The effect of land supply restriction on the risk of Hong Kong indirect real estate

Abstract

Our study examines the role of restrictions on the new land supply in changing the sources of risk of investing in Hong Kong property companies (indirect real estate). In particular, we investigate whether development oriented property company had higher idiosyncratic (unexplained) risk during the period when supply of new land through auction by the government was restricted (1984-1997). We utilized quarterly data from 2Q1978 to 4Q2005 to estimate the multifactor variance decomposition models. Our empirical results show that there was a significant increase in idiosyncratic risk for the all listed property companies from 1984 to 1997. This supports the prediction of our hypothesis that restrictions on the supply of new developable land will result in an increase in the indirect real estate idiosyncratic risk, the major source of which is the uncertainty in obtaining approvals before development, which does not exist for newly supplied land. We also found that development oriented property companies, as opposed to investment oriented property companies, experienced a larger increase in idiosyncratic risk from 1984 to 1997. These findings are also applicable to any changes in policy/legislation, physical constraints, or other factors that resulted in a decline in the ratio of new developable land (free of pre-development risk) to all sources of land for development.