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Making sense of the property marketDemographics, as well as a shift in policy on how China provides housing to its citizens, will have an impact on prices, says TIGER TONG09 July 2012The existence of a large property bubble in China has been highly debated for quite some time now. Bearish observers believe that China has constructed tens of millions of empty housing units, while the bulls point out that China’s urbanisation rate is only 50 per cent, suggesting that the country’s property developers still have a large opportunity ahead.The true picture is more complicated. Without doubt, a large price bubble exists. Based on property prices provided by the National Development and Reform Commission (NDRC), in 2011, to buy a 90 square metre apartment, on average, a buyer would need to pay the equivalent of 19 years of household disposable income in Tier-one cities, 11 years in Tier-two cities, and nine years in Tier-three cities. There is little doubt that apart from genuine buyers, there is also an army of speculators behind China’s property boom.But speculation alone can’t explain the formation of a price bubble. Even though China has adopted a series of tightening measures against speculation since December 2009 and home-purchase restrictions have virtually excluded speculators from the market, property prices have remained firm. We estimate that average property prices have declined only 5 per cent from their August 2011 peak. With transaction volumes picking up momentum since May, there is an increasing risk that property prices may rebound in the near future.Besides China drastically reversing its monetary tightening in 2009, which sent property prices shooting through the roof, there is genuine demand behind the nation’s property boom. Such demand has been intensified by demographics.In 2011, the number of marriages registered in China was 12.8 million, 63 per cent higher than in 2002. In China, owning a property is often a pre-requisite for a successful marriage proposal, and it is often considered the groom’s, or his parents’, obligation to buy property.At the same time, as the Chinese population has become richer, the divorce rate has also risen sharply, much like it has been in many countries. Divorces in China stood at 2.9 million in 2011, 2.4 times that in 2002. Divorces typically add to the demand for property.Although one may be overawed by the number of buildings which have mushroomed across China, speculation about unoccupied units may be exaggerated. In reality, it is not possible for China to have 60 million to 80 million empty housing units as some bears fear. From 1995 to 2011, total completion of residential units was estimated to be close to 110 million, just enough to accommodate the incremental urban population during the same period.Golden decadeThe demand-supply gap has in fact narrowed in the past few years. For example, the ratio of the number of urban housing completions to urban new family formation (marriage plus divorce) has dropped from 1.7x in 2002 to 1.2x in 2011.Besides the sudden surge in new family formation, most new couples are the first generation of the one-child policy. They have significantly higher purchasing power than their counterparts 10 years ago. Moreover, young couples often get financing support from their parents, who have saved substantially over the past 30 years.These social trends have been accompanied by a drastic policy shift in how China provides housing to its citizens. Since the privatisation of the housing sector in the late 1990s, the private sector has become the predominant source of housing supply. For example, private housing completion by floor space was 70 per cent of total housing completion in urban China in 2010, against 30 per cent in the late 1990s.
Chinese developers have enjoyed a golden decade, thanks to the support of local governments. From 2003 to 2010, under the Hu and Wen administration, the profit margins of housing developers trebled from 5 per cent to 15 per cent whereas margins in the industrial sector remained at 5 per cent.If China’s demographics maintain their current trend, perhaps the property bubble will inflate further. But the favourable demographics are likely to taper off. The number of marriages in any given year is highly correlated with the number of women aged 25-34 years. Thus, we may soon see the number of marriages peaking, as the number of women aged 25-34 years is expected to see a decline from 2017.More importantly, the parents of those young couples are already in their mid-50s or 60s, bordering on retirement age. Thus, couples would soon need to support six adults (themselves plus two sets of parents), in addition to one or two children. This swift demographic shift will be quite painful.Based on a United Nations forecast, while China’s old-age dependency ratio based on the current retirement age (retirees as a percentage of the working-age population) rose from 19 per cent in 1980 to 26 per cent in 2010, it will rise sharply to 68 per cent by 2040. The inflection point has arrived.The provision of housing is also part of the government’s obligations. China has begun a big wave of public housing construction since 2010. The planned 36 million public housing units from 2011 to 2015 will be a game changer. For example, housing starts for public housing in Beijing in 2011 were twice the number of units sold by developers in 2010.So far, the promised huge supply of public housing has not come through. But given the government’s track record, China should be given the benefit of the doubt, as public housing could be the only mechanism that will allow China to deflate the property price bubble while avoiding a hard landing.In the long run, China may well nationalise the property sector partially, and the good times that developers enjoyed will vanish. But in the near term, the central government has to keep home-purchase restrictions in place while giving local governments a bit more leeway to stimulate the market. After the sudden policy reversal in 2008-09, the government cannot afford to fool people twice.The writer is a China strategist with IIFL Securities
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