Realty check: Asian real estate market feels the heat Asia Pacific Economic Outlook, Q2 2016

As housing runs into rough weather in Asia, various economies in the region are considering different approaches to spruce it up, while some, such as Singapore, are trying to put curbs on demand itself. All in all, every effort points in one direction: preventing a housing bubble.

A house—or more modestly put, a shelter—is among the most basic needs of any human being after food and clothing. So, as economies develop over time, housing demand—for residential purposes and as an asset class—increases, thereby aiding growth of the sector. Surprising then that in fast-growing Asia, where incomes are rising and millions are coming out of poverty, the housing story is getting a little sour. In many economies, housing has run into rough weather after a few years of stellar growth, raising fresh concerns for policymakers who are already grappling with financial market volatility, slower economic growth, and rising household debt. Some policymakers are calling for a correction to increase affordability (as in India) and hence, restore demand.1 Others are trying to put curbs on demand itself (as in Singapore).2 But, all of them will be hoping to prevent a housing bubble. Worse, if a bubble indeed emerges, policymakers will be eager to prevent a hard landing with its detrimental impact on other parts of the economy, especially banks and households.

All eyes on Hong Kong

Given its reputation as Asia’s premier financial hub, the property market in Hong Kong has been the most sought after, in line with London and New York. Hong Kong’s property market also has a close correlation with the global economy. It’s a matter of concern then that after years of sharp growth, property prices in the city are declining just as global GDP growth and that of neighboring China are slowing. In January, property prices declined for the fourth straight month in Hong Kong (see figure 1). Prior to that, prices had gone up by an astounding 183.9 percent between November 2008 (the last major trough) and September 2015 (the latest peak). Arguably, some volatility in property prices should not be a concern. But, the data tell us that both in the number of straight months of decline and the quantum of decline, the downturn so far is the largest since November 2008.

Special_Figure 1. Property prices in Hong Kong peaked in September 2015, declining after that

What makes the latest decline more worrying is the trend in property prices relative to rental yield (defined as rent divided by price). Since January 1993, price and rental yield have crossed paths at every property market downturn until 2008 (see figure 2). After that, both have been travelling in opposite directions. This means housing as an asset is increasingly dependent on capital gains, a trend that is disconcerting since it has continued for long. As both prices and yields reverse course a bit, the question is not whether they will meet (it will be disastrous if they do) but how much they will edge closer.

Special_Figure 2. Rental yield and price have moved apart since the previous major downturn in 2008

A sharp increase in house prices over the last eight years has also hit affordability, a contentious issue in Hong Kong.3 While property prices went up by 183.9 percent between November 2008 and September 2015, nominal personal disposable income grew by just 44.7 percent in roughly the same period. This again casts doubts on whether this price increase is indeed sustainable.

There are two other data trends that add to the worries. First, the total number of agreements for sale and purchase of building units is now at the lowest for the period between January 1993 and January 2016. While the number of agreements might not be the best criteria to measure healthy real estate activity, a look at the value of agreements shows us that the latest figure is the lowest since February 2009.

Second, the trend in outstanding mortgage loans also does not paint a strong picture. Between March 2008 and September 2015, outstanding mortgage loans went up by 82 percent. In the seven years prior to that, loans grew by a mere 10 percent. Worryingly, loans appear to be slowing down, indicating that the credit push behind the real estate boom in Hong Kong is waning.

It’s not just Hong Kong—there’s trouble brewing in other Asian cities as well

Singapore, the other major dollar hub in Asia, is already experiencing a slowdown in real estate. Prices are down by 2.7 percent since Q1 2015 after rising by 45.5 percent between Q1 2009 and Q1 2015 (see figure 3). Taipei City (in Taiwan) has fared worse. Between January 2009 and January 2015, property prices went up by 69.3 percent before correcting by 12.7 percent since then (see figure 4).

Special_Figure 3. Growth (percent) in real estate prices in key cities in Asia (based on quarterly data)

Where prices are not going down, they are certainly slowing as in Jakarta, Mumbai, and Delhi. The only exceptions are China’s top five cities. But, even here, the figures throw up some concerns. For example, in Shanghai, Beijing, and Shenzhen, prices have been shooting up in the past year (see figure 4). The latest surge in property prices in these cities comes at a time when equities are taking a hammering (down by about 42 percent since mid-2015). So, if households in China shift focus to real estate, it might make a bubble out of the current market.

Special_Figure 4. Growth (percent) in real estate prices in key cities in Asia (based on monthly data)

Banks in Asia will be hit hard by any real estate downturn

Slowing real estate in Asia, or worse, declining house prices, have come at a challenging time for banks, which are already dealing with slow economic growth. As a result, overall credit creation and that for housing are likely to be slower this year than in the last few years (see figure 5).

Special_Figure 5. Credit growth since December 2009 has been high in key Asian economies

Asset quality worries

For countries like India and, to a lesser extent, Indonesia, a troubled real estate sector could add to worsening asset quality in banks. For example, between Q1 2011 and Q3 2015, non-performing loans as a share of gross loans more than doubled in India’s banks.4 Indian banks, in particular, will also have to contend with declining housing affordability in big cities—and hence demand for credit—amid increasing exposure to troubled companies in real estate.5

Real estate problems at a time of declining trade finance income

In major trade hubs like Hong Kong and Singapore, banks are already witnessing a decline in a key asset—trade finance—due to slowing exports.6 For example, in Hong Kong, year-over-year growth in credit to finance imports, exports, and re-exports has been negative since February 2015.7 Growth in export volumes in emerging Asia is at its slowest since 2009 and is unlikely to pick up this year.8 Any trouble in the housing market will hence make matters worse for banks.

Demand for credit will likely also slow down as households deleverage

Banks will also likely have to contend with slower growth in loan demand from households than in the past few years due to high household debt in the region.9 Households are likely to focus more on repairing their balance sheets, especially in many South East Asian economies (see figure 6).

Special_Figure 6. Household financial liabilities as a share of disposable personal income (percent) will stay high

Already battered, banks stocks will likely suffer more if housing falls

An unravelling housing market will likely hit bank valuations further. Already, banks are bracing themselves against declining global macro fundamentals, a rise in financial market volatility, and unorthodox monetary policy across the world.10 The FTSE Asian Banks index is down by about 27 percent since June 2015 (see figure 7), worse than the overall market performance (the MSCI Asia-Pacific Index excluding Japan is down 17.3 percent).

Special_Figure 7. Equities are already under pressure; banks could suffer more from a real estate downturn

Households may also feel the pain

With equities hammered, any housing downturn will dent household wealth further. A fall in house prices will likely hit household wealth, especially at a time when equities are also declining (see figure 8). Equity markets have been taking a hit since June 2015, when the tide started turning in Chinese equities. The CSI Shanghai-Shenzhen 300 stock index, for example, is down by 42.6 percent relative to its May 2015 peak. Declining equities in China, along with global growth concerns, created a domino effect across Asia. A fall in housing will likely dent household wealth further, given the region’s large share of real estate in household assets.11

Special_Figure 8. The downturn in equities has already dented household wealth in Asia

Consumer spending will likely also suffer

Slowing household wealth comes at a delicate time for Asian consumers. As economic growth slowed a bit, real income gains also slowed down. According to Oxford Economics, average annual growth in personal disposable income for many economies in Asia during 2013–15 was slower than in 2010–12 (see figure 9).12 Slower income gains amid declining household wealth will likely impact consumer spending, thereby depriving key export-dependent economies of a major source of growth at a time of slowing trade growth.

Special_Figure 9. Average annual growth in real personal disposable income has slowed down in key economies

Between a rock and a hard place

For now, policymakers are trying to prevent a hard landing. The problem is, in a scenario of flat or slow price growth, property price levels will still be high relative to affordability. If it stays that way, growth in housing will be slow until it becomes more affordable. This also shifts attention to affordable housing, where Singapore has fared better than others. In less affluent economies, however, the blueprint for affordable housing is still not clear. For example, India does not appear to have a strong implementation schedule in place despite a pledge of housing for all by 2022. In China, if restrictions on migration from villages to cities are relaxed, demand for housing will increase. But, if prices stay high, the key again would be affordable housing.

Will a drop in house prices help affordability in emerging economies in Asia and, hence, spruce up demand in the medium term? While some economists might prefer the markets to find their balance, the worry for policymakers will be the quantum of any drop in property prices. Authorities would prefer a calibrated correction in property prices. A hard landing will likely have strong repercussions for the wider economy, especially banks and households. In the case of Hong Kong, the impact of any sharp correction could also spread beyond its borders. Economists will be desperately hoping against such a scenario. The question is, will Hong Kong oblige?