A Talk to Department of Economics & Finance, CityU, 8 March 2014 Why Real Estate Developments Can Make Huge Profits in Hong Kong? by Dr Edward CY Yiu Associate Professor Urban Studies Programme Chinese University of Hong Kong 1 How Big is the Difference? • From 2010 to 2013 – Interest rate increased 20%; – Housing Rent increased by40%; – Housing Price increased by 80%. 2 Benchmarking of EBITDA Margin Company EBITDA Margin 2012 Company EBITDA Margin 2012 SHKP 40% SJMH 10% Swire Properties 68% Giordano 19% Link REIT 69% Macau casino 24% Company Gross Profit 2012 URA 123% Avenue by URA 237% Why Developers Can Outperform Others and Achieve Excessively High Margins? 3 4 Ways of Making Profits • Monetary Policy (negative real interest rate) – borrowing capacity determines winners • Too Big To Fail (Government Bailout) • Land Policy (monopolistic and limited land supply, oligopoly real estate supply, …) • Development Financial Engineering (PPP, RDI, Concessions, …) 4 Negative Real Interest Rate • Gordon Growth Model – Constant rental growth rate (g) – Discount rate (r) 2 T -1 ( ) ( ) ( ) + + + a a1 g a1 g a1 g + + + + P0 = K 1 2 3 (1 + r ) (1 + r ) (1 + r ) (1 + r ) T t -1 T a(1 + g ) = t ( ) + 1 r t =1 a = if T and r > g r-g Negative Real Interest Rate a = $200,000 g = 2% Discount Rate (r) % change Property Price % change Scenario 1 r = 6% Scenario 2 r = 5% 1% $6,666,666 33% Scenario 3 r = 4% 1% $10,000,000 50% Scenario 4 r = 3% 1% $20,000,000 100% Scenario 5 r = 2.5% 0.5% $40,000,000 100% Scenario 6 r = 2.1% 0.4% $200,000,000 400% $5,000,000 250 When Discount Rate Comes Close to Expected Growth Rate, Property Price Increase can be Non-linear 200 Property Price ($m) v. Discount Rate (%) [assume g=2%] 150 100 50 0 2.10% 2.5% 3% 4% 5% 6% Negative Real Interest Rate drives Property Price Up • Both theoretically sound; and • The only one empirically confirmed in the following 3 dimensions! • It is empirically valid in the past data; • It is empirically valid in other countries; • It is empirically valid in prediction (future). Theoretical Logic • RIR = -4.17% in Feb. 2013 • mortgage payment < rent; • hibor (0.23%) < inflation rate (4.4%) • mortgage rate (2.25%) < yield rate (3.3%) • rental growth in 2012 (13%) • price growth in 2012 (28%) • -RIR tempts people to borrow and invest in the housing markets to reap "no-risk" returns and to hedge inflation! • -RIR enlarges the wealth disparity!! http://news.hkheadline.com/dailynews/headline_news_detail_columnist.asp?id=231 644§ion_name=wtt&kw=222 Casual Observations • confirmed the negative relationship hypothesis: • ignore the risk premium first. HIBOR % CPIA yoy % RIR HPI (yr end) 1996 2001 2006 2011 5.48 3.44 4.21 0.27 6.31 -1.60 2.03 5.51 -0.83 5.04 2.18 -5.24 134.5 73.8 93.8 181.1 Why RIR is Negative in HK? • Currency Board Arrangement • Currency exchange rate is fixed! – Linked Exchange Rate (peg) US$1 = HK$7.8; • Interest rate is fixed! – If the rate does not follow the US's, arbitrage can make no-risk profit!! (carry-trade) • Inflation does not follow – Economic conditions very different from the US; – When the economic conditions are opposite, then – Either a LOW INTEREST RATE + HIGH INFLATION; – Or a HIGH INTEREST RATE + HIGH DEFLATION. Intertwined Extraneous Factor - US Currency • US Currency strength – when US$ is weak (as in the 2000s); – foreigners find HK's factors of production cheaper; – attracts foreign funds inflow from strong currency countries into HK to speculate on the negative RIR. – Normally, US currency goes in the same direction of nominal interest rate; – It aggravates the negative RIR effects. US currency index drops from 120 to 70 and back to 80 1/2008 1/2000 1/2013 US interest rate drops from 6.25% to 0.25% Prediction of a Housing Bubble in Oct. 28, 2009 Yiu, C.Y. (2009/07/15) Negative Real Interest Rate and Housing Bubble Implosion - An Empirical Study in Hong Kong, SSRN The prediction was made when the CCL = 75; The recent peak was 123; Now it is 117! http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1434312 When did the Negative Real Interest Rate start? The prediction was made when the real interest rate just started to drop to negative zone (Nov. 2008); It is – 4.17% (in Feb. 2013) Asian Financial Crisis 1997 HK RIR v. HPI yoy of HK RIR v. HPI yoy of HK Subprime Crisis 2007 - US Real Interest Rate of US Negative 2003 - 2005 • Negative 2% in 2003 2006; • Subprime crisis in 2007; • Now, RIR is positive because of deflation. US Annual Housing Return v. RIR A More Robust Empirical Test 2010 JFMPC 14(3), 257-270 Econometric Models' Results -0.83% -2.61% Strongly significant NEGATIVE effects of both positive and negative RIR, but the impact of negative RIR on housing return is almost 5 TIMES stronger! Why Excessive Profits? •Developers know very well about the relationship, and can: •Buy more land •Borrow more money from bankers •Sell less (reduce supply) •Money supply is exogenous •Land supply is monopolized •Property supply is oligopolized 3-party supply control • Tri-party works together to monopolize money-land-property (MLP) supply; • MLP-supply determines space value and therefore investment demand. Control Government Land & Use Money & Credit Property & Type Bankers Developers 24 Too Big To Fail • Moral Hazards • When property price dropped in 2003, the government took all measures to stop it, including: – Stopping land sales; – Stopping subsidized housing (HOS) constructions; – Lend interest-free money for buyers to buy flats; – Open up the housing markets to international buyers; – Investment immigrants could invest property to fulfill the required investment amount. • Bankers and developers are too big to fail? – If they earn money, it is their rights; – But if they lose a lot of money, they would be bailed out. • i.e. returns are developers’ and bankers’, risk is taxpayers’ ! 25 How Big Are Developers? Company Ticker Mkt Cap (US$ in Million) 2013 CKH 1 36,596 SHKP 16 34,123 HLD 12 15,766 Sino Land 83 NWD 17 Kerry Prop 683 Great Eagle 41 Hang Lung Prop 101 = 9.2% of total Mkt Cap of Stock Ex HK HKL 8,224 8,548 8,599 2,251 14,903 14,163 Hysan Dev 14 Swire Prop 1972 15,694 Wharf (H) 4 25,381 Link REIT 823 11,569 Total Mkt Cap https://markets.jpmorgan.com/research/email/v8a880j2/GPS-1267943-0 4,939 200,756 26 Government’s Supportive Roles in the Housing Sector Income Govt cannot let housing price drop Bank Risk Users (Quarters) and Facilitators (Loans) BANKS / HKMC Investors Sole Land Supplier (18% land sale income excl. other related taxes) Govt’s Roles in Housing Market Monetary Policy Policy Maker and Law Enforcer Developers Negative equity and unemployment Biggest Developer and Housing Owner (Public Housing) Private Housing Market (50% households are owners) Private Renters [15%] PRH [30% households] HOS [20%] (by queuing) (by lucky draw) Development Control 27 Land Policy • • • Monopoly of land supply – 99.9% of land are owned by the Government – Land grants are in leasehold interests (mostly in 50-year tenure) – Land Resumption Ordinance allows resumption of land without compensating hope value – Only 24% of land area are zoned for development – Government wears 2 hats: a landlord and an enforcer of land policy and regulations (Conflict of Interests) – Government, when in the capacity of a landlord, does not have to comply with Administrative Law Limited land supply (There is NO High-Land-Price-Policy) – Max 50 ha land sale per annum from 1985 to 1997. – Land sale was virtually suspended from 2000 to 2008. Oligopoly of property development – Huge sum of land premium set a high barrier. – Giant 4 (Big 11) developers take almost all the shares. – Land banks more than the government. – Collusion is easy and possible. – Virtually no foreign competitors (local knowledge and insider 28 information are crucial, see below) Restrictive Land Supply Bef 1997 Land (for all uses) < 50 ha Private Housing Units to be built Ave. 26,000 2011/12 36.8 ha 9,450 2012/13 30.2 ha 10,150 2013/14 25.8 ha 13,550 Target - 20,000 Limited Land Supply • Peng, R. and Wheaton, W.C. (1994) Effects of Restrictive Land Supply on Housing in Hong Kong: An Econometric Analysis, JHR 5(2), 263-291. – “When restrictions lead to an anticipated reduction in overall land supply, the housing market (correctly) expects higher future housing rents, … capitalized into higher current housing prices.” 300.0 40000 35000 250.0 30000 200.0 25000 150.0 20000 15000 100.0 10000 50.0 0.0 HPI Completions (RVD) 5000 0 30 Zoning Effects: SIN v HK Land Use Area (ha)Res. 2010 SIN 2012 HK 10,000 (14%) 9,760 (9.5%) Ind./Com. 9,700 (13%) 2,300 (2.1%) Green 5,700 (8%) ~73,000 (66%) GIC 5,400 (8%) 3,700 (3.5%) Total 71,000 109,200 Land is NOT limited but is at the sole discretion of the government. Country/ city GDP per Capita 51,704 Ave. Living Area (sf) 2,476 Per Person (sf) ~800 US Taiwan 38,357 1,119 ~370 SIN 60,799 1,044 323 Tokyo 35,855 667 ~220 Shanghai 9,055 560 194 HK 50,936 452 161 Ave per person living area of HK = 0.5 of SIN Price to Income Ratio: HK 2011 = 12.6, 2012 = 15 SIN 2011 = 4.4 Collusions • 2003: Hunghom Peninsula case and Mr Leung Chin Man (BD Director). • 2013: An alleged bribery case brought against former Chief Secretary for Administration, Mr. Rafael Hui in connection with several directors of Sun Hung Kai Properties (SHKP), the largest property developer of commercial buildings in Hong Kong. 36 Development Financial Engineering • Private Public Partnership (PPP), such as BOT, BOOT, Sale and Leaseback, … (公私營合作模式) • Concessions (發水) • Land Premium Waiver (地價減免) • Residual Development Intensity (剩餘發展規模) 37 PPP Developer: NWD main contractor: Hip Hing Project Outcome: • TDC have a world class CEC at no capital cost; • NWD took 2 world class hotels, an office tower and a serviced apartment tower at no land cost; • The site was gifted by the Govt in 1984. 38 Ma Wan Park and the Park Island Develop 5,000 residential units, GFA = 3.7 million s.f. Conditions: Provide a public theme park of 2 million s.f. SHK has to invest $1 billion in the park SHK bears the costs of relocation of villagers Cyberport (or Bel Air?) The Government's equity contribution will be based on the land value assessed at the time of grant of the development right; PCG's capital contribution is estimated at $7 billion. Why PCG? Any tendering process? Government Share of the Profit? $4 b Free Land Premium - URA Items (HK$ million) 2009 2010 2011 2012 2013 Revenues 1,413 9,663 3,647 3,690 5,341 (4,685) 6,993 2,159 2,431 4,292 (41) 6,977 9,186 11,770 16,207 (216) (3,177) (922) (64) (1,018) Surplus without land premium waiver (4,675) 3,841 1,287 2,520 3,419 Accumulated surplus without land premium waiver (1,366) 2,475 3,762 6,282 9,701 % of waiver to 45% 43% 3% surplus http://www.ura.org.hk/media/1736032/p97_financial_highlights.pdf 24% Surplus with land premium waiver Accumulated surplus with land premium waiver Land Premium Waived 41 Land Premium Negotiations • “…a modification is a contractual negotiation between landlord and tenant and should not be disclosed to any third party until the deal is done…” • Land Premium Negotiation is a black-box process: – No Public Scrutiny – No Judicial Review – No Evaluation or Auditing Process 42 Land Premium Case – Yan On Hospital • Only 54% of the site was used to build a hospital; • The remaining 46% of the site was rezoned to build private residential development; • Land premium $0.61b in 2004; • Hill Paramount was sold in 2010 with total considerations of $3.5b; • i.e. profit > $1.6b. • Profit rate > 100% Audit Commissioner Report http://www.aud.gov.hk/pdf_e/e5 9ch04.pdf (26 Oct 2012): 43 6 Types of Concessions 1. Disregarded GFA (Carpark and loading/unloading areas excluding PTT 2. Disregarded GFA other than carpark and L/UL areas (e.g. plant rooms and similar services) 3. Disregarded GFA in hotel under B(P)R 23A(3) 4. Exempted GFA of green features under JPN 1,2 5. Exempted GFA of amenity features and other exempted areas 6. Bonus GFA 7. Unclassified Concessions 44 Typical Concessions • Typical concessions include carparking space, balconies, working platforms, bay windows, clubhouses, utility, recreational facilities, amenties, … Cohorts Balcony Workin g Platfor m Externa l Wall Bay Window Others (Clubho use, …) 0 1972 36 0 45 0 1986 0 0 75 16 1993 0 0 61 52 2010 22 16 132 34 GFA SFA UR (%) 850 793 93% 907 817 90% 48 945 732 77% 7 1,030 785 76% http://hk.apple.nextmedia.com/news/art/20101016/14559693 Concessions – Harbour City case • Wharf Properties Ltd and Ano v. Eric Cumine Associates, Architects Engineers & Surveyors and Others Privy Council Appeal No. 45 of 1989, 1991 WL 1124849 (Privy Council), [1991] 2 HKLR 6, [1991] HKLY 747; [1991] 52 BLR 8, [1991] 2 HKLR 154, CACV000052/1988, CL 48/1985, and HCA 13431H/1983; Omission to claim Nonaccountable gfa (sm) Harbour City 6,029 Hotel gfa concessions (sm) 5,722 Ocean Centre 1,839 Marco Polo Hotel 1,184 Prince Hotel 1,480 Sub-total Total Dedication gfa bonus (sm) 6,029 2,664 16,254 7,561 Plot Ratio Transfer • Dedication and Surrender (to public use) • So called Bonus GFA; • stipulated in s.22 of the Building (Planning) Regulation. • If the dedication of set-back area for public passage or surrender of land for road widening at ground level is consented/acquired by the Government, • bonus GFA that equals to five times the area surrendered/dedicated or less than 20% of the permissible plot ratio, whichever is the less, may be granted in return for the private area surrendered/dedicated to the public. • HSBC ground floor concourse. UC - Change of site classification • Widening of street: – Island Resort project at Siu Sai Wan was changed from Class B to Class C, due to an increase of street width; – There are now substantial remaining plot ratio. • Marriage value: – Two Class B sites married and forms a Class C site; – Who owns the extra unused gfa? UC - OZP Conditions • Planning Approval Condition: – 13 carparking space should be restricted for the church users only; – There are now substantial remaining plot ratio. • Incompliance?: – CKH sold 11 out of the 13 carparking space to 3rd parties; – The Church agreed the sale; Our Lady of Mount Carmel Church Case UC - OZP Conditions are NOT Enforcable?! • Government said they have no right to enforce the conditions, and have no intention to follow up the case; • LD - no restriction of carpark sale; • BD - not related to health and safety; • TPB - no restriction of carpark sale. Approved Building Plan shows that the carparks are for church use only UC - Lease Conditions • Estoppel: – A.G. v Fairfax Ltd [1997] HKLRD 243; – What is an European Villa? – Is a 14-storey building an European Villa? If it has been allowed to be built for 40 years, then … • No limit of height: – The height restriction is waived! – A tower of 38-storey was built! – Profit increased by 400%! Residual Development Each floor area = 400sm Intensity • Maximum permissible gross floor area = site area x designated plot ratio; • i.e. gfa = sa x pr; • Max plot ratio is 10.0; • Max site coverage is 40%; • Max gfa = 1,000 x 10 = 10,000 sm. • 25 storey x 400sm@ = 10,000 sm. • Covered area = 400sm (40% sa). • If only 10-storey was built, • Then 6,000 sm gfa remain. • RDI = 6,000 sm 25storey 10storey Site area = 1,000sm pr = 10, sc = 40% How RDI makes extra profit? • In plot ratio calculations, all the 4 lots are combined as one site area; • But in DMC and land sales, the 4 lots are separately owned; • When there are some remaining gfa in the plot ratio calculations, which owner of the 4 lots owns them? RDI: Who moves my cheese? • RDI is valuable, but: – It is NOT a tangible asset; – It has NOT yet existed; – It is just a rights (or a potential opportunity); – Yet, – It comes from the land; – It cannot be separated from the site area (gfa=saxpr); – Who owns the site, who owns the rights! RDI: CINAT case • Cinat Co. Ltd. v AG, PC Appeal No. 31/1994, [1995] 1 HKLR 128, from CACV000131/1993 and HCMP003876/1992 • At no. 121 King's Road, North Point, there is a triangular piece of land (IL no. 2273 S.A. and R.P.) was reserved by the Government for MTR station. • The then owner had agreed to dedicate the triangular site for public purpose. • In return, the triangular site area had been counted in the calculation of bonus site coverage and bonus plot ratio for the development of Carson Mansion. • But the Government did not sign the Deed. RDI: CINAT case • Is there any development potential of the subject site? • Interestingly, the appellant paid $12m to buy the triangular site and made application for a development of 36-storey commercial buildings. The BA rejected the application by stating that "...the permissible plot ratio and site coverage ... have been almost fully utilised." RDI: Mei Foo Sun Chuen Stage 8 Site Area : 183, 480 sf Was originally an oil depot Redeveloped in 1985 57 MFSC: Plot Ratio Calculations • gfa = site area x plot ratio • Site area = 183,480 sf • Included the remaining LPG tank (hidden line) MFSC: Who owns the Remaining plot ratio • Who owns the 1.0224 remaining pr? • If site area excluded the LPG plant, it should be owned by Stage 8 owners; • But the site area included the LPG plant, and can the owner of the LPG plant claims all the remaining plot ratio of the whole site? • The Government says YES! • Making huge profit from thin air? The End comments are welcome. 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