The risk of a real estate bubble in Hong Kong has reached its highest level since 2015, according to a report released last week, but experts are divided on whether the city’s property market still offers investment potential.

The 2017 UBS Global Real Estate Bubble Index released on September 28 placed Hong Kong in the bubble risk category, with a score of 1.74, after scoring 1.52 in 2016 and 1.67 in 2015. Any score above 1.5 is considered to be a bubble risk.

UBS said a mixture of investor demand, firmly entrenched expectations of increasing property prices, and a fear of missing out on capital gains had left Hong Kong and Australian city Sydney at risk of marked property value corrections.

“Hong Kong’s housing market surpassed its previous peak level in 2011 and seems to have lost its touch with fundamentals ever since,” Matthias Holzhey, Zurich-based head of Swiss real estate investments at UBS, told AsianInvestor.

Hong Kong’s housing price index peaked at 172.9 in October 1997, but prices then fell for many years and only surpassed that level once more in February 2011, according to government data.

The UBS report defines a bubble as a “substantial and sustained mispricing of an asset”, although somewhat unhelpfully it admits the existence of one cannot be accurately identified until it bursts.

Despite the historically high property valuations, some funds are still interested in gaining exposure to Hong Kong property.

Allianz Real Estate, the property investment manager that is part of German financial services company Allianz Group, is looking to allocate around 5% of its €53 billion (US 63.5 billion) global portfolio to Asia Pacific. That includes Hong Kong, said Rushabh Desai, chief executive of Asia Pacific at Allianz Real Estate.

 “I wouldn’t say the market is in a bubble, but I think the market is very tightly held, and that creates the pricing to be much more stronger than what would have been in an open market economy,” Desai told AsianInvestor.

“I don’t think we have enough exposure in Hong Kong as of today,” he added. “We would like to get some more.”

Expensive living

UBS’s global real estate index derives Hong Kong’s score from a weighted average of five sub-indices, including price-to-income ratio, price-to-rent ratio, change in mortgage-to-GDP ratio, change in construction-to-GDP ratio, and inflation-adjusted price index.

The city’s price-to-income ratio was 10.7 as of August, according to Hong Kong real estate agency Midland Realty, based on the price of a 500 square foot flat. That was the highest figure in nearly 20 years.

The UBS report said Hong Kong housing was the least affordable of 20 global cities covered. It noted that real prices were nearly three times higher than in 2003, and rising 10% annually, on average. The most recent figures from the Hong Kong government show that the housing price index rose for the 17th straight month in August.

However, Desai said he was most concerned with identifying decently yielding investment opportunities amid the rising prices.

“It doesn’t make a compelling argument for us to say, ‘look, let’s go and buy something at a 3.5% (yield) in Hong Kong, when you can buy that in New York City as well,’” he said. “While we would like to get, from an allocation point of view, exposure to Hong Kong, we are now looking at things which are slightly higher on the yield curve.”

He said the best value is to be found outside of the traditional commercial office space and retail environment, in alternative real estate.

“One of our funds invested in a data warehouse in Hong Kong, which has worked pretty well,” Desai said, with annual net operating income yields ranging from 5% to 5.2%. He also said higher yield opportunities exist in conversion projects, where industrial buildings have been transformed into office or residential spaces.

Stable for now

For all of the warning signs identified by UBS, Holzhey said he does not foresee any short-term major corrections Hong Kong’s property market. He cited strong investor purchasing power, an improving economy, and low vacancy rates as supporting today’s prices.

Hong Kong’s commerical property rates in Central are also being supported by an inflow of Chinese corporate demand, despite rising prices.

However, Holzhey warned that the long-term outlook for Hong Kong remains highly uncertain, with the level of house prices’ relying on strong investor sentiment.

“The observed trend of up to real 10% annual price growth in the last decade appears unsustainable. In the longer run, a high degree of prudence is warranted,” he said.

Despite the low yield environment and the high pricing level of the market, Desai expressed confidence in Hong Kong real estate investments, citing the stability of the dollar-pegged Hong Kong currency.

“We would be interested in Hong Kong because we can mitigate one of our risks in terms of currency,” he noted.