Crazy talk about property prices back to normal

Now that Hong Kong property prices have moved from the outer stratosphere to rest precariously on Planet Fantastic, there is much loose talk about a move back in the direction of the ridiculous. New World Development, one of the colony's big property developers, has just forecast that prices will rise again by some 10 per cent in the coming year.

The ever bullish Michael Green from the Nomura Research Institute in Hong Kong goes further. He believes a serious supply shortage is about to emerge which will send prices back up to the crazy levels which people in the colony describe as "normal".

What are we talking about? According to the Hongkong Bank, the average price of a 430 sq ft flat, in other words a flat much smaller than practically all council flats and built to far lower specifications, is now around HK$1.68m (pounds 142,000). A flat approaching the size of a average three bedroom apartment in London would cost at least pounds 400,000. Office rentals, which have fallen more sharply than residential prices, remain as high as pounds 8,500 a month for 1,000 square feet in the central district. Companies moving out of the prime area have been able to rent an equivalent office space, a couple of miles away, for some pounds 2,500 a month.

The high prices have driven many companies out of the territory in search of lower costs in places such as Singapore. It was thought the laws of supply and demand would kick in about now and start to pull prices down. The fact that Chinese rule over Hong Kong will start in less than 600 days might also have been thought to act as a depressant on prices. Even on the supply side there are reasons to suggest that demand might be satisfied.

At the end of last month the government let it be known that the supply of land for the construction of residential property could hit a record this year. The increased land supply is mainly derived from development sites surrounding the rail link to Hong Kong's new airport and is in line with the general policy of releasing more land for residential development.

The government is Hong Kong's sole freeholder and supplier of land. It creates supply by redevelopment, redesignation and reclamation work. However the government cannot determine the rate at which developments actually take place. Research by the Nomura Research Institute shows that consents to commence work on residential buildings have slumped to a 30-year low. Consent issue is down by 73 per cent since the boom days of late 1992.

At first glance it might be thought that developers are losing confidence and are therefore reluctant to proceed with projects, while downward price pressures would be accelerated by greater supply. Nomura's Michael Green argues that the slowed rate of development will lead to a short-term critical supply shortage, producing yet another boom in residential prices.

Mr Green may well be right if it turns out that demand is primarily a function of the need for living space, rather than a reflection of the investment prospects for property and the availability of funds to finance these investments.

However, a set of figures from Hongkong Bank seems to indicate that demand will remain depressed as the affordability ratio remains stubbornly high at some 95 per cent. This figure is calculated by comparing median household incomes with the average mortgage repayment required for the purchase of a 430.5 sq ft flat. The affordability ratio is more or less unchanged from 1992 and early 1993 when property prices reached their last peak.

This calculation is slightly problematic because it takes no account of existing property owners investing the proceeds of a previous property sale in a new purchase. However, as a general indication of what can be afforded, it is a useful exercise. If the average British family were required to stump up such a high level of mortgage repayment, the British property market would go from being flat to comatose, but in Hong Kong people seem to have access to money derived from all sorts of sources which are hard to pin down.

It is also worth pointing that, in an attempt to draw some of the speculative pressure out of the property market, the government strong-armed the banks into imposing a 70 per cent limit on mortgage advances, meaning that buyers have had to scrape around to find 30 per cent of the money required to make a property purchase. In Hong Kong, properties over 10 years old are considered to be ancient, so most banks offer a lot less than 70 per cent of the cost on these properties.

Frustrated by this restriction, some developers have started offering finance schemes of their own which tiptoe round the government's limit. These schemes, and an easing of prices, have brought buyers back into the famous queues that used to greet every new development regardless of quality.

With property counters accounting for almost 27 per cent of the stock market's capitalisation - and far more in real terms because practically every listed company has substantial property holdings - the fortunes of the property and stock markets are inextricably linked.

As matters stand property companies are restraining the growth of the market as a whole. However, property counters are showing new signs of life. More importantly, most of them are not so highly geared as they were during the last property crash of the early 1980s and so there are few takers for the theory that another property crash is looming.

Logic-defying as it may be, what is happening is that prices are settling down at a level which is merely crazy rather than absurd, and the likelihood is that property values will move up again soon, but not necessarily in excess of inflation, which is now hovering just below 10 per cent.