Dr. L. H. LiAssociate Professor

Dept. of Real Estate &Construction,HKU

Real Estate Economics(RECO6011) e-mail : lhli@hkucc.hku.hk Web site : www.lilinghin.com Tel : 2859-2128 (Dept. of Real

Estate & Construction)

Please Switch Off Your Mobile Phone , I Have Had Enough Brain Damage From the of My Own Cell Phone !

Real Estate Economics The purpose of this course is to provide students

with a basic understanding of the economics of real estate and urban land development. This module is NOT ABOUT MICRO/MACRO economics. The programme is conducted over different sections of lectures and tutorials. The following gives a general outline of the course for reference only and is not designed to be a definitive course guide. The key reading list is also by no means exhaustive and students are expected and strongly encouraged to browse through the library before lecture.

To save a few trees for the monkeys, students are required to download supplementary (to required readings) lectures notes (from www.lilinghin.com click on various REE notes under “Information on MSc lectures” to download. If you have problems in doing so, please let me know.

PROGRAM OUTLINE

Section 1 : Real Estate Market and Cycles

  It will start with introductory

discussion on the market structure for real estate economy, followed by an examination of the formation of real estate cycles in general and in Hong Kong.

Section 2 : Real Estate Appraisal   This section intends to cover the

basic techniques of real estate investment and development appraisal. It will therefore start with introductory AND VERY BRIEF discussion on various types of simple traditional appraisal models and theory of land value (some of which have been covered in the Real Estate and Investment module).

Section 4 : Risk Analysis in Real Estate Investment

  Having covered the applicability of

various appraisal theories, the next question is naturally - So What ? If we assess the value for a particular asset, does that mean we will go ahead with the investment ? How do we know our decision is right ? How would the variables in the appraisal change ? How can computer help ?

Section 5 : The Economics of Urban Land Policy  

This will examine the impact of urban land policy in different environments. The lecture discusses the role of urban land policy. Moreover, socio-economic impact of urban land (political) decisions will be examined in the context of Hong Kong such as the role of government in the market.

Real Estate Market Structure Market Structures in Real Estate and

Construction Perfect competition or monopoly ? Characteristics of perfect competition

Characteristics of perfect competition Large numbers of players ? Homogenous products ? Free entry and exit ? Perfect information ? Number of Customers Identical factor prices ?

Real Estate Cycle – A theoretical Framework

Property cycle can be defined as “… current but irregular fluctuations on the rate of all-property total return, which are also apparent in many other indicators of property activity, but with varying leads and lags against the all-property cycle” (Key, et al , 1994)

Real Estate Cycle – A theoretical Framework

Do real estate cycles really exist ? degree of volatility of return Wheaton (1987) applies econometric model using real

rents, level of office employment, expectations about future space needs(proxied by the ratio of current and previous period’s office employment), and area of occupied office space as determinants of demand.

He finds that rents do not move quickly to clear market leading to extended length of cycles, and

Supply reacts more to vacancies and rents than does demand, thus causing instabilities.

What other causes ?

Factors causing fluctuations :

mis-match between the demand and supply factors, the lags between the planning and production of space – Role of market data in minimizing these gaps

Monetary and taxation deregulation led to price inflation intensified competition in the financial sector led to

excessive loans on sometimes unjustified projects Easier capital flows and property finance offers a wide

range of debt and equity finance opportunities, for good and bad projects

internationalization of the world’s financial sector leading to new specification for commercial real estate and obsolescence of traditional supply

Real Estate Cycles in Hong Kong Long upward trend since 1984 with only

minor adjustments in 1989 and in 1992, until 1997.

Since 1992, relative cyclical movements were becoming more obvious, but new peaks normally climbed to higher levels as compared to the last peak.

This pattern continued until after the Asian financial crisis in 1997 when prices bottomed down to the 1992 level

Chart 1 : Transaction Volume and Property Price Levels

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deflated property price index (overall)

Real Estate Cycles in different sectors in Hong Kong

Demand for residential units had remained fairly steady before 1997 due to various reasons.

On the other hand, different sectors performed differently

Chart 2 : Cycles in Real Estate Sub-Sectors in Hong Kong

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1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Overall Domestic

Overall - Retail

Overall - Office

Overall - Industrial

Real Estate Cycles in Hong Kong – political influences

the smaller residential flats out-performed the luxurious class from 1984 to 1992, then the reverse happened.

Due to some political reasons, supply in various domestic sub-sectors has been distorted.

Chart 4 : Residential Market Cycle

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deflated property price index (overall)

deflated property price index (A)

deflated property price index (B)

deflated property price index (C)

deflated property price index (D&E)

Real Estate Cycles in Hong Kong

The fact that more sites available for small unit projects were put to the market was not a strategy, but incidental to some political developments after the Sino-British Joint Declaration in 1984

Hence, supply of properties from the government land market had been highly unstable

Table 2 - Major Land Disposal Pattern (Urban Area) 1985-1997

Year Urban Area

  C C/R R1 R2 R3 R4 I CP

1985-86   3 2 3 1     2

1986-78   11   4     4  

1987-88 1 2   3 1   2  

1988-89 4 1 1 2     3  

1989-90 4 1   1     1  

1990-91 3 1 1       1  

1991-92 1 2 1 6 2   1  

1992-93 1 3 1 2     1  

1993-94 2     2        

1994-95 2   4 2     1  

1995-96 2 3 1 1 1      

1996-97 2 2 1   2 1    

Total 22 29 12 26 7 1 14 2

Source : Data compiled from Government Land Sales Record, Lands Department, Hong Kong Government.Note :

R1 to R4 residential land for different degrees of development intensity. R1 is the most intensive type and so on.

C -commercial land

C/R - residential land with commercial elements allowed

I - industrial land

CP - land for car-parking use

Real Estate Cycles in Hong Kong – correlation with stock market

Real estate market had been highly correlated to that of the stock market only before the burst in 1997.

limited and inactive bond market and there is a lack of other investment vehicles.

Most of the blue-chip companies listed in the Hong Kong Stock Exchange are either property developers or property-related conglomerates.

Chart 5 : Stock and Real Estate Market Cycles in Hong Kong

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Real Estate Cycles in Hong Kong – interest rate

Interest rate in Hong Kong has been set to follow the tend of the US pattern, leading to the role of interest rate in the monetary policy in Hong Kong being relatively inactive.

The HK interest rate, on which the mortgage rate bases, cannot always reflect the actual macro economic situation.

As a good inflation-hedge tool, demand for real estate will soar under an artificially-low interest rate period leading to rising prices

Real Estate Cycles in Hong Kong – government policy

New Government New Policy: In October 1997, the Chief Executive mentioned

nothing except a promise to achieve a supply of 85,000 units of housing flats and a target of home ownership increased to 70% in the long run.

This promise represents a substantial increase in housing supply in Hong Kong given the previous total supply of housing flats from 1992-1997

Housing Supply Pattern 1985-2000 in Hong Kong (*Note : Figure for year 2000 accounts for statistics up to the third quarter of the year )

Public Rental Public Sale Private TOTAL

1985 29598 20206 34613 84417

1986 28432 6480 33013 67925

1987 24976 8974 33629 67579

1988 31701 8802 30122 70625

1989 46393 18776 30621 95790

1990 32885 17518 31483 81886

1991 25486 16726 40728 82940

1992 11039 5740 25683 42462

1993 34295 33109 26854 94258

1994 17098 4594 34350 56042

1995 17349 16672 20753 54774

1996 18358 10725 17183 46266

1997 16046 21535 15886 53467

1998 14123 21093 19489 54705

1999 29382 22493 31504 83379

2000* 18784 16064 16597 51445

Can the Gov’t dictate supply ?

The new “socialist” style of land management system in Hong Kong after 1997 with production indication might not be effectiveness as the government cannot control all supply channels of housing

Table 5 : Contribution of Housing Supply Via Government Land Auction Channel

Year Annual new completion of housing floor space (1,000 sq.m.)

Floor area available for housing development via government land auctions (1,000 sq.m.)

% of supply from auctioned land on total supply

1991 1831 365.64 20%

1992 947 316.64 33.4%

1993 1514 400.47 26.5%

1994 1255 222.18 17.7%

1995 1089 370.16 34%

1996 769 219 28.5%

    Average : 26.68%

Source : L.H. Li, (1996) , Development Appraisal of Land in Hong Kong, Hong Kong : Chinese University Press

Real Estate Cycles in Hong Kong

This market expectation, when faced with a market failure, started to search for explanations in the government policies for the burst of the bubble.

One of these being the over-production of government-subsidized housing, or the HOS, for sale in the market.

Is it true ?

Real Estate Cycles in Hong Kong

The Bank Sector – Eager to lend you an umbrella on a sunny day and ask for it back when it rains.

Bank sector in Hong Kong has been under rather strict scrutiny by the quasi-central bank, the Hong Kong Monetary Authority(HKMA).

There has never been a major deregulation as such.

Real Estate Cycles in Hong Kong

Proportion of loans to property investment outweighed that to individual for purchasing private housing flats in the mid-80’s, but the situation got reversed since late 80’s until after the burst of bubble in 1997.

Banks have been keen on trying channel their funds into mortgage loans, eg. Pushing down mortgage rates.

Chart 8 : Property Finance and Real Estate Cycle in HK

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Domestic Property Index

Real Estate Cycles in Hong Kong

Banks are pushing too much finance opportunities in good market, and

Setting too many barriers for bridging loans in bad times