Chinese Property Bubble May Collapse in a Year or Two

Wed, Dec 11, 2013 - 3:21pm

A property bubble is brewing in the East, and it’s probably got another year or two before prices severely correct.

Successful Hong Kong-based money manager Puru Saxena tells Financial Sense Newshour listeners in a recent interview how home affordability in Hong Kong and China is now “off the charts”. Commercial property prices recently peaked in his building at $3000 (US dollars) a square foot and are now down around $2000-$2500. Sound ridiculous? It is. And Puru thinks it’ll get much worse.

“If you look at the HKMA (the Hong Kong Monetary Authority) report, which they publish every 6 months, they’ve said that housing affordability is now off the charts. It takes almost 14 years of income to buy a property in Hong Kong and this has now surpassed the ratio we saw in 1997, which was the last peak before property prices fell by 65%.”

“The only reason why property prices haven’t come down more,” he says, “is because interest rates are still at historical lows. Because we are pegged to the US, our interest rate is virtually zero. You can get mortgages at 2, 2.5, 3 percent; but the problem is, in Hong Kong, you can’t get fixed rate mortgages so all the debt is a variable rate mortgage.”

“I believe that Hong Kong real estate is very vulnerable to a big big downdraft when interest rates go up or even if there’s a whiff by the market that interest rates are going to start going up. I think that’s when the party will end.”

Will another bust be as devastating as in the past?

“I think it will be because of this policy of not giving out fixed interest rate mortgages. Hong Kong’s real estate has historically been very volatile. We’ve had huge upswings which go on for maybe 10, 12, 13 years and then you have massive collapses. When interest rates go up, everything goes down, and prices go down for 4 or 5 years. And this is not in the recent past—this has been going on since the 1970s. We had a big bust in the early 80s. We had a huge bust in ’97, which bottomed out in 2002-2003. And now we’ve been going for about 10 years; I think we’ve got another year or two to go and then when interest rates start going up in the US, then we’ll have the next big downdraft. And, if you look at the previous buying opportunities in Hong Kong, the home affordability ratio was under six, both times at the bottom in the early 80s as well as in 2002-2003, so you could buy real estate here for less than six times your average income and I suspect we’re going to get there again. If you fall from about 14 years from down to six, you can do the math, it takes a 60-65% plunge to get to those sort of numbers.”

How expensive is the real estate market going for in Hong Kong?

“At the bottom of the market 10 years ago, property here sold for about $450 (US dollars) a square foot. Recently, just before the government clamped down, transactions occurred for almost $3000 (US dollars) a square foot…before the peak of the market. Since then prices have come down to about $2000-$2500 a square foot in this building in the higher floors, but these are the sort of numbers that you are talking about. It’s just astounding that the economy is pretty sluggish and that the values of real estate have gone through the roof…everybody is complaining about the exorbitant rent that they’re paying. The rents here are just killing business left and right.”

We hear stories in the West of see-through cities, see-through buildings in China. Are these stories true or as great and numerous as people say?

“Yes. There is a huge huge oversupply of real estate in China. People have hoarded real estate without even any tenants inside…they’ve used housing, and poorly built housing in many cases, as a store of value just like people have been holding precious metals as a store of value. People think, ‘Well, you just by real estate and the direction is only up—it can never go down,’ and we all know how well that ended in America. There’s a huge supply problem in China. There are a lot of empty office buildings, cities that are vacant. You also have residential units just lying vacant, being hoarded by people that could care less about the cash flow because real estate has gone up in value.”

If you'd like to listen to this entire interview with Puru Saxena where he also gives his outlook for commodities, emerging markets, gold, and the US stock market, you can do so by CLICKING HERE to subscribe. In addition to hearing from money managers, institutional investors, and other experts regularly interviewed for FS Insiders, you’ll also gain access to our entire archive of past interviews.

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