Hong Kong Real Estate Is Unsinkable but Property Stocks Are Treading Water

By Joanne Chiu | The Wall Street Journal

Home prices have almost tripled since 2009, but shares of major local property developers are trading at a discount to their net asset value

Home prices in Hong Kong jumped nearly 17% last year, helping make the city the least affordable home market in the world. Photo: Anthony Kwan/Bloomberg News

Hong Kong’s red-hot property sector isn’t showing signs of cooling, but shares of local real-estate developers aren’t keeping pace.

Home prices in the city of 7.4 million people have nearly tripled since 2009, jumping nearly 17% last year alone, despite mortgage-tightening measures from the government aimed at cooling the buying frenzy.

The surge has made Hong Kong the least affordable home market in the world, according to research firm Demographia . It estimates the average apartment in the city cost 6.19 million Hong Kong dollars (US$789,000) in 2017.

On two weekends in March, local home buyers snapped up 1,070 apartment units at a new housing complex called the Malibu, which is being built on reclaimed land in the city’s New Territories region. Local developer Wheelock & Co. racked up HK$9.16 billion in sales in just four days, a reflection of pent-up demand for housing. The cheapest apartment sold was a one-bedroom unit that cost HK$6.83 million. It was measured at 367 square feet.

Wheelock’s revenue last year climbed 17% to $9.05 billion, while net profit rose 26% to $2.6 billion. Yet shares of the developer are down 4% from a year earlier, significantly underperforming the benchmark Hang Seng Index’s 29% gain over the same period.

Major Hong Kong property developers—including Sun Hung Kai Properties Ltd. SUHJY 0.19% , CK Asset Holdings Ltd. 1113 1.08% , Henderson Land Development Co. and New World Development Co. NDVLY 2.46% —are trading at an average 40% discount to their net asset value, despite strong sales and earnings growth in 2017. They traded close to book value when property prices previously peaked in the late 1990s, but have been deeply discounted for much of the past decade.

The local property giants have also fallen far short of some Hong Kong-listed Chinese developers, whose shares soared to record highs last year due to strong sales growth in the mainland, despite heavy debt levels. In contrast, some Hong Kong developers have more cash than debt.

Rising property prices in Hong Kong increase the risks for equity investors, said Cusson Leung, J.P. Morgan’s head of Hong Kong property research. Mr. Leung, who expects another 10% to 15% increase in residential prices in 2018, says the disconnect between Hong Kong developers’ stocks and the property market will continue.

Global investors are feeling less upbeat about Hong Kong property stocks, in part because they have doubts about the sustainability of high home prices and the looming threat of rising interest rates. Developers, meanwhile, have been reluctant to sell major assets while the property market is strong, Mr. Leung said. Consistently low shareholder returns and an intensifying competitive landscape aren’t helping, he added.

The sector’s stocks have gone from being growth plays to defensive bets with slower asset turnover, said DBS analyst Jeff Yau. That is partly because property sales are no longer the primary earnings generators for many developers. Mr. Yau estimated that more than half of developers’ profits are generated from growing rental portfolios.

Aggressive rebates to home buyers have hurt developers’ profit margins, said Alfred Lau, property analyst at Bocom International , the investment banking arm of Shanghai-based Bank of Communications Co. He estimated that pretax margins for local developers were 23% to 25% last year, compared with as much as 32% in the past several years.

With the possibility that margins won’t rebound soon, some Hong Kong developers could look into speeding up the conversion of cheaper farmland away from prime parts of the city. Others could accelerate new project launches to beat interest-rate increases.

Rates have been a risk for some time, Wheelock Chairman Douglas Woo said on March 12.

Another concern for stock investors: the record prices that a number of Chinese developers paid last year in Hong Kong public land auctions. That could limit future profit potential on new projects, as local firms have to compete with mainland peers for sales.

Demand for housing among city dwellers is pent up, with recent property sales attracting a wave of interest from buyers and property agents. Photo: Bobby Yip/REUTERS

For Hong Kong’s fiscal year ending on March 31, the city estimated record income of HK$163.6 billion from land sales and existing leases, a 28% increase from a year earlier. That was 62% higher than its original estimate.

Mr. Woo said he expects the market to remain competitive. On March 9, Wheelock said it would pay HK$6.4 billion for a site under construction on the site of the city’s old airport. The seller was HNA Group Co., a Chinese conglomerate that has been trying to sell assets to raise cash and pay off debt.

Wheelock bought the land for 15% more than HNA paid the government in early 2017. Mr. Woo called the higher price “market level,” adding that Wheelock would consider bidding for HNA’s other land plots in the vicinity if they came up for sale.

The deal reflects both strong demand for scarce, prime waterfront land and optimism about demand for housing, said Peter Yuen, a managing director at property consultant Savills, which had no involvement in the Kai Tak deal. He expects larger Chinese developers to continue their pace of expansion in the city, which will bolster prices.