Over the past two years, Hong Kong real estate prices have risen as employment has steadily improved. As shown in the chart below, Hong Kong’s unemployment rate is now close to 3 percent–a far cry from the 8.6 percent high in 2003. Additionally, rising consumer incomes have boosted domestic consumption, which accounts for 60 percent of Hong Kong’s gross domestic product (GDP).

Source: Bloomberg

Hong Kong does face inflationary pressure, as evidenced by the latest reading from its consumer price index (CPI) which shows that inflation increased 5.7 percent year over year. We expect inflation to remain at elevated levels for at least the first half of the year.

Hong Kong’s relatively high inflation is largely a consequence of its policy to peg its currency to the US dollar, which means that this special administrative region (SAR) of China is essentially importing US monetary policy. The Federal Reserve has attempted to bolster US economic growth through an accommodative monetary policy. But that approach to monetary policy has resulted in the SAR’s economic growth being accompanied by higher asset prices.

Although Hong Kong’s real estate prices have weakened recently, the lower availability of land this year will put a floor under real estate prices. Furthermore, the government’s efforts to dampen the overheated property market appear to have succeeded, so policymakers are unlikely to pursue further measures on this front. Finally, banks have started to ramp up mortgage lending, which has led to increased activity in the so-called secondary real estate market.

Barring a shock to the global economy, real estate sector stocks should continue their upward trend, as depicted in the chart below. Our favorite Hong Kong property developer is Long-Term Holdings Portfolio member Sun Hung Kai Properties (HK: 16, OTC: SUHJY).

Source: Bloomberg

Since its incorporation in 1972, Sun Hung Kai Properties has established itself as Hong Kong’s leading property developer. It is the largest developer of private homes in the city, with a market share of about 19 percent, and has a reputation for high-quality construction and workmanship.

In addition to property development, Sun Hung Kai Properties has investment properties and interests in telecommunications, infrastructure, freight forwarding and information technology.

Sun Hung Kai Properties’ investment property portfolio has a gross floor area (GFA) of 34 million square feet, of which 28 million square feet is located in Hong Kong, representing 8 percent to 9 percent of the SAR’s total square footage. This investment property portfolio generates roughly USD1.3 billion each year in net rental income, and is one of the fastest growing rental portfolios among all of Hong Kong’s property developers.

Sun Hung Kai Properties should post solid numbers when it reports its interim results next week, particularly because of strong sales in two of its luxury residential projects, Imperial Cullinan and The Wings. Imperial Cullinan is expected to account for around 70 percent of sales.

Rental and hotel operations should also produce decent results. The firm’s hotel operations should benefit from the outstanding growth in Hong Kong’s tourism. Almost 42 million tourists visited the SAR last year, the highest tourist tally in Asia and a remarkable achievement for a city of seven million people. The majority of tourists–close to 30 million–came from China. 

Tourist-related receipts now represent 14 percent of GDP and tourist shopping now accounts for almost half of Hong Kong’s retail sales. Consequently, hotel rates have also been rising, as have retail space rentals.