Follow the money. It's a old saying in investing that's never made a lot of sense as it often means following the latest fad and ultimately buying high and selling low. So I'm going to propose an amendment and urge you to "follow the smart money". By this I mean that you should study what businessmen and investors with long, successful track records are doing with their money. And possibly invest alongside of them. Unlike most investors who feel they have to chase returns to get rich, these people are already wealthy and can pick and choose which asset classes to invest in. Given this freedom, they are often attracted to assets which offer value relative to other assets. It pays to know what these people are buying and selling.
Which brings me to an important development in Asia this year. It's become clear that many real estate investors in Hong Kong and Singapore are cashing out of property. These investors are among Asia's wealthiest and they're starting to exit their favourite asset. If this implies that property in Hong Kong and Singapore is close to peaking, as I suspect it does, then it has negative implications for the economies and stock markets of both cities. On a longer time horizon though, a re-balancing away from property as the primary driver of wealth generation could well prove beneficial.
Investors selling property assets
I've been hearing a lot of anecdotes about insiders selling out of real estate, especially in Hong Kong. So an article in The Wall Street Journal this week entitled "Big players cash out of Hong Kong property" [14] naturally caught my eye.
The article points to a wave of property initial public offerings (IPOs) about to hit the market. The sellers include New World Development, a large conglomerate, which is hoping to raise US$1 billion in an offering of some of its hotels. Another big Hong Kong conglomerate, Hopewell Holdings, wants to raise up to US$800 million in an offering of some of its (unspecified) properties. Also, Great Eagle Holdings, owner of The Langham Hotel chain, is hoping to raise US$800 million from selling off hotels in Hong Kong.
It comes after Hong Kong residential property prices increased 120% over the past four years, while commercial property prices rose 90% during the same period. It also follows the Hong Kong government introducing more draconian measures to limit property price rises. In February, the government increased stamp duty on residential property purchases by 2x to up to 8.5%.
Hong Kong isn't alone in witnessing an increasing number of real estate IPOs. Singapore has seen a similar pattern this year. There's more to come as Indonesian billionaires, the Riady family, is planning to raise US$800 million in an IPO of its Singapore hotels.
Similar to Hong Kong, Singapore has struggled to bring property prices under control. Recently, the government there introduced its seventh measure - including increased stamp duty and higher down payment requirements - in the past two years to curb price rises. Residential housing prices in Singapore have started to stabilise but they're still up 59% since bottoming in the second quarter of 2009.
Reasons for cashing out
It's not difficult to understand the motives behind the real estate investors who are selling. The property bubbles in Hong Kong and Singapore have been fuelled by three factors:
- Money printed in the West has found a home in tangible growth assets in Asia. This has been particularly the case for Hong Kong, which pegs its currency to the U.S. dollar. This has resulted in Hong Kong money market rates closely tracking those of the U.S. even when domestic conditions diverge. This has meant significantly negative real rates (interest rates well below inflation), often a central driver to property bubbles.
- Chinese growth has also aided the bubble. Chinese investors wanting to diversify their assets outside of China have found their way to Hong Kong, Singapore and, of course, many other places.
- Governments, principally in Hong Kong, have been timid in addressing the price rises. Increasing social tensions, brought on by asset bubbles primarily benefiting the rich, have forced them to act more decisively.
The savvy real estate investors now cashing out know that the tailwinds which have driven property prices to their recent highs could easily turn in future. It's clear that governments in Hong Kong and Singapore are becoming more concerned with property price rises and are willing to act to curb them. Also, quantitative easing (QE) won't last forever. When QE goes, a key driving factor behind Asia's property bubble will disappear. Finally, Chinese economic growth of +8% can't be counted on from here on. Regular readers will know my bearish views on China's economy in the near-term. The wealth investors exiting property may share the same concerns.
More importantly, these investors most probably realise that better value can be found elsewhere. All segments of property in Hong Kong and Singapore are undoubtedly expensive. The Economist magazine suggests they are the world's second and third most expensive residential property markets on a price-to-rent basis, 69% and 57% overvalued versus long-term averages respectively.
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In Hong Kong, the average residential property rental yield is close to 3%. Effectively, you're paying a 33x price-to-earnings ratio for Hong Kong property. That compares to the 11x that you'll pay for the average Hong Kong stock.
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The investors exiting local property would also be able to see the much better rental yields offered outside of Asia, in the likes of the U.S.. There, they can get yields of +6% in a less frothy market and where debt is still very cheap.
Where they'll put their money
The obvious question is: where will the real estate investors put their excess cash? The obvious answer is that they may switch from expensive property segments into less expensive ones in their home countries. Thus in Hong Kong, residential property appears among the more expensive. A switch into commercial property may make sense, particularly as upcoming supply is relatively limited. This switch is what property experts such as Colliers [17] are betting on. This theory has some credibility. After all, property investors know property and switching between different segments would be within their comfort zones.
But I think any switch would be limited. As mentioned earlier, much of the selling by real estate insiders is in commercial property. They're clearly not bullish on this segment either. Moreover, they'd know that if property rolls over on the residential side, it would impact the economy. Particularly in Hong Kong, where property contributes about 18% to GDP. Commercial property is very sensitive to economic conditions and would suffer if this scenario took place.
Another potential place to park the cash raised by real estate sales is in the stock market. Morgan Stanley strategist, Jonathan Garner, has taken a slightly different angle to raise the possibility of the Hang Seng Index (Hong Kong's main stock index) reaching 50,000 by 2015 (it's currently 22,300). Garner suggests that the Hang Seng Index has significantly lagged Hong Kong residential property prices, when historically they've been closely correlated (unsurprising given the importance of property to Hong Kong's economy). He argues the stock market is due to play catch up.
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My problem with this argument is that stocks may not play catch up, but property prices could fall instead. This would, inturn, heavily impact the stock market.
It depends on what you believe is more likely: a rise in stocks or a fall in property prices. My bet is on the latter and given the recent sales by real estate investors, they may well be in the same camp.
If not stocks or other property segments within their home countries, then where will the real estate investors put their money? I think overseas property markets are a fair bet.
My wife, who manages a portfolio of hotel assets for one of Australia's largest property developers, tells me that Singapore companies have been large investors in Australia of late. Frasers Centrepoint is involved in building a massive US$2.1 billion mixed use development near the main train station in Sydney's central business district. Recently, Ascendas Group bought a US$572 million hotel fund managed by Australia's Mirvac Group. Far East Orchard is forming JVs to development its hotel business in Australia. And K-Reit has partnered with Mirvac in two office developments to date.
It's clear form this that the trend of Asian real estate investors looking overseas for better opportunities has already begun. Australia is attractive to some given the low cost of debt and decent yield on offer. I would expect the U.S. and other less bubbly markets than Australia to attract more attention from investors in future.
What if property's best days are behind it?
There's a larger question that probably hasn't been considered as much by the wealthy Asian property investors. And that is whether property in Hong Kong and Singapore may be close to topping out not just for a few years, but for a decade or more? Given the overvaluation of property in these markets, this possibility can't be ruled out.
The reason that I raise this is because it would have far-reaching consequences. Asians are known to have an abiding love for property. Many suggest that it's because property is tangible, unlike money that you put in the bank or into the stock market. I think that like the western world prior to 2008, property has realised incredible gains for investors in Hong Kong and Singapore over the past 40 years. And that's what they've fallen in love with.
Consider that two-thirds of Hong Kong's 50 wealthiest people have made their money primarily in real estate. It's an extraordinary statistic.
No asset goes up forever though and property tends to move in very long cycles. What if we are close to the start of a major long-term downturn? (a downturn doesn't have to mean declining prices as even stable prices will result large losses in inflation-adjusted terms). What if property isn't the key driver to wealth in the likes of Hong Kong anymore? And what if the two-thirds of Hong Kong's 50 wealthiest people from a real estate background, becomes one-third in ten year's time?
Many people in Hong Kong and Singapore could never imagine some of these things happening. But I'd suggest they're inevitable at some stage. It's a matter of when, not if.
Such an occurrence would have some significant silver linings though. There's little doubt that a declining or flat property market for a long period of time would have a significant impact on the economies of Hong Kong and Singapore. But I'd argue that it would be a healthy adjustment that may better balance their economies over time. Being over-reliant on one sector is never healthy.
Property's downfall may also prove beneficial to other asset classes, such stocks and bonds. Knight Frank [19] estimates that Asia's wealthiest have 31% of their net worth tied up in property, compared to 16% in Europe, for instance. And they only have 15% of their wealth in stocks. A long-term shift towards stocks may make more sense, particularly when the economies of their home countries become less dependent on property asset appreciation.
Finally, less wealth coming from property would mean more wealth coming from other sectors. The wealthiest citizens may come more from manufacturing or other service industries. They're likely to be less attracted to buying property than the current batch of real estate investors. That could prove a boon for stocks and the still under-developed Asian bond markets.
This post was originally published at Asia Confidential: http://asiaconf.com [20]