Real Interest Rate Effect on Housing Price Cycles

[substantially revised on Mar 12, 2019]

The cyclical housing price change pattern is clearly depicted in the Hong Kong housing markets, especially for the short-term cycles in the past 16 years. Figure 1 shows the six cycles of Hong Kong Housing Price Year-on-Year (YoY) Change. The negative correlation between negative real interest rate and housing price change has been very strong since the Global Financial Crisis 2008, the housing price change has been in the positive zone for almost the whole decade from 2010–2018, when the real interest rate was deep in the negative zone in Hong Kong at the same period (Figure 2).

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Figure 1 Hong Kong Housing Price Index Change YoY, Source: RVD (2019) [1]
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Figure 2 Real Interest Rate of Hong Kong 2008–2018. Source: HIBOR and CPI HK

The housing price change shows a very clear short-term cyclical pattern with about 2–3 years period from peak to peak. The latest cycle (the 6th cycle since 2003) fits the cyclical pattern with the latest YoY change of housing price drops from the peak of 22% in Jun 2017 down to 0.3% in Jan 2019. It corresponds to the rise of interest rate in Hong Kong via the currency board system in the wake of the rate increase by the Federal Reserve in the US.

However, there is also a medium-term cyclical pattern which is more difficult to study, due to the lack of housing price index data. For example, it is well known that there were several severe housing price plummets in Hong Kong, such as the 1963, the 1974 and the 1981 incidents. Roberts (1975) made some remarks on the over-supply of housing causing the 1963 bank-run incident [2] extracted as follows (but no empirical test):

“Developers could not repay building loans, because they could not sell the flats. They could not even meet interest payments, sometimes compounding at 1.5% per month. Banks endeavoured to exercise their power of sale as mortgagees, but still the property did not sell. The banks’ security had evaporated. Inevitably, runs started on small banks, and some were forced to close their doors. The panic among depositors even extended to the leading Chinese-owned bank, which had in fact conducted its affairs impeccably and had preserved adequate liquidity of its assets, but such was the force of rumour that depositors, anxious to withdraw their cash, lined up in queues which stretched out into the street. Stacks of gold bullion bars displayed behind the counter did little to assuage their fears, and the run continued until an announcement was made that the HSBC had acquired a majority interest in the bank.” [2]

The 1974 incident is quite clear to be related to the abolition of the Bretton Woods agreement by the US President Nixon in 1971, causing worldwide inflation and a long period of excessively high interest rate raised by the Federal Reserve.

However, since the earliest official data series of housing price index in Hong Kong is from 1994, all the plummets before 1994 cannot be tested empirically. Figure 3 shows the Hong Kong Housing Price Change YoY from Jan 1994 to Jan 2019. There was a more substantial and longer-period fall of housing price to about -40% max. and lasted for 6 years from 1998 to 2004.

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Figure 3 Hong Kong Housing Price Index Change YoY, 1994–2018. Source: RVD (2019) [1]

The short-term cyclical pattern is “punctuated” by a medium-term bubble burst. This incident is commonly agreed to be caused by the Asian Financial Crisis in 1997, which happened together with an increasing real interest rate from the 10-year negative zone in 1987–1996 to the positive zone (Figure 4 extracted from Yiu, 2018 [3]).

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Figure 4 Negative Real Interest Rate from 1987 to 1996. Source: Yiu (2009) [3]

We have tried to build a longer period housing price index for Hong Kong private housing markets from 1984 onwards, based on the transactions of the biggest private housing estate in Hong Kong, to carry out an empirical test of the effects of real interest rate, among others, on the housing price change. Figure 5 shows the results that negative real interest rate (1Q lag) imposes a strong and significant effect on the growth of housing price in Hong Kong.

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Figure 5 Empirical Evidence of the Negative Relationship between Negative Real Interest Rate and Positive Housing Price Change, from 1984Q3 to 2009Q1 Hong Kong. Source: Yiu (2009) [2]

Interestingly, a similar pattern of the punctuation seems to be repeating in recent months. After about 10 years of negative real interest rate, it has just been crossing from negative zone to positive zone since 2018. Yet, the Federal Reserve of the US seems to be slowing down or even stop the rate increase trend in view of the recent warning signals of global recession. How would it affect the housing price in Hong Kong would take time to reveal.

But we can learn the lesson elsewhere as the effect of interest rate on housing price is not only valid in Hong Kong, but is also recently found to be critical in Australia. The recent plummet of housing price in Australia is found to be dominantly caused by the rise of interest rate and the tightening of mortgage loans. Two economists of the Reserve Bank of Australia, Trent Saunders and Peter Tulip, show that “much of the strength in housing prices and construction over the past few years can be explained by the fall in interest rates,” and the tightening of credit limits “seems to be important in the decline in house prices in 2018”. [4]

An article analyzing the effect of tightening the mortgage loans on the housing price change in Australia will be published in early April in HKEJ (2019). [5]

[1] RVD (2019) Private Domestic — Price Indexes by Classes: All Classes (1999=100), Statistics, Rating and Valuation Department, Hong Kong SAR Government.

[2] Roberts, P.J. (1975) Valuation of Development Land in Hong Kong, HK: HKU Press.

[3] Yiu, C.Y. (2009) Negative Real Interest Rate and Housing Bubble Implosion — An Empirical Study in Hong Kong, Journal of Financial Management of Property and Construction, 2009, v. 14 n. 3, p. 257–270. https://hub.hku.hk/bitstream/10722/81854/1/content.pdf

[4] Wright, S. (2019) RBA research shows rate cuts inflated the property market, March 11. Sydney Morning Herald. https://amp.smh.com.au/politics/federal/rba-research-shows-rate-cuts-inflated-the-property-market-20190311-p513ak.html

[5] HKEJ (2019) The Causes of the Australia Housing Price Plummet, Hong Kong Economic Journal (Chinese), April, Vol 505. (to be published)

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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