This is the fourth of ten articles I intend to write on Hong Kong’s deep structural contradictions. In this and the next article I shall analyze housing and domestic property in Hong Kong. This area best illustrates one of the deep conflicts between the policies of Cowperthwaite and MacLehose, and their legacies.

Public pressure on government to reintroduce the Home Ownership Scheme (HOS) reappeared when negative interest rates and rising home prices in the private market reignited concern among middle income households that their aspirations for homeownership were being frustrated. This has forced the government to ask the Housing Society (HS) to develop 5,000 flats under the ‘My Home Purchase Plan’ making them available to people with a household income of under 39,000 HK dollars, or a personal income of under 23,000 HK dollars. After five years tenants in these flats are given the option of purchasing them or another unit. They have a two-year window in which to decide and can apply 50% of the rent, paid over the five years, towards their purchase. The core feature of the program is to provide a financial subsidy rather than a totally bricks and mortar approach.

　

Why Demand for Home Ownership is Hot

The government’s housing policy since the 1970s is best described in its four policy papers. The outcome of which is best illustrated by Table 1 below giving the percentage of households by tenure and the type of housing they have occupied  between 1971-2010.

Table 1

In 1972 the Housing Authority was created under the Ten-Year Housing program to provide decent living accommodation for 1.8 million people, over a ten-year period.  It aimed to achieve this by building 53 new public housing estates and converting 19 old ones. In 1978, the HOS, Public Sector Participation Scheme (PSPS), and other loan schemes were also introduced to meet residents’ aspirations for homeownership.  Eventually only half that target was achieved with the construction of 180,000 new public rental flats and 23,000 HOS flats providing housing for 1 million people.

In 1987, a new Long Term Housing Strategy was introduced to help families to acquire suitable and affordable homes. The emphasis was on constructing flats for purchase rather than for rental as a long-term solution to meeting the demand. By 1996, the total stock of subsidized rental and sale flats had reached 657,000 and 199,000, respectively. Like the 1972 Ten-Year Housing program the actual number of flats constructed was only half the original target.

Again, in 1997, a 10-Year Housing Plan was announced by C H Tung with the aim of building not less than 85,000 flats per year, of which 50,000 would be public housing. This was with the view that over 70% of people would have their own homes by 2006, with the added promise that the waiting time for public rental housing would shrink to three years. The Tenants Purchase Scheme (TPS) was announced in December 1997 to provide an opportunity for at least 250,000 families living in public rental housing to purchase their flats at affordable prices. This vision was one that would have been eagerly endorsed by MacLehose. Tung relied mostly on public provision for its delivery and to a lesser extent the TPS. The construction plan was pursued vigorously in the public sector by a strong leadership team and, in contrast to earlier programs, was kept on schedule. I have often wondered whether the Housing Authority’s unfortunate piling scandal was an inevitable outcome of the furious pace of development in this period.

The 1997 vision ground to a halt in the midst of the worst recession and deflation in Hong Kong’s history. In mid-2000, a Review of the Institutional Framework for Public Housing was commissioned by the government to map out a way forward. The Review was an important policy statement indicating that public resources should be (1) focused on meeting the demand from families in the low income group rather than meeting the demands of middle income households, and (2) administered increasingly through direct fiscal subsidy to meet such demand rather than a bricks and mortar approach.

These revised policies also represented a departure from the MacLehose welfare state approach that had dominated housing development since the 1970s. The 1997 vision went unmentioned. The report also halted the HOS and the TPS programs to ensure stability of the private housing market by avoiding overlap. The use of direct fiscal subsidy to help the lower income groups has not been followed up, but the waiting time for public housing rentals reached its three-year target  a few years ago. 

The government’s approach to policy decisions as a whole is now the source of much public criticism. And housing policy is one area where a solution can be found with relative ease and where the benefits from getting it right will yield huge dividends for society immediately and over the longer-term. Below I shall outline a solution and next week discuss its costs and benefits.

I believe there is an enormous aspiration within this community for home-ownership. The past 30 years have convinced the people of Hong Kong that property prices are highly volatile, but they will rise and anyone who is caught without a flat to call their own will have much to regret later in life. There are many reasons for this.

Firstly, the rapid economic development of the region will increase external demand for Hong Kong properties both as investment opportunities and status symbols.

Secondly, the heightened awareness of environmental protection and conservation has made development more difficult, uncertain and has already caused delays.  As supply slows property prices will rise.

Thirdly, although not all residents in Hong Kong are assured of a prosperous economic future, the city itself has a huge opportunity to continue to advance economically and its bright future will be reflected in inflated   property values.

Fourthly, Cowperthwaite’s legacy of low tax rates, limited government, and balanced budgets will ensure that policies that jeopardize  property values will have system-wide consequences, not least of which is the local banking industry.

Finally, with 53.4% of domestic households being owner-occupiers the advent of plunging property prices will not be politically popular.

　

Why Home Ownership is Difficult Among the Young

Public interest in home-ownership at present is of course fuelled by rapid increases in property prices, low nominal interest rates, negative real interest rates, and low unemployment. We witnessed a similar situation in the mid-1980s, so the public is familiar with it. The difference between then and now lies in the typical households’ economic circumstances. In the mid-1980s the transformation of Hong Kong from a manufacturing to a service economy was just beginning. Household income among the middle income groups was rising rapidly and was expected to keep doing so. People were confident that they could, over time, beat the rising property cycle.

Today, while we are facing the same set of conditions in the property market the typical middle income household is much less confident of its ability to get ahead of the cycle. The structural transformation of the economy is complete and many among the middle income groups are less certain of how rapidly their income will rise in the future, making them more fearful and desperate when property prices take off. And when they are advised to be patient, to start as renters before becoming homeowners, this advice falls on deaf ears and is perceived as irrelevant if not hypocritical.

According to a survey of 1063 individuals over the age of 18, conducted by Citibank in September 2010, some 80% of young households aged 18 to 29 claimed they needed financial support from their parents to make their first purchase. By contrast, among households over 60 years of age only 10% had needed to rely on parents’ financial support when they made their first purchase. These figures are not surprising. The older generation bought their homes before property prices accelerated ahead of income growth and at a time when the economy was thriving.

In a city economy where property prices, for whatever reason, rise faster than incomes over long periods of time, as they have in Hong Kong, the younger generation is unable to buy an inner-city home. In other cities younger people might buy in more affordable suburbs and gradually climb the property ladder. Developers build new homes in these areas for this very reason. But in Hong Kong in recent years the supply of land and new flats has lagged behind the rise in property prices. Now many cannot even afford to buy in remote locations.

Those among the younger generation that are fortunate enough to have wealthy parents can make property purchases in the city with their parents’ help. The onset of negative real interest rates and rising inflation have allowed existing property owners to re-finance their properties to make new purchases, often for their children’s use. My own observations suggest that most local purchases of new flats in Hong Kong in recent years have been made by households that have property of their own to begin with. Housing wealth is increasingly being concentrated among the haves. The have-nots are increasingly left out and they certainly feel this.

Governments everywhere have always reacted to public disquiet when property prices surge by clamping down on speculators. Such measures curtail price rises for a period of time, but they do not address the underlying reason for price surges – which is excess demand. Clamping down on speculation is sometimes justified to prevent the advent of asset bubbles. These are a problem only when there is excess leverage, not when there is excess demand. Excess leverage can be controlled through the regulation of bank mortgages. Excess demand must be addressed through one of two channels: increasing housing supply, or subsidizing the have-nots.

　

Trading-up is Limited to Existing Home-owners

The government has recently stated that the total supply of land for the coming year will provide some 30,000 to 40,000 residential flats and, in addition, the construction pipeline for public rental housing will provide 11,200 and 16,700 flats in 2011-12 and 2012-13, respectively. This is a bold attempt to correct the present excess demand. Whether it will happen in time, and at what point of the business cycle we will be when the supplies hit the market, is difficult to foretell in the present environment.  Manipulating housing supply to accommodate business cycles is generally a fool’s public policy; a point that was recognized in the 2002 Review. We may be lucky enough to get it right once but can we repeat the trick again?

The government’s ‘My Home Purchase Plan’ will introduce a fiscal subsidy to eligible citizens. It is interesting to note that as a fiscal subsidy it is consistent with the approach advocated in the 2002 Review against a bricks and mortar approach in favor of fiscal measures. But it is inconsistent in that it provides public subsidies for middle income groups rather than focusing on those of low income.

The policy issue today is whether we should meet middle class aspirations for home-ownership – a vision embodied in the 1997 plan discussed earlier. And if so whether we should achieve this through reviving the Homeownership Scheme, as has been advocated by many quarters, and thus continue the MacLehose legacy, or through some other means.

The last boom-bust property cycle, which corrected in 1997, left many of Hong Kong’s middle income households devastated. However, some came through and thrived. The current boom-bust cycle is likely to make the survivors of the last boom-bust cycle thrive even more, but the have-nots are unlikely to benefit much. This will polarize society where the housing ladder, so often seen as the means to savings protection and wealth enhancement, is no longer functioning for the have-nots. Intergenerational mobility is only available to those who already have propertied assets. I believe we should take on a practical vision to enlarge home-ownership in the community so that even the have-nots can benefit. This cannot be achieved through supplying more land, building more flats, and introducing measures like the ‘My Home Purchase Plan’ alone.

At the end of 2010, out of the total stock of residential flats an estimated 1.24 million (52%) were built by the private sector and 1.14 million (48%) by the public sector. Among domestic households, 37.5% were owner-occupiers in private housing, 16.8% were tenants in private housing flats, 31.1% were tenants of subsidized public sector flats, and 15.9% were owner-occupiers of subsidized public housing.

A reported 320,047 or 15.9% of domestic households are HOS owner-occupiers. These flats were sold at a discount to the owner-occupier over a period of 30 years with the discounted premium varying from 14% to 60% of the estimated market value at the time of sale; most of the flats were discounted by 30% to 45%. When these flats are subsequently sold on the open market (not the HOS secondary market of eligible purchasers) the owner must repay the HA the discounted premium. But this amount is determined on the basis of the market value of the flat at the time when the premium is paid, not when the unit was first purchased from the HA. Such a method allows the HA to capture a substantial part of the appreciation of open market prices on these flats. 

　

Real Subsidies to HOS Owners is Limited

This method of calculating the premium payment implies that government has retained partial ownership of the HOS unit. The “owner” had only secured a user’s right indefinitely with the prospect of purchasing full ownership at a later date after making a further payment for the full value of the unit. This counter-intuitive approach contrasts sharply with private housing arrangements, whereby the owner pledges his unit to take out a mortgage loan from a bank for an amount equal to the difference between the purchase price and the initial down-payment. The loan amount is fixed at the moment the unit is purchased. Unlike private homeowners, the HOS owners must chase after a moving discounted premium.

In the 30 years since the HOS flats were first introduced, a total of only 64,668 or 20% have completed payment of the discounted premium. As a consequence, 255,379 or 80% of the flats are still unavailable for sale on the open market. The low turnover is shocking and is entirely the result of the chosen method of calculating the discounted premium. I do not think this is by any means a generous deal and the value of the subsidy received is very modest.

By removing the incentive of HOS owners to sell these flats on the open market the government also fails to collect the locked up discounted premium on them.  The HOS unit owners hold on to their flats for too long. I believe it is time the government reviewed its discounted premium collection policy on these apartments. A much better approach would be to fix the payment of the discounted premium at the price when the unit was initially sold. Once this premium has been paid the owner is free to sell their unit on the open market five years after the initial purchase date, as required under present regulations. This would be a triple-win policy.

First, the HA would be likely to collect more paid-up premiums, faster. Second, the HOS owner will know with certainty what he owes the government from day one. Such terms are more beneficial to the owner – as if the government is providing a subsidy equivalent to an interest-free mortgage loan to be fully-paid within a pre-specified maximum period.  The structure of these terms would make it more similar to the standard practices in the private mortgage market. Third, if only 2% of the 255,379 HOS flats become immediately available for sale on the open market then aspiring new homeowners would not have to wait another three years for the ‘My Home Purchase Plan’ flats to be built.

　

Ill-defined Property Rights Complicates HOS Redevelopment

Operationally this can be done very quickly as the original price of the HOS flats is known and so is the original discount. Would this be considered giving away valuable land resources by the government? I do not believe so because the land has no real alternative use and should be treated as having been sold on day one. Moreover the first HOS flats were sold some 30 years ago, in another 10 to 20 years they would be in need of redevelopment. How can this take place if the discounted premium has not been paid up on most of the properties in a building? There would be a minefield of ill-defined property rights with insurmountable negotiations costs.

I believe the purchase price of flats to be constructed under the ‘My Home Purchase Plan’ should also be set for the prospective tenant at the time the tenant takes up rental. If this is not determined at the outset, and if property prices rise significantly after five years beyond the affordability of the occupying tenant, then he is stranded, and the Plan would have failed if most intended purchases fail to occur. Subsequent re-contracting at that time would be a very bad idea for all parties.   

The Tenant Purchase Scheme should also be reactivated.  In 1998, the plan was to sell 250,000 flats within 10 years. Until the plan was halted in 2002, a total of 183,408 Public Rental Housing (PRH) flats had been designated for inclusion in the TPS, of which 117,137 flats had been sold. So far only 641 TPS flats have had their discounted premium paid, which is less than half a percent of the sold TPS flats. Like the HOS flats the discounted premium should also be set at the level corresponding to the price at which the units were first sold to the sitting tenant. This would again increase the number of available TPS units for sale on the open market to meet the aspiration for homeownership within the population. Some of the remaining 66,271 unsold units could also be sold off sooner as the new terms for calculating the discounted premium would become more favorable and known to the sitting tenant.  In addition more PRH flats can be identified for inclusion in the TPS to complete the program of selling 250,000 PRH flats.

My recommendation here does not require any changes to existing arrangements. The only change is to reset the discounted premium to the moment when the HOS and TPS flats were sold by the HA. As for the ‘My Home Purchase Plan’ flats the HS should also preset the selling price five-years down the road at the level prevailing in the market when the flats are first rented to the eligible tenant. Operationally this proposal requires minimal and easy-to-adjust changes. The construction plans in the pipelines of the HA and HS are unaffected. This is a truly shovel-ready proposal. The pay-offs will be enormous because it will loosen up a very rigid MacLehose legacy and utilize the market framework to immediately meet some of the aspirations for homeownership. And it will cost the government nothing. In the best of circumstances it could even bring in a faster flow of premium revenue.