Hong Kong-based finance still prepared to lend based on good collateral
The China Evergrande situation is sure to affect Hong Kong SAR’s residential market, with the good news being that first-time homeowners could find prices more affordable in the short-term, Hong Kong developers will be predominant player in the market as China developers take a pause, and financial lenders are keen to point out that it’s business as usual, as long as the borrower can secure collateral in the city.
China Evergrande ran aground on the mainland’s Three Red Lines policy, which regulates developers’ borrowing ability according to three metrics – keeping their liability-to-asset ratio under 70%, net debt-to-equity under 100%, and cash-to-short-term-debt multiple above 1.0x. Developers were given until 2023 to meet the target.
"Near term, we expect less activity than usual from mainland private developers in Hong Kong."
The policy, introduced in August last year, is one among a series of rule changes to various sectors of the mainland’s markets. Mainland developers had been encouraged to expand their reach – including into other sectors, with easy access to finance, which led to many being overleveraged and Beijing becoming more concerned about their debt exposure.
The Three Red Lines policy has arguably worked, with many companies diligently striving to reach the policy’s metrics, allowing them to borrow modest amounts. However, other companies, like China Evergrande, could not find a winning solution, and the result is playing out now.
On 15 October, the People’s Bank of China (PBoC) held a press conference on the third quarter’s financial statistics and publicly mentioned the Evergrande case for the first time. PBoC believes the spillover effect on the financial system is manageable, Evergrande is an isolated case while most developers are operating steadily, and the property sector is healthy. The bank’s remarks were much needed and soothed market anxiety.
Additional caution expected from international investors
Even assuming the situation pivots to the best-case scenario, investor behaviour as a whole is likely to change, even though the Hong Kong property market may not have been hard hit. Near term, we expect less activity than usual from mainland private developers in Hong Kong. None of this will put investors off the ever-healthier Hong Kong market, but we will see more due diligence from lenders and investors. This focus could see banks lean towards a more conservative approach with their lending resulting in a cap rate expansion and a price correction in the property market in the short term.
"The tapering of competition to purchase land could lead to the Hong Kong Government slowing its release of land to ensure premium price is achieved."
China Evergrande’s situation has brought China’s policy changes to global attention, which may impact Hong Kong’s external investors, especially if they imagine that Hong Kong’s residential market faces the same regulatory steering to adopt a similar policy. Going forward, expanding cap rates will compress investors’ returns, meaning they will maintain a cautious view of the Hong Kong property market in the midterm.
The idea of possible policy changes being brought to market would be something valuers would consider as risk, which would apply to Hong Kong too. Yet, we could see investors leaving the perceived insecurity of the Chinese corporate bond market (especially the high-yield portion) for the relative security of Hong Kong’s property market.
What does this mean for the Land Sales Programme?
Mainland developers are predominantly housebuilders and were highly active in Hong Kong’s residential market. For example, eight of the 13 Kai Tak residential land sales went to mainland developers (fully or as consortium participants) from 2018 to 2021. For those developers that have already purchased land, we don’t see much impact, but it will curb the appetite and activity of those in Hong Kong for at least the next two years.
The tapering of competition to purchase land could lead to the Hong Kong Government slowing its release of land to ensure premium price is achieved. After all, land is one of the few ways the HKSAR can raise money. The direct impact of this would lead to keeping housing prices high, impacting short-term supply, intensifying the housing issues despite the 2021 Policy Address emphasising the Government’s long-term projects to support housing supply. This is of course a hypothetical outcome as the worst-case scenario, and highly unlikely.
On the other hand, if Beijing’s Common Prosperity philosophy inspires the HKSAR Government and developers are serious about helping to ease Hong Kong’s housing crunch, land sales may continue as planned, which would directly benefit that portion of the population struggling to afford a home in one of the world’s most expensive property markets. This result would be more in line with the Policy Address proposals to ease the housing shortage. More people entering the housing market make Hong Kong’s residential property sector more robust, with an upswing in ownership.
Undoubtedly, Hong Kong developers will relish increased opportunities to purchase land, with mainland competitors pausing their activity. The situation presents good opportunity for Hongkongers to use the hiatus to their advantage and reinforce their position in the sector.
Hong Kong has a large pool of accessible finance available for those who might want to raise funds. The China Evergrande situation may make lenders more sensitive about lending to property developers in general, mainland or otherwise. Local developers’ gearing level is generally very low (avg 20%), and many of them perform better than mainland companies on the Three Red Lines test. Colliers has also interviewed a range of lenders who noted that as long as a developer had solid collateral in Hong Kong, they would still be able to borrow at a reasonable rate within the SAR.