Liang Hongfu

HK estate model relevant

By Liang Hongfu (China Daily)
Updated: 2005-11-08 05:57

When the Hong Kong property market was on the boil in the 1980s and early 90s, many mainland enterprises jumped on the bandwagon and laughed all the way to the bank. At that time, there were enough profits for almost everyone to share. And the much admired and widely copied "Hong Kong model" of real estate development was born.

The model, which focuses on quick return of capital from pre-sales of apartments - sometimes before the first pile was driven, has been replicated in many mainland cities with considerable success. In a typical Hong Kong development project, the developer would arrange to sell all the apartments long before completion to one or more dealers who then market and sell to the public. It is common for each apartment to change hands several times before it is ready for occupation.

The developer is no different from a manufacturer to whom land is the raw material and apartments are the finished products. The faster the developer can churn its capital, the more property projects it can build to turn a profit. Such is the game many mainland developers have learned to play.

But even the well-tested "Hong Kong model" could not overcome the swings of the market pendulum, especially the one in 1997 that was greatly exacerbated by the outbreak of the Asian financial crisis. The subsequent collapse of the Hong Kong property market has greatly discredited the "Hong Kong model" that seemed powerless against the erosion of confidence that sent property prices plunging more than an average 60 per cent since 1997.

To be sure, none of the major property developers is known to have been in danger of default despite their high gearing ratios. But their way of doing business that brought them great wealth in the past has been increasingly brought into question by former admirers, especially those on the mainland.

More mainland property developers, particularly those who have studied in the United States, have shifted allegiance to what they called the "US model," which involves the use of different types of financial instruments to "spread" the risks arising from erratic price swings. This has given rise to the popularity of REITs, or real estate investment trusts, which are property-holding entities whose shares are traded on the stock exchange.

But Hong Kong developers need not feel dejected. There is nothing inherently wrong with their model.

It is just that they have never found the need to use REITs or any other exotic financial instruments to "spread" the risks. Instead, there is no shortage of dealers, agents and home buyers who are willing to share the risks with the developers so that they, too, can share the high returns. The rule of the game in Hong Kong and on the mainland is high turnover to generate high returns.

In a market where demand continues to outstrip supply, rental income is often too low to justify the holding of real estate with appreciating value. A property company that depends on rental income for its earnings will invariably become a take-over target of predators who can generate greater returns for shareholders by re-developing those properties for sale.

The Hongkong Land saga is a case in point. The "noble house" that owns nearly all the prime office buildings in the choicest areas of Hong Kong's central business district nearly fell prey to local rivals a number of times in the 80s and early 90s. Its "independence" was assured only after a complicated and controversial share transaction that established a takeover-proof cross-holding with its affiliate, Jardine Matheson.

The US model may sound sophisticated, especially to the ears of the US-trained MBAs who are conversant with the latest financial terminology. But it is a model developed in a market that bears little resemblance to the ones in Hong Kong or on the mainland.

If the use of financial instruments were such a great idea in Hong Kong, local developers and their highly-paid financial advisers would have already flooded the market with their issues. The fact that the Hong Kong government is the only landlord who has ever had a plan to issue REITs shows that the Hong Kong model is far from becoming obsolete.

Let us not exaggerate the power of financial instruments as a shield against risks. The Federal Reserve just issued a warning against the overheating of property prices in the United States.

Email: jamesleung@ chinadaily.com.cn

(China Daily 11/08/2005 page4)