Property Owners Should Manage Their Expectations

According to the Rating and Valuation Department’s residential property price index, Hong Kong’s residential prices rose 10% in the first seven months of 2018 before plateauing in August—the first month to not record an increase since March 2016. Since then, the overall property price index has fallen 3.7%, signalling a modest but steady decline in secondhand property prices. Sales volumes have had a more significant pullback, dropping 37% in September from average monthly sales volumes over the previous 12 months.

This downtrend in property prices across Hong Kong and Kowloon has been triggered by several interrelated factors. Rising interest rates have increased concerns that higher mortgage burdens will reduce demand in the future. As we’ve mentioned before, interest rates are nowhere near levels that directly constrain demand. However, worries of higher rates in the future have permeated the psychology of investors. Broader stock market jitters driven by trade war fears and post-brexit uncertainties have also contributed to a flight toward conservatism. Finally, the significant media attention on the change in sentiment has created even more caution. In this environment of general uncertainty, it is no surprise that property values and sales volumes have both retracted in the last few months.

Rents are likely to fall (even if stats don’t yet show it)

Home prices and rental levels have always been highly correlated, rising and falling almost in unison. However, despite falling home prices across districts, the government’s rental price index recorded an all-time high in October, an increase of 5.1% since the beginning of the year.

Although rents still seem to be at an all-time high, they are almost certainly about to decline, if not already starting to do so. It is only a matter of time before statistics, which lag the market by about two months, will show this. Although rental prices should follow sales prices, a temporary dislocation can occur when potential purchasers choose to rent instead, increasing rental demand. If this happens before landlords begin reducing rental prices, higher rents will result.

However this boost in rental demand should be temporary. As sales prices fall further, owners keeping their property vacant to sell will change their minds and begin renting out instead, thus increasing supply. If general economic uncertainty continues, people may also begin downsizing and moving to less expensive apartments. Both the above will lead the rental market on the way of the sales market. Landlords who don’t adjust asking prices may see longer vacancy periods and lose rental income.

Landlords leasing their units should do so quickly

In any cyclical market, people interpret or recognise the peak at different times. Some owners remain hopeful that the high rental and sales prices of a few months ago will soon return. However, data increasingly suggests at least a moderate correction. Assuming this continues, more and more landlords will adjust their expectations and reduce prices. This will create a selffulfilling market adjustment and landlords who adjust prices first are likely to sell or lease their properties faster (and ultimately at higher prices than those who hold out for too long).

Holding out for a high rental level is a risky move. Each month of lost rent reduces returns by 4.2% (over a 24-month lease) even if your target rent is achieved. In a declining market, the more time passes, the more rents will have to be lowered to attract tenants. In this market, we’d suggest property owners prioritise leasing their units quickly—even if it means accepting a slightly lower price—to avoid more significant long-term income losses.