Fitch: The Hong Kong residential market is slowly recovering, but pressures remain in commercial real estate and fiscal risks

Fitch Ratings stated that the Hong Kong residential property market is expected to maintain a moderate recovery trend, but due to ongoing macroeconomic uncertainties, the extent of the rebound is limited.

Fitch indicated that residential property prices and transaction volumes have risen, supported by a low interest rate environment, the wealth effect from a strong stock market, and an increase in rental yields, which has helped stabilize market sentiment. New immigration policies, including talent schemes, have also boosted demand, with new home sales expected to reach their highest level in over a decade by 2025. However, the ongoing promotional policies from developers and a cautious market outlook suggest that the rebound in the residential market is unlikely to have a significant or lasting positive impact on fiscal revenues.

In contrast, Fitch expects commercial real estate to remain under pressure, with office rents significantly below pre-pandemic levels. Thanks to strong capital market performance, there has been an increase in office leasing activity in Hong Kong's traditional core business districts recently, but high vacancy rates and structural headwinds facing long-term demand continue to exist, which may constrain the willingness to acquire commercial land in the short term. Given the cautious macro outlook, developers may adopt a selective strategy when acquiring new residential land, which will drag down the government's land sale revenue. Exposure to commercial real estate remains a major risk for banks, especially those providing substantial loans to vulnerable small and medium-sized borrowers.

Fitch stated that Hong Kong's banking sector is expected to maintain a prudent stance, even as residential mortgage activity picks up, with a continued focus on asset quality and credit standards rather than pursuing loan growth. The banking sector's funding, liquidity, and capital positions remain robust, but Fitch anticipates that the banking sector will not provide significant support for real estate market activity. The asset quality of residential mortgage loans is stable, but the weaker commercial real estate sector may continue to face pressure.

Fitch expects that Hong Kong's fiscal flexibility will continue to be constrained by declining real estate-related revenues, although short-term stock trading stamp duties may offset some of the related impacts. As of the fiscal year ending March 2025, property stamp duties and land revenues account for about 5% of total government revenue, down nearly 30% from five years ago, and their share of GDP has fallen from over 6% five years ago to less than 1%. One reason for this is that the government has decided to suspend new commercial land auctions in this fiscal year to address high office vacancy rates and weak market demand. The recent recovery in residential market sentiment has only provided limited support, and real estate-related revenues are likely to remain well below historical levels.

Fitch expects that capital expenditure growth, including projects related to the Northern Metropolis, will keep government spending and financing needs high. By the end of 2025, fiscal reserves are expected to stabilize at around HKD 640 billion, accounting for nearly 20% of GDP, but still far below the peak level of over 40%. Against the backdrop of weak land revenue recovery and ongoing spending pressures, Fitch will continue to closely monitor the sustainability of revenue sources and the management of capital expenditures ahead of the new fiscal year's budget announcement. As the government needs to address the rising spending demands in the medium term, Fitch anticipates that broadening the revenue base without compromising Hong Kong's competitiveness will continue to face challenges