Better the Hong Kong Property Devil You Don't Know?

(Bloomberg Gadfly) -- Chinese companies have been gorging themselves on land in Hong Kong, outbidding the local developers that have long dominated the market and raising fears that apartment prices in the world's least affordable city will become even more stretched.

Aspiring home buyers need not panic just yet. While prices will inevitably rise a little further, what's driving these mainland Chinese firms isn't just pursuit of gains. They are buying land in the former British colony to diversify away from a home market where profits are shrinking amid government cooling measures, and to hedge against a depreciating yuan. On that front, Hong Kong, with a currency that's pegged to the dollar and a stable legal framework, makes perfect sense. The city also offers the allure of being a stepping stone to investments in the U.S. and the U.K. 

In the past couple of years, Chinese companies have become active bidders in Hong Kong government land tenders, growing ever larger as they shunt aside local titans including billionaire Li Ka-shing's Cheung Kong Property Holdings Ltd.

The new arrivals aren't all property firms: They include aviation conglomerate HNA Group Co., better known for an overseas acquisition binge that's included stakes in Hilton Worldwide Holdings Inc. and other hotel brands. The real estate unit of state-owned China Minmetals Corp., the country's biggest metals trader, has also made a foray into Hong Kong.

They're paying over the odds for the privilege.

Logan Property Holdings Co. and KWG Property Holding beat 13 bidders last month to pay a record $2.2 billion for a mass-residential site in Ap Lei Chau island, where a new subway connection opened in December. HNA has bought three sites in the Kai Tak area, site of Hong Kong's former airport, forking out 88 percent more than the highest forecasts for the first parcel in November, according to Jones Lang LaSalle Inc.

The Chinese companies are inflating values in a market where home prices have already become frequent front-page fodder for newspapers. Despite government curbs imposed in November that doubled the sales tax to as much as 30 percent for foreign purchasers and 15 percent for all others except first-time buyers, apartment hunters have been unfazed.

Real estate prices are at record highs, rebounding 16 percent since bottoming at the end of March last year. With interest rates remaining low, there's still plenty of demand -- especially for new apartments, for which developers are offering concessions such as as free furniture and easier payment terms.

Hong Kong home prices since March 2016

+16%

But even as they push land values ever higher, it's hard to see how Chinese developers will be able to raise finished apartment prices to the levels that would enable a reasonable profit.

To illustrate how little room they have to maneuver, take a look at HNA. It paid HK$13,600 ($1,752) per square foot for its latest site in Kai Tak, where adjacent apartments are now going for HK$20,000, according to JLL regional director of valuation, Dorothy Chow.

Tack on construction costs of around HK$5,000 per square foot (the average in Hong Kong), plus payments for architects and interest costs, and HNA would be lucky to have much left if it sells apartments at current prices.  To achieve a profit margin of at least 20 percent, the average expected by Hong Kong developers, the Kai Tak site would have to command a price of HK$25,000 per square foot.

That's a 20 percent increase from current levels -- no small ask for a property market where prices have almost doubled in the last five years.

Few of the recent mainland Chinese land buyers have built apartments in Hong Kong before, much less sold them. (China Overseas Land & Investment Ltd. is one of the few that has been operating in the city for years.) 

Given that their aim is to use Hong Kong as a stepping stone out of the mainland and to conserve capital,  they probably won't be as anxious to maximize profits as the local developers, which have been frequent targets of public dissatisfaction as home prices have soared.

That should be at least some comfort to Hong Kong's hard-pressed property seekers. Sometimes the devil you don't know may actually be better than the one you do.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

To contact the author of this story: Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net.