HK Housing 2004: Shortage Increasingly Apparent Franklin Lam UBS Securities Asia Limited HKSAR From depression to delight • Housing is a multi-year, trending market In housing, where institutional investors are absent, private buyers dominate. As with most ‘retail investor’ markets, housing is driven more by the emotions of fear and greed than cold analysis. Hence, home prices tend to make multi-year, oneway moves as more people enter a rising market or exit a sinking one. • Trend reversal seen in Q303 should accelerate into 2004 Prices have fallen for six years but 2003 should see the first upturn. While record affordability, low ownership, plentiful cash and positive carry are well acknowledged, few have credited the much-improved predictability of this asset class since key changes in public housing and land sale policies in 2003. The pendulum does swing back—similar ‘disbeliever’ stories in gold and stocks have reversed this year. We continue to believe that Hong Kong is poised for a fiveyear+ upswing in housing that should see prices rise by 30%+ before end-2004. • Finally, the ‘obvious’ shortage gets noticed in 2004 This report focuses on the dynamics of this upturn and complements A new upcycle begins, as rising confidence fuels strong fundamentals, 24 September, which addressed the macro backdrop. We forecast acceleration into 2004 as accepted views in the market (wrongly, we believe) swing from oversupply to multi-year shortage—a key factor driving the 1990-97 bull market that saw home prices gain 219% versus an 85% rise in income levels. • 18 reasons for our optimism We cite 18 reasons including: 1) Landbank of only 2.7 years, well below the four-year JIT. Developers can earn >35% profit from rationing out stock. 2) No ‘1997 emigration’ selling of >10,000 units pa in the 1990-97 cycle this time. 3) Technical and other tests show little resistance until the weekly home price index rises 64%. Stock triggers include rising prices, property launches, Application List in Dec, auction in Q104 and rising ‘natural reverse flows’ from China. We still prefer companies with large landbanks: SHKP, Sino Land, Hang Lung Properties and New World Dev for their high NAV sensitivity to the residential and retail property markets. ***** © 2004, Author(s), UBS Securities Asia Limited, HKSAR: All rights reserved. No part of this paper may be reproduced, distributed, published, or transmitted without the prior permission of the copyright owner. Global Equity Research ab Hong Kong UBS Investment Research Real Estate Sector Comment HK Housing 2004: Shortage Increasingly Apparent From depression to delight 28 November 2003 ! Housing is a multi-year, trending market www.ubs.com/investmentresearch In housing, where institutional investors are absent, private buyers dominate. As Paul Louie with most ‘retail investor’ markets, housing is driven more by the emotions of fear [email protected] and greed than cold analysis. Hence, home prices tend to make multi-year, one- +852 2971 8735 way moves as more people enter a rising market or exit a sinking one. Franklin Lam Trend reversal seen in Q303 should accelerate into 2004 [email protected] Prices have fallen for six years but 2003 should see the first upturn. While record +852 2971 8876 affordability, low ownership, plentiful cash and positive carry are well Hong Kong Property Team acknowledged, few have credited the much-improved predictability of this asset class since key changes in public housing and land sale policies in 2003. The pendulum does swing back—similar ‘disbeliever’ stories in gold and stocks have reversed this year. We continue to believe that Hong Kong is poised for a five- year+ upswing in housing that should see prices rise by 30%+ before end-2004. Finally, the ‘obvious’ shortage gets noticed in 2004 This report focuses on the dynamics of this upturn and complements A new upcycle begins, as rising confidence fuels strong fundamentals, 24 September, which addressed the macro backdrop. We forecast acceleration into 2004 as accepted views in the market (wrongly, we believe) swing from oversupply to multi-year shortage—a key factor driving the 1990-97 bull market that saw home prices gain 219% versus an 85% rise in income levels. 18 reasons for our optimism We cite 18 reasons including: 1) Landbank of only 2.7 years, well below the four-year UBS does and seeks to do business JIT. Developers can earn >35% profit from rationing out stock. 2) No ‘1997 with companies covered in its research emigration’ selling of >10,000 units pa in the 1990-97 cycle this time. 3) Technical and other tests show little resistance until the weekly home price index rises 64%. reports. As a result, investors should be Stock triggers include rising prices, property launches, Application List in Dec, auction aware that the firm may have a conflict of in Q104 and rising ‘natural reverse flows’ from China. We still prefer companies with interest that could affect the objectivity of large landbanks: SHKP, Sino Land, Hang Lung Properties and New World Dev for this report. Investors should consider this their high NAV sensitivity to the residential and retail property markets. report as only a single factor in making their investment decision. ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 65 1 HK Housing 2004: Shortage Increasingly Apparent 28 November 2003 Contents page Summary 3 Paul Louie [email protected] — Market to focus on NAV expansion via growth in margin and landbank ..........................3 +852 2971 8735 — 18 reasons why home prices should rise .........................................................................3 Franklin Lam Demand is fine, supply is short 10 [email protected] +852 2971 8876 — (1) Structural demand has shifted out ............................................................................10 Eric Wong — (2) Supply is low, inventory rationing already taking place.............................................11 [email protected] — (3) Supply will exhaust by 2006......................................................................................13 +852 2971 6430 Beatrice Ho, CFA — (4) 2004 land sale unlikely to quench demand...............................................................16 [email protected] — (5) Four year construction cycle still the norm, new sites no help until May 2006 .........17 +852 2971 7235 — (6) Profit maximisation requires rationing of limited stock ..............................................19 — (7) Absence of elasticity in secondary supply ................................................................20 — (8) Where is the resistance level? ..................................................................................23 2004 demand catalysts 27 — (9) Positive land auction in Q104 to signal premium on the housing ‘futures’ market....27 — (10) Increasing awareness of looming housing shortage and sustained rise in home prices..............................................................................................................................27 — (11) Investment demand as an accelerant .....................................................................27 — (12) Recovery of the trade-up segment..........................................................................29 — (13) Income stabilisation to reverse wage cut perception and release precautionary cash................................................................................................................................31 — (14) GDP and natural reverse flow momentum..............................................................34 — (15) Work permit scheme and investor immigrants........................................................34 — (16) Firming up of rentals ...............................................................................................35 — (17) US$ weakness or HK$/Rmb strength .....................................................................35 — (18) CEPA and other schemes to boost two-way flows .................................................36 Company update 37 — Sun Hung Kai Properties................................................................................................38 — Cheung Kong..................................................................................................................43 — Henderson Land.............................................................................................................46 — Hang Lung Properties.....................................................................................................50 — Hang Lung Group...........................................................................................................53 — Sino Land .......................................................................................................................56 Appendix 1: Possible sites to be included in Application List 60 Appendix 2: History of land sale and timing of completion 61 Appendix 3: Land premium conversions since 1998 64 Cover picture provided by Sing Tao Daily. UBS 2 HK Housing 2004: Shortage Increasingly Apparent 28 November 2003 Summary Market to focus on NAV expansion via growth Market turning very fast: Prices up 13% in margin and landbank and volume has doubled in two Over the past two months, home prices have risen by 13.6% and recaptured the months; 2003, the first ‘up’ year since year-beginning level. With continued strength in price momentum, we expect 1997 the full year to show a price rise of around 5%, making 2003 the first year