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CURTAIN CALL: Housing Authority, exit stage left By Andrew Taylor October 2002

Civic Exchange Room 601, Hoseinee House, 69 Wyndham Street, Central. Tel.: 2893 0213 Fax: 3105 9713 Website:

CURTAIN CALL: Housing Authority, exit stage left Housing policy has made it to the limelight again with Chief Executive C.H. Tung and

Financial Secretary Antony Leung both, finally, acknowledging publicly that private housing prices are a major input in the performance of the domestic economy. Sadly they are looking at pro-active intervention to “push prices up a bit�. This is the last thing we need, the 55%

of households that are home owners in Hong Kong deserve their wealth to be determined by the market, not by the short-term whim of government policy.

A slightly brighter outlook for housing policy arises from comments from Michael Suen, Principal Official for Housing. He announced recently one of the first potential moves on Housing Policy - the removal of the Landlord and Tenant Ordinance, Part 4. The removal of

this legislation will create a proper investment property market in Hong Kong and shows the government is actually looking to increase the role of the market in setting prices. In the

same announcement he focused on increasing people's confidence in the operation of the market and stated he saw no mechanism available to the government to increase prices. It looks as though the government maybe moving the right way but again will suffer from poor marketing of policy.

Any potential change in policy could be the kick general economic sentiment Hong Kong so

desperately needs. Indeed, if we look closely at the economy, our external and financial

sectors are performing relatively well it is the domestic sectors where depression reigns. If a positive change in housing policy is coupled with a sensible population policy, it could be a strong basis on which Hong Kong can again develop. Figure 1

A Job Completed 20.00%








12.00% 10.00%




6.00% 4.00%



% Consolidated Revenue (RHS)

20 01

19 99

19 97

19 95

19 93

19 91

19 89

0.00% 19 87

19 85


Inadequately Housed (LHS)

The reason the death knell has been sounded for the Hong Kong Housing Authority (HA) is

because it has completed its mission. The chart above highlights the remarkable job the Public Rental Housing has done in improving the housing lot of Hong Kong over the last 17


years. By the HA’s definition, only 5% of the population was inadequately housed (on a floor area per person definition) as at the end of 2001.

The concern is that despite this improvement in the public tenant’s lot, post-1997 the

spending on public housing expanded substantially. It moved from providing socialised housing to a poorly housed population to promoting home ownership. Now that the government is even having trouble enticing the community to buy, public housing’s role is again being questioned. Having achieved the 1970s British socialist ideal of housing half of

the population in council flats does Hong Kong need to continue to spend over 14% (HK$42bn) of consolidated expenditure on public housing? ‰

When Hong Kong has a HK$65bn budget deficit?


When there are more units of accommodation than households?


When inadequate housing is affecting less than 5% of the population?


When the projected development schedule of the HA would result in private vacancy rising in excess of 10% based on current population and supply forecasts?

The HA has historically been self-funding through sales of Home Ownership Scheme (HOS) flats so the direct burden of public housing hasn’t been on the general revenue account read










inefficiencies due to higher construction costs in the public sector than the private market. The private market is now successfully poaching potential HOS buyers and particularly HOS

owners who are within two years of the original purchase allowing a re-sale to the HA at the

same price. With HOS appearing increasingly irrelevant in light of adequate supply and

attractive affordability in the private market, the HA’s self-financing ability will disappear and the government is in no position to pick up the tab. Without the HOS subsidy, how is the Government going to pay for the 30% of the population in socialised rental housing and the subsidised mortgages it says it will use to replace HOS

sales? The sums are not insignificant. The total budgeted expenditure of the HA for FY02/03 is HK$43bn similar to the Government’s budgeted fiscal deficit of HK$45bn.

Within the HK$43bn of budgeted expenditure, the budget for construction and the overhead costs allocated to construction are around HK$15.8bn. This will provide around 30,000 flats

(average of coming three years). Assuming an average of unit size of 550sf a flat this equates to construction costs of HK$988 per sq ft, which is 15%-25% more than the private

developers spend on a mass residential development that is of a much higher quality. There

is no need to dwell on efficiencies in the public verses private sector but it is a clear enough why the public sector should not be providing housing.

The HA has achieved it goal of reducing the waiting list for public rental housing to 3 years

and seems happy to keep it at this level. Judging from its tenant’s purchase scheme and various comments made recently, it seems likely that housing 30% of the population would be a ceiling the government will avoid breaching. Assuming a constant 30% of the market 2

and the government’s current population growth forecasts, between now and 2006 there is

the requirement for an average net addition of 7,004 public rental units. This will cost HK$3.8bn p.a. at current construction costs, a saving of HK$12bn over the current

development schedule if the HOS was also abandoned completely. Clearly, this saving would be less if the HA continued to demolish older estates to upgrade them. At the HA’s operating level, there will be a deficit without any sales of HOS units. Indeed, this operating deficit (prior to construction) would approach HK$1.6bn. However, if we assumed only the 7,004 public rental flats production, keeping all other numbers the same we would be looking at a cash deficiency as follows: Figure 2

Assumed Cash Deficiency, Normalised Low Supply

HK$ m Ca pita l Account Ad justed Construc tion Exp end itur Non Construc tion Exp end iture

(3,806) (1,089)

Current Account PRH Surp lus Com m erc ia l Surp lus

(2,266) 953

Tota l Ca sh Defic enc y


Ca sh Reserve YB 2002/ 3 Forec a st Ca sh Reserve YE 2002/ 3

24,579 15,945

Assum ed Cost of Renta l Sub s Assum ed Renta l Pa yb a c k

462 8.23

So, even providing the units under a no HOS and steady state public rental assumption, we would only be looking at a cash deficiency of HK$6.2bn rather than the currently forecast

deficit of HK$8.6bn. It should also be noted that despite the HA getting the land for free they are loosing money on letting out the public rental housing. There is a cheaper way to do things.

By giving the additional public rental tenant a HK$10 per sq ft per month cash rental

allowance, the HA may actually save money. Not counting the time value of money,

maintenance, forgone rates and management fees it would take 8.23 years to payback the cost of constructing a unit with this allowance. Moreover, there are a number of peripheral benefits to this policy: ƒ

More choice to the consumer in terms of location and quality


Easier to control income ceilings (assuming they re-apply for the allowance each year)


Management, construction etc will move to the more efficient private sector


Premiums and rates will be paid to the government



Investment market developed (HK$10 per sq ft rental @ 6% yield = HK$2,000 per sq ft)

In the Chief Secretary, Donald Tsang’s, recent re-statement of housing policy, there was an

announcement of a trial run for cash rental allowances. This should be pushed through as quickly as possible. Replacing the production of 7,004 units with rental allowances, the deficit could fall to HK$2.4bn with the individual beneficiary actually having a better quality of accommodation.

Clearly, over time this policy will attract increasing numbers of public rental tenants, which

in turn should reduce the requirement of maintaining the existing public rental housing. The older disused properties – particularly those in the urban areas – can then be sold off with

the proceeds going to fund the continuing provision of rental housing. The commercial property could also be securitised to provide additional capital which could provide a one off payment of up to HK$10bn. There is also a mid-term potential benefit to the general

revenue account in that the private sector will be paying premiums to produce units due to lower levels of crowding out.

The provision of interest free mortgages is a far simpler problem. Currently the value of outstanding mortgages is HK$650bn (both private HK$545bn and HOS HK$105bn) while the

total reserves of the government are HK$1,090bn (US$95bn foreign reserves and HK$350bn

fiscal reserves). Allocating some of these reserves to back low interest mortgages for first

time homebuyers would be the easy way of providing subsidised house purchase opportunities. Mortgages are typically repaid in 7 years in a normal market and as such (at a

1% population growth rate) we would imagine the maximum exposure required would be HK$45bn backed by reserves. As it is a mortgage, it is repayable rather than an expenditure

item and many of these mortgages could be securitised by the Hong Kong Mortgage Corporation. The relatively small size of the mortgage allocation against the total reserves clearly minimises the moral hazard of using the reserves for such a purpose.

There is still a de facto transfer of wealth assumed in this policy as income taxpayers and

current holders of private property have built the bulk of the reserves and will be allowing the wealth they generated to be used by the new homebuyers. Moreover, by getting out of the provision of supply and encouraging re-investment in Hong Kong at the personal level, the government should be increasing sentiment and promoting the decimated domestic demand sector.

The production schedule of the Housing Department will take at least 3 years to slow which

will provide a problem in the private market. On the Government’s current population targets and a 3.1 person household, there is a requirement 90,677 units between now and FY05. The private sector is due to produce 85,000 units over this period and has a further 60,400 units vacant. It would thus be extremely silly not to start moving the Government out of the market now. The numbers above are estimations based on the fairly general data available and they should not be dramatically out of line. If this policy change is to have the

best overall effect on the economy and the housing market it will need to be well articulated


and the emphasis put back to the market determining property prices, with no interference from the Government.

Now that we have solved that problem (easy on paper isn’t it), we need to consider whether the private sector can pick up the slack.

Private Sector Supply – Grabbing the Gauntlet On current population forecasts (which may be on the low side) and current supply forecasts (which are probably too high) the following are the scenarios for private vacancy rate in the

residential market. Note these are purely demographically based forecasts, which rarely pick

up the often volatile cycles in demand but do show the underlying “real” demand for property. With the Government committed to producing around an additional 50,000 units, it looks like vacancy will come closest to the current forecast. Figure 3

Private Vacancy, Suggested and Actual Public Supply 12.00% 10.00% 8.00% Current Forecast 6.00%

Rental Subs Public = 7,004 p.a.

4.00% 2.00%

19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05


Even without the forecast supply of public rental units in the market, the private vacancy rate will remain high, and with that, vacancies will rise to very high levels. If net new public

rental accommodation is replaced by rental subsidises the vacancy is manageable and

unlikely to cause a bubble in the current low inflation environment. The Government may wish to consider a major increase in the demolition of the older public rental blocks in the near term if a flood in the market is to be avoided. Current supply forecasts appear high. This is based on such evidence as plummeting consents to commence work and high

construction sector unemployment. Thus, the overall vacancy figure is unlikely to hit these extreme levels.

There is thus no apparent danger of a supply shortage if the Government removes itself from the market. The pre-1997 constraints are also clearly not an issue. The developers can

easily raise cheap capital, there is an abundance of construction labourers (remember the days when there were calls for more immigration of construction workers) and there is no

land limitation. In the inflationary boom of pre-1997, there was actually an incentive for

developers to slow production to keep earnings growth down to “sustainable” levels, which 5

further constrained supply. Quite the reverse is now true and the developers are expected to increase volumes in line with demand when the market has free reign.

Demand: The Devil is in the Detail Based on current demographic trends, the required growth rate in Hong Kong’s residential

stock of units remains staid. It should be noted that the Government, under Donald Tsang’s supervision, is putting together a population policy, which will likely focus on attracting “foreign talent”, especially from the mainland and increasing the overall rate of growth. Another potential reason for the bleak demand picture is that unlike every other housing

market in the world, private residential home-ownership is falling. This distressing chart can be interpreted three ways. Figure 4

Private and HOS Ownership Levels 45.00%





16.00% 14.00%








6.00% HOS Ownership (RHS)

20 01

19 99

19 97

19 95

0.00% 19 93

0.00% 19 91


19 89



19 87


19 85

Private Ownership (LHS)

While each of the three explanations will contribute to declining private home-ownership, the most plausible reasoning is that the marginal buyer has been attracted to the public accommodation because it is so cheap.

The chart above highlights that the private home ownership rate plateaued as HOS ownership jumped up in 1989/90. A removal of additional HOS will be key in getting the population to re-invest in Hong Kong and at a market – rather than subsidised – rate. As

already noted, this massive subsidisation of housing cannot continue in a mature economy

with lower price, economic and population growth rates and a fully-housed population.

Thus, if the Government wants to encourage home-ownership rates it has to encourage a decent return on the investment – read price increases.


Figure 5

New Private Owners and Take-Up 90,000 80,000 70,000

Add Private Own

60,000 50,000

Private Take-Up

40,000 30,000 20,000

Public Take-UP


20 02

20 00

19 98

19 96

19 94

19 92

19 90

19 88

19 84

19 86


An alternate explanation of the plateau in private home-ownership since 1988 is that confidence in the future of Hong Kong has remained stable at a very low level for 14 years.

Moreover, it has taken a 50% discount to market value (i.e. HOS) to entice the marginal buyer into the market. The shutting of the stock market in 1987, Tianamen Square in 1989,

the war inspired drop in tourist arrivals in the early 1990s, a continual niggling concern over the transfer of sovereignty followed by the Asian financial crisis and a poor housing policy

since 1997 have all dented confidence. Nevertheless, the economic success of Hong Kong should have overpowered all these concerns and increased the private home-ownership levels to well in excess of their current levels. Especially considering the massive potential for wealth creation through price increases for much this period.

The final explanation is affordability. Home-ownership was out of many peoples’ reach – certainly an argument used widely at the time. Figure 5 suggests there maybe something

behind this explanation as well. Other than in 1991 and 1992, the number of additions to home-ownership declined from 1988 onward. With cheaper prices things improved into

2000 but have since fallen away. It is also counter-intuitive that overall home-ownership as a percentage of overall population has been falling since 1988.

Figure 6 also highlights a potential problem when looking at future demand for property. Private household size has effectively remained constant over the last 15 years whereas in the public arena and thus overall the household size has dropped dramatically. One would expect private households to shrink as confidence returns to the market. The 3.2 people per

household is well above the 2.65 seen in western developed countries. Each 0.1 reduction in household size represents approximately another 40,000 units’ worth of demand.


Figure 6

Public and Private Household Size 4.4 4.2 Public H'sehold Size

4 3.8 3.6

Private H'sehold Size

3.4 3.2

19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02


The huge supply of new public accommodation is the major reason we have seen such a

reduction in household size in the public sector. The Government were forced to open HOS to singletons in an attempt to keep demand flowing as supply ballooned after 1997, which caused much of the rapid decline in household size over that period. With little difference

between public and private sectors in terms of household size it can be said that the HA has effectively achieved its goal and can now move out of the market.

There is further potential to get household sizes down closer to the developed world

averages but it will take increased confidence in Hong Kong’s future by the populace or

massive subsidisation. Clearly, subsidisation can no longer be afforded but the first may be achieved in line with an economic resurgence.

Housing Policy and the Economy: A Kick Up the .... Domestic Hong Kong needs a very large boost in confidence. The external sector is performing well, which has historically been a lead indicator of an improvement in the

overall performance of the Hong Kong economy. The trade numbers for July 2002 are

further evidence of the external sectors’ success. However, the domestic sector does not

appear to be following on this time. It is probably not a function of the cost structure of the economy as the most directly affected sector – trade - is the best performing sector in the economy.


Figure 7

Sectorial Unemployment

O ct -9 Ja 7 n9 Ap 8 r-9 Ju 8 l-9 O 8 ct -9 Ja 8 n9 Ap 9 r-9 Ju 9 l-9 O 9 ct -9 Ja 9 n0 Ap 0 r-0 Ju 0 l-0 O 0 ct -0 Ja 0 n0 Ap 1 r-0 Ju 1 l-0 O 1 ct -0 Ja 1 n0 Ap 2 r-0 2

18 16 14 12 10 8 6 4 2 0




Whol & Ret




Economists have pointed to the budget deficit and the Government’s general poor

performance as destroying public confidence. Unfortunately, there is little doubt that there

is widespread dissatisfaction with the leadership and administration of Hong Kong as a whole. The incidence of negative equity and associating it with housing policy has linked

the Government’s policy with poor domestic demand. To improve domestic demand, the Government needs to make its policies more homeowner friendly.

To date, policies have been interventionist and have created some worrying examples. The handling of the leasing of Cyberport (a private sector-government joint venture) is a case in point. Not content to sit on vacant space to wait for a cyclical upturn in the IT sector when the Government could fill the project with appropriate tenants, it undercut the private office market for the administrative offices of IT firms. A similar but more extreme form of crowding out has occurred in the residential market.

This crowding out has accentuated the destruction in wealth that the Asian financial crisis imposed on the middle class in Hong Kong. While there is little doubt that the property bubble needed bursting, with 20/20 hindsight the problem has been unnecessarily dragged

out by the Government as the comparison with Singapore shows. If anything Singapore should have suffered a greater fall in prices as the private residential market is proportionally smaller, more discretionary and suffers from a proportionally much greater inventory overhang. Moreover, Singapore’s economic hinterland has suffered more through the Asian financial crisis and IT meltdown.


Figure 8

Hong Kong and Singapore Residential Prices, Confidence destruction 100 90 80 70 60 50 40 30 Hong Kong



10 0 3Q97










The pressure is now clearly on the Government to get out of the residential market to a

much greater extent has previously been envisaged. The pressure is being applied by the

people who pay for the Government – Hong Kong’s middle class – who are the same people who have suffered most at the hands of its policies. Donald Tsang’s re-statement of policy in June was just the start.

A well-articulated and well-marketed strategy should provide a huge boost to domestic

sector confidence in Hong Kong, which will translate to an improvement in the overall economy.

There needs to be a massive slowdown in public housing construction so its

influence on the private market is neutral or less. The Government should give out cash

rental allowances, stop the HOS, and resume providing housing under the general account of the government’s budget to increase transparency of the cost of public rental housing. The pros and cons for the overall economy are highlighted below.


Pros and Cons of Absence of Public Housing In Favour: No additional supply Would





Against: No additional supply It is further evidence of flip flop





government has made Savings at the budgetary level

Will cause more unemployment from







unemployment in the construction industry There might be a cycle

Would help potential buyers believe

the market will set prices, not some ill-defined “stable prices� target of government. Wider benefit to the

economy is evidence the government will not interfere.

An improvement in the residential market




concerns over negative equity leading to higher domestic demand.

Improved confidence in the ability of the government and the future of

Hong Kong will reduce household size





conditions and more demand for residential



construction unemployment


Reduction of population in Public

A cash rental allowance will create an

Rental Flats

investment market at the bottom end of the mass residential market.

Overall cost to society of housing the population will fall.

With the external sector doing well there is clearly still a role for Hong Kong to play in the

global economy. Moreover, there is the opportunity to develop a number of businesses with China as a source of cheap labour and a potentially massive market over the coming years. 11

There is also a huge role for finance that will occur in Hong Kong. Hong Kong’s current problem is principally domestic and requires a serious boost to confidence to get domestic spending running again.

Getting the Government out of the housing market would be a good start. This paper highlights the reasons why and many ways how the government should extricate itself form the market. With the hard-earned reserves suffering from the fiscal stimulus the government is currently using to kick-start the economy, a rapid implementation of confidence building housing policy would now appear critical.



Housing policy has made it to the limelight again with Chief Executive C.H. Tung and A slightly brighter outlook for housing policy arises...

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