Buying An Expensive Nest

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Hong Kong property prices have been on an unusually steep upward track for over a decade, but they have just hit a new level – probably not a spike – with the city already easily the most expensive in terms of real estate in the entire world.

What is driving the valuation surge is not local factors. The Hong Kong economy is doing okay, but it could do better, and the overall system is facing challenges with a change in chief executive coming this year and basic questions about the autonomy of the territory’s legal system becoming gradually more pertinent in terms of commercial implications.

No, the Hong Kong property market is driven by factors spilling over from the mainland. The policy of “One Country Two Systems”, cleverly proposed by Deng Xiaoping  more than 30 years ago, has served all sides well and is the core factor in terms of Hong Kong property. Hong Kong’s legal system is not that of the mainland’s and property ownership rules are different. How it will change when the famous “50 years of no change” is up in 2047, who knows, but for now ownership of property in Hong Kong is much more categorical than ownership of property on the mainland.

China property is all owned by the state with all property “ownership” being in land usage rights for a finite period of time, specifically a maximum of 70 years. What happens when the 780 years is up is not clear, but for many Chinese people buying property on the mainland, they know at some level that this is not ownership in the sense of freehold property ownership in the United States, Europe, Japan or Taiwan. Which consciously or unconsciously means that people are buying in order to sell – a speculative mindset.

Hong Kong property is not freehold either – with the single exception of the land plot occupied by St John’s Cathedral just above Central. But it is leasehold with leases stretching up to 999 years, and more importantly backed by a legal system and precedence, that provide a high degree of confidence that if it’s mine, it really is mine. From a China perspective, that it’s a pretty revolutionary concept.

The long-term uncertainty over property rights on the mainland came to a head last year thanks to a situation in the city of Wenzhou where two leases of 30 years came up for renewal in mid-year, and the local government declared a piece for rollover of the leases art one third of current market value. As a precedent for the middle class and home “owners” throughout the whole country, this was unacceptable, and there was a muted paul for about six months from Beijing as everyone considered the implications. In late December the decision came down to roll over the Wenzhou leases for free, and everyone breathed a sigh of relief. There is no precedence formally in the China system, and what happened was basically the party-state simply kicking the problem down the road a ways.

The property ownership question is reminiscent of the Leonardo di Caprio movie inception involving various levels of reality ending up with a piece of paper in a safe at the most basic level. On that piece of paper, in this metaphor, is written the word “freehold”.

And so rich Chinese individuals and Chinese companies pile unrelentingly into the Hong Kong property market, one of the most cramped enclaves on the face of the planet, with one of the highest population densities. New land is constantly being reclaimed from the sea to fuel the demand, and keep the Hong Kong government comfortably solvent.

The Hong Kong authorities have tried cooling the market down with higher stamp duties and other measures including more inventory. New home sales accounted for 30 percent of total property sales last year, compared to just 10 percent in 2010. But it’s being driven by far bigger issues, the same ones driving China capital flight to the United States and elsewhere. Plus Hong Kong;s long-term advantages – good governance, efficient administration and free market policies.

In fact the increased land sales by the Hong Kong government could be said be exacerbating the problem with Chinese developers bidding frantically for plots that come up for auction, thereby driving up assumed prices across the board. Early this year, HNA Group Co. outbid such Hong Kong giants as Cheung Kong Property Holdings by offering HK$5.5 billion for a piece of land in what was once Kai Tak airport.

Then came the auction for a piece of land on Ap Lei Chau – literally “duck’s tongue island” – which is situated in the southern district of Hong Kong, close to Aberdeen. The winning bid exceeded prior market expectations by 50 per cent, and the whole market jumped as a result.

The price of HK$16.86 billion was offered by Logan Property Holdings, based in Shenzhen, and Guangzhou’s KWG Property Holding, thereby paying HK$22,118 per square foot for the site. The proportion of land plots bought by mainland companies was about a third of the total last year, with Hong Kong developers increasingly unable or unwilling to compete.

But this is still just the beginning. Unless that 50 years ends ahead of schedule, that is.