GlobalPresentations

Priced out of paradise

Christopher Dillon speaking at the FCC in Hong Kong
Photo: Susanna Leung

 

September 10, 2018—The following is a transcript of a presentation entitled Priced Out of Paradise that was delivered at the Foreign Correspondents’ Club in Hong Kong on June 28, 2018. A video of the presentation is available here.

The presentation provides suggestions for people who want to buy a home in hyper-expensive cities, like Hong Kong, London, Shanghai, Singapore, Sydney and Vancouver. The presentation explains:

  • How to research your city’s housing market so you can recognize—and act on—a bargain
  • Strategies for buying more home with less money
  • Techniques for getting exposure to your city’s real estate market, when you can’t afford a home you’d want to live in
  • Opportunities and pitfalls when buying in a different city, state or province, or in another country

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Priced out of paradise

In March 2018, a 209-square-foot apartment in this unfinished building in Pokfulam—on the west side of Hong Kong Island—sold for a cool one million U.S. dollars. At 209 square feet, the apartment is about one-third larger than a standard 20-foot shipping container, like the ones on the right in this picture.

That’s an astonishing amount of money for a tiny home in a nice, but not terribly exclusive neighborhood. Record-breaking sales like this are common in Hong Kong. In June, a parking space changed hands for HK$6 million, or about three-quarters of a million U.S. dollars. Transactions like these are responsible for Hong Kong’s ranking as the world’s least-affordable city for residential real estate in the 2017 Demographia survey.

With a median multiple of 19.4, Hong Kong is expensive, but it’s not alone. Demographia’s top 10 includes Sydney, Vancouver, San Francisco, Auckland and London. Other major cities in the top 25 include Toronto at 11, Seattle 19 and New York at 22.

So what can you do if you live in Hong Kong or another hyper-expensive city, you want to buy a home, but you are priced out of the market? In the presentation that follows, I’ll propose three possible solutions: defining the problem, substitution and looking further afield. I’ll also give you tools to evaluate your options, avoid common mistakes and make better decisions.

Define the problem

The first solution is to define the problem. It’s easy to say that homes in your city are too expensive, but what—exactly—can you afford? For example, would the tiny apartment I mentioned a moment ago represent good value at $500,000, instead of $1 million? How about $250,000?

To define the problem, you’ll need to understand your city’s housing stock and price history, and your ability to get and repay a mortgage. Websites operated by real estate agents and government bodies will give you the market data. And your bank will be happy to tell you how much you can borrow.

With this reality check, you could discover that you simply can’t afford a home that you’d like to live in. More on that in a minute. You could learn that, by changing your buying criteria—such as the home’s size, its location or its age—you could afford to buy. Or you could find that everything would be perfect if you found a bargain or the market dropped 25%.

I’ve lived through four major corrections in three frothy markets—Calgary, Canada, in the 1980s, Tokyo in the early 1990s and here in Hong Kong in 1997 after the Asian financial crisis and five years later during SARS. In all four downturns, buyers waiting on the sidelines were happy to see prices drop. Each market correction was sparked by bad news. And each played out very differently.

In Calgary, which is Canada’s oil and gas capital, interest rates topped 21% in 1981. In late 1980, the federal government introduced the National Energy Program, which hammered the local energy industry. Home prices dropped as much as 40%. That’s a massive and unusual correction in a developed economy like Canada. It took years for Calgary to recover.

In Tokyo, the correction was part of a larger economic collapse. It’s taken more than 20 years for Tokyo prices to rebound. New condominium prices in Tokyo are still below the record set in 1990. In resort towns, you can buy a livable condo for as little as ¥1 million, or US$10,000.

Here in Hong Kong, the Asian Financial Crisis caused home prices in some parts of the city to drop two-thirds in a period of months. SARS claimed 299 lives and extended the misery. There was another small drop during the Global Financial Crisis.

Hong Kong people wanting to buy a home chased prices on the way up and worried about over-paying on the way down. And prices continue to rise.

There are three takeaways here. First, the timing and duration of market corrections are difficult to predict. As the economist John Maynard Keynes famously observed, “The market can stay irrational longer than you can stay solvent.” Second, it’s easy to talk about buying in a downturn, but it takes courage to write a check when prices are falling.

Third, knowing what constitutes fair value—for you and from a historical perspective—makes it easier to recognize a bargain and buy during a correction.

But what happens if you are in an expensive city—and you want to buy because you think prices have room to rise—but you can’t afford a home you’d want to live it? Consider buying a substitute.

Buy a substitute

Starting with physical property, you can buy a less expensive home and rent it out. Usually, that means a smaller, older home; a dwelling in a less desirable location; or one that needs repairs. In some cities, commercial or industrial real estate is an option. In Hong Kong, there is a thriving market for car and even motorcycle parking spaces.

This is a proven way to obtain exposure to your local property market. But there are drawbacks. First, within a given city, luxury property behaves differently than mass-market homes, and residential differs from commercial and industrial. So this is not a perfect hedge.

Second, for rental properties, mortgage rates are generally higher and the loan-to-value ratio—the amount of money you can borrow as a proportion of the property’s price—is lower than when you are buying a home for your own use. You’ll also need to deal with tenants, or pay an agent to do that for you, and maintenance and repairs. Finally, income taxes in Hong Kong are modest. But in Canada, so-called “amateur” landlords’ rental income is taxed at the same high rate as salaries.

Another way to gain exposure to a specific real estate market is through financial instruments such as real estate investment trusts. REITS are companies that own income-producing real estate and distribute that income to shareholders, usually in a tax-efficient way.

Many REITs are listed on a stock exchange and combine liquidity with attractive yields. REITs let you invest in everything from a diversified global real estate portfolio to narrow sectors like hospitals in the United States, offices in Hong Kong or shopping malls in China. Unlike a home, your holding in a REIT can be subdivided. You can buy or sell 100 shares at a time.

Real estate–based unit trusts and mutual funds are another option. You can also buy shares in real estate companies. This includes developers, mortgage-issuing banks, hotel chains, builders, component manufacturers and more. Individual shares are a granular way to invest, one that exposes you a higher levels of risk and reward. Financial instruments lack the warm fuzzy feeling—as well as the tax and maintenance bills—that come with owning bricks and mortar. But they are liquid, sub-dividable and portable.

Look further afield

But what if none of these solutions scratches your real estate itch? Then it may be time to look to a different province or state, or even to another country.

But before you call your travel agent, you need to ask, “Why am I doing this?” That’s because the ideal residence, source of rental income, and retirement or vacation home all have different characteristics.

And there is no single “perfect” property that meets all of these objectives. For example, the home that offers the best rental yield is often not one you’d want to live in. Having a clear goal—whether that’s earning income, generating capital gains or offering a retreat for your family—increases your likelihood of success. Sometimes, renting and investing offers the best combination of liquidity, flexibility and value.

If you are going to buy, there are a few things that you should know.

Let’s start with the basics. Can an individual own land? In Hong Kong, for instance, all land is owned by the government, except what’s under St John’s Cathedral. You can own a building, but only the government can own land. China is similar: the state and collectives own all land.

Owning a building is good, but owning land, which is called freehold, is almost always better. Land doesn’t depreciate like a building does. Ownership offers more security and opportunities to use, exploit and develop the property.

Next, can someone with your passport (or passports) own property? In Thailand, for example, if you are not a Thai national, you cannot own land. You can own a building, but not the land underneath it. The same is true for the Philippines.

In Australia, foreigners can only buy new properties, unless they have special government approval. For many years, foreign buyers and local agents ignored this rule, but the Australian authorities have started enforcing it and unwinding transactions. New Zealand has proposed similar legislation.

Even if your passport is order, in some Chinese cities, for instance, you have to establish residency and pay local taxes for several years before you can buy. This is one reason why fake marriages are common in China.

If foreigners can buy, there may be extra taxes. In Hong Kong, for instance, you pay a higher rate of stamp duty if you are not a permanent resident.

In Singapore, the rate of Additional Buyers Stamp Duty ranges from zero for a Singapore citizen buying her first home, to 5% for a permanent resident buying a first home, to 20% for a foreigner buying any residential property. The Additional Buyers Stamp Duty is on top of a Buyer’s Stamp Duty that ranges from 1%–4%.

Interestingly, Japan compares favorably to other countries in this regard. With a few exceptions, there are no restrictions on foreigners owning Japanese land. And when foreigners buy, they pay the same tax rate as Japanese do.

In some places, there are post-acquisition taxes. For example, Vancouver has an empty home tax for owners who do not rent out or use their property on a full-time basis. Taxes like these can make a pied-à-terre that you use a couple of times a year un-affordable. Toronto, incidentally, is considering a similar tax.

In some countries, vendors will “get around” local ownership restrictions by using nominees or holding companies. These approaches may be legal and they can protect your interests. But, if you attempt to evade the spirit of a local ownership law, you may encounter problems. In general, courts don’t enforce illegal contracts.

If you can’t own the land, you may be able to lease it. My home is built on land that was leased from the British Crown for 999 years in 1800s. That lease, which survived the change in Hong Kong’s sovereignty in 1997, is effectively freehold ownership, because it will survive me and my family.

Short-term leases—like the 35- to 70-year leases used in places like China and Indonesia—can be a problem. The lease may be renewed when it expires, but there is no way to guarantee the term or the cost of renewal. The value of leased property declines as you approach the end of the lease, and it can difficult to get a mortgage for a home built on leased land.

In summary, you need to determine what you can own and know what you are buying, whether it’s a building or a building with land.

Paying for your purchase

Once you have determined what and where you can buy, you’ll need to pay for it. This is an area where residency makes a difference. For example, it’s common for U.K. nationals living in Britain to get a mortgage in France for a home in France. But it’s difficult for a foreigner who lives outside Japan to get a mortgage for a home in Japan.

Countries have different regulations that shape their mortgage markets. For example, 30-year fixed rate mortgages are common in the United States, but in Canada the longest you can get is a five-year, fixed rate loan. Some places allow interest-only, buy-to-let and balloon payment mortgages, while other jurisdictions outlaw them.

As property markets became frothy, regulators tightened lending rules. For example, in Canada, borrowers must now demonstrate that they can repay a mortgage based on an interest rate that is 200 basis points—or 2 percentage points—over the actual lending rate. That means if you are borrowing at 3%, you have to prove that you can repay a loan at 5%.

If you borrow across borders, expect to pay a higher interest rate than a local, have a lower loan-to-value ratio and have a shorter loan term. Entrepreneurs, commissioned salespeople and anyone whose income is unpredictable will find banks are not very welcoming when they apply for a mortgage. In general, the more money you put up, and the less you need to borrow, the more receptive the bank will be.

Paying cash can be a smart move. Cash allows you to move quickly—and buy a property from a motivated seller—because your purchase offer is not conditional on arranging financing. But if you are bringing cash across borders, make sure it’s properly documented or you may have trouble repatriating your funds when you sell your home. This is particularly true in places like China, which have capital controls.

You should also consider the legal environment in the jurisdiction where you are buying. Whether the country uses civil law, common law or a hybrid, it’s essential that the legal system is transparent, that contracts can be enforced and that you receive equal treatment as a foreigner. That’s one reason why real estate is more expensive in places like the United Kingdom and the United States.

Off the plan purchases offer a unique set of challenges. Every weekend, unfinished developments in cities like London and Bangkok are sold in hotel function rooms in Hong Kong, Singapore and other cities.

These homes have several major risks, including late delivery, bankrupt developers, defective design and construction, and limited regulatory oversight. In Hong Kong, for instance, you don’t need a local real estate agent’s license to sell overseas property. Buying from a reputable agent who is representing an established builder is wise. Knowing your legal rights is essential, particularly if the property is in a developing country.

If you are buying a home in a country where English is not an official language, the sale and purchase agreement will be in the local language, whether that’s German, French or Japanese. In general, English-language translations are not legally enforceable, so ensure you understand the documents that you are signing.

If you are planning on living in your new home, check that your lifestyle isn’t an issue. For example, if you are gay or enjoy smoking cannabis, Vancouver or San Francisco might be a better choice than Singapore, which has strict anti-drug laws, or Malaysia, where gay sex is illegal.

Speaking of lifestyles, before buying a place that you will live in—even part time—spend time in the area to ensure you like the weather and amenities. Rent a place for a couple of weeks in the summer or spend a couple of weekends at different times of the year, so you can get beyond the marketing materials.

Countries like Japan actively encourage foreigners to buy real estate, but parts of Canada, Australia and New Zealand are less welcoming, especially to people who buy homes and leave them empty. Foreign buyers are often perceived as being rich and politically powerless, which makes them attractive targets for taxes and regulations.

Finally, in 2002, then United States Defense secretary Donald Rumsfeld replied to a question at a news briefing by saying “There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know… it is the latter category that tend to be the difficult ones.”

Rumsfeld’s comments were about the Iraq war, but they are equally true of international real estate, where there are a million surprises waiting for unsuspecting buyers. To give just a few examples:

If you buy a place in Phuket, Thailand, there’s a good chance you’ll have have to pay extra to have water delivered to your home, because there is a chronic shortage of fresh water

If you buy a home in the U.K., you could be responsible for paying for upkeep of the local church under an ancient doctrine called chancel repair. One recent case, which took 17 years to resolve, cost a homeowner 200,000 pounds.

In the United States, the area 100 miles from the Canadian and Mexican borders is subject to the Department of Homeland Security’s internal checkpoints. Americans living in or traveling through this border zone can be subjected to motor vehicle stops and what the Cato Institute calls “constitutionally dubious searches.”

You can never eliminate all the surprises. But you can improve your odds by reading the local newspaper, by talking to people who live in the area and by renting before you buy. You can also hire someone to do the research for you.

Wrapping up

So, to recap, before you write off your city as too expensive, do some research. Investigate your local options in terms of size, age and location, and your ability to repay a mortgage. With this information, you’ll be able to recognize and act on a bargain and take advantage of a market dip.

Second, consider substituting a smaller rental unit, or commercial or industrial property for your dream home. You can also hedge against rising home prices with real estate investment trusts, mutual funds or shares.

Third, buy in a different state or province, or in another country. If you buy internationally, ensure you know what you are purchasing and buy land if possible. Investigate financing before you commit, and ensure you understand your legal rights and obligations. Finally, learn about local issues by talking to owners, reading the local paper and renting before you buy.

You can also email [chris {at} dilloncommunications {dot} com], with “Checklist” in the subject line, for a free, 127-point buyer’s checklist that covers buildings, land, title, developers, overseas and off the plan purchases, income and recreational property, and much more.

Thank you for your attention, ladies and gentlemen. I’d now like to open the floor to your questions.