(This essay was published in Hong Kong Economic Journal on 25 April 2018.)
Housing Shortage has always been a Private Renter Market Problem
Hong Kong’s current public housing policy was devised against a background in which the central housing problem was overcrowding in the private housing sector. By 1971, private renter households comprised 46.3% of all households. The degree of sharing (defined as the total number of housing flats per household) was 0.54 in private renter housing flats.
At that time the vast majority of private housing tenants had very low incomes and could only afford low-rent public flats. So the fact that public housing policy in the 1970s focused on low-rent public flats made sense. Singapore, in contrast, had more foresight to focus on homeownership at the very outset.
Within Hong Kong’s public rental-housing sector, there was also a group of tenants with middle-income means who were interested in homeownership. Many were former squatter households that had been allocated low-rent public flats following squatter clearance, without an initial means test. This resettlement-housing program was started after the famous Shek Kip Mei fire of 1953. From today’s vantage point, one could think of some of these households as public tenants by accident or coincidence.
Similarly, the private housing sector also contained a group of households with middle-income means. Both groups were interested in homeownership and demanded subsidized sale flats. This led to an evolution of public housing provision so that two-thirds was for rent flats and one-third for sale flats. The famous “housing ladder” concept was born.
The fact that the net proceeds from selling one subsidized sale flat could pay for the development cost of two low-rent public flats made it fiscally sustainable to have two-thirds of public housing as rental flats. The allocation of subsidized sale flats became more or less evenly split between applicants from the public housing sector (the Green Form Applicants) and the private housing sector (the White Form Applicants).
This public housing strategy was appropriate for the 1970s and 1980s when the primary challenge was to meet the rental demands of a large segment of low-income households in the private sector, and the ownership demands of a smaller segment of middle-income households that existed in both the public and private housing sector.
But by the 1990s the situation had changed completely. The public housing strategy had substantially reduced the degree of sharing in the private rental sector and the problem of over-crowdedness was largely alleviated (see Figure 1). The share of private renter households had dropped from 46.3% of all households in 1971 to 18.8% in 1991. The number of housing flats per household had increased from 0.54 in 1971 to 1.00 in 1991 among private renters.
At the same time, growing prosperity in Hong Kong and a host of external economic factors had increased the attractiveness of homeownership.
However, the original public housing strategy did not change under these new circumstances. Amid booming housing prices are under political pressure, the government introduced a variety of ad hoc measures to meet the demand for homeownership, like the Sandwich Class Housing Scheme in 1995, My Home Purchase Plan in 2010, and Green Form Subsidized Home Ownership Pilot Scheme in 2016. These ad hoc measures have made reforming public housing policy even more complicated by creating diverse and conflicting constituencies.
But what it did not do was initiate a systematic review of public housing strategy to reprioritize from a tenancy heavy model to an ownership heavy model, with the possible exception of the ill-fated and partially flawed Tenant Purchase Scheme in 1998.
Ironically, as private home prices have continued to rise and the housing shortage in the private rental housing has led to the mushrooming of sub-divided units, more and more households have shifted their demand to public rental flats. These have become the only units they can afford, and they are more spacious and of better quality than old private sector flats, especially sub-divided units.
Unfortunately, this situation has obfuscated the real housing issue since the 1990s, which should be the unsatisfied demand for homeownership. The strategic aim of public housing policy should be to meet the demand for home ownership for those with modest means in a prosperous and modern Hong Kong. The only question is how to do so, especially after property prices have skyrocketed.
Housing affordability today has two main challenges. First, the high down payment makes it very difficult for those with modest means to enter the market unless they have well-off parents to help. Second, land values, which make up the major component of high housing prices, are now well beyond the reach of even high middle-income families as a result of an unprecedentedly long property market boom cycle and an extremely constrained supply of land.
The first challenge is about capital market imperfections. The second challenge is a timing issue for households that have to enter the market at a high point of the business cycle.
To address these two challenges, I propose a method to sell new public flats and privatize the existing stock of public flats. There is a great moral challenge in all this because while private property prices are unaffordable to many, it is politically divisive to provide very generous subsidies to some and not all. There are also concerns about setting a bad precedent that encourages a nanny state. Nonetheless, I believe it is well within our reach to strike a balance between all the competing considerations that is fair and sound.
How to solve the severe housing challenge?
Turning public flats into homeownership flats is by far the fastest way to address our housing crisis and the myriad issues that arise from that. My research over the past three decades has led me to this inescapable conclusion and pointed to how we can achieve this for both new and existing public flats.
Most new public flats should be for sale and not for rent. Those who do not want to buy now and wish to rent should have the option to buy later.
The key issues in this are how to price the sales and what restrictions should apply to resales. It is absolutely important that they not be sold in the same manner as Home Ownership Scheme (HOS) and Tenant Purchase Scheme (TPS) flats, which impose the exorbitant unpaid land premium on owners when they try to sell their flats. This severely limits turnover such that each year, fewer than 2 per cent of HOS flats and 1 per cent of TPS flats are sold.
To understand how my proposal would work, let us assume the market value of a new public housing flat on the open market is $4 million, of which $1 million is the development cost and $3 million is the current market value of land for this flat. The government would use the average market value of land in the past 10 years for this particular public flat to determine the land value component of its sales price. This would not be a discount, but an averaging process that would smooth out fluctuations in the market. Let us assume that the average land value would become $2 million instead of $3 million because prices have been rising for the past 10 years.
The Housing Authority would then offer the public flat for sale to eligible households for $1 million with a 5-10% down payment. This would cover the development cost of the flat. The household then could apply for a mortgage loan from a bank with government guarantee, as is the current practice with HOS flats. The successful occupant would not be allowed to alienate the flat on the open market or the secondary market for subsidized flats for the first 5 years.
The average land value of $2 million would be an outstanding debt owed to government on which an interest charge fixed at, say, 2 per cent per annum would be levied. The interest charge would begin to take effect only after the moratorium on resale of the flat was lifted, i.e. 5 years after purchase. The key idea here is that interest should not be charged when restrictions on the right to alienate a property are imposed.
Public flat owners should be allowed to rent out space to tenants. They could do this immediately if they rent to eligible tenants, e.g., those on the Applications Waiting List for public rental housing, because this would help to perform a service that the government is committed to but is unable to immediately fulfill. Otherwise, they could rent to tenants on the open market after the 5-year resale moratorium has been lifted. The rents to be charged in both cases would be set in the market.
The repayment terms on the outstanding $2 million loan from government could be set at longer terms than are offered by banks, lasting for the expected life of the building. If the financial circumstances of the household deteriorate unexpectedly, the government might even approve a temporary arrangement that allows the owner to only service the interest charge on the outstanding loan without paying down the principal. The government therefore would perform an insurance role.
The central idea here is that the government becomes a creditor instead of a joint equity holder in the flat. This should give hope to the owner that there is a realistic chance of repaying the loan eventually. It also allows the owner to reap the full capital appreciation of his property in the same way as owners of private property do.
The arrangement would also allow the government to recover the development cost immediately, and the indicated 10-year average land value eventually. Since land value is a receivable of the government, it can be securitized and sold on the capital market.
This approach also addresses the affordability issue by having the government bear various market risks and correct capital market imperfections that affect less-advantaged households more seriously. It would not represent a generous subsidy to some and not others because there would be no direct subsidies. The flats would be sold at near market prices and interest would be charged on unpaid debt.
The same principle can be applied to the sale of the existing stock of public flats. Public rental housing flats can be sold to the sitting tenant, with the land value set at the past 10-year average land value of the flat. The value of the structure would incorporate the depreciated book value of the original development cost, plus the appreciation in construction costs.
A question does arise about existing subsidized public flats (HOS and TPS flats). They have been already sold, so what should be the outstanding unpaid value? If the original sale price was 50% of the market value of the flat at that time, then one should treat half the structure and half the land value as having been paid for. The value of the unpaid portion of the original development cost of the structure should then be depreciated, but incorporate the appreciation in construction costs. The unpaid land value should be valued at the 10-year average of past land values from today.
There is no reason why the Home Starter Scheme and the Green Form Subsidized Home Ownership Scheme should not be adopting these principles immediately as pilot schemes.
In a similar spirit, government cooperative housing can also be unfrozen by applying similar principles. This could even open up prospects of redevelopment of some of these units.
I have heard it alleged that the middle class would object to giving low-income households such a lucrative deal – that society is prepared to provide them with shelter, but not satisfy their homeownership aspirations. This accusation is based on a false premise.
Currently, the land value and development cost are not recovered in the rents of public rental housing flats. A proper accounting would show that the middle class is paying for the provision of public housing through taxes in one way or another. And it is very expensive for them and for society.
My proposal sets the sales price at near market levels so there is no obvious discount. Government assistance is merely to bear market volatility risks and correct capital market imperfections for low-income households, many of whom are now in effect the sinking middle class.
A second objection I have heard is that the government should not encourage low-income households to take unusual risks, because what if the property market crashes?
A property market crash is stressful both for substantive and psychological reasons. But since the “$2 million debt” used in the exposition above is carried on the books of the government, both stresses can be readily minimized. The substantive threat of foreclosure and an inability to reschedule debt payment can be resolved if the creditor is the government. And the psychological stress of the homeowner can be eased by knowing the substantive concern has been taken care of, so they will outlast the market crash.
A third objection stems from the government’s troublesome experience in operating the TPS scheme with rental flats in the same building. This is a management nightmare.
When TPS flats were sold, not everyone in the building bought them. Those who did know some of their neighbors were not buying. So why did they buy? Some were smart. They planned on behaving as tenants on some issues and as owners on others. By gaining ownership of the flat, they could pass it onto their children and also be exempted from the threat of Double Rent measures. But they could behave as tenants when it came to sharing renovation costs.
This has become a time bomb for both HOS and TPS flats. If the building eventually needs to be redeveloped, there will be considerable challenges in dealing with homeowners of flats whose unpaid premiums have yet to be settled. No one will be interested in buying such old flats. But these buildings can only be redeveloped if the owners are compensated to vacate the flats they own in principle – otherwise, most would be unable to settle the outstanding premium (an amount that rises with land values over time).
The real difficulty in all this is that owners generally do not see their flats as fully owned because that unpaid premium is so unaffordable and keeps on rising with land values over time. My proposal presents an attractive way of resolving this problem.
The debt would be fixed and not rise with land values, so it would be affordable. Such a situation would mean many more tenants in a building would be willing to buy the flats. When the overwhelming share of the flats in a building is owned, it becomes far easier to align the interests of occupants. The task of relocating those who prefer to remain as tenants would also be much easier.
Clearly, the current public housing policy needs to be changed because a growing share of the 1.2 million public flats is increasingly underutilized. Many consist of one- and two-person households and a substantial number of these are elderly households. At the same time, young adult members are moving out and crowding into private flats and sub-divided units. Privatization would allow many existing public flats to get into market circulation and provide immediate relief for the housing shortage in the private rental market.
A program that subsidizes flat sales would revive hope for both the low- and middle-income strata. It would not depend on generous handouts, but rather smart allocation. The government would simply be helping less well-off families to join the homeownership ladder by providing nearly risk-free debt financing and smoothing out market risks due to property price volatility, so that capital market imperfections were corrected.
Such a public housing policy would make better use of existing scarce housing resources immediately, be sustainable for the long-term, and narrow the economic and social divide that Hong Kong is experiencing due to the inequality of housing wealth.
Refocusing public housing policy towards homeownership would represent a major policy shift. Why is it imperative that the government do so today? And what would happen if it fails to do so? This is the subject of my next article.