ASIAVIEW: Wrong Hong Kong


When William Ackman, founder of New York hedge fund Pershing Square Capital Management, hinted in an August investor letter that he was contemplating an attractive stand-alone investment that would require modest capital but stood to make extraordinary profits, his readers must have scratched their heads given how gloomy the global economy was looking.

The natural reaction would have been to assume it was some off-market, one-of-a kind transaction that was more about specific circumstances than calling a macro event with far-reaching ramifications.

Therefore, it was surprising when last month Ackman placed a bet based on Hong Kong finally bringing the curtain down on its 28-year peg to the US greenback (between HK$7.75 to HK$7.85 to US$1). Others have played that wild card before without success. Still, whether a far-flung bet or not, his admission to the play at a recent investor conference certainly stoked the ongoing debate about whether the two currencies should remain joined at the hip.
With a US government fumbling with one ineffective fiscal policy after another against a backdrop of 9 percent-plus unemployment and interest rates near zero percent, such an economic environment coupled with Chinese growth has caused soaring inflation in the special administrative region of late (7.9 percent as of July). As a result, talk about a property bubble bursting in Hong Kong has grown alongside one in mainland China.

Talk about a property bubble bursting in Hong Kong has grown alongside one in mainland China.

Many still believe a de-pegging of currencies remains unlikely. To them, Ackman’s bet is precisely that – a bet. For private equity real estate firms, the potential for currency separation is another reason to stay on the market sidelines. Exceptional situations aside, there is little going on in the market for dollars marked with high return expectations anyway, and the event of a separation between the Hong Kong dollar from its US counterpart could make for a fascinating window for those laden with dry powder when the time comes, particularly if the city’s investment market stays largely stagnant.

The outlook from Hong Kong-based firms is that a pricing correction is coming if things continue on their current trajectory. Just how much value is wiped off Hong Kong real estate – DTZ estimates the total value of the city’s invested property to be $184.5 billion – remains to be seen, with opinions varying between 15 percent and 30 percent.

Whatever the scale, it is clear that precipitating factors to such an event already are in play. In the month of July, office sales were down markedly, with one GP pointing to just seven strata sales (sales of individual office floors). “The significance of strata sales being down is a sign that local investors and speculators aren’t active,” he said. “We don’t think it’s a seasonal summer holiday issue, rather it’s reflective of the global situation.”

Real estate lenders already seem alive to Hong Kong’s situation. In March, the Hong Kong Monetary Authority was early to publish a guideline capping leverage at 50 percent for all commercial real estate investments, which obviously is curtailing buyer’s borrowing capabilities. Prior to its guideline, leverage levels were around 60 percent on average, occasionally creeping towards 70 percent.

Such leverage levels are not comparable to the 90 percent gearing that were permitted in the US or Europe immediately prior to the global financial crisis, so we should not expect swathes of defaults or distressed exits. More predictable is the lingering of a wide bid-ask spread. As such, off-market deals where sellers accept realistic corrections are really all private equity real estate firms can hope for.

Of course, when such a recalibration will happen is anyone’s guess. Speak to Andrew Moore, principal at Hong Kong-based Pamfleet, and you’ll hear it could take six months before the bubble deflates and sellers embrace reality. Speak to the bigger MGPA and you’ll hear predictions of a correction in one to two years.

Nobody is saying Hong Kong’s real estate fundamentals are not intact

John Saunders, Asia chief executive officer at MGPA, told Bloomberg last month of his concerns about the unsustainable direction in which Hong Kong real estate was heading. “We import all the growth from China, then we pay for it with a monetary policy that’s designed to drag the US out of deflation and economic chaos,” he said. “It’s massively inflationary.”

Nobody is saying Hong Kong’s real estate fundamentals are not intact. There is leasing demand – Citibank just took 42,000 square feet at Swire Properties’ One Island East, for example. Development is tight too, with 2012’s and 2013’s projected combined supply reflecting that of half an average year. GDP forecasts still look good at 5.6 percent for 2011, and unemployment is at an enviably low 3.5 percent. Exceptions aside, however, the market’s pricing has become grossly positioned thanks to its macroeconomic vulnerabilities.

While Ackman can afford to make his bet, private equity real estate firms, which deal in bricks and mortar, should make their plays based on pricing relative to tenant demand. Such firms are better off watching to see what happens. If the currency does de-peg, there’s a buying window. In the meantime, as long as Hong Kong remains tied to the US, they would do better by waiting for a more locally-driven correction.