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Premium on first-hand residential market

(Published by South China Morning Post, 21 Jul 2010)

Just over a year ago, the headline price for 39 Conduit Road was HK$71,280 per square foot, but recently the developer announced that all but four of the 24 properties sold for record prices had fallen through.

While the market is still asking whether there were any back-room deals, others are raising a more fundamental question: Is there a standard for valuing flats sold in the primary residential market?

In the secondary market, well-known valuation firms typically use a simple and straightforward standard – the prices of similar flats sold in the area most recently, or market comparables. Banks normally approve the mortgage application based on the valuations of these third-party firms. This decades-old practice prevents a seller conspiring with a friend to sell his unit at a price much higher than the market value and trying to cash out through the mortgage.

Theoretically, units in the primary market should be valued according to the same criteria. However, local developers have justified higher selling prices with various reasons to the point where new projects are inevitably priced much higher than other existing properties in the same area. Over the years, the valuation agencies have acceded to the views of developers and found it reasonable to arbitrarily attach a 50 per cent or higher premium compared to second-hand properties nearby. Now, second-hand housing transaction prices are no longer a good indicator of where the primary market should trade. Instead, the prices of the first batch of flats sold become the new standard of fair valuation for any additional units sold in the same development. As long as there are bona-fide buyers of the first batch, prices will be considered reasonable.

In most cases, banks will approve mortgages under this objective valuation and base the valuation equivalent to the selling price. However, last year, many banks became wary of such extreme premiums on primary market transactions and decided to only allow the borrower to leverage up to 60 per cent of the selling price, rather than the Hong Kong Monetary Authority-mandated loan-to-value cap of 70 per cent.

This new valuation standard helped boost prices in the primary property market. From 1996 to 2004, the average prices of first-hand residential transactions were less than two times higher than the secondary property market. This gap has widened in recent years to 2.5 times.

High valuations in primary developments affect not only prospective buyers, but the entire banking system.

When property prices rise, the high valuations may not be a problem and the premium may be considered more reasonable after construction. But, when the market falls or is expected to fall and buyers discover that the market price is much lower than their purchase price; they may choose to cancel the deal or simply stop making mortgage payments.

If the government wants more realistic primary market transactions, it should provide more land in the long run and limit the amount of additional floor space that developers can add, as suggested by a recent report by the Council for Sustainable Development.

In the short term, if we can implement this standard: primary market valuations should be based on the transaction prices of similar properties in the same area which has a greater direct impact. When the developers’ asking price is HK$10 million, while the valuation is only HK$7 million, any buyer would think twice before buying.

Leland L. Sun



Leland L.Sun
Director and Founder of Pan Asian