Over the past four months, Hong Kong land sales have rocketed.
In February, two Chinese developers paid HK$16.9bn bid for a residential site in Hong Kong. This was 43% higher than the previous record of HK$11.82bn that Sino Land paid 20 years ago during the height of the 1997 bubble. I suppose, it’s like the first person to break the four-minute mile, once someone shows that it can be done, the records just kept tumbling. By mid May, Henderson Land raised the bar by another 38% with its HK$23.28bn winning tender for a Central commercial site then just two weeks later Nan Fung upped the record again to HK$24.6bn for a site near the old Kai Tak Airport.
So what is going on here?
While the simplest explanation is that bidders are pricing in some pretty fanciful assumptions (see Pure Imagination), could these crazy land prices be the unintended consequences of some well-intended government policies? Specifically, we are referring to how the Government changed from selling land via public land auction to a land tender system.
In order to find out, I have asked my two kids, aged 10 and 7, to help me out with a little experiment. But before that, some background on the land sale mechanism in Hong Kong.
Background on Government Land Sale system
In Hong Kong, the Government owns all of the land and each year, it “sells” the land for private use by granting 50 year leases. This system had been in use for decades (the first land auction took place in 1841 in Macau) but what had changed more recently was the sales mechanism.
October 2011 – From public auction to closed tender
Prior to October 2011, the Hong Kong Government used to sell land both through public land auction as well as through a closed tender process. For instance, in the fiscal year March 2011, of the 11 sites sold that year, all were sold by auction. However, by the next year, tenders now made up 75% of the sites sold. By last year, all sites were sold by tender.
So, why was the change made?
The actual rationale was never really explained but I think the officials were worried that the excitement from the land auction would spill over to end-users and cause home prices to spiral up.
Take the last public land auction as an example. In September 2011, a small residential site in Yuen Long received 162 total bids from eight different parties. The final price of HK$361mn was 84% higher than opening bid. You can see that when the Government is trying to cool the market, this type of hotly contested auction was less than helpful.
So someone decided, let’s sell the land via a closed tender system instead. In this case, interested parties are asked to submit a sealed bid by a certain deadline. Then after a few days, the winning bidder and the winning bid are announced.
Much less excitement, or so they thought…
Good in theory but terrible in practice
But like many things, what sounds good in theory often lead to unintended consequences. The problem was that while the auctions could be exciting, they also provided a lot of transparency on the price discovery process to the market. Although participants could try to disguise their identities, you can still see what the other guys are bidding.
As we’ll see later on, the closed tender process did the exact opposite and actually back-fires on the original intent.
Experiment – What is the fair price for jelly snacks?
In order to test out this theory, I conducted a little experiment using some snacks that my kids love.
This picture is a little Japanese jelly snack. Each pack comes with six little jellies inside and costs around $13 from the supermarket.
First, the tender…
In the first case, I decided to sell the jelly packs to them using the tender mechanism. I told them that they are supposed to keep their bids confidential, that there is a minimum reserve price so if they only bid $1, I won’t part with my jelly snack. They have five minutes to submit their bid.
The first point to note is that they immediately began to discuss what they should bid. So, collusion and bid rigging almost appears to be in-born.
The second point to note was the huge spread between the two bids. My 10-year-old bid $20 and lost to my 7-year-old who bid $100, nearly 7x the actual market price. As the $100 is way above my reserve price, I awarded the Lychee flavour jelly pack to my 7 year old.
Then, the auction…
Next came the auctioning of the Peach flavour jelly pack. I once again went through the rules with them. I told them that I would announce the opening price, if they want to bid, they can raise their hand. Similar to the tender, I have a reserve price, so I might not sell it if the bidding is too low.
I started the bidding at $5 and surprisingly there were no bids. After a few warnings that if there are no bid, then no one gets the jelly pack, my 10-year-old raised his hand at $5.
Again, there was silence, no bidding from my 7-year-old who was earlier happy to pay $100 for the jelly. I warned that $5 is still too low, I’m not going to part with it. After a bit more encouragement, my 10-year-old raised the bid to $10.
It was going slowly but as the bids were still too low, I again warned that the jelly would be withdrawn. This time, my 7-year-old jumped in and bid $15. With the auctioning bug now catching on, she then proceeded to bid against herself and raised the price to $20.
Since this has now reached the earlier tender price from my 10-year-old, he did not want to over pay. I lowered the increment to only $1 and at $21, he went for it.
Not wanting to lose the jelly, my 7-year-old jumped back in and bid $22.
I was hopeful that the bidding action may start to heat up. But even though I said that at $23, it would only be $2 more than his last bid, he wouldn’t go for it.
In fact, they started to converse again with the older one telling the younger one not to bid again and instead they can share the spoils. They wouldn’t budge and the bids stayed at $22. At the end, my 7-year-old won both packs of jelly.
Key takeaways from this auction-tender experiment
So, what’s the conclusion here?
- (1) The tender fetched a price that was 4.5x that of the auction ($100 versus $22)
- (2) The tender resulted in a much larger spread between the highest and second highest bid ($100 versus $20)
- (3) If the idea is revenue maximization, then tender is the way to go.
- (4) If the idea is to restore supply-demand equilibrium while limiting price growth, although the auction process may appear more exciting, the greater transparency actually limits price growth especially when there are unsophisticated bidders involved.
- (5) Even though the auction process results in a lower price, it was still able to cover my costs, so there is no risk of “wasting a resource”. In total, the $122 raised nearly covers my costs by 4.7x.
As a final note, what I haven’t told them is that I actually have two more packs of the jellies in the fridge. So, while the participants may think that they are bidding for a limited resource, if one is able to be patient and trust that more supply is coming, the fair price may be lower.
At some level, I believe the kids do know that there is more supply. I can always go to the super market to buy more. But, in the current environment of easy money and instant gratification (or the fear of losing out), what is a +50% premium?
Bring back the public land auctions.