Effects of competition level on the pricing of first-hand residential properties

Abstract

 Property prices in Hong Kong have undergone an exponential increase over the past decades. Despite a slight decline in recent years, prices are still considered unaffordable by the global standard. There is a general belief and blame on the government and developers that the lack of competition in the real estate development market has fuelled the industrial and economic concentration among a few dominant property developers. This study attempts to explore the belief by assessing the competition level of Hong Kong first-hand residential property market where developers could exercise their pricing power and therefore influence the first-hand property prices. Herfindahl–Hirschman index (HHI) is adopted in this study to assess the concentration level of the first-hand property market by district and territory. The results reveal a moderate level of concentration in new housing supply generally while certain districts, such as Kowloon City where the new development area Kai Tak is located, are considered more competitive. The study also tested the relationship between competition level and housing prices at the project level. Given the limitations of HHI in measuring competition at the project level, the key to assessing the project-level competition is to measure the monopoly profit, that is the price-cost margin of the residential units, also known as the Lerner Index (LI). The empirical results found a positive correlation between LI and first-hand property prices, indicating that an increase in competition (a decrease in the monopoly power of the developers) would reduce the first-hand property prices. Further analysis also revealed that this effect is stronger in high concentration markets as opposed to low concentration markets. The findings carry certain implications for both the public and private sectors. This study proposes a novel channel for the government to improve housing affordability by promoting a greater competition level among developers. It could be achieved by reducing the entry barriers for new entrants and encouraging competition between incumbents through land disposal policy, tendering practice, financing regulation, development control mechanism and legislation. On the other hand, the findings also suggest that mergers may be employed by private developers to enjoy economies of scale and sustain their market power.