Competitive advantages and the proximity of investment: evidence from Hong Kong-listed real estate development firms in Mainland China

Abstract

ABSTRACTThis study examines the investment behaviour of Hong Kong-based real estate firms in Mainland China. Using a sample of individual land transactions, we find that firms with higher value of growth options, as perceived in the capital market, are more likely to invest actively and further away from their home base. However, over time, Hong Kong developers tend to decrease their level of activity in Mainland China, indicating that the ‘liability of foreignness’ becomes a significant challenge. Our findings highlight the importance of balancing strategic expansion with the inherent risks of operating in distant emerging markets.KEYWORDS: Growth optionsinvestment activitiesreal estate developmentslocation choicesHong Kong developers Disclosure statementNo potential conflict of interest was reported by the author(s).Notes1. The oral auction follows a typical English open-outcry ascending auction, the tender is akin to a sealed-bid auction, and the listing auction is an ascending auction in two stages (Cai et al., Citation2013).2. First, the Chinese central government has issued a series of policies to ensure ‘housing is for living in and not speculation’ since 2016 (MOHURD, Citation2015; The State Council, Citation2016). Second, as required by China’s deleveraging campaign from 2015, Mainland developers face tight regulation to lower their high debt ratio and slow down their land buying, which could make Hong Kong developers more competitive in the land market. Lastly, there has been a significant change in the political relation between Hong Kong and Mainland China since 2019 due to the Hong Kong protests in 2019 and the passing of the Hong Kong national security law in 2020.3. The details of these 31 HK firms are available upon request.4. The arithmetic mean return of the Hang Seng Index (HSI) was about 8.35% per annum between 2004 and 2015; meanwhile the mean return of the Hang Seng Index – Properties (HSP) was around 11.80% per annum. Hong Kong developers typically aim for a profit margin of 15–20% when purchasing land, so a discount rate of 12% seems reasonable. On the study of the US equity market from 1976 to 1995, Dechow et al. (Citation1999) found that the historical average of abnormal earning persistence was about 0.62.5. We examined the V/P ratios of real estate firms listed in the Shanghai and Shenzhen stock exchange markets. We found that Mainland real estate firms were trading significantly above their book values, with an average V/P ratio of 0.583 during the study period. The variation in V/P ratios could be attributed to two factors: Firstly, the difference in accounting rules for valuing a firm’s book value, particularly when it comes to land development. Secondly, the difference in pricing of these real estate development firms in the stock market.6. Separating state-owned enterprises or firms controlled by corporates or individuals in Mainland China would not alter our main findings. Among the 31 listed Hong Kong-based real estate firms, 13 of which were controlled by corporates or individual in Hong Kong, and the remaining 18 were controlled in Mainland China. These results are not tabulated to conserve space in the document, but are available upon request.7. Exp (−0.492*-1.058)-1 = 0.683.8. Since the number of land purchases made by a firm in year t can be zero and is typically small (the average land purchase is 3.374 as shown in Panel A of Table 1), applying a log transformation of log(1+y) to this variable would have a more pronounced downward effect on the regression coefficients. For this reason, we have used the number of land purchases in its original form in this study. The results of using a log transformation of the number of land purchases are available upon request.9. See Gabaix (Citation2009) for more information on power laws in economics and finance.10. These results are available upon request.11. The estimated annual return of HSI and HSP indices are available upon request.