Some warn about an imminent plunge of property prices triggered by the global credit market turmoil, which has seen its impact on the local stock market. The Hang Seng Index has lost about 30% from its October 2007 peak, wiping out more than HKD7 trillion of wealth. While both sectors tend to be affected by some common factors, the stock and the property cycles are not necessarily synchronised.

The culprits of previous major property downturns were excess supply suppressing prices and rising interest rates and high property prices eroding buyers' affordability. The present rally is likely to be resilient, underpinned by tight supply, more favourable affordability and negative real interest rates.

End-user demand for residential property looks set to surge, underpinned by a comfortable level of housing affordability. Our calculation shows that if mortgage rates stay benign and household income grows steadily, the affordability level would not deteriorate to 1997 levels unless property prices soar 30% per annum for the next three years.

While buyers can afford to buy, the anticipated future annual supply of 11,000-12,000 units in the next few years can hardly fully match the demand for 17,000 new units every year. The perceived shortage has been attracting speculators to the market. Speculative activities, as measured by confirmor transactions, are on an uptrend. Nevertheless, confirmor transactions as a percentage of all secondary transactions were mild at 4.3% in February 2008, well below the 9.7% at the peak of 1997.

Investors are also shifting their money to residential properties to get better returns. Low borrowing cost at 2.5% relative to higher property yield at 4%-5% makes property investment more attractive.

The perceived supply shortage in a few years' time is the key to the latest property market rally. The government's upward-biased land policy plays a role. Recently, lands were sold at sky-rocketing prices, which is an important indicator of future property prices. More land sites would be put onto market this year as announced in this year's Budget. But, it often takes more than three years from a land sale to the completion of a project.

The risk is less of an imminent correction, but more of property prices being pushed even higher on continued anticipation of tight supply. This will elevate the risk of a bigger adjustment in the future when supply inevitably increases or future property demand weakens.

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Economic Focus (March 27, 2008). Hang Seng Bank Limited. All rights reserved. Reproduction of article(s) in whole or in part is permitted provided the source is quoted. Please direct any inquiry to Treasury, Planning and Research Department, G.P.O. Box 2985, Hong Kong.