(This essay was published in Hong Kong Economic Journal on 4 September 2013)

 

Addressing the housing aspirations of the public is the centerpiece of the present government.  A detailed housing strategy to develop land and increase housing supply is being prepared. One of the most important reasons why housing prices in Hong Kong are high is the rigidities and inflexibilities of regulatory control of land and housing. These rigidities make it very difficult, costly, and time consuming to make land and housing supply available in the public or private sector.

 

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.

 

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 from 10 years to 5 years in June 1999 and then to 2 years in May 2005. Second, until May 1982 all HOS units could be sold on the open market after the restriction period without having to settle any unpaid land premium. No such premium was set on these early HOS units. But since then and starting with Phase 3B of the HOS units the owner must first settle a newly introduced unpaid land premium with the Housing Authority (HA) in order to sell the unit on the open market.

 

This new restriction created a huge disincentive for owners of HOS units to sell their units on the open market and trading activity has since been very limited. I estimated that less than 1% of the stock HOS units in each year are sold. Over time, as the land premium has continued to rise with private property prices, the possibility of settling the unpaid land premium has become ever more remote for HOS, as well as TPS homeowners. Both groups face the same predicament. 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 “locks-in” 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. Access to this market for the purchase of secondary HOS units was limited. Three categories of “eligible households” were permitted to buy units in these HOS units without having to settle the unpaid land premium. These were (1) occupants of existing public rental housing tenants, (2) applicants on the Waiting List for public rental housing, and (3) existing homeowners in HOS units. The first category of “eligible households” formed the basic source of Green Form applicants for new first-hand HOS units.

 

White Form applicants, defined as those households living in private housing units applying for new first-hand HOS units, were not allowed to have access to the HOS secondary market. If they wish to purchase a secondary HOS units they must settle the unpaid land premium first, which effectively meant they were restricted to purchasing a second-hand HOS unit through an open market arrangement.

 

Dominance and Market Competition

 

The HOS secondary market had been very inactive ever since it was created. 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 by government 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 expectations because many well-off tenants continue to hold onto their PRH units.

 

The reason for this is the HA’s narrow-minded focus on generating circulation of housing units only “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 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 role as Hong Kong’s pre-eminent developer and landlord.

 

The HA also did not want to encourage the circulation of housing between the public and private sectors, except in a highly limited way – by retaining an exorbitant unpaid land premium. For them the HOS secondary market was a mechanism for recovering public rental housing units and 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.  In keeping the HOS secondary market largely separated from the open market it posed no real threat to the existing institutional set up.

 

The HOS secondary market was essentially a slightly reduced protectionist for preventing the public housing units for entering the private market. Such a measure is familiar to economists who study international trade practice and policy. The high tariffs (i.e., unpaid land premiums) were retained, but lowered for some eligible traders.

 

Partial Liberalization of the HOS Secondary Market

 

The HOS secondary market has two main 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. Under a new government proposal 5,000 White Form applicants were allowed to buy HOS units in the secondary market each year without having to settle the unpaid land premium at the time of transaction.

 

This is arguably a positive move to relax one of the many restrictions separating the public housing sector from the private sector; and is intended to revive the HOS secondary market and assist more private sector tenants to become HOS homeowners. 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. Such criticism is beside the point. How can a market be revived if prices do not rise? But do these prices at which HOS units are transacted represent a genuine market price? What is the quality of the price signal that would result from these additional transactions?

 

What is the genuine market price for HOS units? To get an answer for this question let us consider the supply and demand for HOS units. In the HOS secondary market there are 261,509 units that have not settled the unpaid land premium in 2011-12. They represent the supply pool of HOS units. We cannot know with the same precision what is the potential number of eligible White Form applicants in the market, but it is likely to be quite large given the criteria is set at income levels of $40,000 per month for families and $20,000 per month for single individuals; in addition there are asset restrictions. The actual number of submitted White Form applications in 2012 was reported to be 66,000.

 

The market price paid for the units will be determined by successful matches of eligible White Form applicants with the occupant vendors of the HOS units. Out of this large potential pool there will always be some who would be willing to pay a very high price for a suitable HOS unit in the secondary market. The suitability of an HOS unit will depend on the attributes of the available housing units with respect to location, size, and quality of the unit in meeting the individual preferences of these White Form applicants. It is entirely possible that some potential buyers would be willing to pay very high idiosyncratic prices because of their specific personal preferences.

 

What Price Must White Form Applicants Pay?

 

But what is the minimal price the occupant vendors of HOS secondary units would be willing to accept for their units. This is not too difficult to figure out. A vendor would be willing to sell provided he is able to get back a somewhat equivalent unit somewhere in the private sector assuming he does not have idiosyncratic preferences for his own unit. The equivalent unit can, but need not be in a nearby location. This means the buyer would have to pay approximately the market price for some private housing unit to purchase the HOS unit.

 

If this is the case then a natural question that arises is why didn’t the prospective White Form applicant just go ahead and buy a private housing unit instead. Isn’t the whole purpose of the exercise to allow those who could not afford to buy private housing units to purchase presumably cheaper HOS secondary units? If so then isn’t this much ado about nothing? And why would these private housing tenants be willing to pay close to private market prices to purchase a HOS unit, which still has an unsettled land premium on it?

 

The key issue to recognize about what the whole exercise accomplishes is that it allows vendors and purchasers with idiosyncratic preferences to find each other. Let me use an illustration to show what is happening. Let us start with an occupant vendor living in a HOS unit in the Pokfulam area. He now prefers to live in the Tin Shui Wai area because he now travels frequently to Shenzhen to visit his son’s family who lives there. But as an HOS occupant who has not settled the unpaid land premium he cannot afford to buy a private housing unit in North-West New Territories and there are not other options.

 

Next comes an eligible White Form applicant living in the Aberdeen area and is only interested in living in the proximity of this area. If he can afford to purchase a Tin Shui Wai private housing unit then these two parties can have a match. The White Form applicant can pay enough money to help the HOS unit occupant vendor to purchase a Tin Shui Wai unit in exchange for his Pokfulam unit. The 5000 White Form application exercise allows these two parties to find each other. This is the beauty of the market and voluntary exchange. It allows the two parties to fulfill their idiosyncratic wishes.

 

Let us think more carefully what is the nature of these transacted prices? These are prices that occupant vendors of HOS units are willing to accept. The occupant vendor still needs a place to stay and is only willing to give up his unit in exchange for another unit. So these prices must enable them to purchase a somewhat equivalent unit somewhere in the private sector. Therefore the buyer must pay the purchase price of this other unit. The market price for HOS units will be determined by the price of somewhat similar private housing units somewhere in Hong Kong that the occupant vendors are willing to accept.

 

From the vendor’s point of view he prefers to sell his unit to a White Form applicant rather than on the open market. When selling to a White Form applicant he does not have to settle the unpaid land premium, whereas he would have to do so if he sells it on the open market. The reason why so few HOS units are sold on the open market is the result of the high unpaid land premium. The occupant vendor is often unable to afford another somewhat similar unit in the private sector if he has to settle the unpaid land premium after selling his unit on the open market.

 

A White Form applicant who is willing to offer the occupant vendor a price higher than what the seller can get on the open market net of the unpaid land premium has a better chance of getting the unit. And his offer must be sufficient for the occupant vendor to purchase another unit on the market. This happens when both the White Form applicant and occupant vendor have strong idiosyncratic preferences. One is willing to offer such a price and the other is willing to accept it. This explains why when we add the unpaid land premiums to the transacted prices they could sometimes be even higher than the market’s evaluation of the worth of the HOS unit should it come onto the open market as a private housing unit.

 

Now we are ready to return to the issue of whether the transacted prices are genuine market prices? They are the market prices of idiosyncratic transactions. These idiosyncratic prices are created by the idiosyncratic way in which the government has chosen to relax the restrictions to allow a select group of households to enter the market. The transacted prices we observe are those that resulted from a successful match of participants with idiosyncratic preferences. It also explains why there are so few such transactions.

 

Unbound White Form Applicants and What Next?

 

Deregulation therefore creates trading opportunities previously not available. What is the volume of such potential matches in the market? Nobody really knows. By restricting the exercise to qualifying only 5,000 applicants the full potential has not been realized. Removing the limit of 5,000 applicants will allow more such mutually beneficial matching transactions to occur. Transactions prices will not vary much with how many qualified White Form applicants are approved. The transacted prices will have to be around the purchase price of a somewhat similar unit somewhere in the private sector that the occupant vendor is willing to accept. And there will be some variation depending on the idiosyncrasies of the buyer and the seller in each transaction.

 

Property prices in the HOS secondary market will obviously increase. 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

 

Year Total HOS/PSPS/BRO/MSS/FFSS TPS Units sold for over 2 years but less than 5 years Units sold for over 5 years
1998/99 178,708 178,708 0 25,563* 153,145
2000/01 231,301 211,494 19,807 69,067 162,234
2002/03 322,052 264,184 57,868 129,607 192,445
2004/05 357,847 267,238 90,609 96,966 260,881
2006/07 353,825 258,845 94,980 23,528 330,297
2008/09 371,144 258,695 112,449 25,848 345,296
2010/11 377,020 261,709 115,311 24,545 352,475
2011/12 378,646 261,509 117,137 14,466

 

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 can do better to consider more deregulation. First it can remove the cap of 5000 White Form applicants. Second, it can devise a new method for setting the unpaid land premium on HOS and TPS units with a view to lowering it significantly. Third, it can revive the TPS program that was halted in the year 2000 and increase the available supply of units in the HOS secondary market.

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