(This essay was published in Hong Kong Economic Journal on 19 April 2017.)
Housing Malaise is Not Simply Insufficient Housing Units
The housing malaise in Hong Kong is often seen as a problem of demand growing faster than supply. Government policy aims to (1) manage demand by discouraging transactions through high stamp duties and mortgage down payments in the shorter term, and (2) increase housing supply by finding as much land as possible and squeezing as many units into every development site in the longer term.
Accordingly, the housing malaise is interpreted as a straightforward problem of insufficient housing units. This appears to account for why existing housing units in the private sector are being sub-divided to meet the excess demand and the waiting time for public sector units has lengthened. Such an approach assumes that once enough public and private housing units are built, the malaise will disappear.
But this logic may be flawed because in Hong Kong we have long had two housing sectors: a private market sector and a public non-market sector. Today they respectively house 53.5 per cent and 45.7 per cent of households. These two sectors are connected through a housing ladder. Lower-income households first occupy the subsidized public rental housing sector. As their economic situation improves, they upgrade into the subsidized Homeownership Scheme (HOS) sector and eventually graduate into the more expensive private housing sector.
Our current housing malaise is not only about insufficient units, but also high prices. Three decades of rising property prices have made a very large number of households wealthy because their properties have appreciated greatly in value. They are the primary drivers of local private housing demand either for investment or to help finance home purchases for their children.
The demand for private housing units has increased by so much that the housing ladder has been broken for a large majority of the less well-off households. They cannot afford to live in private housing units without government subsidies or assistance.
The present income eligibility criteria to qualify for the Homeownership Scheme units is set at a monthly household income of $52,000. This implies government accepts that if a household earns less than this, it should receive some form of government provided housing subsidy. According to government surveys, about 80 per cent of households have monthly incomes below this level.
By implication, the government is saying that in principle 80 per cent of households qualify for public housing subsidies. If this is correct (!), then it is not at all obvious that government policies are focused on delivering such a housing goal.
Many middle-income households find current private housing prices to be unaffordable even if their household incomes are above $52,000 a month. Furthermore, since so few units are supplied each year, many of those eligible today would no longer qualify in future as their incomes rise.
Upward mobility through the housing ladder has become increasingly difficult for low- and middle-income households. Their incomes have lagged behind overall economic growth. Meanwhile, their numbers are swelling, especially among low-income households, as a result of rising cross border marriages and rising divorces and remarriages. This has led to unmet demands for subsidized housing.
Historically, public sector housing occupants moved into the private housing sector because of upward mobility. Today, they move into sub-divided units in the private housing sector, which is seen as downward mobility. This is the only form of housing that they can afford. Given that sub-division is not permitted in the public housing sector, the main burden of accommodating the increased demand from the less well-off households must take place in the private rental sector.
The requirement that adult children of existing public sector tenants must be deregistered in order to prevent them from ‘inheriting’ the right to stay in the public rental housing units also adds to the pressure for sub-dividing units in the private rental housing sector. The regulatory restriction that prevents sub-division in the large public rental sector is raising rents and property values indirectly in the relatively small private rental sector.
For this reason, it is important to recognize that rising market rents and prices are not solely driven by well-off local households and overseas buyers. The increased demand from those without means is probably an equally important source of rising private housing rents and the growth of sub-divided private housing units. This is reflected in the decline of average household size in the public rental sector from 5.1 in 1976 to 2.8 in 2016, while that in the private rental sector has decreased from 3.3 to 2.6 over the same period (see Figure). In the most recent decade it has started to rise.
Our housing malaise has so many complex interconnected dimensions that simply building more public and private units will not suffice as a solution. First, the balance between public and private housing units is a divisive issue. The balance has been shifted by the current administration from 50-50 to 60-40 in favor of public units. But less supply of private units only fuels private housing prices, which recent experience has demonstrated cannot be held down by punitive stamp duties. Rising housing prices further infuriates those who cannot wait or qualify for public housing.
Second, building more public rental housing may not reduce the shortfall if it encourages more cross-border marriages either through first marriages or remarriages that increase family formation numbers. If such demand is incentivized, the housing shortage among less well-off households will not be narrowed. Therefore, it matters greatly how public housing subsidies and assistance are provided and whether they will improve or worsen the housing malaise.
Third, if we only focus on building more units to meet the housing shortfall, then eventually a 60:40 ratio of public to private sector housing may become inadequate for accommodating our population because the economic divide cannot be narrowed. This would certainly imply the end of limited government and low taxes because public housing spending will soar.
The economy will also suffer because an increasingly large share of our highly valuable land resources will be committed to a use whose economic value cannot be released and captured by anyone, including the government. The economic and social divide between the ‘haves’ and ‘have-nots’ due to property ownership will not be narrowed, leading to long-term negative political consequences.
Reforming Public Housing Policy
Obviously a new public housing strategy has to be devised. This can be undertaken in four steps.
Step 1: Sell most new public housing units (instead of renting them) using a new financing arrangement to assist households that are not well off.
Most newly supplied public housing units should be available for sale. Conceivably an entire building could be designated as either for sale or for rent. The sales price could be the market price and be divided into two parts: the development cost and the land value. For illustration assume that the development cost is $1 million and the land value is $2 million. Land values will depend on location.
Households that choose to purchase the units will first pay the development cost. An initial 5-10 per cent down payment will be required and the balance paid with a mortgage loan from a bank. Government will provide a guarantee to banks to facilitate mortgage lending. Units bought cannot be transferred on the open market for 5 years, subsequently they can be freely transferred on the open market and the owner will receive all capital gains.
The land value will be fixed at the time of initial purchase and will be paid for as a loan from government. The loan will be at a fixed interest rate of 2 per cent and the charge will start after five years, when the units can be transferred on the market. The outstanding government loan can be repaid by installments on fairly long flexible terms so that individual households could afford the payments. If the owner fails to make payment, then the sum will be deferred and charged to the outstanding loan.
The proposal does not provide a direct subsidy towards the purchase price. It is a financing arrangement to assist households that are not well-off and cannot pay a high down payment and get a mortgage loan from a bank. Such assistance does not cost the government any resources because the land would otherwise have been used to build public rental housing free of charge. In fact, the government will now be able to recover part of the land values gradually.
Conceivably, the public may be willing to provide some direct subsidy to the less fortunate in society. This can be introduced through a discount on the sales price, which may vary with the circumstances of the household. But this is purely a political decision.
The new public housing scheme is in effect a government intervention to correct capital market imperfections confronting those who are not well-off when they seek loans from banks. It exposes no party to any risk. The owner gets an opportunity to become a homeowner, bequeath the asset to his next of kin, and reap any value uplift like any homeowner.
If an eligible household does not wish to purchase the unit upon entry to the new public housing program, then he has the option to rent first and buy later. All individuals will only be eligible once in a lifetime for ownership financing by government.
Step 2: Extend the new financial arrangement to existing public housing units.
After successfully taking the first step, the government can advance towards the second step, which would allow a much larger pool of eligible households currently occupying public housing units to become homeowners. In determining the appropriate sales price of existing units, the same principles adopted above shall be used. The government will first determine the original market price of the unit at the time they were completed and available for occupation.
For public rental housing units and unsold TPS units, the above original market price will be accumulated at a compound interest rate of 2 per cent to arrive at the current sales value. A depreciation rate will be applied on the estimated development cost, but not on land values. The same financing arrangements will then be applied. (If the depreciation rate used is 2 per cent, then it will exactly offset the accumulated interest charge on the development cost.)
For sold TPS and HOS units with outstanding unpaid land premiums, the appropriate sales price shall be determined in the same manner. Any sums that have been paid initially will be deducted before the outstanding amount is accumulated at a compound interest rate of 2 per cent to arrive at the current sales value.
Step 3: Facilitate redevelopment.
Many public rental housing estates are very large, which could make future redevelopment costly after the units are sold off to separate household owners. To reduce the transactions cost of redevelopment, stratified titles shall be defined for each building and not on the entire housing estate. Provision for forced sales could be triggered if at least 80 percent ownership shares vote in its favor. Government public housing units completed after 1997 should be made available for sale as soon as possible.
Step 4: Think about old estates.
Many public rental housing estates are quite old and some will have to be redeveloped within say two decades. The pros and cons between redevelopment as a public housing estate under the Housing Authority versus relying on the market after privatization needs to be considered. If the latter is chosen, it may be useful to consider a lower threshold for triggering forced sales, say at most at 70 per cent.
Privatizing the entire stock of public housing will improve economic efficiency, foster social harmony, and empower citizens politically. It will narrow the divide and disparity that is plaguing many communities everywhere. Hong Kong would not have come to its current stage had housing been privatized shortly after 1997, which I had hoped for at the time. It is late, but not too late, to arrest the populist drift towards authoritarianism. If land values are so released, our community will be enriched and invigorated. Hong Kong is blessed to have valuable land resources that can have the potential to finance a better future for all. They should not be left to waste.