Evolving institutions to tackle asymmetrical information problems in the housing market: A case study on ‘shrinkage’ of flat sizes in Hong Kong

Abstract

The phenomenon of floor area ‘shrinkage’ of newly completed units has long been a hot debate issue in Hong Kong's housing market. Prior to the enactment of the Residential Properties (First-hand Sales) Ordinance in April 2013, news reports had revealed that the actual useable areas of some presales housing units only accounted for 50% of the gross floor areas proclaimed in the sales brochures. Notwithstanding the alarming situation, ‘shrinkage’ of flat size is, in fact, a lawful act in Hong Kong. Akerlof (1970) suggests that under information asymmetry, lemons tend to crowd out non-lemons. This study attempts to investigate whether an adverse selection process is taking place in Hong Kong's housing market with reference to the shrinkage phenomenon. To measure area shrinkage, 13 private mass housing developments located on the Hong Kong Island were chosen, and a total number of 16,946 flats, were involved. This paper shows that the market is full of lemons due to the delay in responses of the law governing the sales of first-hand properties. We found that the carpet areas of the selected housing developments had fallen short of between 23% and 49% of the proclaimed gross floor area, as stated in the sales brochures. Analyzing a total number of 55,227 transactions between 1991 and 2013 of the subject premises, it shows that the turnover rates of units with the highest shrinkage ratios are about 45% more than those with the smallest shrinkage ratios. ANOVA tests have been carried out and illustrated that there are significant variations between each tenth percentile of the flats in accordance to the flat shrinkage ratios. This paper concludes with a discussion of the evolution of institutions in Hong Kong's housing market to tackle the lemon problems. Attention has been placed on the effects of mandatory, voluntary and third party information disclosure. The lessons learnt in Hong Kong will shed light on policies and legislations for the fast expanding housing markets in developing countries, especially those densely populated Asian cities undergoing rapid urbanization.