Do rising interest rates In the US point to a downturn in Hong Kong property prices?
August 22, 2013 / By
Since the US Federal Reserve announced its intentions to taper its bond purchasing program in May, yields on long-dated treasuries have been steadily rising as investors exited the market. The sell-off has seen yields on 10-year Treasuries rise by about 80 basis points since the announcement and on Monday (19th August) reaching their highest level since July 2011.
While the Hong Kong stock market was down by as much as 15% in June, following the US Federal Reserve’s announcement (the local bourse has since recovered to be down by just 3%), yields and pricing in the city’s property market have remained largely unchanged.
Given the currency peg between the US and HK dollar, one would expect that rising interest rates in the US would translate into higher rates here in Hong Kong. So are Hong Kong property prices about to go over the falls?
Not so fast.
The current yield spread between Hong Kong property and US bond markets can be largely explained by interest rates moving up at the wrong end of the yield curve. While the rise in long-dated treasury yields has increased the cost of borrowing for institutional investors and developers seeking to raise capital through the bond markets, interest rates on short-dated Treasury Bills, which policy and bank borrowing rates are typically referenced to, have and continue to remain at close to zero per cent. This means that holding costs enjoyed by most property owners in Hong Kong remains unchanged. While the higher “risk free” rate offered by long-dated US Treasury bonds have raised the yield expectations of property investors, very few of those who are already invested in the local property market have shown an inclination to exit the market and even less have been willing lower asking prices to exit the market.
The reluctance on the part of owners to lower prices stems largely from the low holding cost environment. The disincentive for owners to exit the local property market is further heightened by the resilience of the commercial and residential leasing markets, where rents have generally held steady or slowly crept higher over the past six months. The current policy environment also makes it difficult and more costly for investors to re-enter the local property market should they choose to sell because of the higher transaction taxes.
So what can we expect moving forward? Firstly, while higher interest rates will likely continue to put upward pressure on property yield expectations over the near term, any broad based correction in property prices in the immediate future is unlikely. Some segments of the local property market, where pricing has moved significantly ahead of rental growth expectations could see a correction in prices but we do not expect any correction to be severe or widespread. Secondly, the higher expectations on cap rates will likely be met through rising rentals rather than the lowering prices. Thirdly, we maintain our view that a broad based cyclical correction in prices is unlikely to materialise until policy rates clearly begin to move higher, which we still do not foresee happening until 2015.
