The warm reception of the List by the market is due mainly to the careful planning that was put into it to balance many different interests:

• Out of the 17 sites available, 14 are for residential and 3 for commercial usage. Based on areas covered, their relative ratio is 8:2. Out of the 13.02Ha of total areas, 10.45Ha are for residential usage, with new units to be constructed only half of market expectations.
• There are about 7800 new units that can be built on those 14 residential sites, 62% less than the 20500 potential new units from the last land auction. Taking into account of 3 years of construction lead-time, the first batch of units will not be completed until 2007/08 at the earliest. Combined with other projects already underway, supply of new flats in 2007 could well dwindle to just 10000 units, the least since 1976.
• As a result, the year 2004, 2005 and 2006 are most likely spent on digesting the 79000 new units that are either under construction but not yet sold or offered for sale or other unsold inventories. Post 2006 supply of new flats could well become insufficient.
• The 8:2 ratio of residential to commercial sites is appropriate given current market demands. 9 out of the 14 residential sites are less than 1Ha. And the 3.3:6.7 ratio of R3 sites to R1 & R2 sites satisfy the needs of luxury flats and smaller units development blueprints by different developers.
• The 17 sites sidestep those oversupplied districts such as West Kowloon and Tseung Kwan O, paving the way for more balanced property market developments.
• The 17 sites are estimated to be worth between HKD14-17bn. If they were all auctioned off subsequently, Government receipts could be second only to the record HKD32.2bn received in the 1997/98 auctions in the post handover history, which bodes well for Government finances.

The List Upholds Market Orientation Principle

In the Chief Executive's 2004 Policy Address, the property market was no longer the main focus. The Application List released days later serves as a good complement to the Government's housing policy. The market votes for it with confidence because the List is consistent with the "small Government, big market" doctrine that the Government first proposed two years ago and then carried through with steadfast determination. The housing policy has thus turned decisively market oriented.

In the November 2002 Housing Policy Statement delivered to the Legislative Council, the Government had fundamentally shifted its policy agenda. The statement clarified that the Government was to provide subsidized rental housing for families in need, and that the Government would withdraw from the role of property developer by halting the production and sale of public subsidized flats, thereby minimizing its intervention in the market. As for the future role, it should principally focus on land supply and provision of rental assistance only. It decided to cease land auctions altogether and halt the Application List until end of 2003. One year later on October 15, 2003, in another statement on the implementation and consolidation of Housing Policy to the Lego, the Government reasserted its commitment, proposed to coordinate with railway property projects and vowed that new land supply would only be triggered from the List thereafter. Although this amounted to almost a "non-measure", the resumption of the Application List was considered by many fresh evidence of the Government's withdrawal from the market and letting market demands dominate the housing policy.

The Application List used to coexist with regular land auctions. Market opinions had it that before the List was halted in 2002, many sites included lacked market interests. And those that were left off in the List were usually retained in next year's. Along with regular land auctions, the system seemed to work by the Government deciding on behalf of the market what real demands were. As a result, it was not a true market oriented mechanism. Now that regular auctions are suspended indefinitely, land supply hereafter will only come from the Application List. Under the system, interested developers may submit an application to the Government for any of the sites on the List, offering a minimum price as well. If the Government considers the minimum price acceptable, it will put up the site for sale by open tender or public auction, taking the offered price as the upset price and following the principle of selling the site to the highest bidder. In case the upset price is not met in auction, the Government will withdraw the site to ensure that public assets are not sold at unreasonably low price. By doing so, the Government has completed the transformation from actively targeting supply and acting as a developer to subjecting the property market development to market demands. In addition, the sites selected in the List showed careful planning aiming to reduce Government intervention and increase transparency. Thus from now on, market participants will bear the results of pure market volatility without unnecessary Government interventions, which should be a win-win situation for both parties.

The System Still Has Room for Perfection

Since this is the first Application List under the current system, the Government is inclined to refraining from adding new sites into it. Instead, it wants time to examine market's response for further revisions. Therefore, the system is still in its initial stage, and its implementation and perfection will remain the focus of market attention.

Even with such a system, the Government indeed can still target supply indirectly by influencing the choice and quantity of sites selected into the List. Three scenarios exist. Under the first scenario, market demand could be tremendous and overwhelm the land supply in the List. Under such circumstances, although the Government is not prepared to add to land supply in the short run, it will have to study whether a more flexible mechanism needs to be in place when the property market resumes healthy growth. Otherwise, with short supplies, property prices and developers' stock prices could be squeezed higher within a short period, creating the impression that the Government is supporting high land price, which is inconsistent with its original intention of withdrawing from the market. Under the second scenario, demand and supply could reach equilibrium, achieving the goal of the List and the emergency system needs not to be triggered. Under the third scenario of oversupply, whether the sites left unattended to should be retained in next year's list as usual needs to be studied. An alternative is to adopt an independent annual review process. Besides these scenarios, the issue of consulting developers and professionals before compiling the List needs to be studied as well because it affects the quality of the List. Systematic approach, transparency and market neutrality should be the major considerations of the consulting issue.

According to the List, the production volume for the year 2007/08 could well be the lowest since the handover (or in 30 years). In order not to create a supply gap after absorbing excess supplies within the next three years, there are measures that could be taken by both the market and the Government. On the market side, developers could increase supplies by expediting the process of compensating for land price premiums or converting land usage. Judging from recent stock placements and convertible bonds issuance by certain developers, the market may already set in motion such procedures. On the Government side, it can still resort to the delayed development projects by the two Railway corporations and the empty public subsidized flats. But it must be emphasized that these should remain the last resort only, after being systematically and cautiously designed. Otherwise the market sentiment could be damaged if an impression is created that the Government still intervenes in the market based on its own assessment of the development trend of the property market. The best solution may still lie in the market itself.


Potential Impacts on the Property Market

At yearend 2003 when we made our official forecasts about the property market's trend in the coming year, we concluded that economic fundamentals had reversed course, which should be sufficient to turn the five-year slump in the property market around. With the Hong Kong dollar weakened further along with the US dollar, pressure on general property price was further reduced. It was only due to oversupply concerns that our forecast maintained a cautious tone by predicting a moderate 5% rise in general price level based on the Price Index compiled by the Rating and Valuation Department. Transaction volume was expected to rise more by 20%. And luxury flats will see the most gains, matching historical pattern in the early stage of economic recovery. Judging from the market's reaction to the Application List, price performance of the overall property market may overshoot our forecast.

According to the Government's own estimates of private property market supply in mid 2003, in the next several years, flats under construction but not yet sold or not yet offered for sale amounted to 59000 units. Unsold flats of completed projects amounted to 20000 units, bringing the total to 79000 units. In the 5 years of 1998-2002, take-ups totaled 101040 units or 20000 per annum. And considering there may be certain vacancy ratio for the purpose of turnover, then the potential new supply of 79000 units could be naturally absorbed in the years of 2004, 2005 and 2006. Of course, the property market development is always dynamic. Take the year 2000 for example when Hong Kong's real economy grew by 10.2% because of the stock market bubble, the take-ups for that year surged to 29180 or 50% higher than the five-year average. Therefore in 2004 if Hong Kong's economy could grow by about 5% according to consensus, take-ups could well exceed the 20000-unit average again, thus possibly putting an end to oversupply ahead of schedule.

In this case, new supply of private flats in 2007 could well make multiyear low. And because of the more balanced developments among different areas, the overhanging oversupply situation in the private property market could be reversed completely. Then the development projects by the two Railway corporations and other public housing schemes will become the key to the market. Currently, KCRC's development projects could yield 46000 units, and MTRC 21000 units according to estimates. In the Housing Policy Statement of October last year, the Government said that arrangements had been made with the two corporations so that KCRC's flats would come into the market no earlier than 2008/09, and MTRC's units in 2007 at the earliest. This paved the way for the market to digest oversupply in the next three years. Yet it also raises the question of what to do after 2007. As the Government's arrangements with the two Railway corporations are not permanent ones, their development projects could still impact the market in the medium run if no solution is found in the next few years. If this is to happen, although the Application List System is more market oriented, the property market could still experience an unwelcome boom-bust cycle as a result. Therefore, the three parties need to work out a solution.

The general property price could rise well before oversupply is eliminated by 2007 simply due to market expectations. But if price surges too fast within a short time frame such as 12-18 months, it may not be in the best interest of the healthy development of the general market. Current economic fundamentals are not supportive yet of large surge in property price as economic transformation and the demographic and educational reforms are all long-term endeavors. The closer economic partnership between China and Hong Kong tends to cap the upside of premiums that Hong Kong properties enjoy relative to China's. The convergence of the H share and A share prices last years are satisfactory to investors because it was achieved by H shares rising more than A shares. The convergence of property prices on both sides should take the cue from stocks. If unfortunately, it is Shenzhen's price that rises but Hong Kong's that declines, or the already expensive Hong Kong property price rises more than Shenzhen's, expanding its premiums along the way, then it would not be consistent with principles of economic integration. In view of these, it would be a better outcome if Hong Kong's property price could maintain a steady instead of volatile uptrend in the medium to long run. Recently, because of hot money inflows, the banking system's aggregate balance continues to expand and interbank and deposit rates are reduced to almost zero. Hot money may partially flow into the property sector as a result. As expectations of dwindling supply continue to grow, the probability that rise in property price deviates from economic fundamentals has increased. While everybody is finding solace in the reviving property market, caution must be exercised toward such a development as well.

Dai Daohua
Economist