The intense interest for a residential-property site in Hong Kong's rural New Territories shows how mainland Chinese companies are edging their local rivals out of their own city.
Flush with cash that they are desperate to get out of the mainland, Chinese companies are willing to pay over the odds for even modest sites. That is driving up prices in what's already the world's most-expensive place to buy a home.
Higher land prices present a problem for Hong Kong's listed developers, who will be forced to cope with thinner profit margins. It's also well worth watching the shares of listed mainland developers to see if they're able to learn lessons abroad that they can apply at home, where building standards are frankly shoddy.
Hong Kong is a microcosm of an expanding trend, typically the first destination for a mainland company that is keen to branch out. Sydney, San Francisco, New York and London are also on the shopping list for Chinese property developers, and increasingly, smaller U.S. cities, too.
Chinese developers bought 30% of all the land sold by the Hong Kong government in 2016, having been entirely absent from the market until five years ago. Most recently, mainland developers feature heavily among the 35 formal expressions of interest lodged with Hong Kong's subway operator, the MTR Corp. (MTRJY) , for a site at the Kam Sheung Road Station.
The location, although just some 20 miles away, is considered the boonies compared to Central and Hong Kong island. At 18.1x income, downtown Hong Kong is the least-affordable place to buy residential real estate, according to Demographia, as I explained at the start of the year.
Kam Sheung Road is instead in an area that still has the occasional pig farm and is otherwise dominated, industry-wise, by automotive scrapyards. Still, in bidding for the site, Hong Kong developers face competition from China Overseas Land & Investment (CAOVY) , China Resources Land (CRBJY) , the overseas arm of China Vanke HK:2202, and Yuexiu Property Group (GUAZY) .
Yuexiu is smaller, but otherwise that's a virtual "Who's Who" of the mainland's largest property companies. The mainland companies KWG Property HK:1813, Logan Property HK:3380, Shimao Property HK:0813, Sino-Ocean Land (SIOLY) and the family of the management of Agile Property (AGPYY) have all also bought sites recently in Hong Kong -- among others.
The latest site would yield 1,652 apartments and 1.23 million square feet of residential development. Appraisers have valued it at around HK$8.4 billion ($1.1 billion), according to the South China Morning Post, or HK$6,800 ($874) per square foot. That's a far cry from the HK$30,900 ($3,970) paid in May 2014 for raw land on the luxury "South Side" of Hong Kong island.
Those prices seem bargain-basement to Chinese property companies. Luxury properties in Shanghai and Beijing, while not quite at Hong Kong levels, are still shockingly expensive. And the Chinese companies are desperate to diversify away from a weakening currency and slowing economy. They also hope to learn from the approach of overseas partners and competitors.
The local developers trying their luck at auction include New World Development (NDVLY) , the property subsidiary of Wheelock (WHLKY) , Cheung Kong Property Holdings (CNGKY) , Henderson Land (HLDCY) , Sino Land (SNLAY) and two privately held developers, Nan Fung Group and Chinachem Group.
The Hong Kong companies will have to compensate for higher land prices and therefore lower margins by boosting sales, according to a Feb. 27 report from Standard & Poor's. The "crowded and competitive" market for bidding on development sites will keep a floor under prices for raw land, the rating agency says.
Since November, HNA Group, the privately held parent of Hainan Airlines, has bought four plots at the site of Hong Kong's old airport, Kai Tak, which is being redeveloped. With the company paying an average of HK$13,415 per square foot, home prices nearby have risen by almost half, according to the brokerage Jones Lang LaSalle (JLL) .
The K City development, being built at Kai Tak by the Hong Kong company K Wah International Holdings (KWHAY) , has been selling for around HK$18,900 per square foot. That's a surge of as much of 50% from market expectations prior to HNA's acquisitions, JLL says.
Poly Property Group, the Hong Kong sister company of the mainland developer Poly Real Estate SH:600048, in March launched sales of its first residential development in the city with Vibe Centro, another Kai Tak project. It paid HK$3.92 billion ($500 million) for the site in 2014. Poly priced its units at close to HK$20,000 per square foot.
To compensate for the high price, Poly has joined the ranks of developers offering "nano flats" that are within the budget of first-time buyers. Some of the Vibe Centro apartments are as small as 228 square feet. Other developers have launched apartments measuring less than 200 square feet even on Hong Kong island, in higher-end neighborhoods such as Central, Western and Wan Chai.
S&P forecasts that property prices will fall 5% to 10% this year in Hong Kong, with the supply of new flats increasing and interest rates -- linked to U.S. rates thanks to Hong Kong's dollar-pegged currency -- rising. But the market has defied all expectations so far. Prices in April are at an all-time high, according to the property brokerage Centaline, virtually triple their 2008 lows.
Hong Kong developers could withstand even a 20% decline in home prices and rents before running into problems with debt, S&P believes. Transaction volumes should improve up to 5% this year, pushing developers to go for bulk sales to compensate for trimmer margins.
S&P calculates that the average home-owning household is spending 63% of its income to service mortgage payments, above the long-term average of 50%. Every 100 basis-point increase in interest rates should weaken the debt-servicing ability of Hong Kong-ers by 10%, S&P believes.
A significant fall in house prices in Hong Kong is unlikely, however. More than 60% of homeowners have paid off their mortgage altogether. Holding power is strong, and there's none of the massive leverage that led to the crash during the Asian Financial Crisis 20 years ago, when households were spending more than 100% of their income on home loans.