Hong Kong: It's Back!

Real estate is booming, shoppers are spending, and Disneyland is on the way. Beijing is doing its part by letting mainland tourists flow in. But is this just another bubble -- or the real deal?

Danny C.Y. Leung is a man in a hurry. The 42-year-old oversees apartment sales in Western Mid-Levels -- an affluent Hong Kong neighborhood of twisting streets and towering apartment blocks on the slopes of Victoria Peak -- for Centaline Property Agency. Leung manages 128 salespeople in 10 offices, and he can't keep up with the 300 deals his staff books every month -- quadruple the volume of two years ago. "I don't have time to spend on my own family," says Leung. "We are showing and showing and showing." Then again, he was able to buy a $6,100 Franck Muller watch for himself and a $3,600 Rolex for his wife. He has good reason to open up his wallet: Not only is his employer prospering, but Leung says an 800-square-foot flat he bought six months ago for $213,000 as an investment has jumped in value by over 50%. "It's just crazy," he marvels.

It's the kind of crazy Hong Kong loves. The city these days is full of stories of people who have made a killing in property, sometimes buying and selling apartments within days. After being flattened by the Asian financial crisis of 1997-1998, the dot-com collapse of 2000, and the SARS epidemic of 2003, the residential property market is roaring back to life. In October a 4,620-square-foot apartment in Branksome Crest, a luxury high-rise with views of Victoria Harbor, sold for $16.7 million. That's $3,615 per square foot, surpassing 1997 highs of nearly $3,000 per square foot. Then in April a penthouse in Kowloon sold for $21.3 million, or $3,979 per square foot. It's not just ritzy new buildings, either: The Centaline Index, which tracks prices in the secondary market, has nearly doubled since mid-2003, and in April nearly 16,500 properties changed hands -- the highest monthly turnover since 1997.

Lavish Consumption

The booming property market isn't the only barometer of Hong Kong's economic health. Hong Kongers are once again exhibiting their fabled displays of conspicuous consumption, splurging on meals of Kobe beef at $110 per serving and $600 bottles of Bordeaux. In Central's tony Landmark shopping mall, Louis Vuitton, Fendi, Prada, and Christian Dior are all expanding their boutiques, and department store Harvey Nichols -- controlled by local tycoon Dickson Poon -- is building a 60,000-sq.-ft. emporium.

Why the exuberance? A slew of factors have kicked in to boost the economy, including timely help from Beijing and Hong Kong's agility in capitalizing on China's super-hot growth. Hong Kong companies have invested more than $240 billion in the mainland, and businesses based in Hong Kong -- with a population of just 6.9 million -- employ more than 12 million people in China, mostly in the thousands of light manufacturing plants that have sprung up in the Pearl River Delta north of the city. China remains Hong Kong's biggest trading partner, with two-way trade of $232 billion last year, and more than 2,000 Chinese companies operate in the city. Not only is Hong Kong the de facto capital of the Pearl River Delta, it has also been able to beat back all of the mainland cities challenging it as the financial capital of the whole country. As China booms, Hong Kong booms.

As a result, Hong Kong's real gross domestic product shot up 8.4% in 2004. In part that reflects a sharp recovery from SARS, which dragged down growth in 2003. But GDP is also expected to climb a more-than-respectable 6.7% this year, according to brokerage CLSA. The benchmark Hang Seng stock index is up 22% in the past 12 months. Unemployment has been steadily falling, from a peak of 8.8% two years ago to 5.9% now, as expansion has led to thousands of new jobs for qualified accountants, lawyers, ad execs, and consultants. New grads can expect starting wages of about $15,400 annually, up 20% from a year ago, according to Hong Kong University of Science & Technology.

The good times could still get out of control. Hong Kongers really know how to engineer real estate bubbles, and there's always the possibility that this could turn into another one. But for now, "everything is in the clouds again," says Michael Ying, chairman of Esprit Holdings Ltd., the Hong Kong-based retailer that operates stores in Asia, Europe, and the U.S. Hong Kong's consumer confidence index hasn't been this good in six years, ACNielsen (VNUVY ) reports.

True, some parts of the economy are still playing catch-up. Average prices for mass housing stand at $435 per square foot, up 51% since January, 2004, yet they're still "miles off the all-time high" of $1,000 a square foot in 1997, says Franklin Lam, a property analyst at UBS (UBS ) and owner of several luxury flats that he rents out. But he's betting that prices will continue to climb, hitting $640 per square foot by the end of 2006.

It's all a big change from the funk Hong Kong sank into just a few years ago. The collapse of the property bubble and the Asian financial crisis in 1997 sent the city into a downward spiral of job losses and deflation. In part the peg holding the Hong Kong dollar's value steady against the U.S. greenback was to blame. Other Asian countries devalued their currencies, but in Hong Kong the adjustment came through lower prices rather than a cheaper dollar. As a result, by 2003, real estate prices had tumbled an average of 70%, leaving more than 100,000 homeowners owing more on their mortgages than they could possibly hope to gain by selling their apartments. To match the technology investments won by places such as Shanghai and Singapore, the government in 1999 unveiled an ambitious plan to build an info-tech hub, dubbed Cyberport. But the complex ended up adding extra office space to the market just as prices were heading south, and it attracted precious little high tech.

While Hong Kong seemed to lose its way, its revived rival to the north, Shanghai, became China's "it" city, luring the investment and glitz that had been Hong Kong's specialty. Chipmakers Advanced Micro Devices and Infineon Technologies (IFX ) and photo giant Kodak (SI ), among others, shifted regional headquarters to Shanghai from Hong Kong. Go-go Shanghai had aggressive politicians plotting its rise. Meanwhile, Hong Kong was stuck with the uninspiring Tung Chee-hwa, a former shipping tycoon who lacked the common touch. Hong Kong hit bottom in the winter and spring of 2003, when SARS made its residents global pariahs. Then, on July 1 of that year, nearly half a million people took to the streets to protest the Hong Kong government's mismanagement of the economy and its plans to impose a Draconian security regime.

Memories of those days are fading fast. Deflation has run its course, and the consumer price index started rising again last July. Only 14,000 homeowners now remain saddled with negative equity. The credit-card delinquency rate, which peaked at 1.9% of all outstanding credit-card debt in 2002, fell to just 0.44% by last December, according to the Hong Kong Monetary Authority. "There is a positive wealth effect," says Vincent H.C. Cheng, who was just appointed chairman of HSBC Holdings PLC's (HBC ) Hong Kong-based Asia Pacific operation.

The feel-good mood extends to politics. In December, Chinese President Hu Jintao publicly upbraided Tung, and in March the unpopular 67-year-old chief executive stepped down, saying the job was taking its toll on his health. Tung's replacement is Donald Tsang, a former Financial Secretary who is well respected by both Hong Kong's business leaders and common folk. Although pro-democracy politicians are crying foul, a Beijing-controlled committee of 800 Hong Kong elites will formally "elect" Tsang, who rose up through the ranks of the civil service, as Tung's replacement on July 10.

The date that really matters, though, is Sept. 12. That's when Hong Kong Disneyland is scheduled to open -- with a price tag of $3.5 billion for the park and infrastructure improvements -- 90% paid for by the government. Hong Kong officials figure the park will attract 1.5 million tourists annually who wouldn't have come otherwise. Within a decade, as mainland incomes rise, they expect twice that many. They'll soon have other attractions to visit, too. Plans call for a wetlands park in the New Territories, a 5.7 kilometer cable-car ride on Lantau Island near Disneyland, and a new harborfront promenade in Kowloon.

Hong Kong has Beijing to thank for all those mainland tourists. In the past two years, Chinese policymakers have offered a host of initiatives to ease Hong Kong's economic malaise. One of the biggest: fewer restrictions on individual travelers from the mainland, whose numbers soared 44%, to 12.24 million, last year. Chinese tourists accounted for 12% of all retail sales last year, up from 5% in 2000, according to a Goldman, Sachs & Co. (GS ) report. They helped push retail sales up 9.1% last year, which created jobs and encouraged locals to start spending more. And a 17-month-old pact called the Closer Economic Partnership Agreement (CEPA) gives Hong Kong companies the same status in China as their mainland rivals in dozens of sectors. That means Hong Kong execs don't have to waste time and money finding joint-venture partners as they push deeper into the mainland. "You can't imagine the opportunities this opens up," says Victor Fung, chairman of Li & Fung Ltd., a leading Hong Kong trading company.

Increasingly, Hong Kong's service providers are supplementing the efforts of Hong Kong manufacturers by exporting their expertise to the mainland. On May 10, MTR Corp., which operates Hong Kong's subway network, agreed to help Wuhan, a city on the Yangtze River in central China, in developing three subway lines. The company, controlled by the Hong Kong government but with 25% of its shares traded on the Hong Kong stock exchange, has similar projects in the works with Shenzhen and Beijing.

Intellectual Capital

Hong Kong hasn't lost its edge as the mainland's center for financial services, either. Investment banks, law firms, and accounting firms are bulking up to handle demand from Chinese companies. Hong Kong continues to be the destination of choice for mainland companies looking to raise capital, eschewing their own stock exchanges, which are languishing near six-year lows and have yet to shake their casino-like reputations. Last year, 44 mainland enterprises listed their shares in Hong Kong, raising $9.76 billion, while an additional $4.5 billion was raised in secondary offerings. By yearend, 304 Chinese companies were listed in Hong Kong. It helps that fewer Chinese companies want to list in New York now that Sarbanes-Oxley rules governing U.S. publicly traded companies are so strict. What's more, China is decades behind Hong Kong in terms of the sophisticated financial instruments that make the global capitalist economy tick. Short-selling, for instance, is banned on the mainland, and there is little trading in futures or derivatives.

Financial firms and other businesses have sound reasons to stay in Hong Kong despite the allure of the mainland: English is the language of business. Taxes are just 17.5% for corporate profits and 16% for personal income, with no levies on interest or capital gains, compared with tax rates of 33% or more on the mainland. Hong Kong has a strong rule of law, its currency is fully convertible, and there are no restrictions on capital. Banks are privately owned and, unlike most on the mainland, aren't plagued by corruption and bad loans. "Hong Kong will continue to be a very important financial and business center for a long time, irrespective of the importance of Beijing or Shanghai," says Neil Torpey, a partner at Paul, Hastings, Janofsky & Walker, a Los Angeles law firm with a 45-member office in Hong Kong. The skills of the city's workers in everything from accounting to preparing an enterprise for a public offering far outstrip those available in China, Torpey says. "The intellectual capital here is qualitatively different from what exists in cities in the mainland," he says.

To tap that intellectual capital, mainland companies are flocking to Hong Kong. InvestHK, the city's development agency, says 20% of its inquiries now come from Chinese companies, up from zero five years ago. "We spent a century and a half being a springboard into China," says InvestHK Director General Michael Rowse. "Now [the Chinese] want to use Hong Kong as a springboard out." The agency has helped companies ranging from Mongolian restaurant chain Little Sheep to drugmaker Tong Ren Tang open Hong Kong operations. Two years ago, InvestHK helped Beijing software house Ufida set up a two-man office in Hong Kong. The unit has since grown to 18 people, and Ufida is selling accounting software and financial systems-integration services to manufacturers and banks in the city. "If you want to be global, this is the place to test the waters," says Frederick Kong, Ufida's general manager in Hong Kong.

The influx of mainland companies is helping to boost commercial property rentals. After years of oversupply in the Prime Grade A office market, rents have soared in the past 12 months, from lows of $22 to as much as $60 per square foot per month, the same levels they hit in 1997, according to HongkongLand Holdings Ltd., the largest landlord in the Central District. The hotel industry is out of its slump as well. On reclaimed land overlooking Victoria Harbor, a 399-room Four Seasons Hotel is set to open in September, with rates starting at $490 per night and climbing to $5,125 for the Presidential Suite. "There is unprecedented demand," says General Manager William MacKay. "Hong Kong is right back to 1997 levels."

With so many tourists and businesspeople from the mainland flooding in, Hong Kong is figuring out how to cater to them. Lan Kwai Fong, a downtown neighborhood with dozens of pubs, is becoming a destination for Chinese tourists. So Lan Kwai Fong Holdings Ltd., which owns 27 bars and restaurants in the district, has set up concierge booths staffed by Mandarin-speaking women to help Chinese visitors. "The Chinese government has smothered us with tourists," says Allan Zeman, chairman of Lan Kwai Fong Holdings.

Even as Hong Kongers enjoy the upswing, however, the revival's staying power faces challenges. A key factor in the booming property market has been low interest rates, which have failed to rise even as the U.S. Federal Reserve has tightened its monetary policy. Normally, Hong Kong rates follow those in the U.S. because the city's currency is pegged to the greenback. But lately, rates have stayed low due in part to a surge in speculative money. Investors are betting that if China revalues its currency against the greenback, the Hong Kong Monetary Authority will do the same with the Hong Kong dollar. "It's a concern that so much foreign capital has flowed into Hong Kong, with the side effect of driving asset prices up," says Financial Secretary Henry Tang. Conversely, if Beijing were to revalue the yuan and Hong Kong didn't follow suit, the flow of funds could quickly reverse and send property prices south. On May 18 the HKMA tweaked the peg to counteract upward pressure on the Hong Kong dollar.

There are still competitive issues to deal with, too. Hong Kong's port is losing out to cheaper facilities on the mainland. Last year volume handled by ports in neighboring Shenzhen grew 28%, while Hong Kong's gained only 7.5%. High prices are taking a toll elsewhere, as many owners of small and midsize businesses face huge rent hikes. Tai Cheong Bakery, a cozy shop famous for its egg tarts (and a favorite of Chris Patten, Britain's last governor of Hong Kong) is planning to close after seeing its $4,900 monthly rent double. "Many people are struggling to survive," says David Hui, managing partner of Chan Kwong Kee Jewellery Co., a 58-year-old family business that has a small shop in Central.

It's not just potential financial and business woes that could dampen Hong Kong's spirits. As factories in the Pearl River Delta belch out tons of toxins daily, air pollution has gone from bad to worse -- which could make Hong Kong a far less attractive place to live, work, and visit. And despite Tsang's popularity, widespread resentment against Beijing's refusal to allow democratic reforms could lead to political unrest. And, of course, the reappearance of SARS or an outbreak of avian flu could devastate Hong Kong once more.

But Hong Kongers are a tough lot, and they figure they can survive whatever awaits them. Now it's time to celebrate: Property is hot, business is booming, and Mickey Mouse is on his way. Today, at least, Hong Kong seems to have recaptured its old magic.

By Frederik Balfour and Bruce Einhorn, with Simon Cartledge in Hong Kong

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