Churchouse Letter
May 2011                   by Peter Churchouse

Are Property Cooling Measures in Asia Starting to Bite?

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It is truly a bipolar, two speed world. Asia (and other emerging markets) have come through the financial crisis running in top gear, so much so that the economic brakes are being applied fiercely in many countries. By contrast most western countries are at stall speed, struggling to ignite normal growth rates, with parts of Europe in the grip of full blown financial/debt crises.

The roles are very much reversed from the conditions of the late 1990’s when Asian economies went into serious meltdown, for reasons very similar to those that have beset North America and Europe in this cycle. Excess debt, easy credit, excess consumption, excess real estate investment and speculation were the seeds of Asia‘s financial crisis, similar to that of the west today. High current account deficits and artificially pegged currencies were part of the Asian mix. The west has added its own ingredients to the disaster in the form of waves of derivative instruments that have done the reverse of what their proponents claimed. Seems we never learn!

So why has Asia survived this cycle better than most?

The cynic in me suggests that Asia simply did not have the time to get itself into too much trouble following its own crisis that took until around 2003-2004 to work its way through the system. Governments and corporations were only just getting shot of their financial problems when this latest crisis hit. In addition, Asian governments and central banks responded to the current crisis in almost the same way that their western brethren did.


With fear in their eyes they too embarked on massive monetary and some fiscal easing, egged on by western governments to carry the baton of growth that would hopefully rebalance the global economy. In retrospect it might be now argued that Asian governments and central banks did more than was necessary, but it is easy to be wise in retrospect. They are now living with the consequences – rise of potential asset bubbles.



The abyss of economic disaster seemed almost bottomless in late 2008, and it is hard to blame governments for taking strong, preventative actions.

However, although many of us expected Asian economies had the potential to outperform most western economies in the aftermath of the crisis, the sheer speed and power of recovery has surprised many. The upshot of this V-shaped recovery has been an almost universal surge in credit extension, much of which seems to have found its way into hard assets, particularly real estate, pushing prices sharply off their post crisis lows and in many cases to record new highs. While the west has been flirting with deflation (until recently), Asia has been worrying about a new round of asset bubbles in real estate. From the early part of 2010 growing angst about asset bubbles has produced varying degrees of tightening measures specifically aimed at reducing the pace of growth of real estate prices. Nowhere has this flurry of policy activity been greater than in China where it seems that virtually every week a new series of measures are introduced. A brief summary of measures introduced by some of the governments in the region is shown in Appendix A-C . These have embraced a wide range of measures:

  • Administrative controls on real estate sales and purchase activity,
  • Administrative controls on developers’ activities,
  • Boosting of reserve ratios of banks to drain liquidity out of the system,
  • Imposing swinging taxes on certain forms of real estate transactions,
  • Raising interest rates,
  • Imposing real estate occupation taxes,
  • Lowering loan to value ratios for housing mortgages,
  • Outright banning of certain forms of transactions,
  • Curbs on multiple home ownership.

Governments and central banks are walking a tightrope here. Too much tightening could invoke a crash in asset markets, that could lead countries back into recession, and create a great deal of political backlash from people who see that governments and banks have deliberately undermined their personal wealth. Too little and the asset bubble keeps inflating, with the risk of an even greater crash at a later date. And also further political grief from people who have not yet got on to the property owning ladder.

Governments are rightly mindful of the fact that too little action to tighten liquidity by central banks such as the US Federal Reserve and the Bank of England (not to mention central banks in Ireland, Greece, Spain, Portugal etc.) was essentially the root cause of the greatest financial crisis since the 1930‘s.

So how successful have Asian governments been at curbing the surge in real estate asset prices? I will not enter the debate here about whether certain markets are in bubble territory or not – we have discussed this in previous notes. Suffice here to try to examine the impacts so far of tightening measures.

China – the Biggest Risk, the Most Forceful Tightening

China is probably the most interesting case. Its property tightening measures in the past year have come in a torrent, on an almost daily basis, with indications of possibly more to come still. The commitment to slow property prices has come from the highest level in the land in no lesser personage than the premier himself, Wen Jiabao. Whereas most policies in other countries seem aimed at simply curbing the rate of increase of prices, China’s premier is talking of bringing down property prices. While this may play well to those who do not own their own homes (or investment properties), it is hardly likely to be viewed too favorably by the 60% or so of families in the major cities who may now own their own homes.

So far there seems to have been little strong evidence of a significant slowdown in prices or transactions volumes, or indeed construction in China, despite some pretty draconian cooling measures, but the turning points are appearing.

But it is Different in China!

Some of the most dangerous language in the investment world. The China property bulls (and I am one on a long term basis) point to the differences in the China market compared to other markets. These may be valid points, but only up to a point. They cite the high levels of cash buyers in the market. They cite that belief that China has so few places to invest money that property is a logical choice for those wishing and able to invest. It is true, there is limited ability to access offshore investment possibilities, there is little in the way of pension funds, mutual funds or other investment vehicles for listed securities. Property is, almost by default, the only investment vehicle available to many middle to upper income people.

There is indeed genuine strong need for housing to cater for the waves of mi-grants from rural areas to cities, to upgrade from obsolete and inadequate city housing, to allow for relocation of communities. But as anyone familiar with suburbs in the major cities, it is not unusual to see whole buildings and estate with no more than 30% – 40% of units actually occupied.

Some people argue that demand is buoyed by the cultural quirk that home ownership is a status symbol and also a prerequisite of marriage.

Other arguments claim the oft noted phenomenon of “inflation creep”. If you expect prices of goods and services to rise, you are inclined to buy now rather than wait. A similar argument is given in China for housing, despite rising interest rates and tightening availability of borrowing for housing purchase.

Millions of Cash Buyers for Residential Property

Many argue that tighter lending conditions for housing have little effect because for many developments, some 30% – 50% of buyers pay entirely in cash, or pay a very large portion in cash. While this may be so, one has to ask where millions of people are getting the hard cash from to enable them to pay cash for what is a high ticket item such as an apartment. For example a typical middle of the road apartment in one of the Tier 1 cities is likely to set the buyer back a healthy US$170,000 or more. And this is in a country where the per capita GDP is less than US$5,000, and an “average” apartment in such cities costs as much as 20 – 23X average household income (versus about 5X at the height of the US housing bubble).

Figure 1: Beijing Monthly Primary and Secondary Residential Sales

Beijing Monthly Primary and Secondary Residential Sales from January 2005 - January 2011. Bar chart with axis on left hand side shows Residential Gross Floor Area (GFA) sold (mil sqm). Line Chart with axis on right hand side shows Average Sales Price (ASP) RMB/sqm. Jan 2011 data shows a drop in the GFA sold, while ASP continues to grow.


I cannot recall this phenomenon of such a high proportion of cash buyers in any other property markets either in Asia or elsewhere that we have looked at in the past, bubble or no bubble.

So Where is all this Hard Cash Coming From?

With so many people buying properties with 100% cash or very high levels of down-payment, one has to ask quite where this money is coming from? Quite frankly, I don’t know, but having seen other bubbles before in Asia, I fear that much of the so-called cash buying is being funded through debt that has been acquired for another purpose. For example, in Thailand’s bubble in the 1990’s, the banks claimed before the crisis that only about 12% of their lending was to real estate. However, it transpired that a great deal of lending was for “corporate” or “personal” purposes, and was in fact applied to real estate investment of one kind or other. Banks were in effect deluding themselves (perhaps deliberately) that they had only a modest exposure to real estate lending during the bubble.

I would not be surprised if something similar is going on in China right now. We all know that China’s economy has been in rapid growth mode, but to believe that so many millions of people are earning so much cash that they can buy big ticket items like apartments with cash, often two or three units, seems to stretch credibility – just a bit!

Figure 2: Shanghai Monthly Residential Sales

Shanghai Monthly Residential Sales from Jan 2005 - Jan 2011. Residential Gross Floor Area (GFA) sold (mil sqm) and Average Sales price (ASP) RMB/sqm.


In the wake of the 2008 crisis, China’s banks were instructed to go forth and lend, lend, lend in 2009, and they did so with considerable abandon. While no one knows for sure, estimates suggested that some 25% of the approximately US$1.4 trillion of new bank lending that poured into the economy found its way into real estate based loans of one kind or other. This would presumably include both loans to developers, investors and consumers. While the government publicly espoused the desire to curb new lending in 2010, total new bank loans still totaled some US$1.1 trillion, again, much going into real estate backed loans.

I would not be surprised if the figure was in fact closer to 50%, with many organizations, particularly state owned enterprises borrowing for “general corporate purposes” but in fact funneling such borrowings into real estate projects and investments.


Forgive my skepticism, but we should be prepared ultimately to discover that the actual property based exposure of financial institutions in China is much higher than we currently think.


Are Tightening Measures Working in China?

On this subject views are divided, but of all the material I see on the China property market, on balance, opinion seems to be that the tightening measures are not working. I am not so sure in view of recent data that is coming to the fore. It looks, all things considered, that some degree of cooling is happening, both in transactions volumes and in pricing.

Transactions volumes traditionally fall sharply over the Lunar New Year period and rebound strongly in the following 3 or 4 months. This year the rebound has been muted and moving averages of average daily property transactions in the core major cities are now pointing distinctly down (see Figures 1-5).


Given the “noise” in the data, and the impact of seasonal factors associated with the Lunar new year holiday period in February, it is difficult to be unequivocal in calling that a slowdown is in place but evidence is leaning more and more in that direction.


Figure 3: Weekly Transactions in 1st and 2nd Tier Cities in China (Primary Markets)
Weekly Transactions in 1st and 2nd Tier Cities in China (Primary Markets) per thousand square meters from August 2008 - April 2011. 1st Tier Cities in red solid line, 2nd Tier Cities in black solid line, 6 week moving average for 1st Tier Cities in dotted grey line, 6 week moving average for 2nd Tier Cities in dotted red line. Note: First Tier Cities include: Beijing, Shanghai, Guangzhou and Shenzhen. 2nd Tier Cities include Tianjin, Hangzhou, Chongqing, Chengdu, Hefei and Changsha. (MA: Moving Average, 6 weeks).

Figure 4: Weekly Residential Sales in First Tier Cities – Subdued Volumes Post Lunar New Year

Weekly Residential Sales in First Tier Cities from May 2008 - March 2011 - Data shows subdued volumes post Lunar New Year. 1st Tier Cities include Beijing, Shanghai, Guangzhou and Shenzhen.

Figure 5: Weekly Residential Sales in Second Tier Cities

Weekly Residential Sales in Second Tier Cities from May 2008 to February 2011. 2nd Tier Cities include Tianjin, Chongqing, Chengdu, Wuhan, Hangzhou, Suzhou, Nanjing, and Changsha.

Figure 6: National Property Prices in China – Starting to Show Signs of Slowing Down?

National Property Prices in China in Renminbi per Square Meter - Starting to Show Signs of Slowing Down? Chart from February 2007 to February 2011.


Charts of average daily property transactions volumes for major cities in China do appear to be turning downwards, in a way that does not seem explainable simply by seasonal trends.


The downdraft in transaction volumes is most notable in the four Tier One cities (Beijing, Shanghai, Shenzhen and Guangzhou), where government cooling measures have been most focused. In all these cities monthly average sales volumes for the January/February period in 2011 are down between 11% and 57% compared to the same period in the years 2006 to 2010.

Figure 7: Average Daily Sales for Primary Residential Properties in 1st Tier Cities

Average Daily Sales for Primary Residential Properties in 1st Tier Cities from October 2010 to May 2011. Cities Charted are Beijing, Shenzhen, Shanghai, and Guangzhou.


For the six Tier Two cities average transaction volumes for the same period are up about 39% from the average of the 2006 – 2010 period.

There is also growing evidence of some slowing in residential prices. For 68 of the 70 large and medium sized cities in China, average prices of new buildings is higher than a year ago. However, taking a closer month on month view, cracks are beginning to appear. For example, in all four Tier One cities, average prices were down in February compared to January, and were down also for 3 of the 6 Tier Two cities.

Casting a slightly wider net, half of the largest 18 cities in China experienced a decline in average prices in February compared with January, but all are still up year on year. The pace of price appreciation on a Year on Year (YoY) basis seems to be slowing. For example, Government property price data for March show that in Beijing prices were up 4.9% YoY, compared to up 6.8% YoY in February. For Shanghai the March pace slipped to 1.7% compared with 2.3% the previous month.

Figure 8: Tier 1 and Tier 2 City Property Transactions Statistics

Tier 1 and Tier 2 City Property Transactions Statistics. Sales Volume in February 2011 (Month on Month): Tier 1 Cities Average -64.60%; Beijing -60.80%; Shanghai -83.20%; Shenzhen -55.90%; Guangzhou -48%; Tier 2 Cities Average -18%; Tianjin 15.30%; Shenyang 3.50%; Chengdu -13.60%; Wuhan -57.30; Xiamen -67.10%; Changsha -33.20%. Monthly Average Sales Volume January-February 2011 (Against 2006-2010 monthly average): Tier 1 Cities Average -39.30%; Beijing -30.60%; Shanghai -57.80%; Shenzhen -41.40%; Guangzhou -11%; Tier 2 Cities average 42.1%; Tianjin 19.60%; Shenyang 55.90%; Chengdu 31.60%; Wuhan -28.10%; Xiamen 5.20%; Changsha 129%. Price Change for February 2011 Month on Month: Tier 1 Cities -8.10%; Beijing 0.50%; Shanghai -10.60%; Shenzhen 0.90%; Chengdu -2.30%; Wuhan 1.50%; Xiamen -2.10%; Changsha 4.30%.


It would not take too long, at this rate, for many cities to be experiencing YoY declines in average prices in the coming few months.


There are increasing reports of developers launching properties at prices significantly lower than prices achieved at launches in the same developments some months ago.


Supply Side Boom Adds to Risk Profile

While transactions volumes appear to be slowing and there is early evidence of some slowing (not yet reversal) of price trends, China is set to see an explosion of new supply in the coming one – two years. The credit boom of 2009 (and 2010) has led to a building boom on the part of the nation’s 60,000 plus developers. In recent years, annual property sales (in terms of square meters of space) has exceeded annual completions, reflecting robust demand from end users and investors. That may be set to reverse as supply accelerates at a time when the pace of sales looks to be slowing. In 2010 some 600 million sq m of residential space was completed, similar to 2009, but area under construction has risen from 2.5 billion sq m to approximately 3.2 billion sq m.

And the pace of construction starts has continued to accelerate in the first part of 2011.


Total area under construction by the end of February equaled 71% of the total for all of 2010. The huge surge coming to the market just implied by these construction figures looks likely to be as buyer activity slows, raising the spectre of widespread discounting of new launches to get product off the books of the developers.


Figure 9: Gross Floor Area Already Under Construction in China

Gross Floor Area Already Under Construction in China from 2000 to Feb 2011. GFA under construction by million square meter as a bar chart on the Left Hand Side axis, and Year on Year Percent % change on the Right Hand Side axis.

Figure 10: New Construction Starts (Area)
New Construction Starts by Area (in thousands of square meters) from December 1996 to February 2011, with Year-on-Year Change on the right hand side axis.


This raises the risks also of developers, who have typically not been too shy of taking on debt, running in to debt service problems, bringing with it risks of increasing non-performing loans at the major banks.

If the primary market starts to reverse, then the secondary market is likely to go into an even sharper reverse. The secondary market is already quite thin with most Chinese families preferring to buy new rather than second-hand properties.

How Will Chinese Households React to Any Downturn in Residential Property Prices?

Property ownership in China is a relatively new phenomenon. In 1990 private home ownership in major cities amounted to no more than a few percent of total housing stock. Today, more like 60% plus of households in many cities own their own home. I cannot think of a country where home ownership has been transformed as quickly as this. Even during this rapid rise in home ownership there have been some hiccups on the pricing front. Following a massive surge in supply in the major cities such as Shanghai and Beijing in the early 1990’s resulting in substantial vacancies, property prices, both residential and commercial took a tumble in the second part of the 1990’s. Similarly in the 2001-2004 period residential prices fell modestly in many of the major cities, from 5% or so to as much as 20%. Rentals fell much more and office prices and rentals suffered much steeper falls.

The fact is, however, that is the post 2003 era that has seen the very rapid surge in housing construction, home ownership and residential prices. The question that should concern policy makers and investors in China is how the Chinese households might react in the event of a significant downturn in property prices that sees owners in circumstances of negative equity.

The mortgage system has never been truly tested in China.

Will such circumstances lead to homeowners simply defaulting on mortgages in large numbers, or will they carry on servicing mortgages that are under water? If the US experience is anything to go by, owners will default in droves.

If the Hong Kong experience is anything to go by, exactly the reverse is likely. For example, in the last major property crash in Hong Kong from 1997 to 2003, when property prices fell by approximately 60%, and more than 12% of private homeowners were in negative equity, mortgage defaults rose to only 1.3% of all mortgages outstanding. Households kept servicing the mortgages despite the negative equity situation.

Will China Homeowners Revert to Iron Rice-Bowl Attitudes, or Pay up and Shut Up?

But Hong Kong people perhaps have a different attitude to life than their cousins across the border who have been brought up under an “iron rice bowl” social framework, where families enjoy (suffer?) a cradle to grave existence – where virtually everything from housing to education, jobs, healthcare and even food is provided by the commune or the work unit. That is far from the conditions in Hong Kong where the culture is very much one of self-reliance, with little in the way of safety nets.


In the event of a significant fall in property prices, will the character of homeowners reflect the self-reliant characteristics of the Hong Kong culture, or fall back into the “iron rice bowl” mentality in which responsibility for debt service becomes abrogated to someone else?



In the event of a wave of defaults on mortgages, will the banks in China have the legal powers to foreclose on defaulting properties, evicting owners? Even if they have the rights to do so, will they have the stomach for such behavior? For sure it will prove a very hot political potato.

If I were a betting man, I would suggest that the predominant behavior in China households will be to do everything possible to continue to service their mortgage and retain their living space. The safety nets are not there. Also most households (like in Hong Kong) have substantial equity in their homes, unlike much of the US market. Also the non-recourse nature of the US mortgage market and the ease of passing through bankruptcy does less to encourage defaulting home owners to hang in. It is easier to simply walk away, particularly when you have little to no equity at risk.

Figure 11: National Residential Sales Levels Over Previous 5 Years

National Residential Sales Levels Over Previous 5 Years (October 2005 to October 2010). Gross Floor Area sold in pink and Sales Amount in blue, both as Year on Year change. Falling trend in monthly sales reversed from September 2010 onwards.

Declines in Transaction Volumes and Prices Very Likely.

Although the data is still mixed and “noisy”, my guess is that we are in the early days of a pull-back in property transactions activity, and are likely to see residential prices trend down in many of the major cities.

Government’s myriad of cooling measures are starting to bite.

Already we are seeing some Month on Month falls, but almost everywhere Year on Year prices are still up. A continuation and wider spread of Month on Month (MoM) declines will likely give way to the emergence of YoY price declines in many locations and possibly for the country as a whole.

I am not of the view that the laws of economics have been repealed in this in-stance. Tightening ability of potential buyers to enter the market, coupled with a likely surge in supply is highly likely to have some impact on pricing. How much is the key, and its impacts on the banking system are the unknowns at this stage.


Having spent more than 30 years watching China’s march towards a more entrepreneurial and business like economic model I have learned one thing. Never underestimate the ability of the China government to achieve its stated objectives, particularly with regard to domestic economic policy.



It is still very largely a command economy, and the authorities can pretty much do whatever they want, unburdened by parliaments, Congress, democratic institutions and the like. I am sure they will achieve their stated aim of slowing/reversing the current upsurge in property prices.

Asset Price Slowdown – Yes! Crash – No!

My guess also is that a major crash of the kind we saw in Asia in the late 1990‘s and in western markets in the past few years is unlikely. Just as the authorities have the ability to engineer a strangling of property liquidity, they equally have the ability to do the opposite and turn the taps back on again in the event of a direr outcome than is desired.

For this reason, expect the China economy to continue be a “stop-go” economic model which will likely produce volatility in earnings, growth and asset prices.

China Property Stocks – A Perverse, Positive Outcome is Likely

A good many of China’s best property companies are listed in Hong Kong and now grace the top league of property companies globally in terms of market capitalization.

Since the onset of tightening measures in China, the Hong Kong listed China property stocks have traded nervously in anticipation of policy risk. The result is that the stocks are now trading at valuations (PE ratio and Discount to Net Asset Value) at the low end of their historic ranges. The market has discounted some degree of fallout in the property market resulting from policy measures that have been introduced. Probably correctly.

Looking ahead, if we are right that a slowdown in the property market in the form of transactions and prices is indeed underway, and becomes widely apparent, there is likely to be a slowdown in policy measures directed at the property sector, and possibly a withdrawal of some measures. Depending on the extent and depth of any slowdown there may be a reversal of tightening measures and a new round of measures aimed at encouraging home ownership, new housing construction etc.


Perversely, the sooner we see clear signs of a slowdown in China’s property markets in terms of transactions volumes and prices, the sooner we are likely to witness solid outperformance of China property stocks listed in Hong Kong as the overhang of policy risk is lifted from the market.



Just as stocks have reacted negatively in anticipation of tightening measures, they may well react positively to any hint of an end to property specific cooling measures. Stocks will not need to see a reversal of policy measures, just an end to introduction of new cooling measures.

Figure 12: China Monthly Property Stock Index – Listed in Hong Kong

China Monthly Property Stock Index - Listed in Hong Kong from January 31 2000 to January 31 2011.


I noted this phenomenon a couple of months ago. From mid-March most of the China property names rallied very strongly from around 15% or so to around 40% plus in anticipation of good 2010 results and, in my view, some belief that the tightening cycle for property policies may be near an end. Since the last week of April most have given up some of these gains in the general market weakening that we have seen, but most are still well above their March lows.

If this prognosis is correct, we may see China property stocks rally further throughout the year, and even if the move back to around their longer term valuation ranges, upside of 20% plus may be the order of the day. The large “bell weather” China property stocks listed in Hong Kong include the following:

Figure 13: “Bell Weather” China Property Stocks Listed in Hong Kong

Bell Weather' China Property Stocks Listed in Hong Kong in May 2011. China Overseas Land and Investment, Code (RIC): 0688.HK, Market Cap: US$15.6 billion, P/E: 11-12 x 2011, Disc to NAV: -30%. China Resources Land Ltd, Code (RIC): 1109.HK, Market Cap: US$ 9.1 billion, P/E: 13 x 2011, Disc to NAV: -45%. Agile Property Holdings Ltd, Code (RIC): 3383.HK, Market Cap: US$5.6 billion, P/E: 9.5 x 2011, Disc to NAV: -45%. Shimao, Code (RIC): 0813.HK, Market Cap: US$4.7 billion, P/E: 7 x 2011, Disc to NAV: -60%. Guangzhou R&F Properties Co Ltd, Code (RIC): 2777.HK, Market Cap: US$4.3 billion, P/E: 6 x 2011, Disc to NAV: -60%.

Hong Kong – Cooling Measures Show Signs of Working

While China has launched a seemingly endless series of measures aimed at cooling its property markets, those launched by the Hong Kong authorities have been much more sparing and quite targeted. These have comprised leaning on banks to lower loan to value ratios for properties above a certain value and imposing very hefty stamp duty taxes on properties bought and sold within a short period of time, supposedly to deter so-called “speculators”. In addition, banks have taken the opportunity to raise mortgage rates a little also, particularly those based on the local Hong Kong Interbank Offer Rate (HIBOR). This has raised the effective rate of this kind of mortgage (recently as much as 60% of all mortgages) from around 0.8% – 1.0% to more like 1.1% – 1.5%. Although up, such rates are still probably the lowest mortgage rates of the developed world, but do indicate an upward trend, and a move away from the record low levels that consumers have enjoyed over the past 18 months or so.


The cooling measures do seem to be working insofar as there does seem to be a genuine downturn in transactions volumes. While there is a lot of “noise” in monthly transactions volume data, the moving average charts do seem to be leaning towards the downside (see Figure 14).


Figure 14: Hong Kong Total Residential Monthly Transactions Compared to the Quarterly Moving Average

Hong Kong Total Residential Monthly Transactions Compared to the Quarterly Moving Average from 2002 to April 2011. April Figures are forecasts only.


One of the largest residential agency brokers in Hong Kong estimates that new home sales fell by around 40% in April compared with the previous month. This data of course can be very heavily influenced by a surge or dearth of launches of new sales by the developer community.

Perhaps more telling is the estimated 25% decline in April secondary market transactions compared with March. The estimated sales volumes of secondary market properties fell to around 6,400 in April, (7,635 total residential sales including primary and secondary) the lowest since March 2009, right in the immediate wake of the financial crisis. Sales volumes of more than 10,000 per month have been common in the bull market of late 2009 – late 2010.

Some commentators suggest that buying sentiment was weighed down by uncertainties in the wake of the Japan Tsunami and concerns over nuclear fallout. While this may be true, the trend of falling sales was in place before the Japan Tsunami – the April data will have accelerated the medium term downtrend.

Although sales volumes are down, there is little evidence yet in the price data of a meaningful decline in average prices. Generally speaking potential sellers, both households and developers, are not under great financial pressure to sell in a hurry – unlike the situation in China. For example, average gearing of the major property developers in Hong Kong is less than 30% compared to more like 2 to 3 times that in China’s listed property developers. Similarly households are not highly leveraged, neither from their credit card accounts nor for property. The general rule for years has been for mortgage loan to value ratios of 70% maximum, suggesting that most owners have a significant equity cushion.

So holding power is strong, both at the consumer and developer level.

There are still many positive underpinnings of the residential market:

  1. Housing production is running at around half of the average annual levels of the 1990‘s, so supply is tight.
  2. Completions expected for 2011 at 10,670 units is less than the estimated completions in 2010 of 13,400 units. For 2012 estimated completions will rise to around 13,700 units still well below the 24,000 – 25,000 averages of the 1990‘s. While the Hong Kong government is releasing more land for housing, this will take several years to come to market, and in any event, will not raise housing production to levels even close to those of the 1990‘s.
  3. Falling unemployment and rising household incomes are supporting demand.
  4. Mortgage interest rates are still extremely low by historical standards and by world standards, and would have to rise by at least 250 basis points to get back into the ball-park of long term averages. The prospect of the Federal Reserve tightening by that much in the near term is not high.
  5. Imposition of tighter regulations in the financial sectors of Europe, UK, and the USA, at the margin, is driving an increase of professionals in these sectors to relocate in places such as Hong Kong and Singapore. The aftermath of the earthquake in Japan is likely to also lead to a gentle move of financial market professionals from Tokyo to other parts of the region. Given extremely tight sup-ply conditions for upper end housing in Hong Kong and to a slightly lesser extent, Singapore, even a trickle of new entrants can put substantial upward pressure on rentals, which will underpin prices.
  6. Bank liquidity is still high, but while mortgage lending was the only lending game in town, recently demand for borrowing for other purposes is increasing and loan to deposit ratios of Hong Kong banks has risen from less than 60% to more like 80% right now. There is less pressure to be as competitive in the mortgage market as was previously the case.

The case for an easing of price pressures is given weight due to the lowering of loan to value ratios for upper middle and high end housing. Down payments that typically were 30% now are more like 40% to 50% for housing of this category. For cheaper mass market housing – which accounts for about 85% of all private housing, 70% LTV‘s (loan to value ratios) are still the norm, but banks are more inclined to subjectively lower their own valuations on which they base their mortgage loans.


On balance, I would have to guess that the measures introduced so far to cool the residential market will have the desired effect in slowing the rate of price appreciation (which was a hefty 10% in the first quarter of 2011), but it will take time. I do not expect measures introduced so far will lead to a major downturn of residential prices.



Cooling measures introduced in previous cycles have normally taken some months to produce a slowdown or decline in prices. If another quarter goes by and prices have continued to move up at a pace similar to Q1, government and banks will be under pressure to introduce even further cooling measures.

A danger here is that some external forces or events emerge that drive local economies into reverse, and doubly affect asset prices to the downside. Hong Kong‘s property markets are notoriously volatile and can often react sharply to negative news both internal and/or external. Such an outcome could have an even bigger negative impact on asset prices than the current measure that have been put in place.

Slowdown in Property Price escalation a Catalyst for Renewed Share Price Upside in Real Estate Stocks – a Slowdown Will Signal End to Cooling Policies

As with China, we might expect to see property stocks take a turn for the better if there is some clear evidence of a slowdown, but not a sudden crash, in prices as it may well signal an end to government directed tightening policies in housing markets.

Figure 15: Total Market Cap of Major Property Developers’ Stock in HK

Total Market Cap of Major Property Developers' Stock in HK circa May 2011. Sun Hung Kai, Code (RIC): 0016.HK, Total Market Cap: US$39.6 billion, FY1 P/E: 16 x, Disc to NAV: -31%. Cheung Kong Holdings Ltd, Code (RIC): 0001.HK, Total Market Cap: US$35.9 billion, FY1 P/E: 11.6 x, Disc to NAV: -26%. Henderson Land Code (RIC): 0012.HK, Total Market Cap: US$15.6 billion, FY1 P/E: 20 x, Disc to NAV: -35%. Sino Land Co Ltd, Code (RIC): 0083.HK, Total Market Cap: US$9.1 billion, FY1 P/E: 17.6 x, Disc to NAV: -37%. New World Development, Code (RIC): 0017.HK, Total Market Cap: US$6.8 billion, FY1 P/E: 9.4 x, Disc to NAV: -51%.

Figure 16: Hang Seng Property Index (HSP) vs Hang Seng Index (HSI)

Hang Seng Property Index (HSP) vs Hang Seng Index (HSI) from June 2010 to May 2011.

Since the introduction of the swinging stamp duty taxes in November 2010, property stocks have significantly underperformed the overall market, following a very sharp outperformance by the sector in the earlier part of 2010.

The major property developer stocks are now trading at very reasonable valuations – 20% to 48% discounts to net asset value (NAV) and 2011 PE ratios of around 13X to 19X. Dividend yields are a respectable 2% – 3%. Balance sheets are very healthy with net debt/equity ratios of 5% to 29%. This list includes Sun Hung Kai Properties, the world‘s largest listed property stock by market capitalization, Cheung Kong, Henderson Land, Sino Land and New World Development.

Most of these stocks also benefit from owning substantial commercial properties, where in the office sector we are seeing price and rental increases rivaling (and exceeding) those of the residential sector.

Singapore – Faster Out of the Blocks Than Even Hong Kong

Singapore‘s residential market surged rapidly out of the blocks in 2009 in the Asian recovery post the Lehman induced crash. The pace of recovery was at least as strong as for Hong Kong, and in some respects even more powerful. Prices of private residential properties have easily surged beyond the peaks of 1997 and 2007/08. The surge in Singapore was also underpinned by easier liquidity conditions but the Singapore market also benefited strongly from the opening of a new casino which drove GDP into the stratosphere at the time. Like other markets the Singapore government has introduced measures aimed at curbing speculative activity in particular. Curbs have included reducing the ability of buyers to use their Central Provident Fund savings for investment property purchases and also a series of very high stamp duty taxes imposed on property “flipping”.

Some Possible Early Evidence of Slowing Sales but no Evidence of Price Declines – Yet

Latest data show that there has been a modest slowdown in property sales trans-actions in the past 2 – 3 months compared to a year ago, but it is far from a dramatic slowdown. Transactions for Q1 in all markets in Singapore were down Quarter on Quarter (QoQ), but it certainly appears that sales by short term investors have dropped significantly in the wake of government stamp duty measures.

On prices, there is no evidence of any reversal in property prices in either the private sector in the Housing Development Board (HDB) re-sales market. Ac-cording the government published data, the private property price index moved up 2.2% QoQ to a record high in Q1, slightly down from the 2.7% pace in Q4 of 2010. This implies a recovery of about 55% since the market bottomed in early 2009.

Public sector built housing (HDB units) have risen by around 13% YoY.

Figure 17: Primary and Secondary Residential Property Sales in Singapore

Quarterly Primary and Secondary Residential Property Sales in Singapore, from Q1 2002 to Q1 2011. New Sales in Blue and Secondary Sales in Yellow

Figure 18: Primary Residential Sales Take-up in Singapore

Primary Residential Sales Take-up - Singapore from Q2 2006 to Q1 2011.

Figure 19: Secondary Residential Properties Sale Volumes (Resale and Subsale) in Singapore

Secondary Residential Properties Sale Volumes (Resale and Subsale) in Singapore from Jan 2007 to Jan 2011. Resales are in grey, SubSales are in Yellow, with a 3 month moving average of secondary volumes in blue.

Figure 20: Singapore Residential Price Index (Primary and Secondary Properties)

Singapore Residential Price Index (Primary and Secondary Properties) from 1975 to 2011. Chart based to 100 in Q1, 1991.

So far the evidence for a slowdown or reversal in housing prices in Singapore is not there. Ample liquidity still prevails, and negative real mortgage rates are likely to continue for the time being. Such conditions are usually very supportive for residential property markets. In addition, there is a positive yield spread over the cost of a mortgage.

Figure 21: Singapore Price vs Volume (Primary and Secondary Residential Properties)

Singapore Price vs Volume (Primary and Secondary Residential Properties) from December 1995 to December 2010. Includes Secondary turnover in number of units/quarter (Left Side) and the Price Index (Right Side).


Of the 3 markets we consider here, the Singapore property sector looks least affected by policy measures aimed at cooling rising real estate asset prices. If a slowdown does not occur, and prices keep moving up at their current pace, there is increased risk of further cooling measures being introduced.

CapitaLand is the “elephant” in Singapore‘s listed property stock universe. Its share price performance we believe has been impaired by the potential impact of government property cooling measures. Such measures do not seem to be having much effect – at least so far. The stock has substantially underperformed the overall market over the past year and is trading at just below book value – a position that it has only rarely traded at in the past 5 years. Its average P/BV has typically been around 1.25 X. It is also trading at approximately 35% discount to its NAV, again, well below historical averages. Its 20% gearing poses low financial risk. The key risk to a return of performance is the likelihood of further property cooling measures that could be introduced by the Singapore authorities.

Figure 22: CapitaLand (CAPL:SP) vs FTSE Strait Times Index (FSSTI)

CapitaLand (CAPL:SP) vs FTSE Strait Times Index (FSSTI) from June 2010 to May 2011.

Figure 23: FTSE Real Estate Index (FSTRE) vs FTSE Straight Times Index (FSSTI)

FTSE Real Estate Index (FSTRE) vs FTSE Straight Times Index (FSSTI) from June 2010 to May 2011.

Appendix A: A Brief Summary of Policy Changes Initiated in China in the Preceding 3 Years:

Jan, 2007 – The government says it will increase taxes to discourage sales of large homes and will start taxing the appreciation of property values based on actual market prices.

Aug 7, 2007 – China bans foreign investors in Chinese real estate from borrowing offshore.

Sept 28, 2007 – China raised down payments for second homes to 40 % from 30 %.

Jan 16, 2008 – China raises the proportion of deposits banks must hold in reserve for the 11th time since the start of 2007 to keep a flood of liquidity from entering the economy.

Jun 7, 2008 – For the fifth time in 2008, the central bank raises the amount lenders must hold in reserve by a full percentage point, an indication of official alarm over the huge amount of cash flooding into the economy.

Oct 22, 2008 – China announces a series of policy changes: lower mortgage rates, reduced down payments, lower transaction taxes.

Nov 7, 2008 – China announces a 4 trillion yuan ($585 billion) two-year stimulus package. A tenth, or 400 billion yuan, is to be used on construction of affordable housing.

Dec 9, 2009 – China says individuals must own their homes for five years to be eligible for sales tax exemption, up from the previous minimum of two years. It also says it will increase supply of lower-cost housing.

Jan, 2010 – State Council announces they intend to increase housing supply of mid-low end ordinary units nationally, and subsidize housing segment. Intention is also to suppress speculative demand through differential tax and interest rate treatments (in particular for second home buyers). The central government pledges to supply financial support to selected regions on development rental housing.

Apr, 2010 – The State Council announces new measures to curb rapidly rising property prices. These include: Suppressing speculative demand by using differentiated credit policies for different buyer‘s groups. For the purchase of a first home with size over 90sqm, down payment is at least 30%. For the purchase of a second home, down payment is at least 50% and mortgage rate is at 10% premium to PBOC base rate. Adjusts the structure of housing supply, to ensure that policy housing and small-to-medium sized units make up at least 70% of the total land supply. Use tax measures and adjust existing tax rates. Chinese banks raise the reserve requirement ratio by 50 basis points to attempt to restrict lending, for the third time in a year. This brings the reserve ratio required by most large banks to 20%.

Aug 5, 2010 – Regulators order lenders to test the impact of a fall in house prices of up to 60 percent in key cities and instruct banks to stop extending mortgages to people buying their third homes in four of the cities – Beijing, Shanghai, Shenzhen and Hangzhou. Developers are urged to accelerate property construction so as to increase supply

Sept 29, 2010 – China imposes a down payment of at least 30 percent for all mortgages, including those for first home buyers, and orders banks to halt all mortgage lending for third homes.

Oct 19, 2010 – China surprises by raising interest rates for the first time in three years from 5.31% to 5.56% for the one-year Yuan lending rate.

Dec 25, 2010 – China raises mortgage rates for people borrowing from the housing provident funds by 25 basis points after the central bank increased benchmark interest rates by the same amount.

Jan 26, 2011 – China raises down payment on second homes to 60 percent and orders local governments to restrict the number of homes each family can buy.

Mar 18, 2011 – China raises banks’ required reserves for the sixth time since November to tame inflation.

Apr 5, 2011 – China’s central bank increases interest rates for the fourth time since October, to 6.8%.

Source: Reuters, JP Morgan, Morgan Stanley

Appendix B: A Brief Summary of Policy Changes Initiated in Singapore:

Jan, 2009 – Developer-assistance measures, including extension of project completion periods and tax deferral, introduced for land under development.

Sep, 2009 – Withdrawal of interest absorption scheme to promote a more sustainable market.

Dec, 2009 – Confirmed Government land sales reinstated.

Feb, 2010 – Seller Stamp Duty of 3% introduced on properties sole within 1 year of purchase. Loan to Value (LTV) lowered for home loans from 90% to 80%.

Mar, 2010 – Eases triggers for accessing sites on the Reserve List. Government announces a greater variety and range of sites to be included in the H210 Reserve List. Minimum Occupancy Period for public housing resale flats is raised to 3 years.

Aug, 2010 – LTV lowered for second mortgages, to 70% from 80%. Increase of cash down payments for second mortgages to 10% from 5%. Apply Seller Stamp Duty for properties sold within 3 years of purchase (up from year). A higher income ceiling for the public housing ‘Design-Build-Sell’ Scheme for flats from S$8,000 up to S$10,000 per household. Government promises an increase to public housing supply to 22,000 units from 16,000 units in 2010. Tightening of public housing rules to ensure public housing is primarily for owner-occupation, discouraging investment in public housing for rental yield.

Jan, 2011 – LTV for first homes remains at 80%, but for second mortgages LTV lowered to 60% from 70%. Seller Stamp Duty is now raised to 16%, 12%, 8% or 4% if a property is sold within 1,2,3 or 4 years of purchase respectively.

Source: Morgan Stanley; JP Morgan; Bloomberg; Reuters

Appendix C: A Brief Summary of Policy Changes Initiated in Hong Kong:

Mar, 2010 – Government announces plans to launch close to 3,700 Home Ownership Scheme housing units in order to satisfy demand from lower income families. Effective as of April 2010, stamp duty for units in excess of HK$20 million increased from 3.75% to 4.25%. Extensions on Stamp Duty payment were removed.

Apr, 2010 – Regulations to increase the transparency of information disclosure on pre-sales are altered to include: at least one sample unit at the show flat must display the exact hand-over standards and developers are required to release the price list 3 days before the sales launch. For small developments, a minimum number of units to be launched in the first batch will the higher of 30 flats or 30% of the total units available for sale. For larger developments the minimum number of units to be included will be the higher of 50 flat or 50% of the total units available for sale.

Aug, 2010 – Increased land supply initiatives, including 3 government land auctions proposed. Government pledges to speed up redevelopment of Kai Tak. Planning Department considering increasing land supply via changing land uses and speeding up the provision of land at new areas. Land to be made available on the 2011-2012 Application List will provide more than the 9,000 units under the 2010-2011 list.

Nov, 2010 – Homes sold within 6 months of purchase will now incur a 15% stamp duty, which will be charged equally to buyers and sellers. Deferred payment of stamp duty is disallowed for all property. Down-payments rise to 50% for properties costing HK$ 12 million or more, and up to 40% for properties between HK$8 million and HK$ 12 million. For residential properties valued at $12m or more, the LTV ratio is capped at 50% (previously 60%). For residential property in the $8m—$12m range, the LTV ratio is capped at 60% (previously 70%) maximum loan amount is HK$6 million. For mortgage loans with 90% LTV ratio, the maximum mortgage size will be lowered to HK$ 6.12m compared to HK$ 7.2m previously. Extra stamp duty, ranging from 5%-15% on residential properties sold within 24 months after purchase was also introduced. For properties resold within 6 months or less after initial purchase, the Stamp Duty (SD) will be equal to 15% of the resale transaction value. For properties resold more than 6 months, but less than 12 months after initial purchase SD is 10% of resale transaction value, and 5% for properties resold more than 12 months but still less than 24 months after initial purchase. SD is not levied on properties after the 24 month ownership point.

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