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Hannah Jeong

The Federal Reserve raised interest rates in March and hinted it could do so six more times in 2022. Though the Hong Kong Monetary Authority (HKMA) hiked in lockstep, it does not necessarily follow that local commercial banks will match the pace and frequency of future US increases.
Commercial real estate investors in Hong Kong closely watch for any Fed pronouncements on the direction of interest rates as they are acutely aware of how they could impact their investment returns.
The local peg to the US dollar makes any US interest rate movements particularly relevant to the HKMA because of the city’s linked exchange rate system.
Programme for higher rates
The Fed on March 16 raised its key interest rate by a quarter point, and suggested it could lift it six more times, up to a total of 100 basis points, before the year is out, as it tries to fulfil its mandate of full employment and keeping the annual inflation rate to about 2 per cent.

The HKMA also raised its base rate by 25 basis points to 0.75 per cent, saying it would continue to “closely monitor market situations” to maintain financial and monetary stability. Geopolitics, macroeconomic developments and the pandemic may affect the pace and frequency with which the Fed changes rates this year, it added.
Hong Kong’s base rate moves according to a preset formula: either 50 basis points above the lower end of the prevailing target range for the US federal funds rate (currently 0.25 per cent to 0.5 per cent), or the average of the five-day moving averages of the overnight and one-month Hong Kong Interbank Offered Rates (Hibor) – whichever is higher.


Typically, a US rate increase would ring alarm bells for commercial real estate investors in Hong Kong because of the potential for higher borrowing costs. However, the HKMA noted in its statement that Hibor does not increase automatically when the Fed rate does, and that banks will make their own decisions based on supply and demand.
Also of relevance to the Hong Kong property market is that a direct link between the capitalisation or cap rate – which commercial real estate investors commonly use as their rate of return – and Hong Kong interest rates, is not apparent anyway.
Importance of cap rate
The cap rate is a key concern for commercial real estate investors because it reflects their expected return on the amount invested. If an interest rate hike increases an investor’s risk, it will expand the cap rate, or investment risk, at the same time.




Interest rates are not the only factor that affects the cap rate, however. Investors also look at variables such as inflation, liquidity, capital controls, supply and demand – a key driver of the Hong Kong market – and the economic outlook.
A lower cap rate usually corresponds to a higher valuation, better prospects of returns and a lower level of risk, and vice versa.
One only has to look back to the three years from 2005 to 2008 for evidence that the correlation between the cap rate and interest rates is not rock-solid in Hong Kong. In that time, the cap rate narrowed despite a hike in the three-month Hibor.

Mild impact
Even if the HKMA decides to increase interest rates by the same amount as the Fed for the rest of the year, there are three reasons to think they will have only a mild impact on risk to commercial real estate investors in Hong Kong.
First, we expect the HKMA to move slower in increasing rates to minimise any negative economic impact.
Second, too much capital is chasing the limited supply of quality assets in Hong Kong. A large number of funds have raised new money in 2022, all eager to find good opportunities in the market. This competition will counterbalance the potential cap rate expansion.


Third, geopolitical tensions might boost the inflation rate faster than the interest rate. This is highly likely to keep Hong Kong in negative interest rate territory, where the interest rate is below the inflation rate.
While the Covid-19 pandemic continues to create uncertainty and likely to slow investment decision-making, negative real interest rate conditions will offer a good buffer to investors.
More caution
With mild pressure from the interest-rate hike, commercial real estate investors can take solace from evidence that the direct link between higher interest rates and lower investment values in Hong Kong is not as established as one might assume.
As long as investors are not highly leveraged financially, the expected interest rate hikes will not put immediate pressure on the market.
Hannah Jeong is head of valuation & advisory services at Colliers in Hong Kong


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Business

Property

Hong Kong & China


Direct link between local interest rates and cap rate or investment return is historically weak
Negative real interest rate, more funds chasing limited pool of assets and other market variables could insulate the commercial property market



Should property investors be worried about the pace and frequency of rate increase in the US? The link between local interest rates and asset valuation is not well-established.


Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


Column

Concrete Analysis