The fundamental factors supporting the Hong Kong property market, from a shortage of houses to record low mortgage costs, are well known. However, similar arguments were used to justify the residential property market in the US in 2006, and in Hong Kong itself in 1997. In the latter, when the bubble popped, real estate prices fell 70%, not bottoming until 2003. Overall, I’d caution that following the correction seen late last year, property prices are once again heading into unsustainable territory.

According to residential property market data from Colliers International, The Peak area property price index fell 25.0% from a high in Q3 2008 to its trough in Q1 2009. The Mid-Levels area, meanwhile, saw a 31.9% drop during the same period. Since then, however, the market has rebounded strongly, surging 23.4% in the case of The Peak and 10.4% in the case of the Mid-Levels. Given that the economy remains very weak (real GDP contracted by 3.8% y-o-y in Q2 2009, and nominal wage growth remain is negative territory), it would appear that this has the hallmarks of a liquidity-driven bubble.

Prices Diverge From Rents
While it could be argued that the market has undergone a healthy correction in a larger uptrend, driven by improving fundamentals, it needs to be kept in mind that a number of factors disagree with this assertion. The continued fall in the Colliers International rental price index is a case in point. While house prices have rebounded, rent costs have continued to decline. Rent prices in The Peak are back down to 2007 levels, while rents in the Mid-Levels are back to 2006 levels. As a result, the ratio of the price index to the rental index has soared since the start of the year, reaching new highs in The Peak area.

Affordability Improvement Short-Lived
The correction in Q3 2008 certainly helped to improve housing affordability. While average wage rates (as tracked by the Hong Kong Census and Statistics Department) have come down since the 2008 peak, the fall in house prices outpaced this, resulting in a sharp fall in price-to-wage ratio. However, this has been short-lived, with the ratio once again heading up to its recent high.

Double-Dip Fears Growing
Identifying a potentially crowded market is one thing, but determining when a change in sentiment will occur is a different matter altogether. With policymakers in the US and China unlikely to make the shift to tightening liquidity any time soon, and the Hong Kong authorities highly unlikely to revalue the Hong Kong dollar at this point, the property boom could continue for a long while yet. However, if and when a correction comes, this could have serious consequences on the overall economy, as was the case following the property crash of 1997.