(This essay was published in South China Morning Post on 5 October 2016.)


Since the mid-1980s, the difference between private residential property prices and building costs has risen dramatically, averaging 70% higher when compared to earlier periods.


This increased gap is a measure of the regulation cost of development and building construction and it explains why development has been slow, why fewer units have been supplied, and why they are fetching much higher prices relative to construction costs compared to the past.


How does the regulation of land development and building construction in Hong Kong delay housing supply?


Regulators seek to minimize incompatible land uses and maximize compatible ones – to generate positive neighborhood effects and mitigate negative ones. Markets alone sometimes fail to correct for these effects, which is why planning rules and building codes have been invented. Unfortunately their effects on land and housing supply are not always foreseen.


In Hong Kong, there is a belief that rising property prices are the result of conspiracy between an oligopolistic property development industry and corrupt government officials. The coincidence of four factors has contributed to that belief: a tight, slowly developing housing market, the perception that government has always had a high land price policy, the failure of government both before and after 1997 to sufficiently increase the amount of land for development, and the market dominance of a few large property developers.


I have not found this narrative to be a sufficiently convincing explanation for rising property prices. Although the four developers came to dominate the market due to historical circumstances surrounding the development of satellite towns in the New Territories, their good acumen (or fortune) in accumulating land exchange entitlements, and the redemption of these entitlements before the restoration of sovereignty, however, the gap between property prices and building costs started to rise rapidly in the decade beginning in the mid-1980s before they achieved market dominance. And it continued after 2012, when the government introduced punitive measures to curb their pricing powers.


To me, the most consistent explanation of why housing supply has declined in the past three decades is the rising regulatory cost of development. This also has historical roots.


The rising value of land after China’s opening and the worldwide shift to containerization increased the transactions cost of making land available for development. It made landlords in rural areas less willing to surrender land at existing compensation levels. The planning system tried to respond but has not been successful so far even though a new Town Planning Ordinance was finally brought into play after almost two decades of consultation.


One way the shortage of housing could have been avoided is through the plot ratio, which is used to control development. If plot ratios had been increased, housing supply would not have declined by so much and housing prices would not have risen by so much.


Plot ratios can prevent the development of excessively high population densities that overburden the infrastructure provisions in neighborhoods, so as to protect the quality of the living environment. They can also protect the value of existing properties by creating scarcity.


But there is a push-pull between relaxing the plot ratio to facilitate development in the interest of those without property, and maintaining it to protect the interests of property owners.


Refusing to increase the plot ratio contributes to higher housing prices. The benefits are spread among all property owners. The costs are borne by all those who want better housing and are not yet property owners. Wealth is redistributed from the “have-nots” to the “haves,” from the young to the old.


In a democracy, where the majority of the voters are property owners, the winning coalition would tend to favor preventing development.


The original purpose of the plot ratio was not to limit development, but to promote safety, health, leisure, conservation, and so on; but these too may have the same perverse effects on development.


Indeed the proliferation of rules creates more opportunities to retard development. It takes time to meet the requirements of every rule and survive public consultation (and confrontation).


Over the past three decades, Hong Kong’s housing and land policies have been riddled with problems. The cost of developing rural land in the New Territories has become more difficult because it is more difficult to get agreement on proposed development plans. Attempts to revamp the planning system have not solved the problem. Plot ratios on approved developments could not be raised sufficiently to increase housing supply on the same plot of land. The government was also negligent in preparing more land for development and underestimating housing demand growth.


The shortage of housing is a serious problem with no quick solution. In a highly divided political environment, rushing things will not get us to the destination faster.

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