House Price Developments in Macao *

Transcription

1 * P. S. Un Research and Statistics Department, Monetary Authority of Macao Abstract Significant rise in house prices has provoked considerable public concern in Macao over the past few years. It has a direct linkage with wealth endowments of individuals, which are responsible for the relative strength in consumer spending, and ultimately economic growth. On the other hand, overvaluation of properties, if prevailed, could generate negative impacts on financial stability and operations of business entities. This paper explores the feasibility of applying various evaluation techniques of house prices to the case of Macao, aiming to offer some objective criteria for reference of policymakers, house buyers and credit institutions. * Editor s note: We are grateful to Rose Neng Lai of the University of Macau for her useful comments on an earlier version of this paper

2 1. Introduction House prices in Macao have raised considerable public concern after the average transaction price of residential units hit a historical high of MOP11, 317 per square metre in the third quarter of 2006, a total upsurge of 84.8% since the first quarter of 2002 according to official statistical sources. As major corrections in the housing market could undermine financial stability, central banks in different countries have to consider the negative impacts that could be caused by property price overshooting. This paper introduces several popular metrics in assessing current house price levels, which could be applicable to the case of Macao. Besides, fundamental demand variables such as population, household income and mortgage interest rate are highlighted as leading factors of long-term trends of house prices. Our goal is to offer some objective criteria for evaluating local property price developments, which could help all involved parties to assess the risk, ultimately promoting the economic stability. The remainder of the paper is structured as follows. The next section discusses features of the local house market. Rising prices and volatility have attracted most public attention, while the market has witnessed increases in foreign presence and short-term transactions. Section 3 adopts some popular indicators, including the price-to-income ratio, the price-to-rent ratio and Poteba s user cost of housing, to assess house prices in Macao. Notwithstanding their present limitations, these handy indicators could be developed into a robust evaluation base in future as the time series of the statistics extend over time. Section 4 highlights fundamental factors of housing demand that would have a long-term impact on house prices in Macao. The last section concludes

3 2. Features of the Property Market After years of rising prices, building units sold in Macao saw a sharp 21.5% decline in transaction volume in The features of the property market are observed as follows. 2.1 Pro-cyclical property market As shown in Chart 1a, steady growth in sales volume had been witnessed for the decade before Apart from the dramatic surge of sales in 2001, the number of building units sold moved largely in line with the business cycle from 1994 to However, the percentage change of building units sold was more drastic than that of the GDP growth from 1994 to 2006 as indicated in Chart 1b. The volatility of building units sold has appeared to be more severe in recent years, while historical property booms and slumps reconciled consistently with the economic cycle. (Units) 40,000 35,000 Chart 1 a: Economic Growth and Building Units Sold (%) 30,000 25,000 20,000 15,000 10,000 5, Building Units Sold Real GDP Growth Rate (right scale) Source: Macao Statistics and Census Service (DSEC)

4 (%) Chart 1b: Economic Growth and Building Units Sold Percentage Change of Building Units Sold Source: DSEC Real GDP Growth Rate 2.2 Surging transactions and prices of old buildings 1 As indicated in Chart 2, lower-price old blocks have turned to be more popular than dear new buildings for house buyers since Compelled by the lofty prices of new houses, more potential house buyers have viewed old buildings as their preferred options. As a result, the transaction volume of old buildings soared considerably from 4,656 units in 2000 to 26,681 units in Although the new building turnover rebounded to 8,170 units in 2006, it lagged far behind the 18,230 old building units sold. 1 New building units are classified as: 1) In the Macao peninsula, residential and commercial properties built within the last four years, and industrial properties built within the last five years. 2) In Taipa and Coloane, residential and commercial properties built within the last six years and industrial properties built within the last 10 years. 3) The others are classified as old building units

5 Chart 2: Building Units Sold as per Record of Stamp Duty (Units) 35,000 30,000 25,000 20,000 15,000 10,000 5, Building Units Sold New Building Old Building Source: DSEC. Driven by the soaring trading volume, the rise in transaction prices of old buildings has been particularly strong. The average transaction price of residential units that were completed from 1990 to 1999 rose 33.5% in 2005 and 9.7% in The average transaction price of buildings completed in and before 1989 also leaped 33.6% and 18.6% in 2005 and 2006 respectively. After a hefty surge in 2004 and 2005, the transaction price of new buildings that were completed in and after 2000 only edged up 0.5% in 2006 (Table 1)

6 Table 1: Average Transaction Price of Residential Units per Square Metre of Usable Area, by Year of Building Completion Year of Building Completion Year Quarter Average 2000 and after From 1990 to and before Annual Annual Annual Annual MOP Change MOP Change MOP Change MOP Change (%) (%) (%) (%) ,261 7,797 6,919 4, ,123 7,188 6,755 4, ,196 8,330 6,703 4, ,233 7,792 7,006 4, ,483 7,574 7,269 4, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Source: DSEC. 2.3 Increase in intermediate transfer of title for new buildings The ratio of intermediate transfer of title to total transaction for new buildings grew considerably from 0.27 in 2002 to 0.82 in 2006 (Table 2). This indicated that an incremental proportion of new building buyers did not have their full transfers of ownership completed. Such phenomenon could be explained by increased speculative activities and prolonged procedure for home ownership entitlement

7 Table 2: Building Units Sold as per Record of Stamp Duty Year Month Total New Building Old Building Ratio of Intermediate Transfer of Title to Total Transaction Total Ratio of Intermediate Intermediate Transfer of Transfer Title to of Title* Total Transaction Total Ratio of Intermediate Intermediate Transfer of Transfer Title to of Title* Total Transaction Total Intermediate Transfer of Title* ,831 1, ,158 1, , ,556 1, ,509 1, , ,823 4, ,510 2, ,313 1, ,644 6, ,963 5, ,681 1, ,400 7, ,170 6, , Jan , , Feb , Mar , , Apr , , May , , Jun , , Jul , , Aug , , Sept , , Oct , , Nov ,093 3, ,336 3, , Dec ,959 1, ,323 1, , Note: * Intermediate transfer of title refers to the transfer of immovable property whose full transfer of ownership has not completed. With fiscal effects, payment of stamp duty of 0.5% for transfer of property produces legal effects for the respective transaction of residential unit of a building. Source: DSEC

8 2.4 Flow-in of external capital Driven largely by the optimistic prospect for the gaming industry, a huge amount of foreign capital has flowed into Macao. Foreign buyers who expect future capital gains from Macao assets have formed a considerable faction of demand for local properties. 2 High expectations of capital gains have been a supportive factor of the growth of property prices. Foreign investment in the property market has been highly visible. In 2006, the value of building units purchased by non-residents surged 22.7% to MOP12.9 billion, representing about 51.3% of the total value of transacted building units. On the contrary, the total number of non-resident buyers for transacted units slid 0.3% to 11,710, which was approximately 35.2% of the total number of buyers for the year Well-publicised examples include: 1) Sjova-Almennar, Iceland's largest insurance provider, bought a block of flats in Macao from Shun Tak Holdings and Hongkong Land for HKD782 million in ) Morgan Stanley Real Estate Funds, Pioneer Global Group and Wachovia Bank acquired AIA Tower, formerly known as International Gateway in Macao in ) Polytec Asset Holdings planned to raise HKD5.81 billion by new share placement and issue of warrants to finance three Macao property projects in May

9 Table 3: Number of Buyers of Transacted Building Units and Value of Transacted Building Units by Buyers Status According to Stamp Duty Records Year Month Residents Total Number of Buyers Nonresidents Percentage of Nonresidents to Total Buyers (%) Annual Change (Nonresidents) (%) Residents (10 3 patacas) Total Value of Transacted Building Units Nonresidents (10 3 patacas) Percentage of Value of Transacted Building Units by Nonresidents to Total Buyers (%) Annual Change (Nonresidents) (%) ,056 4, ,352,668 2,589, ,321 6, ,915,937 3,064, ,133 9, ,716,072 6,570, ,130 11, ,307,71210,490, ,551 11, ,225,89912,870, Monthly Change (Nonresidents) (%) Monthly Change (Nonresidents) (%) 2006 Jan. 1, , , Feb. 1, , , Mar. 1, , , Apr. 1, , , May 1, ,253, , Jun. 1, , , Jul. 1, , , Aug. 1, ,549, , Sept. 1, , , Oct. 1, , , Nov. 2,040 3, ,127,353 2,554, Dec. 2,435 1, ,589,540 3,891, Note: If there were more than one buyer in a building unit transaction, the total number of buyers would be counted. Source: DSEC

10 3. Metrics in Measuring House Price Developments The price-to-income ratio, the price-to-rent ratio and Poteba s user cost of housing are popular measures in advanced countries that provide an easy reference for assessing the appropriateness of house price levels (OECD 2005). In the following analysis, we apply these measures to the case of Macao. 3.1 The price-to-income ratio The price-to-income ratio is frequently used to measure the affordability of potential house buyers. Index of nominal house prices and index of per capita disposable income are generally used for computing the price-to-income ratio. If income growth consistently fails to catch up with increase in house prices, house purchase will become out of reach for average buyers. Therefore, when the price-to-income ratio exceeds one for some time, it would lead to downward pressure on house prices. Chart 3 shows the price-to-income ratio of Macao, which is calculated by using the index of average transaction price of residential units per square metre and the index of median monthly employment earnings from the Employment Survey. 3 The price-to-income ratio had grown steadily before reaching its peak in the third quarter of The average transaction price then stood at MOP11,159 per square metre. Downward pressure on house prices had loomed, signaling a possibility of overvaluation. With lower average transaction price, the affordability ratio had shrunk until a rebound was observed in the third quarter of Since the data of household disposable income is not available in Macao. The median monthly employment earnings are used to compute the price-to-income ratio

11 Chart 3: Price-to-Income Ratio Source: DSEC. 3.2 The price-to-rent ratio 2002 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q-3 The price-to-rent ratio, which illustrates the cost of owning versus renting a house, is another indicator in assessing house prices. The price-to-rent ratio in Macao is obtained from dividing the nominal house price index by the rental sub-index of the consumer price index (CPI). It is more advantageous to rent rather than buy when house prices are high relative to rents, and vice versa. Akin to the affordability ratio, the price-to-rent ratio had grown steadily and exceeded one since the third quarter of 2004, indicating increasing attractiveness of rent. The ratio had continued to rise and hit its peak in the third quarter of 2005 as the level of rents had failed to keep up with house prices. The price-to-rent ratio had then slid moderately as house prices moved downwards, but it rebounded in the third quarter of 2006 in line with the price-to-income ratio

12 Chart 4: Price-to-Rent Ratio Source: DSEC Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Limitations of price-to-income ratio and price-to-rent ratio The price-to-rent ratio and price-to-income ratio are widely adopted indicators for evaluating the appropriateness of house prices. However, certain limitations should be noted upon their application to Macao. First, official data of house prices in Macao have only been available since Construction of long-term averages of the price-to-income ratio and the price-to-rent ratio is thus not possible, though this concern will disappear with data to be accumulated over time. Second, as the definitions, frequency and quality of data vary greatly across countries, it would be of little meaning to compare the results across countries. Finally, the price-to-rent ratio fails to consider implicit costs such as mortgage interest and maintenance expenses for house ownership

13 3.4 The user cost of housing In order to evaluate whether it is more economical to rent or own a housing unit, Poteba (1984) introduces the concept of user cost of housing as the true cost of owning a housing unit. The cost of inhabiting a house should not merely be the purchasing price of that property. The annual financial return of purchasing a house should be the difference between the imputed rent, that is the value of living in that property or the cost to rent an equivalent property, and the opportunity cost of capital the return it would have received if the capital for the house purchase had been invested in an alternative investment (Himmelberg, Mayer and Sinai 2005). In calculating the financial return of an owner-occupied house, one has to consider the returns and risks of alternative investments, property taxes, maintenance expenses as well as expected capital gains from owning a house. Thus, the total annual cost of owning a housing unit can be formulated as follows: Annual cost of house ownership = P t r rf t + P t ω t P t τ t (r m t + ω t ) + P t δ t P t g t+1 + P t γ t, where P t = the price of housing r rf t = the risk-free interest rate ω t = the property tax rate τ t = tax deductible rate r m t = mortgage interest rate δ t = maintenance costs and depreciation rate g t+1= rate of expected capital gains or losses γ t = additional risk premium The expected annual cost of owning a housing unit should be equal to the cost of renting an equivalent housing unit for a year when the housing market is in equilibrium

14 Annual rent = Annual user cost R t = P t U t R t = P t U t = P t [ r rf t + ω t τ t (r m t + ω t ) + δ t g t+1 + γ t ] in equilibrium. If the annual cost of homeownership is greater than the cost of renting, it will be more advantageous to rent rather than own a housing unit, and vice versa. As a rough estimate, the user cost of a housing unit with market price of MOP2,000,000 would be MOP75,622 per annum in Macao. 4 If the annual market rent exceeds MOP75, 622, it would be more economical to buy, instead of rent, this housing unit. 4. Fundamentals in Determining House Prices Properties can neither be erratic nor overvalued if their prices are supported by fundamental supply and demand factors. According to Stiglitz (1990), a bubble exists if high house prices are mainly attributed to unreasonably high expectations of investors towards future capital gains while the fundamental factors do not support such price levels. Although hefty capital inflows can provide some immediate support, house prices of a region should depend on local fundamental factors in the long run. Assume a stable supply in the small city of Macao, such fundamental drivers, largely focusing on the demand side, include demographic developments, trend of mortgage interest rate, growth of household income, etc., and their relevance to Macao is highlighted as follows. 4.1 Demographic developments Both local population and property transactions have been in a long-term rising trend, though in the past few years, the influence of population growth has seemed to be 4 Since there are no official data available for r rf t, r m t, δ t, g t+1 and γ t, the calculation is based on some assumptions about those missing data made by the author

15 insufficient in explaining the large expansion in demand for local properties (Chart 4). However, as the resident population growth has picked up recently with the significant increase in imported workers and immigrants 5, it would be a favourable factor at least for the buy-to-let market. (Person) Chart 5: Estimates of Macao Resident Population and Building Units Sold (Unit) 550, , , , , , , ,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Estimates of Macao Resident Population Building Units Sold (right scale) Source: DSEC. 4.2 Mortgage interest rate Low nominal and real interest rates both have stimulating effect on house prices simply because they can make mortgages more affordable. Since no uniform prime rate is available in Macao, the best lending rate released by the Hong Kong Monetary Authority acts as a proxy for the local prime rate. As shown in Table 4, the nominal rate reached 7.75% in November After a deduction ranged between 2.75 and 3.00 percentage points (i.e. P minus 2.75% to 3.00%), the mortgage rate charged by most banks fell below 5.00% in January In real terms, the mortgage interest 5 Macao SAR has temporarily suspended to accept new applications for residency based on the purchase of property, effective from 4 April, The mortgage rate charged by the HSBC, BOC, Heng Seng Bank, CitiBank was 5% in January. See report in Hong Kong Economic Journal, 6 January

16 rate has been about negative with inflation hovering at about five percent, and hence should be positive to housing demand (Table 5). 7 Table 4: The Best Lending Rate, Effective Best From Lending Rate (%) / / / / / / / / / / / / / / / / / / / / / / / / Note: The best lending rate refers to the rate quoted by the Hongkong and Shanghai Banking Corporation Limited. Source: Hong Kong Monetary Authority, HKMA. 7 The interest rate for three-month fixed deposits in Macao, however, grew steadily from 0.78% in March 2005 to 2.75% in November 2006, indicating higher implicit user cost for home purchases

17 Table 5: Composite CPI Index House Price Developments in Macao Year / Month Annual Percentage Change (%) Source: DSEC Household income In line with the concept of the price-to-income ratio, household income partly determines the affordability of potential house buyers. Consistent increase in household income would also motivate an upgrade in housing quality in terms of usable area and facilities. In Macao, non-wage income of households is not available, and it is assumed that employment earnings are the major source of household income

18 Despite the double-digit real GDP growth in 2003 and 2004, earnings of the working population grew at a slow pace. They did not rise in equivalent magnitude with property prices in 2004 and 2005 (Table 6). However, employment earnings have seen substantial growth since If the favourbale earnings trend extends, it would sustain real estate demand in the long term. Table 6: Annual Growth of Monthly Income, Real GDP and House Price Year / Quarter Median Monthly Employment Earnings Annual Change (%) Real GDP Average Transaction Price* r r r r r r r Note: *Average transaction price of residential unit per square metre of usable area. r Rectified Figures are subject to revisions later on. Source: DSEC

19 5. Conclusion This paper studies various measures of appropriateness of house prices that are widely adopted in advanced countries, and attempts to apply them to Macao. The price-toincome ratio, the price-to-rent ratio and Pobeta s user cost of housing provide simple and accessible ways to assess house price levels, though in the case of Macao, their usefulness is somewhat limited by insufficient time series of relevant data. It is also highlighted that house prices should be determined by local fundamental factors in the long run. The risk of housing bubbles would be low if the purpose of property purchases is for actual private consumption instead of speculation for acceleration in property prices for profit gains. Experiences in developed markets show that house prices can pick up speedily during booming periods but do not slide in the same magnitude in market slumps since most people prefer to take their properties off the market rather than sell at a loss. In addition, a small fall in prices followed by several years of a flat market may be more likely to happen than a sharp dive in house values. Overvaluation could also disappear over time in a generally stable market and economic environment while the house price level could sustain, if the market can wait for improvement in underlying fundamentals such as increase in wages and population growth to catch up. On the other hand, housing market slumps are frequently triggered by deterioration in fundamental factors such as interest rate hikes. Property prices could adjust substantially if fundamental drivers are subject to severe negative shocks. An expected slowdown in the growth of disposable income or introduction of an antispeculative property tax can promptly bit the market confidence (Vartia 2006). With regard to financial stability, the buoyant property market has lifted (i) the demand for mortgage loans, (ii) the sensitiveness of households to changes in interest rates, assets prices and income as well as (iii) the default risk facing the financial sector. As highlighted in an International Monetary Fund report published in 2000,

20 the household sector would become more vulnerable to the adverse shift if a large fraction of their disposable income has been devoted to servicing mortgage debts. Problems could arise if credit assessments are based on overly optimistic assumptions during the period of booming real estate market. A prudent practice is therefore recommended in order to contain potential credit risk. Business cycle effects and feasible downside scenarios with respect to asset prices should be taken into account while granting mortgage loans. It is hoped that the assessment techniques introduced in this paper could provide a useful reference for all involved parties including credit institutions. The financial sector is advised to monitor the collateral values and the affordability of borrowers closely in view of the ongoing property boom and accelerated house prices. It may even be desirable to maintain certain counter-cyclical features for real estate collateralised lending. 8 Until now, the prudent business strategy has been substantiated in the local financial sector as the non-performing loan ratio of Macao banks has stayed at a considerably low level of below 1.5%. 8 For example, a lower loan-to-value ratio could be exercised during the periods of rising property prices by requiring for a larger portion of down-payment by the borrowers

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22 Stiglitz, J. E. (1990), Symposium on Bubbles, Journal of Economic Perspective, Vol. 4, No. 2, Vartia, L. (2006), Finland s Housing Market: Reducing Risks and Improving Policies, OECD Economics Department Working Paper, No.514, ECO/WKP42, September. World Economic Outlook Assets Prices and the Business Cycle, International Monetary Fund, May