(This essay was published in South China Morning Post on 5 April 2017.)

Property prices have again scaled new heights, demonstrating conclusively that regulatory constraints do not work. The scale of the shortage can be surmised by the gap in cumulative family formation numbers and new housing units completed over the past 20 years.

 

The cumulative number of marriages in Hong Kong from 1986-2016 was 1,745,000. Over the same period, the cumulative number of new domestic housing units built was 1,572,000.Assuming demolished units amounted to about 10 per cent of the new supply, then the net increase was only 1,414,000 units.

 

Clearing the backlog of housing demand and meeting new demand will be a major priority for the incoming Chief Executive. It will require a fresh understanding of the complex causes of the persistent shortages seen over the past three decades.

 

This is too difficult and complex a problem to blame it on any single factor: Donald Tsang for failing to provide more land and housing units, or greedy property developers for withholding land and housing supply, or government policy to maximize land revenues, or crony capitalism and plutocracy, and some are downright wrong-headed explanations.

 

The main reason for our land and housing shortages has been our failure to grasp the full impact of China’s opening and global economic integration on Hong Kong: it has created enormous prosperity that has fuelled the demand for housing. As property prices escalated, it also created a huge disparity in propertied wealth between the ‘haves’ and ‘have-nots’ to foment a huge political divide and dissent.

 

Our failure to anticipate the growth in demand has blinded us to the need to increase our land supply aggressively. Most major cities in the world have had a similar experience.

 

Regulatory restrictions have also not helped. Consider the three most important sources of land supply: land reclamation, urban renewal, and conversion of New Territories land – both green and brown sites.

 

The first two sources of land supply have been unimportant for quite some time for various reasons so increasingly; new land has had to be found from the conversion of New Territories land. But this process has also become very protracted.

 

The government’s basic principle is to charge a 100% premium on the increase in value for conversion of New Territories land. The premium is the difference between the government’s assessed ‘after’ and ‘before’ values. This is a correct approach, but disagreements between the developer and the government over assessed values can delay development sometimes for very long periods of time.

 

The ‘before’ value of land has increased enormously over time. Containerization of shipping and China’s opening created a huge demand for storage space, which was met by New Territories’ brown field sites. The logistics industry in Hong Kong would have suffered enormously without these sites.

 

The government calculates the ‘before’ value assuming it is cleared land, which is not always the case. There may be permitted other uses that command a higher value than merely as pure agricultural land. There may also exist buildings and structures that will incur a cost to demolish. Government ignores these factors. The resulting estimated premium may therefore be inflated and not acceptable to the developers.

 

Also, the assessed ‘after’ values often fail to take into account the development costs incurred in demolishing and rebuilding an existing facility, such as a pre-existing transport exchange.

 

When disagreement over the premium occurs, developers wait for market conditions to change in their favor because a lower premium is demanded when government expects the market to soften in the future. The problem is that for three decades the property market has not adjusted downwards (except during the Asian financial crisis), making it less likely for developers to accept what the government is prepared to offer.

 

Clearly there is room for government to set premiums that are more reflective of true values and costs.

 

Some believe that government should resume land resumption and threaten to slap a punitive tax on the leaseholders if they fail to develop it within a specified time, but experiences from other countries show it is far from evident that this provides either a cheaper or faster solution for recovering land. The transactions cost of assembling and clearing land for conversion cannot be eliminated by administrative fiat. It would also damage the integrity of private property rights with negative impacts on long-term property values and the rule of law, and obviously be politically divisive.

 

In the long term, government cannot rely solely upon land conversion in the New Territories to meet housing demand (and other uses). It has little choice but to reinstitute a program of land reclamation as soon as possible. In Hong Kong only 6% of our land has been reclaimed, against 20% in Singapore. The sooner we lay down plans for land reclamation, the better off we will be in shaping long-term expectations.

 

Next week I will look at the pressures on housing from population changes and how addressing the housing problem will be imperative to the government’s future financial health and reduce the divide in society.

 

 

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