Hong Kong’s collapsing land market threatens city’s financing model

(Bloomberg) — Hong Kong’s real estate crisis is cutting off one of the financial hub’s most important government revenue sources.

For decades, the city government has generated huge revenues by auctioning off land to cash-rich developers as prices soared. That helped create Hong Kong’s low-tax regime, which was key to its status as a business hub. The arrangement has largely worked—until recently.

The prolonged slump in property prices is now undermining that model. Falling house prices and rising office vacancies over the past few years have caused developers to either stop bidding on land or to bid extremely low for plots in public auctions. In a sign of how depressed the market remains, Hong Kong’s house price index fell to a near eight-year low in July.

Hong Kong’s government land revenue in fiscal 2023-24 was the lowest since the global financial crisis, and demand is unlikely to return to the levels seen during the property sector’s heyday. The apparent slowdown is putting pressure on Hong Kong to raise revenue from other sources. The city has pledged to build a major tech hub and has other expensive projects underway that could drain its coffers. It also has a rapidly aging population that will require more spending on social services.

At the height of the property craze, the city raised HK$164.8 billion from land. Total property income accounted for nearly a third of Hong Kong’s government revenue that year—the highest since 1989—according to an analysis by Charles Ka Yui Leung, an economics professor at City University of Hong Kong, and other researchers.

In the recently ended fiscal year, the government’s total land revenue fell to just HK$19.6 billion. That was 77% lower than the official budget estimate for 2023-24. For the current fiscal year, which ends on March 31, 2025, the government has estimated total land revenue at HK$33 billion.

Leung said Hong Kong’s property slump and population decline are signs of deep-rooted problems in the economy. Demand for housing is falling as more people emigrate abroad, choose to live in neighboring Shenzhen or stop investing in property because they expect its value to fall.

The era when the city derived income from selling land is over, and “if the government does not think about the expenses and continues like this, we will have to face even bigger problems,” he added.

The Hong Kong government’s drastic move to lift restrictions on buying properties earlier this year has only produced a short-lived rebound. Sales have slowed and prices for new and used homes have continued to fall.

“The land sales market is expected to remain subdued in 2025 and 2026 due to low developer confidence, high inventory levels and high interest rates,” said Hannah Jeong, a land surveyor. The city’s developers are under pressure to lower prices to sell new homes, while also incurring high financing costs and construction expenses, she added.

In the last fiscal year, the Hong Kong government sold just three plots for HK$7.3 billion, the lowest since 2008-09. A plot in the Kai Tak area — once a popular location for developers — sold for the lowest price in nine years in September last year. The city has also seen a record number of failed land bids.

This year, the government has sold one residential plot and two plots for electric vehicle charging stations for a total of HK$722 million. It also failed to sell a residential plot in late July after receiving only one bid that fell short of the reserve price.

An unprecedented and deepening decline in commercial property prices is adding to the challenges. Hong Kong’s office vacancy rate hit a historic high of 16.9% in the first half of the year, while rental prices are expected to fall by as much as 10% in 2024, according to CBRE Group Inc.

Commercial land brought in billions of dollars for the government at its peak a few years ago. The city has not put any commercial land up for sale as of March 2023.

The Hong Kong government has reported a budget deficit of about HK$100 billion in the fiscal year ending March 2024, almost twice as high as previously estimated – largely due to a significant shortfall in land revenue.

The city has now run four deficits in five years, causing fiscal reserves to fall from a peak of HK$1.2 trillion in January 2019 to HK$615 billion by late June. The pattern is unusual because the Hong Kong government is constitutionally required to try to balance its budget and avoid deficits by keeping spending within revenue limits.

Government spending is only set to rise. More than a third of Hong Kong’s population will be 65 or older by 2046, up from 21% in 2021. In addition to the likely increase in social spending, the city is building a HK$220 billion megaproject called Northern Metropolis, which will turn part of the New Territories into a tech hub. It also plans to build three large artificial islands at a cost of HK$580 billion.

In response to a question from Bloomberg News, a government spokesman said the city is trying to raise revenues and is putting more emphasis on trying to control spending growth. That includes reducing the size of the civil service and reviewing major subsidy programs — such as discounts on public transport for the elderly and disabled.

The government is also considering alternative financing options, such as public-private partnerships, and will issue more bonds to help finance its projects. It is expected to issue close to HK$95.8 billion of debt this year, the highest amount in at least 25 years, and will issue bonds worth up to HK$135 billion a year by fiscal 2028-29.

“Increasing debt is not helping to solve the structural deficit in the long term,” said Ryan Ip, vice president of Our Hong Kong Foundation, a think tank. The administration needs to find ways to cut spending and develop new industries so that the economy is not dependent on real estate. “But that will take time,” he added.

To be sure, Hong Kong’s financial situation is still better than most other advanced economies. The government estimates that the city’s public debt to gross domestic product ratio will reach between 9% and 13% over the next four years. By comparison, the U.S. national debt was 123% of GDP in 2023.

The city can’t easily raise income taxes, as its simple, low tax system is one of the financial centre’s biggest attractions for businesses, expats and foreign investment. Earlier this year, the government raised the tax rate for high-income earners from 15% to 16%, affecting just 0.6% of the tax-paying population.

“If the tax rate is too complicated, Hong Kong’s advantages disappear,” said Gary Ng, senior economist at Natixis SA. “In short, it’s hard for Hong Kong to get rid of land financing.”

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