Hong Kong’s extradition turmoil won’t dampen the property market greatly – but China’s economy might

The city’s property market is correlated to the stock market, which remains robust. Moreover, demand from mainland investors continues to be strong while supply of residential and commercial space is limited

Nicholas Spiro

Published: 9:00am, 18 Jun 2019

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As a keen observer of global markets, I have learned not to be dismissive of political risks, especially those that are downplayed by investors yet have the potential to affect sentiment significantly, and may even pose a systemic threat.

In the past decade, the influence of politics on asset prices has not only increased dramatically – the rise of populism, which led to Britain’s decision to leave the European Union and the election of Donald Trump as America’s president, is the best example – but has also made the world a lot more unpredictable.

Over the past week, political uncertainty has been nowhere more acute than in Hong Kong. The mass protests against the controversial extradition bill proposed by Chief Executive Carrie Lam Cheng Yuet-ngor – which for the first time would allow Hong Kong to extradite to mainland China Hongkongers, foreign residents and even those simply passing through the territory who Beijing accuses of serious crimes – have thrown the severity of the threat to the city’s prized judicial independence into sharp relief.

By further undermining the “one country, two systems” arrangement, which allows Hong Kong to maintain its own administrative and economic regime, the bill has imperilled the city’s status as Asia’s leading financial hub. While Lam was forced to suspend the legislation on Saturday, the damage has been done.

Not only have the underpinnings of Hong Kong’s freedoms and autonomy been severely compromised, posing a threat to the city’s business and investment environment, the government and protesters remain at daggers drawn, increasing the scope for a prolonged (and potentially more bloody) confrontation. What is more, the crisis inflames tensions between Washington and Beijing at a time when the trade war has escalated sharply.

For Hong Kong housing, the political instability adds to a list of vulnerabilities that have been weighing on the outlook for the world’s most expensive property market.

While secondary home prices have rebounded spectacularly this year following a short-lived correction in the second half of 2018 – the Centa-City Leading Index, a home price gauge compiled by Centaline Property Agency, reached its highest level ever at the end of May, up 8.6 per cent since the start of this year – prices fell in the week ending June 9. This was the second straight week of declines, with prices likely to have dropped further in the past week as the demonstrations over the legislation erupted into violence.

Furthermore, a liquidity squeeze in Hong Kong’s money markets – the one-month Hong Kong Interbank Offered Rate (Hibor) has shot up more than 40 basis points since June 10, to 2.41 per cent, its highest level since late 2008 – is putting pressure on borrowers, most of whose mortgages are priced off interbank rates.

Yet, while the protests over the bill are stoking uncertainty about Hong Kong’s governance and business environment, the housing market is unlikely to be a major casualty of the turmoil.

Protest diverts buyers’ attention from Vanke, Henderson flat sales

First, sentiment in the city’s property market is correlated with stock prices. A report published by Knight Frank, a real-estate adviser, last January examining which factors influence Hong Kong’s home values the most showed that the level of the Hang Seng Index was the most important determinant.

While other forces are at play, previous dips in the market, notably in 2015, coincided with sharp falls in equity prices. Although it is early days in the stand-off over the bill, the Hang Seng rose 0.5 per cent last week, pointing to the stronger role of external factors, the most important of which is developments in mainland China.

Pedestrians walk past a board displaying the Hang Seng Index, in Central on May 6. Photo: Nora Tam

When parts of Hong Kong were paralysed by the pro-democracy Occupy Central protests at the end of 2014, house prices continued to surge. Yet the surprise devaluation of the yuan in August 2015 and intensifying concerns about China’s economy last summer were enough to trigger sharp falls in home values.

This attests to the acute sensitivity of Hong Kong’s residential and commercial property markets to demand from mainland investors and developers, whose insatiable appetite for the city’s real estate has helped push up prices for residential and office properties to the highest levels in the world.

Even after a 20 per cent fall year on year in mainland investment in the territory’s property markets last year, Hong Kong still accounted for nearly two-thirds of Chinese outbound real estate investment, data from Cushman & Wakefield, another property adviser, reveals.

Hong Kong’s new property tycoons face greater expectations

Second, structural factors will continue to keep house prices at lofty levels. As I have argued previously, the acute shortage of supply – particularly when it comes to the construction of smaller and more affordable units – is far and away the most important determinant of home values in Hong Kong. It is also key to resolving the huge imbalances that have built up over the past decade.

Right now, however, Hong Kong’s entire governance is under scrutiny. The surge in political risk will dampen sentiment in the property market, but the much bigger concern is whether Asia’s top financial centre is losing its appeal.

Nicholas Spiro is a partner at Lauressa Advisory

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