Addressing the housing aspirations of the public was the centerpiece of Mr. Leung Chun-Ying’s campaign for office. His government is now busy preparing a detailed housing strategy to develop land and increase housing supply. As I have explained before, one of the most important reasons why housing prices in Hong Kong are high is not the absence of land, but the rigidities of planning rules and regulations that govern their use. (Please see my essay published in the Hong Kong Economic Journal, 14 March 2012 entitled Why is Housing so Expensive?) These rigidities make it very difficult, costly, and time consuming to make land available for housing development whether in the public or the private sector.

 

The inflexibility of regulatory control is not only limited to land use, but also applies to existing housing units. Industrial space in both the private and public sector is rigidly controlled making redeployment and redevelopment difficult. Such inflexibility also applies in the public housing sector comprising primarily public rental and Homeownership Scheme (HOS) units. These units, once assigned to an occupant, seldom become available for other users even when the occupant no longer wants to remain in the unit; some occupants either leave the units vacant or clandestinely let others use them. The lack of circulation is the major source of inefficiency and inequity in the public housing sector, which I shall discuss in a separate essay.

 

Secondary Market Liberalized

 

Private sector housing units are subject to less rigid regulatory control. Throughout the post-war decades, many private housing units have been converted to uses beyond their original specifications. Hong Kong has always had roof-top structures, cocklofts, bed-spaces, covered verandahs and balconies, cardboard homes under highways, partitioned sub-tenanted rooms, sub-divided rooms and many other innovative extension structures. Until recently these were largely tolerated and there was little stigma attached to making such innovations. This is now no longer the case because the banner to uphold rules and regulations and their enforcement has been hoisted high.

 

When rules and regulations are routinely and regularly circumvented or ignored for long periods of time, it may be that there is something fundamentally wrong with them because they seem to be working against the interests of the people, as Professor Ronald Coase, Nobel Laureate in Economics, has taught us. (Although they are not necessarily working against the interests of those who want to keep the rules and regulations.) There is therefore scope for liberalizing the regime so that more efficient and equitable arrangements can be made that reduce the transaction costs of the arrangements to the benefit of all parties.

 

The government recently relaxed one such regulation: 5,000 White Form applicants will be allowed to apply for HOS units in the secondary market each year. This is a positive move to relax one of the many restrictions in the public housing sector and is intended to revive the HOS secondary market. Unfortunately some criticism of the government for fuelling the property market has surfaced after prices for small sized units jumped in both the HOS secondary and private markets. But this criticism is beside the point. How can a market be revived if prices do not rise?

 

Birth of the Home Ownership Scheme Secondary Market

 

HOS units have always been tradable on the open market, but subject to two requirements. First, there is a resale restriction period after initial purchase, which was first shortened to five years from 10 years in June 1999 and then to two years in May 2005. Second, since the launch of Phase 3B of the HOS in May 1982 the subsidy, in the form of unpaid land premiums, has to be returned to the Housing Authority (HA). The latter restriction offers little incentive for owners of HOS units to sell their units on the open market and trading activity has always been very limited. I estimate that less than 1% of the stock HOS units in each year are sold. Over time, as the land premium has continued to rise, the possibility of settling the unpaid land premium has become more remote for HOS homeowners. The lack of circulation of public sector housing units is directly the result of the exorbitant unpaid land premium.

 

The amount of unpaid land premium is the critical element that chains all housing units in the public housing sector to the HA. Every economist knows that tariffs and quotas can be equally effective in reducing and eliminating international trade. A quota set at zero eliminates all trade. Similarly, a tariff rate set at one million percent would achieve the same effect.

 

In 1997, a secondary market for HOS units was created as a liberalizing measure to encourage the circulation of housing units within the public housing sector. Public rental housing tenants, Green Form applicants on the Waiting List for public rental housing, and HOS homeowners were free to buy the units in the HOS secondary market without having to settle the unpaid land premium. This definition of “eligible households” encompassed about 37% of all households in the population, who could now trade in the HOS secondary market. However, it excluded White Form applicants living in private housing eligible to apply for new HOS units.

 

Unchanged Desire for Dominance

 

Still, the HOS secondary market remained largely inactive. There were very few transactions each year. In the period since 1997, the total number of units transacted on the HOS secondary market without settling the unpaid land premium was 33,840, which is less than 0.8% of the available stock of HOS units in each year.  The creation of the HOS secondary market was a well-intentioned initiative to promote circulation and encourage public rental housing tenants to purchase HOS units so they would surrender their rental units back to the HA and free up “locked-in” public rental housing resources for those on the Waiting List.  But it has fallen short of its goals.

 

The reason is the focus on generating more circulation of housing units within the public housing sector. I stress the word within because these policies centered on accommodating the internal concerns of the HA. While the HA wanted to shorten the queuing time for those on the Waiting List, it was equally if not more keen to retain its role as the developer and landlord for the public housing sector in Hong Kong. Any changes it was prepared to make inevitably were constrained to those that would not threaten its pre-eminent role.

 

The HA also did not want to encourage the circulation of housing between the public and private sectors, except in a highly limiting way – by retaining the exorbitant unpaid land premium. For them the HOS secondary market was a mechanism for recovering public rental housing units, but no more. Their thinking was trapped in a linear logic that saw only one path for their clients to progress through the housing sector: from public rental housing, to the HOS, and to private housing. When this did not happened often enough, they sought to give it the odd push and pull, but without any intention of changing the separation of the public and private housing sectors or the linear progression of households through the HA sector. 

 

Polarization into “Haves” and “Have-Nots”

 

Throughout the 1990s, property and housing prices were rising and society was increasingly divided into “haves” and “have-nots” based on whether they owned property assets. The Ten-Year Housing Plan announced in 1997 promised to achieve the goal of 70% homeownership.  A critical element of the Plan was the Tenant Purchase Scheme (TPS) to sell 250,000 public housing rental units over a 10-year period to sitting tenants. If this had been delivered, it would have gone a long way towards alleviating the gap between the “haves” and “have-nots”.

 

Although the public has always chosen to focus on the development of 85,000 new units as the centerpiece of C H Tung’s housing policy, I believe the TPS initiative was the truly innovative centerpiece of his plan to attain the 70% homeownership goal by 2007. It held out the promise of transforming the system of public provision of rental housing. 

 

The TPS was a bold initiative. The total stock of public rental housing units at the time was about 670,000 so the scale of Tung’s proposal was vastly greater than previous failed attempts to sell public rental housing units to sitting tenants. Unfortunately, the HA imposed restrictions on the TPS that were essentially similar to those that applied to the sale of HOS units.

 

While the TPS units could be sold on the HOS secondary market without settling the unpaid land premium, they could only be transferred on the open market five years after the initial purchase – and then, owners would have to return the exorbitant unpaid land premium to the HA. These requirements effectively created a powerful barrier that kept the TPS units from flowing into the open market. Similar to HOS units, there was really no strong incentive to sell TPS units on the open market. As before, the HOS secondary market of TPS and HOS units could not be integrated into the open market, except at the tail margins.

 

Tenants who acquired TPS units were also allowed to apply for new HOS units within 10 years, as White Form applicants. This decision probably reflected the HA’s hope to encourage the circulation of housing units within the public housing sector. It still kept the HOS secondary market very separated from the open market and posed no real threat to it.

 

As an economist, I see the HOS secondary market as a form of protection. The completely rigid quota system was replaced by a superficially more flexible tariff scheme, but the effects were largely the same. Of course there were some marginal gains for HOS and TPS homeowners.

 

TPS Did Not Dampen Property Market

 

The onset of the Asian financial turmoil in 1997 and the subsequent world economic recession of 2001 led to a double-dip economic recession in Hong Kong.  This sent property prices plunging by 70% from their peak in 1997, leaving the public to languish. The cumulative consumer price level fell by 11.6%, the cumulative GDP deflator fell by 17.5%, nominal GDP fell by 9.5%, and about 57% of the decline in consumer prices was due to the decline in property prices. With a public languishing in negative net worth. Widespread concern emerged over the large supply of public sector housing units that were being produced and brought to the market, and the TPS was one of the factors blamed for contributing to the fall in property prices.

 

On 13 November 2002, the Secretary for Housing, Planning and Lands announced nine new housing policy measures, including putting a halt to the TPS. Only about 115,000 units had been sold in the four years since it was introduced. I believe the decision to stop the TPS was based on an erroneous concern that it had contributed to the decline in property prices and would further weaken the property and housing markets.

 

The TPS could not have contributed to the decline in property prices after 1997.

 

First, 115,000 households were made wealthier through a voluntary transaction, which does not dampen the open property market; if anything the creation of additional wealth has a positive effect on the market. Of course, given the restrictions on reselling TPS units on the open market, the true benefits derived from TPS homeownership were not large. But they could not be negative.

 

Second, for TPS units to have weakened the open property market, they would have had to act on the supply side by flowing units into the open market. This would have required TPS households to first settle the unpaid land premium on their units, which they seldom could afford to do. As we have seen, too few TPS sales transactions actually took place to be able to have any effect on the open market.

 

Third, TPS units sold on the HOS secondary market were sold to Green Form applicants living in public rental housing units or to those who were on the Waiting List. Since these transactions were still within the public housing sector, they could not have produced any spillover effect onto the open market. Moreover, very few TPS sales transactions were recorded in the HOS secondary market for the simple reason that most Green Form applicants had little interest in these units.

 

For these reasons, fears that the TPS initiative dampened the property and housing markets were unfounded. There was simply not enough activity in the HOS secondary market to produce any effect. Plus, the HA had toiled hard to minimize the connectivity between the public and open markets. The fact that exorbitant unpaid land premiums had to be settled effectively eliminated any meaningful possibility of an impact on the open property market. Economics teaches us that exorbitant unpaid land premiums provided an effective barrier to separate the HOS secondary market and the open property market. 

 

The recent government proposal to permit 5,000 White Form applicants to buy existing TPS and HOS units in the HOS secondary market each year comes almost a decade after the TPS program was halted. Its purpose is to revive the HOS secondary market. This appears to officially confirm that the TPS program did not contribute to the weakening of the open property market in the period after the Asian Financial Crisis. 

 

In fact, consider what would have happened had the HA allowed the exorbitant unpaid land premiums to be settled at a much more affordable rate at that time. The HOS secondary market would have become more affordable and more public rental housing tenants would have taken up the TPS offer. This would have produced a considerable positive wealth effect that would have stimulated the faltering property market. (On this point I shall elaborate further in a subsequent essay.)

 

There would also have been no calls to halt the TPS plan of selling 250,000 units and the goal of 70% homeownership would have been closer to realization, helping to reduce the gap between the “haves” and “have-nots”. And today society would not be so divided and public trust in government would not have fallen so low.

 

Unbound White Form Applicants and What Next?

 

History is not always kind, but reflecting on the past and learning from missed opportunities and failures presents us with a better chance of moving forward to meet the challenges of today.

 

The HOS secondary market has two types of clients: (1) the Green Form applicants who do not have to settle the unpaid land premium when they purchase their units, and (2) the open market purchasers who have to settle the unpaid land premium. A third type of client has recently been permitted to enter the market. These are the 5,000 White Form Applicants who will be permitted to buy units in the HOS secondary market each year without having to settle the unpaid land premium.

 

Property prices in the HOS secondary market will obviously increase, as will similarly sized units in the open market. But one must appreciate that the total stock of units in the HOS secondary market will remain fixed for many years into the future. The total number of units that could be traded in 2011/12 with the unpaid land premium still not settled was 378,646, of which 261,509 were HOS units and 117,137 were TPS units (see Table below). It is highly unlikely that these numbers can be increased over the next few years because new HOS units have yet to be developed. We have a situation where rising demand is not matched with increasing supply. And this is taking place with a housing stock that is not only fixed but also quite limited in size.

 

Table: Estimated Stock of Units with the unpaid land premium in the HOS Secondary Market, 1998/99-2011/12

 

 

1998/99

2000/01

2002/03

2004/05

2006/07

2008/09

2010/11

2011/12

居屋第二市場

178,708

231,301

322,052

357,847

353,825

371,144

377,020

378,646

HOS/PSPS/BRO/MSS/FFSS

178,708

211,494

264,184

267,238

258,845

258,695

261,709

261,509

TPS

0

19,807

57,868

90,609

94,980

112,449

115,311

117,137

                 
Units sold for over 2 years but
less than 5 years*

25,563*

69,067

129,607

96,966

23,528

25,848

24,545

14,466

Units sold for over 5 years

153,145

162,234

192,445

260,881

330,297

345,296

352,475

364,180

 

Note: *Units sold for over 3 years but less than 5 years (before 1999)

Source: Hong Kong Housing Authority, Hong Kong Housing Society

 

 

Faced with such a set of conditions I believe the government has little choice but to pro-actively consider increasing the available supply of units in this fixed pool. And the only immediately available source of supply is to revive the TPS program that was halted 10 years ago.

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