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&section_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.
Enquiries to:
[email protected]
60