Introduction
In January 1982 a good sized flat (by Hong Kong standards) on Hong Kong island* cost just over H$1, 000/ft². 32-years later, in January 2014, the same flat cost just over H$13, 800/ ft². That’s a total gain of 1, 280% or a 32-year CAGR of just over 8.5%.
Counting back from January this year we can observe thirteen 20-year periods (the term of one of the most popular mortgage loans) and the returns for each period are summarized below.
From – To Gain CAGR
1982~’02 331% 7.6%
1983~’03 369% 8.0%
1984~’04 606% 10.3%
1985~’05 752% 11.3%
1986~’06 607% 10.3%
1987~’07 603% 10.2%
1988~’08 667% 10.7%
1989~’09 321% 7.5%
1990~’10 487% 9.3%
1991~’11 479% 9.2%
1992~’12 230% 6.2%
1993~’13 246% 6.4%
1994~’14 107% 3.7%
Average 447% 8.5%
[* Throughout I’m using data from the HK Rating and Valuation Department (which only goes back in detail to 1982) following price movements in apartments of between 70 m² ~ 99.9 m² on Hong Kong island. You can review this yourself at http://www.rvd.gov.hk/en/property_market_statistics/]
First, an Important Aside
To not own any property is to be short. You may live in Paris and have an apartment in Rome or work in Hong Kong and keep a home in Phuket which would part-cover a position but to own no property at all is to be short a market that history shows, time and again, tends to rise.
Therefore when you buy a property you go to merely a neutral position. Many mistakenly believe they’re going long. Going long is, in fact, when you buy a second property. Owning just one, and preferably one you can live in, is to merely be putting your house in proper order, so to speak.
The calculation of benefit for property #1 then is fundamentally different from property #2 and beyond. #1 is a buy/rent decision, numbers two and beyond are return calculations which for many (especially in China where investment properties are regularly left empty) need only vaguely reference rent.
The Present Equation
Taking the very real example of an apartment in The Grand Panorama, a (low-end) luxury development in the popular Mid-Levels area (http://www.statelyhome.com.hk/en/PropertyDetail.aspx?ID=cde7d993-dbc1-4db0-be61-9399b66125a1) we find a 971 ft² property available for H$19.6m (H$21, 185/ft²) or a rental of H$43k/pcm.
I’ve sent the spreadsheet embedded here, Gary’s Mortgage Calculator, around before but if you’re seeing it for the first time a bit of background. I created this initially in 2004 for a then colleague, Gary, to demonstrate two things. First, whatever numbers you put in here one remains constant no matter what. The terminal value of rental payments IS ALWAYS ZERO. Second to show how important a regard for a final value of property is when considering a purchase. You cannot simply compare rent versus mortgage payments. [How many times from financially literate people have I heard ‘I can’t afford to buy what I live in’. Why on earth should you; ever!? In 2004 though, at least for a brief while, you could]
From the calculator you can see that the NPV of the Grand Panorama unit bought versus the NPV of the rental payment (check the ‘You win/(lose), today, by’ cell in the bottom left) suggests renting is the better option; but only because I’ve assumed a selling price in 20-years’ time unchanged from today.
A Better Way to Look at It
Go back to the top of this note though and ask yourself is a 20-year assumption of no growth in property values realistic? Of course it’s not, in fact it’s absurd.
What assumption should a buyer make then about an ultimate value of their property? This will vary depending on the individual but the important point here is the market at the margin will be determined by the highest assumption(s).
Ignoring the average of the thirteen observations above and just taking the worst, the last period from 1994~2014, what per-square-foot price today would produce a buy versus rent profit if all property could manage was a doubling over the next 20-years i.e. a 20-year CAGR of merely 3.5% (56% below the average above)?
I’ll save you the trouble of fiddling; the answer is H$32, 200 or a level 60% above present selling prices.
Ah but..
I’ll admit, this argument has holes. The biggest of which is over a 20-year period none of the terms, most importantly interest rates, are likely to remain constant. Double interest rates though and maintaining the 3.5% CAGR you’ll find you still come out ahead.
Where Next?
I don’t know. What we can say about the present level of property prices in Hong Kong is that relative to rents and mortgage rates they don’t seem, presently, to be ahead of themselves.
In the event of an outbreak of serious optimism though (the stock market, only 7% up YTD despite the recent rally, is probably the most reliable local sentiment gauge) it’s quite easy to see how real estate prices could go a lot higher if buyers views of forward values were to be adjusted significantly upwards.