to that, for the first three quarters of 2010 the number of major transactions hovered steadily around the level of 60 to 70 deals per quarter. As the pricing became aggressive, property vendors and buyers became increasingly diverse in their expectation on price. Buyers reckoned that the price is getting too high and took a longer time in decision making, but nonetheless they are optimistic about the market trend, and thus the transaction volume did not experience great change for the last three quarters.

Despite the relatively flat trend of transactions, the composition of major transactions in Q3 showed an interesting change from the last quarter. As of 7 September 2010, office replaced luxury residential to become the most popular choice of properties for investors, constituting 32% of all the number of transactions, which was followed by retail (30%) and luxury residential (26%). Office transactions also made up for the largest share in terms of consideration, notching more than HKD8 billion or 44% of the total consideration at HKD18.1 billion.

Mr Yip commented, “In recent months, vacancy in prime office locations was filled up quickly due to steady occupier demand in the local office sector, boosting the growth of rental. Despite a significant rebound in the local economy, today’s rental level is yet to return to that seen before the global financial crisis, meaning there is still room for further growth. Investors have been paying attention to en-bloc office buildings throughout this year as they are confident of the office rental forecast and subsequent yield. The several mega-sized office deals in Q3, which pushed up the proportion of office among the total consideration, spoke for investors’ preference for this sector.

Office buildings not only drew the attention of local investors but also that of foreign investors, including capital from mainland China. Mr Yip continued, “Domestic funding dominated the property investment transactions in Q3, participating in 89% of major deals, but the share of funding from mainland China is growing from 3% in Q2 to 7% in Q3. Some Mainland investors became more interested in offices too. Apart from Mainland insurance companies or banking institutions that looked for properties in Hong Kong as representative offices, this quarter there were more corporation investors from mainland China who showed interest or even purchased properties solely for investment purpose. For Mainland capital, there are more channels available to invest in office and residential than other types of properties, which contributed to the surge in interest towards office this quarter.

As for luxury residential, the number of transactions was down from Q2, as some investors pondered amid the government’s cooling measures. If taking a look at the buyers’ profile of luxury residential, it can been seen that Mainland capital is a growing force. Mr Yip explained, “The proportion of Mainland capital investing in local real estate (mainly residential) under the Capital Investment Entrant Scheme has been rising in recent years, from 23% in 2007 to 41% as of H1 2010. The increase is worth to take note of.” As for some comments that such kind of Mainland capital contributed to the price rise of local homes, Mr Yip argued that the proportion of this kind of funding among the total consideration volume of HKD254.4 billion is only 1.75% as of H1 2010. “The presence of Mainland capital is increasingly felt but the residential market is still dominated by local buyers,” he said.

Turning to sites, transactions this quarter reflected that investors remain confident of the future demand for residential. Recent deals in Hung Hom and Causeway Bay highlighted a growing interest in the market towards mass residential sites in downtown areas with re-development value. On the other hand, the recent land auctions of prime sites, such as the sale of a residential plot at Mount Nicholson Road in The Peak in late July 2010 for HKD10.4 billion, reflecting an accommodation value of HKD32,014 per sq ft, became an important indicator for luxury residential. “The keen response at auctions showed that many developers were interested in prime plots, and the good sentiment is expected to underpin the development of the luxury property market of Hong Kong Island in the second half of this year,” commented Mr Yip.

In terms of transaction volume, retail was the second favourite among investors. Mr Yip said, “In Q3 most transactions of retail properties occurred in prime locations, as buyers were more confident of the rental growth and yield forecast of these retail properties. Foreign funding, on the other hand, had not been bold in purchasing retail in this quarter but they nevertheless began to show some interest in this type of investment opportunity.

The activities and allocation of foreign capital continue to focus on Hong Kong and other Asian markets, as these locations have a better outlook than many Western markets, which are still plagued by weak economic performance and uncertain recovery progress. Meanwhile, local investors remain alert of investment opportunities that give rise to steady returns. Among all sectors, office properties have the best outlook in the short term because of a sound forecast in occupier demand and rental growth,” concluded Mr Yip.

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