L1 Introduction Spring 2010

L1 Introduction Spring 2010 - Introduction Real Estate...

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Unformatted text preview: Introduction Real Estate Finance Class Hr: School of Economics and Finance The University of Hong Kong [email protected] 9:30 am – 11:30 pm (Tue) 9:30 am – 10:20 pm (Thu) K. S. Maurice Tse Venue: LE1 Why Real Estate is an important subject? More than half of our wealth is stored in Real Estate-major lifelong investment Real estate is a leading indicator of the economy-housing start in the United States. Real estate is the locomotive of the economy. It induces growth and employment of other sectors as well. Real estate is the major source of business to banks. Banks are facing various kinds of risk, one kind of risk is called asset risk. What this course will cover? Real Estate Related Financial Products Transactions in Real Estate Market Various Types of Mortgages Mortgage Backed Securities Relationship between Fixed Rate and Variable Rate Mortgages Real Estate Investment Trusts (REITs) Real Estate Auctions Pre-sale Transactions Default in Real Estate Transactions Income producing properties Land Old properties Valuation I. Real Estate Related Financial Products Real Estate Financing Types of Mortgages Valuation Decision Makings Mortgage-Backed and Asset-Backed Securities Types of MBSs Design of MBSs Risk Management Issues Valuation of MBSs Issues of sub-prime assets Real Estate Investment Trusts (REITs) in Hong Kong II. Real Estate Transactions Real Estate Auctions Major Types of Auctions Optimal Strategy for Buyers Optimal Strategy for Sellers Pre-Sale Transactions Analysis of Pre-Sale Transactions Functions of Pre-Sale Transactions to the Developers Effects on Real Estate Market Default in Real Estate Transactions Default from Buyer Side Default from Seller Side Price Range of Lowest Probability of Default III. Valuation of Real Estate Income Producing Properties Valuation Methods Commonly Used in Real Estate Market Advantages and Disadvantages of Each Method Land Right of Use of Land Concept of Highest and Best Use Valuation Methods for Land DCF Approach Option Approach Old Properties Nature of Ownership Pricing of Ownership DCF and Option Approach Text and Reading Materials There is no required text book for this course. Reading materials for all topics will be handed out in class as well as put on reserve at the HKU library. You are responsible for all materials. Materials and data pertaining to local real estate market will be used throughout the course whenever possible. References: Real Estate Finance and Investments, Bruggeman and Fisher, 9th Edition, Irwin. A standard f inancial calculator such as TI BA35 and HP 12C. Required Tool: Grading Policy The course grade will be based on tutorial discussions on local real estate market, assignments, and the semesterend exam. The point distribution is as follows: Tutorial Participation and Discussion Two Take Home Assignments Semester-End Final Exam 20% 20% 60% Problems sets will be assigned, but they will not be collected and therefore not graded. The purpose of the assignments is to assist you in reviewing the materials and preparing for the exams. Demonstrator Mr. Alan Chu Introduction Residential Property Market in Hong Kong Importance of Real Estate Market Demographic Changes and Housing Demand Affordability Property Price and Related Issues Real Estate Cycle in Hong Kong Population & Demand for Property A flow model Economic Factors Birth (GNP Growth, Foreign Direct Investment, Interest Rates) Death Population Age Distribution: for predicting HH formation Immigration HH Income Level HH Head: male/female Life Style/Taste Emigration Real Estate Cycle in Hong Kong Four stages Boom Recovery Real Estate Market Crisis Depression End Of Syllabus Introduction Residential Property Market in Hong Kong Importance of Real Estate Market Demographic Changes and Future Housing Demand Affordability Property Price and Related Issues Real Estate Cycle in Hong Kong I. Residential Property Market in Hong Kong What is the weight of property market in the Hong Kong stock market?? Let us examine the following figures before the stock market crash in 1997 and the severe economic recession. Market Capitalization and Turnover of Equities by Classification 1991-2000 Market Capitalization and Turnover of Equities by Classification 1991-1995 Classification 1991 1992 1994 1993 1995 2000 Finance 154,038.95 297,853.83 599,732.79 452,383.11 569,955.30 (16.23%) (22.36%) (20.16%) (21.70%) (24.27%) (26.1%) Utilities 175,729.38 222,773.94 420,739.14 321,724.78 327,986.00 (18.51%) (16.72%) (14.14%) (15.43%) (13.97%) (14%) Properties 255,630.86 332,734.83 856,663.59 533,318.52 621,079.47 (26.93%) (24.98%) (28.79%) (25.58%) (26.45%) (25.2%) Con. Enterprises 270,719.63 352,324.30 828,842.42 581,369.61 634,905.23 (28.52%) (26.45%) (27.86%) (27.88%) (27.04%) (24%) Industrials 65,905.23 92,555.92 137,316.42 186,681.87 128,723.88 (6.94%) (6.95%) (6.27%) (5.85%) (6.17%) Hotels 20,832.85 28,148.90 73,623.95 59,058.19 52,074.39 (2.19%) (2.11%) (2.47%) (2.83%) (2.22%) Misc. 6,314.72 5,792,38 9,095.53 8,603.97 4,993.14 (0.67%) (0.43%) (0.31%) (0.41%) (0.21%) Total 949,171.62 1,332,184.10 2,975,379.30 2,085,182.06 2,348,309.95 Market Capitalization and Turnover of Equities by Classification in July 1996 Market Capitalization and Turnover of Equities by Classification in July 1996 Classification Finance Utilities Properties Con. Enterprises Industrials Hotels Misc. Total Market Capitalization (HK$ mil.) 618,248.24 (23.26%) 327,620.43 (12.33%) 745,422.31 (28.05%) 719,048.42 (27.06%) 183,572.44 (6.91%) 57,410.15 (2.16%) 6,128.08 (0.23%) 2,657,450.07 Turnover (HK$ mil.) 15,430.44 (16.83%) 8,718.71 (9.51%) 26,139.93 (28.52%) 25,738.26 (28.08%) 13,821.03 (15.08%) 1,152.15 (1.26%) 660.68 (0.72%) 91,661.20 No. of issues 60 12 91 182 203 15 8 571 Market Capitalization and Turnover of Equities by Classification (2000-2004) HK$ million Market capitalization and turnover of equities by classification - December 2005 Market capitalisation Classification Finance Utilities Properties Consolidated enterprises Industrials Hotels Miscellaneous NASDAQ stocks Total No. of issues 80 18 103 302 417 12 6 7 945 (HK$mil) 2,995,269.94 452,716.25 905,719.58 2,290,206.20 1,378,901.23 68,343.63 22,176.64 N/A 8,113,333.48 100.00 % of total 36.92 5.58 11.16 28.23 17.00 0.84 0.27 Turnover (HK$mil) 75,373.67 8,865.74 44,834.12 73,304.78 73,281.73 1,031.81 2,454.02 0.28 279,146.15 % of total 27.00 3.18 16.06 26.26 26.25 0.37 0.88 0.00 100.00 Hang Seng Index and Hang Seng SubIndex for Properties Correlation coefficient between Hang Seng Index for Properties and Hang Seng Index is 0.9717 Correlation coefficient between Hang Seng Index for Finance and Hang Seng Index is 0.9431 Correlation coefficient between Hang Seng Index for Utilities and Hang Seng Index is 0.6294 30000 25000 Properties 20000 Index 15000 10000 5000 0 HS Index Time Hang Seng Index and Hang Seng Sub-Index for Properties after 1997 Between August 1997 and December 2005 Correlation coefficient between Hang Seng Index for Properties and Hang Seng Index is 0.89 Correlation coefficient between Hang Seng Index for Finance and Hang Seng Index is 0.92 Correlation coefficient between Hang Seng Index for Utilities and Hang Seng Index is 0.63 Hang Seng Consumer Price Index for All Items and Housing 250 Housing 200 150 All Items CPI 100 50 0 Time Demographic Changes and Future Housing Demand R ef: The R elationship Betw een Dem ographic Changes and Future Housing D em and in I ndiana, By George Lentz and K . S. M aurice Tse Housing Demand 2 major factors: Other factors?? Area Demographics (Household formation rate) Expected Future Income of Households Investment needs, change in household structure, change in taste/preference, change in life style. Projections of housing demand generally begins with analysis of demographics. Demographic variables: Size of population: Birth/Death, Immigration/Emmigration Composition of population: Age, Sex, Income, Racial, Ethnic Background Number and types of households: Yuppie (70’s and early 80’s) Dink (mid-80’s to early 90’s) Married with Children (recent years). Population & Demand for Property A flow model Economic Factors Birth (GNP Growth, Foreign Direct Investment, Interest Rates) Death Population Age Distribution: for predicting HH formation Immigration HH Income Level HH Head: male/female Life Style/Taste Emigration Data I: Statistics on Hong Kong Population and Vital Events Mid-Year Population by Sex 1999 Number (‘000) 3264.7 3341.8 6606.5 % 49.4 50.6 100.0 2003 Number (‘000) 3294.0 3509.1 6803.1 % 48.4 51.6 100.0 2004 Number (‘000) 3315.5 3567.1 6882.6 % 48.2 51.8 100.0 Sex Male Female Total Statistics: Hong Kong Population and Vital Events Mid-Year Population by Age Group 1999 Number (‘000) 1 154.3 2 058.0 2 684.2 710.0 6 606.5 2003 Number (‘000) 1 069.2 1 955.8 2982.6 795.5 6803.1 2004 Number (‘000) 1 039.7 1 962.3 3 061.8 818.8 6 882.6 Age Group < 15 15-34 35-64 > 65 Total % 17.5 31.1 40.6 10.7 100.0 % 15.7 28.7 43.8 11.7 100.0 % 15.1 28.5 44.5 11.9 100.0 In 2007, the proportion of population of age 65 and above is between 1/7 and 1/8. Projected proportion for 2030 ?? ¼ !! Statistics: Hong Kong Population and Vital Events Population Growth (Figures refer to growth between mid year of preceding year and mid year of designated year) 1999 19.1 43.7 62.8 +1.0 2003 13.5 2.6 16.1 +0.2 2004 8.1 71.4 79.5 +1.2 Population Growth: Natural increase (‘000) (births less deaths) Net movement (‘000) (inflow less outflow) Total (‘000) Population Growth Rate (%) Statistics: Hong Kong Population and Vital Events Vital Events 1999 51.3 7.8 33.3 5.0 31.3 4.7 30 27 2003 47.0 6.9 37.0 5.4 35.4 5.2 31 28 2004 47.9 7.0 36.6 5.3 41.4 6.0 31 28 Number of births (‘000) Crude birth rate (per 1000 population) Number of deaths (‘000) Crude Death rate (per 1000 population) Number of marriages (‘000) Crude Marriage Rate (per 1000 population) Median age at first marriage (years) Male Female Household Formation in Hong Kong First Marriage (86-97) Number of First Marriage 86 35465 87 41505 88 39110 89 35698 90 39474 91 36495 92 45702 93 41681 94 38264 96 37866 97 39012* Household Formation in Hong Kong Number of Households (‘000) 1992 1996 1999 2003 1997 1 632 1 840 2012 2206 1 922 (+1.7%) (+2.8%) (+1.7) (+2.0) (+4.4%) The source of figures is Hong Kong Annual Digest of Statistics 2004 2257 (+2.3) Change in Household Size HKSAR Government Jan 22, 2008 What is the potential impact on the type of property demanded? Data Set II: Statistics on Property and Construction Stock of Permanent Living Quarters by Type 1999 Number % (‘000) 682 32.6 304 14.5 1105 52.9 2091 100.0 (+2.3) 2003 Number % (‘000) 681 28.8 394 16.6 1295 54.6 2370 100.0 (+1.6) 2004 Number % (‘000) 707 29.3 391 16.2 1316 54.5 2414 100.0 (+1.9) Type Public rental housing (1) Subsidized sale flats (2) Private Permanent housing 3 Total Number of Households (‘000) 1992 1996 1999 2003 1997 1 632 1 840 2012 2206 1 922 (+1.7%) (+2.8%) (+1.7) (+2.0) (+4.4%) The source of figures is Hong Kong Annual Digest of Statistics 2004 2257 (+2.3) Statistics on Property and Construction Property Transactions 1999 2003 2004 Value of registered agreements for sale and purchase of property (HK$ billion): Residential Property Non-residential property Total Property price index (1999 = 100) Private domestic units Private Offices (Grades A, B, and C) 212.0 44.6 256.6 153.6 35.8 189.4 276.7 75.1 351.8 100.0 (-14.6) 100.0 (-25.7) 61.6 (-11.9) 62.5 (-8.6) 77.9# (+26.5) 97.6# (+56.2) Property rental index (1999 = 100) Private domestic units Private Offices (Grades A, B, and C) 100.0 (-11.2) 100.0 (-26.4) 73.6 (-11.8) 74.6 (-12.6) 77.8# (+5.7) 77.9# (+4.4) Statistics on Property and Construction Residential Flats Newly Completed by Type 1999 Number % (‘000) 29.4 35.2 21.0 25.1 33.1 39.7 83.5 100.0 (+52.6) 2003 Number % (‘000) 13.7* 30.2* 4.5 9.9* 27.2 59.9* 45.4* 100.0 (-30.9) 2004 Number % (‘000) 20.6 44.5 1.4 3.1 24.3 52.5 46.3 100.0 (+2.1) Type Public rental flats Subsidized sale flats (2) Private flats Total Statistics on Property and Construction Private Buildings Newly Completed by End-Use Usable Floor Area of ‘000sq m 1999 2003 2004 2578 1587 1638 (+2.0) (-16.9) (+3.2) 1295 999 953 (+48.1) (-26.6) (-4.6) 606 413 469 (-30.5) (+43.0) (+13.7) 195 44 36 (-51.1) (+122.7) (-17.7) 482 132 181 (+26.7) (-45.0) (+36.8) 57.9 31.7 33.8 End-Use Total usable floor area Residential Commercial Industrial Others Total Cost of Construction (HK$ billion) Private Domestic (Overall): Completions, Takeup and Vacancy 2000* 25790 29180 54950 5.4 2001* 26260 19320 60410 5.7 2002 31050 18240 65270 6.6 2003 26400 22490 68780 6.8 2004 26040^ 31400^ 64250 6.2 2005 21200# 2006 17400# Completions Take-up Vacancy Vacancy%+ * 2000 and 2001 figures are inclusive of village houses. However 20022006 figures exclude village houses. ^ Including those private flats converted from subsidized sale flats during the year. + Vacancy at the end of the year as a percentage of stock Forecast figures Breakdown figures: Completions, Take-up and Vacancy Small and Medium Units (saleable area less than 100 sq m) 2001* 24050 17220 54770 5.6 2002 29030 17780 58390 6.4 2003 25000 20080 62980 6.7 2004 23460^ 30890^ 56400 5.9 2005 19900# 2006 16100# 2000* Completions 23460 Take-up 28240 Vacancy 49300 Vacancy%+ 5.2 Large Units (saleable area more than 100 sq m) 2001* 2210 2100 5640 7.3 2002 2020 460 6880 9.6 2003 1400 2410 5800 8.0 2004 2580 510 7850 10.4 2005 1300# 2006 1300# 2000* Completions 2330 Take-up 940 Vacancy 5650 Vacancy%+ 7.5 Demographic Data Set III: HK Monthly Household Income What is the median household income in 1996? 1976 662350 25680a 22580b 6390 1600 1570c 660 560d 952,580 1981 355437 477995 209281 91622 42742 39375 12250 8751e 2561 1261f 3463g 1,244,738 1986 141289 368884 340871 209360 125631 146199 53412 25931 12628 13573 8358 6440 1,452,576 1991 75552 115236 202511 218388 181846 314379 176406 99649 58651 60169 44794 36434 1,582,215 1996 55597 68272 75595 105639 136577 324001 269694 210926 147295 183254 150440 128263 1,855,553 Domestic Households by Monthly Household Income Monthly HH Income (HK$) < 2000 2000 – 3999 4000 – 5999 6000 – 7999 8000 – 9999 10000 – 14999 15000 – 19999 20000 – 24999 25000 – 29999 30000 – 39999 40000 – 59999 60000 < Total no. of HHs Affordability of Home-ownership What percentage of households in Hong Kong can afford the monthly mortgage payments for a 20-year mortgage of $1 million after down payment at 8% and 12% rate of interest? (These rates reflect the level during 96 and 97 in Hong Kong)? Suppose the average HH owns a flat with a 20-year, 8% mortgage. The monthly mortgage payment for every $1million mortgage is: −240 8% 1 − 1 + 12 ⇒ PMT = $8364.4 $1m = PMT 8% 12 Affordability of Home-ownership Recall the monthly mortgage payment for every $1million mortgage is: −240 8% 1 − 1 + 12 ⇒ PMT = $8364.4 $1m = PMT 8% 12 Suppose an average HH owns a flat priced at $3 million (Year 96 was a peak year)? The average mortgage payment per month is $25,094 How does this compare with the median HH income?? Affordability Index The median HH income = $16,932/month Affordability Index (AI) is defined as the ratio of Median HH Income to Average Monthly Mortgage Payment AI = 16932/25094 = 0.67 What does it mean?? Bank’s usual mortgage lending policy requires that HH Income > 2 x to 3 x Mortgage Payment When AI < 2 Low Affordability When AI < 1 Unaffordable Domestic Households by Monthly Domestic Household Income, 1991, 1996 and 2001 1991 Monthly Domestic Household Income (HK$) < 2,000 2,000 - 3,999 4,000 - 5,999 6,000 - 7,999 8,000 - 9,999 10,000 - 14,999 15,000 - 19,999 20,000 - 24,999 25,000 - 29,999 30,000 - 39,999 40,000 - 59,999 >=60,000 Total Number 75 552 115 236 202 511 218 388 181 846 314 379 176 406 99 649 56 851 60 169 44 794 36 434 1 582 215 % of total 4.8 7.3 12.8 13.8 11.5 19.9 11.1 6.3 3.6 3.8 2.8 2.3 100.0 1996 Number 55 597 68 272 75 595 105 639 136 577 324 001 269 694 210 926 147 295 183 254 150 440 128 263 1 855 553 % of total 3.0 3.7 4.1 5.7 7.4 17.5 14.5 11.4 7.9 9.9 8.1 6.9 100.0 2001 Number 65 855 97 568 93 018 116 340 120 721 318 623 262 086 223 708 159 470 219 229 197 311 179 483 2 053 412 % of total 3.2 4.8 4.5 5.7 5.9 15.5 12.8 10.9 7.8 10.7 9.6 8.7 100.0 Problems of Affordability Index HH income may not be the only source of income e.g. personal savings & investment The demand for housing (investment) is affected by ability to make the downpayment for home purchase (usu. 30% of flat price) Mortgage payments consist of interest and principal payment. Principal payment can be regarded as savings that potentially increase the homeowner’s wealth (equity value of property) HH income only reflects the local affordability, but not the affordability from overseas (e.g. China)—particularly so for many low income households in Hong Kong who own properties in China It fails to reflect the exact demand from each income group unless we calculate the affordability index for each group. Property Price in Hong Kong Jan 2002: $3,000 psf July 2003: $2,200-2,400 psf April 2004: $3,500-$3,800 psf Dec 2007: $5,500 psf For period before and after 1997 TKS = Tai Koo Shing ( 太 古 城), 28-30 years old residential estate on east side of Hong Kong Island, popular among expatriates from Japan and Korea. Residential Property Price per sq. ft of gross area 9000 8000 7000 6000 5000 Price 4000 3000 2000 1000 0 TKS Jun 94: $5200 psf Dec 95: $4200 psf Oct 97: $8400 psf Asian Financial Crisis Pre-Sale prohibited by HKG Jan 98: $6800 psf Handover Outlook Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 May- Sep- May- Sep- May- Sep- May- Sep- May- Sep- May- Month/Year Sep- Issues related to the Rise and Fall of Property Price Too High Affordability Problems Falling Property Price Banks are less willing to approve mortgage loans (because of deteriorating value to loan ratio) Homebuyers will have difficulty to get home financing. Even if they do, they will have to pay higher rate of interest. Purchasers are more likely to default on the transaction (by not closing the transaction) in order to cut loss. (similarly, sellers are more likely to default when price is rising) Probably worse to the economy is we see a severe contraction in both consumption and economic growth Government’s Stabilization policy needed Real Estate Cycle From practitioner’s point of view Real Estate Cycle in Hong Kong Boom Four stages Recovery Real Estate Market Crisis Depression Boom and Crisis Boom Crisis Early: pre-sale price < spot price Later: pre-sale price ≅ spot price Boom: Pre-sale price > Spot Price by 10-15% Overly Speculative. Crisis likely: Price is high, but slow & few transactions Boom may last as long as 3-4 years Pre-sale price increases by small margin. Frequency of transactions decreases. Usually sudden e.g. stock market crash 73, 97 Short duration, around or less than 1 year Depression and Recovery Depression Spot price decreases. Pre-sale price may drop by as much as 40% or more. Few transactions: only end-users Number of speculators in negative net worth increases Long transaction period Duration: at least 2 years Early: 99% are end-users in market (almost no speculators) Pre-sale price < spot price Later: Market sentiments gain confidence Pre-sale price and spot price are gradually increasing. Duration: as long as 3-4 years Recovery End Additional Reading Materials SCMP Articles We'll force up flat prices: Leung Real estate cycle may be nearing peak Strong H Cube sales unlikely to boost home values Competition heats up in boutique apartment sector The Relationship Between Demographic Changes and Future Housing Demand in Indiana: A Preliminary Look from the Census by G.H. Lentz and K.S. Maurice Tse, Graduate School of Business, Indiana University ...
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This note was uploaded on 09/06/2010 for the course FINA FINA0805 taught by Professor Tse during the Spring '09 term at HKU.

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