Hong Kong's real estate stocks outperform Hang Seng Index

Stocks have rallied by 30%.

The Hang Seng Property Index has some room to rally in the near-term amid a temporary stabilisation in residential house prices.

According to a research note from BMI Research, however, it believes that there is still plenty of downside left in the Special Administrative Region's property market due to headwinds from extremely stretched valuations, and impending housing supply amid the regulator's macroprudential measures. A further decline in real estate prices will eventually weigh on property equities over the longer term.

Hong Kong real estate equities (as measured by the Hang Seng Property Index) have rallied by approximately 30% since the start of 2016, outperforming the Hang Seng Index's performance of just 5%.

BMI Research believes that there is still some room for the index to head higher in the short-term amid a temporary stabilisation in the territory's residential property prices. Indeed, data from Hong Kong's Rating and Valuation Department showed that private domestic home prices for selected popular developments rose by 0.6% q-o-q in Q216, marking a pause from two straight quarters of contraction.

Meanwhile, the property equity index is trading at 0.8x price-to-book ratio, which is well below its long-term average of 1.1x. Given that such a valuation is close to the lows seen respectively during 2003, 2008, and 2014, this suggests that investors could be taking advantage of extremely cheap valuations.

Here's more from BMI Research:

In our view, the stabilisation in real estate prices in Q216 can be attributed to the aggressive marketing techniques offered by developers such as Sun Hung Kai Properties and Cheung Kong Properties, which offered price discounts of as much 20%.

In addition, they also have been providing potential buyers with the option of a home financing of around 120% of the value of the property, as long as buyers are able to offer another home as collateral. These loans are normally short-term in nature (usually three years and carry an interest rate lower than a bank mortgage). As such, this has attracted buyers to jump back into the real estate market, particularly as expectations that the US Federal Reserve may delay further rate hikes in 2016 grow.

Such attempts by Hong Kong's property developers to prop up housing prices are likely to be short-lived, and we believe that the market has yet to find a bottom. Hence, there is plenty of downside left for the territory's property market over the coming quarters. As such, this will inevitably weigh on the performance of the Hang Seng Property Index over the longer term, despite the rally in 2016.