Hong Kong: Accommodation Value May Fall If Families Start To Have 3 Kids

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

March 2005

Like most of the developed economies, Hong Kong faces a graying population and skewed demographics at the top, i.e. there will be fewer young people to ‘support’ each elderly folk in future, unless, as touted by the government, families have 3 children on average. Leaving aside the issues of child-rearing, personal / family choices, and economic-social environment etc, Accommodation Value (AV, the land price divided by the building floor area which a land lot can have) may actually fall should families start to have 3 children on average. Here’s why:

A)     The current private residential housing stock and supply consists mostly of 2 to 3 bedroom units = and these in turn tend mostly to fall within the 450 to 850 ft2 floor area range, forming the bulk of the so-called ‘mass’ private housing. Many families nowadays have 1 to 2 children.

B)     3 children will mean 4 bedrooms = of course, one can always suggest that small children can share a bedroom, nonetheless, they will grow up one day, and with privacy a treasured item, it may be preferable even if not definitely better to provide a bedroom for each of the kids. This also has not taken into account the fact that some families, a minority nonetheless, will have grandparents living under the same roof as well, which implies 1 more bedroom. In short, the market would need to change and adapt in order to cater to the needs of 3-child families, and design-wise, each unit may have to be increased in size to accommodate 4 or more bedrooms, as the current 2 to 3 bedroom units are probably ‘stretched’ to the fullest already.

C)    Home prices correlate to economic performance / earning power / household income = especially for the mass market, i.e. families do not earn more (or less) via the number of children they have, and in fact, the family budget that can be allocated to housing is likely to be decreased with more children as spending on education and the like will have to be increased. Nonetheless, for simplicity, let us assume the budget allowed for home purchase remains the same.

D)    Purchase price per floor area may fall = say with 2 children, a family may use HK$4M to buy an 800 ft2 3-bedroom unit, i.e. HK$5,000 / ft2. With 3 children, the same family may need to buy a 1,000 ft2 4 bedroom unit with the same HK$4M, i.e. HK$4,000 / ft2. Some readers at this point may be inclined to ask why the family is not required to pay more now that the home is 200 ft2 larger, but this ignores the fact that how much a family can afford / is willing to pay for a home rests not on the (floor) size of the home but on the family’s income earning capacity (now or in future) plus other factors such as mortgage rates, economic sentiment etc. Floor size has little to do with it and this is why North Americans live in 2,000 ft2 detached homes, Europeans in 1,500 ft2 townhouses, and Hong Kong residents in 600 ft2 apartments, for the same US$300,000 price tag (and this is why foreigners ‘feel’ that Hong Kong is expensive!).

E)     Accommodation value drops = using a simplified real estate development’s assessment formula: Sales Proceeds (of a project or unit) – Related Construction Costs (assumed to include all government levies, interest rates etc) – Developer’s Required Minimum Profit = Residual Land Value that could be paid for the land portion.  Putting in the above figures and assume the developer wishes to have a minimum 30% of the proceeds as profit: 1) In the 3 bedroom 800 ft2 scenario = HK$5,000 / ft2 sales proceeds - HK$1,500 / ft2 developer’s profit [30% of proceeds] - (say) HK$1,500 / ft2 construction costs =  HK$2,000 / ft2 residual land value; 2) In the 4 bedroom 1,000 ft2 scenario = HK$4,000 / ft2 sales proceeds – HK1,200 / ft2 developer’s profit – HK$1,500 / ft2 construction costs = HK$1,300 / ft2 residual land value. Generally, construction costs are less flexible to adjust than land costs, as construction contracts may have fixed prices agreed and many building items are imported thus relating very little to local economics.

F)     Land sellers including the government may experience revenue drops (at least on a per land lot basis) = using the above figures, let us assume that a residential land lot can have 120,000 ft2 of built floor area, then 1) In the 3 bedroom 800 ft2 scenario, this means 150 units = HK$2,000 AV x 800 ft2 x 150 units = HK$240M; 2) In the 4 bedroom 1,000 ft2 scenario, this means 120 units = HK$1,300 AV x 1,000 ft2 x 120 units = HK$156M, i.e. only 69% (165 / 240) of what can be expected if more smaller sized units are built.

G)    Wouldn’t the reduced number of units for sale push up prices? = Yes, this is a possibility, yet this assumes 1) The market is very rigid and somehow, by design or coincidence, cannot produce enough supply in the long run to meet the demand; 2) That buyers can and will bid and top up their prices PROPORTIONATELY like this, when there are 150 units, the buyers are willing to offer HK$4M, at 120 units, HK$5M, at 100 units, HK$6M, at 80 units, HK$7M, at 70 units, HK$8M and so on (the mathematics are not precise but the author thinks the readers get the point here). This is unlikely to happen because beyond a certain ‘break’ point, the buyers generally give up buying and rent instead.

In summary, when the demographics changes, there are likely changes in the economy as well, and this in turn means that the real estate economics may also change.

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