Inflated Floor Areas Part 2: Ridding Them Doesn't Lower Prices

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

November 2010


As your humble author has stated in Part 1 of this article and in earlier articles such as ˇ§Average Home Price does NOT increase with Increased Average Floor Areaˇ¨ [September 2002:], feeling, rightly or wrongly, taken for a ride by inflated floor areas is one thing, thinking deflated floor areas would mean lower home prices is delusional.

The reason is simple: what a family or homebuyer could afford is a relatively fixed budget. One earns $X and thus could afford, maybe, a $3X, $6X, or $10X home as the case may be. However, going for a $15X or even 20X home could be financially suicidal.

Likewise for a real estate speculator: one who has the clout, via equity or borrowings, to assemble $100M could bet on $100M of properties. To ask the same person to go for $150M is impossible unless more money is made available.

Looking from another angle, the sellers a.k.a. real estate developers are simply seeking to entice, or squeeze if you like, the prospective buyers and speculators to come up with all the available dollars in their possession. Knowing that a buyer has the power and is willing to pay $10M for a home, it would be incompetent of the developer to only get, say, $9M.

Now, what can one buy for HK$9M (around US$1.15M)? This depends on the city (an economy) in which the buyer is seeking a home. For instance, in Hong Kong, assuming a middle class neighborhood, one may get an 800-1000 ft2 high rise apartment. In California, perhaps a big detached house. In a remote Canadian small town, perhaps the priciest estate home, if any exists, in the neighborhood.  

The overall point is: developers make money by producing products (real estate) which match the various strata of buyer pools and NOT by selling more floor areas. The latter only seems to be so because the prospective buyers still have further purchasing power (money) which has not been formerly revealed. That is, the developers put in more bells and whistles (including more floor areas) to entice the buyers, and the buyers oblige and reveal they can pay more. Given that developers have the upper hand in 1st hand newly built property transactions, the buyer pools will usually be at a disadvantaged position, especially when the market is hot. That is to say, when and if the last dollar has been squeezed, more bells and whistles will not gain the developers any more money, yet the developers generally have years of practice and experience in knowing how many more bells and whistles are required, and when to stop.

What has occurred recently in Hong Kong can be illustrated by this simple (and simplified) story: just like the typical car market, buyers going for the Benz and BMW versus those wanting Camry or Accord could be 1: 9, 2:8, or 3:7 etc. Likewise, in a typical residential market, purchasers going for pricey homes versus those affording average homes could be in similar ratios. In short, there are usually more buyers for simpler homes (and cars).

Now, lo and behold, all of sudden there come plenty of Benz and BMW homebuyers, raising the ratios to 4:6, 5:5, or even 7:3 etc. Unlike the car market, where producers may build more to meet demand, real estate production tends to be less flexible. First, land sites are limited. Second, there are always the time-consuming approval and construction processes. Third, some developers may, in view of more wealthy buyers, reserve formerly average sites for pricier projects.

All these mean some formerly average homebuyers are now PRICED-OUT of the market and those average buyers who could still buy a tiny Benz property would feel sort of taken. From the angle of developers, however, assuming all factors being equal, the profit derived from selling a pricier property could be several times that of selling an average unit.

Where do all these (new) wealthy purchasers come from? North-East-South-West but probably more North these days. Well, asking the US Federal Reserve (and the other central bankers around the world) and peeling into QE1, QE2 etc may also help.

Is there any solution in sight? Not really. Having the Hong Kong government increase land supply may be one but its actual effect will not be felt at once. Also, given the cause being a monetary one, perhaps it requires a monetary answer such as doing away with the HK$ to US$ peg which, however, in turn carries a lot of uncertainties, requires an experienced monetarist team (and luck?), and impacts a broad spectrum of activities and places, definitely not something to be taken lightly. It is also beyond the knowledge, experience, and capacity of your humble real estate analyst-author i.e. read the disclaimer below and Caveat Emptor!

The Financial Secretary Mr. John Tsang said Hong Kong is caught between fire and ice. Earlier, our ex-Monetary Authority chief executive Mr. Joseph Yam had remarked we are now in rare financial chaos not seen for 100 years.

They both have a point. 

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