Political Uncertainty and the Real Estate Risk Premiums in Hong Kong

By Chau, K W | The Journal of Real Estate Research, January 1, 1997 | Go to article overview

Political Uncertainty and the Real Estate Risk Premiums in Hong Kong


Chau, K W, The Journal of Real Estate Research


K W Chau*

Abstract. This study investigates the effects of political uncertainty associated with the 1997 repossession of Hong Kong by China on the real estate market. Such effect is reflected in the change in the real estate risk premiums. A model is derived to estimate the trend of real estate risk premium for each subsector of the real estate market from observable market data. The results suggest that there was a discrete jump in the risk premiums when the 1997 issue was revealed to the public in 1983, indicating investor concern about the post-1997 future of Hong Kong. The increase in the risk premium is much more obvious in nonresidential real estate than in the residential sector. This is probably due to its dual nature (an investment good as well as a good for self-consumption) and the effects of rent control, which only applies to the residential units. However there is also very strong evidence that investor confidence has been increasing recently, thus leading to a decline in the implied post-1997 risk premium, although the increasing confidence is still not sufficient to bring the risk premium back to pre-1983 levels. If the concern about the repossession of Hong Kong by China turns out to be unnecessary after 1997, a re-valuation of the risk premium will take place. This will bring the risk premium level back to the pre-1983 level, assuming no other significant changes have taken place. Other things being equal, such revaluation will result in a one-time discrete increase in property prices. This is in contrast to the common view that investors have already discounted the 1997 Hong Kong/China issue completely.

Introduction

The purpose of this study is to estimate of the risk premium for investing in Hong Kong real estate and to assess the effects of the 1997 repossession of Hong Kong by mainland China, if any, on the risk premium.

Ever since Margaret Thatcher visited China in 1983 concerning the future of Hong Kong, the 1997 issue has been a major concern for all Hong Kong real estate investors. Not only has it affected the thinking of all Hong Kong people, the issue has attracted more and more attention internationally as Hong Kong's real estate investment market has become increasingly international.

In 1997, Hong Kong, one of the world's freest economies, was to be handed back to China, the largest planned economy in the world. Despite the fact that the British Government and the Chinese Government signed the Sino-British Joint Declaration in 1984, which guarantees that the economic system and the life style of people in Hong Kong shall remain unchanged for fifty years after 1997, the investment environment post1997 has become more uncertain. Deng Xiaoping's one-country, two-system model is certainly innovative and is perhaps one of the best solutions for solving the political, economic and ideological issues that may arise as Hong Kong becomes part of China on July 1, 1997. However it is also because of its novelty that uncertainty arises. Uncertainty is always associated with new ideas, although such ideas might prove to be excellent later. Uncertainty about what might happen after July 1, 1997 increases the risk of investing in Hong Kong, but this is especially true for real estate, since real estate is not as liquid as other forms of investment, and real estate assets are immobile.

At the same time, the economic reform in China, which started in 1979, has opened up numerous opportunities for both Hong Kong and overseas investors. Hong Kong's economy has benefited from the huge supply of cheap labour and land in China and vast trading opportunities (due to convenient access to a huge virgin market with a population of 1.2 billion).

Ever since the economic reform in China, the GDP of Hong Kong has been growing at an average rate of 8% in real terms (see Census and Statistics Department, 1994). As a result of this spectacular economic growth, some people argue that the political risk associated with 1997 has been vanishing and has by now virtually disappeared. …

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