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REAL ESTATE: Stamping out Speculators, Stamping on Occupiers-The Impact on Local HK and Foreign Investors
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SUMMARY
 
On 22 February 2013, the Hong Kong government announced new measures aimed at cooling demand for property. Stamp duty was increased across all price bands and standardised for both residential and commercial property. The minimum stamp duty, for properties below HKD 2 million, rose from HKD 100 to 1.5% of the purchase price, and the maximum, for properties above HKD 20 million, rose from 4.25% to 8.50%. The only exemptions are for permanent residents who (i) are first time buyers, or (ii) sell the only property they own to buy another within 6 months. Moreover, the stamp duty for commercial property purchases is to be paid upon agreement, rather than completion of the deal, bringing this sector into line with residential transactions. The Hong Kong Monetary Authority also imposed stricter conditions for banks to apply when assessing mortgage applications and reduced maximum LTV ratios. 
 
Commercial property under scrutiny
 
The announcement of a further round of cooling measures by the government after the local market closed last Friday was hardly unexpected. Government officials had been at pains to highlight a bubble in the residential sector. Indeed, since the previous round of measures were introduced last October, they had also been very forthright in stressing that they would take further action against rising prices. Moreover, various government spokespeople had, in fact, pointed to commercial property as an area that was being closely scrutinised. Despite the signals, government intervention in the commercial property market was not entirely expected given that Hong Kong promotes itself as a low tax area and free trade environment. However, as CBRE pointed out in a report entitled “Buying time: Residential policy moves in Hong Kong” published following the previous set of measures in October last year, “the consequences and outcomes of policy initiatives are not always predictable and can often bring about some unintended side-effects. If prices continue to rise at the current rate then we may see the introduction of further measures going forward and the market should therefore prepare for further uncertainty.”
 
The market assumes this intervention to be an exception to the norm and that the government will remain committed to a laissez faire management of the commercial property market. Furthermore, these measures are viewed as temporary and will be removed once risks subside. It should be pointed out that if the measures were to prove successful, there is a risk that government would gain an appetite for direct management of the market. While this would indeed be a cause for concern we do not consider it to be a likely scenario.
 
Why now?
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The policy measures introduced last October had the effect of making residential property less attractive for speculative investors. However, as CBRE highlighted in the aforementioned report, “while the aim of the latest measures is to curb speculative activity in the residential market, some investors may now turn their attention to commercial property. As such, we expect to see a rise in investor demand for strata-titled offices and industrial units given their relatively digestible lot sizes for private investors and ease of management”. This has undoubtedly come to pass. Such is the demand for property that investment activity has moved beyond the core sectors and we have seen significant demand for car parking spaces, which have generally been snapped up when released for sale. In recent weeks we have also seen, for the first time in Hong Kong, an existing hotel being sold off room by room to private investors (as land lease conditions prior to 2003 permitted this activity).
 
What can we expect?
 
The immediate effect of the new policy measures will likely be to limit the purely speculative and short term trading activity that had intensified in recent months. This will impact mostly on strata title investments, which made up over 50% of investment activity in 2012. Across the market as a whole, we may see heightened uncertainty over the coming weeks and greater volatility in investment volumes. However, these short-term effects are likely to dissipate once investors digest the new measures and come to terms with the increased cost of transactions. As we have seen with previous policy measures, and in other jurisdictions, market forces adapt to form a new equilibrium. In fact, in the six most significant rounds of policy measures aimed at the residential market since October 2009, prices had recovered to pre-policy announcement levels after just one month. With regards to the current measures, while buyers and sellers may take time to adjust, long term commercial property investors will be least affected as immediate capital gain is not a driver of demand and greater focus is placed on property fundamentals. The government’s stated objective for the residential market is to increase land supply for development. However, given the lengthy development process, short term policy has been directed towards counteracting strong demand. While there may be some debate regarding the need for new supply, the government has been very clear in its intentions. Unfortunately, there appears to be no plan in relation to commercial real estate.
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What is the real issue?
 
Hong Kong has an acute lack of commercial space, whether it is office space, retail shops or industrial units. The overall vacancy rate for the office market is less than 3%, despite demand running at half its long term average. When economic activity picks up, demand for office space will follow suit and the space shortage will intensify. Long term urban regeneration plans may be laudable but a lack of clarity and urgency is a major concern. The lack of commercial space logically feeds through to a lack of available investment grade product on the investment market. It also underpins expensive rental levels in Hong Kong and this generates greater interest among investors. In addition, occupiers unable to find suitable space to lease are increasingly turning to the investment market to satisfy their requirements.
 
Companies are currently more cost conscious and some large office occupiers from the finance and banking sector find their margins reduced, perhaps permanently, as a result of weaker business and more stringent requirements and regulations following the global financial crisis. Indeed, businesses currently seeking to expand are generally from lower margin sectors. However, the lack of available space is most acute in cost effective areas, such as decentralised Hong Kong Island and Kowloon. As a result, small, medium and large enterprises compete with investors to secure office space, therefore driving up prices. In the industrial sector, government policy with regards to increasing the supply of residential sites through the revitalisation of industrial space is also squeezing occupiers. This is in a sector which has a vacancy rate of just 1% for warehouse space and where a new 2.4 million sq ft logistics development (Interlink) was 99% pre-let upon completion in 2012. Moreover, space vacated by occupiers moving to Interlink was quickly back-filled due to the strength of demand and lack of alternatives. Of immediate concern to occupiers is security of tenure in existing locations and this is a motivating factor behind some investment deals completed for own-use purposes.
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Looking ahead
 
We agree that measures are needed to address a structural problem in the Hong Kong real estate market. We do not, however, expect the ‘knee jerk’ policy measures introduced to have any lasting effect beyond reducing short term speculative activity. Furthermore, we do not believe that this intervention will lead to a substantial market correction, but rather a slowdown in overall transaction volumes, in the short term. Of greater and more immediate concern though is the lack of a plan to tackle the shortage of commercial space. Government intervention in the commercial property market may have a short term role but will prove pointless if the issue of undersupply across all sectors is not addressed. Increased supply would lead to an easing in rental levels and make the market less attractive for short term speculation. Capital value growth would then ease in comparison to the rate seen in recent months.

By Edward Farrelly 
 
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