Home prices have been driven skyward by cheap money, middle class and city dwellers, but they need to come down
By JOHN FOLEY 06 April 2011
China’s property bubble is so big you can practically see it from space. House prices have been driven skyward by cheap money, aspiring middle classes and rising numbers of city dwellers. Taxi drivers, politicians and hedge fund managers talk of little else. The government tolerated a boom for too long, but prices need to return to earth.
Why do people say China has a housing bubble?
The speed of price rises has been dizzying. In 10 of the country’s biggest cities, the price of new mass-market houses rose more than 10 per cent in the last year. And from 2004 to 2009, prices in 35 cities doubled. As with any bubble, there is no definitive proof.
IMF’s take
The National Bureau of Statistics has abandoned its headline price indicator, saying it masked huge variations. The International Monetary Fund (IMF) has decided that, on a countrywide basis, Chinese property is not yet a bubble. But in some urban centres, it’s a different story.
Consider affordability. In most markets, a comfortable ratio of house prices to average annual household income is around four times. In a metropolis like Beijing, Shanghai or Shenzhen, the current level is more like 12. Even with wages rising rapidly, that’s excessive.
The financial conditions for a speculative bubble are also present. Broad money supply has increased 39 per cent in the past two years. Real interest rates are negative. A hoarding mentality, the result of decades of grievous shortages, looks conducive to investment manias. Investors have only three places to put their funds: in the bank, in stocks or in real estate.
New investment
What’s missing is leverage. As buyers have to put down at least 40 per cent of the purchase price in most cases, a bursting bubble would look different from the recent US housing crash. Still, the fact that prices have reached such levels in the absence of easy mortgage credit shows how much expectations of capital gain have risen.
So who owns all those empty buildings?
That’s the wrinkle: China has a supply bubble too. Rising prices have attracted new investment, but buyers and sellers can’t agree, so apartments sit empty. Ordos, a city in Inner Mongolia, shows up on Google Earth as a pristine ghost town. And a widely circulated rumour in 2010 suggested that 65 million Chinese homes had used no electricity in the previous six months.
The government has helped create this excess. Provinces depend on revenue from selling land for development. Officials at every level have tacitly welcomed building activity, since it pushes up gross domestic product (GDP), on which their success tends to be measured. Even wealthy cities such as Tianjin and Dalian boast visibly empty stretches of prime real estate.
Sellers also have no reason to cut a deal in a hurry. Rental yields, as low as 1-2 per cent, are less than the cost of depreciation, so there is little pressure to rent out properties. And since many speculative owners have little or no leverage, they often do not face cash flow pressure.
The authorities see the problem. China’s banks are being told to clamp down on property-related loans, which made up a quarter of last year’s total, and keep 20 per cent of their deposits on reserve to curb frivolous lending. That doesn’t help Ordos much, but it should ensure ghost towns don’t become a bigger feature of China’s landscape.
So far, politicians have tried to buy time by stopping the market in its tracks. Shanghai and Beijing now limit purchases by non-residents, and third homes are taboo. That has slowed the pace of transactions, which fell 70 per cent from January to February, according to real estate website SouFun.
Speculators, though, are merely waiting for the market to thaw. An annual property tax, which makes it more costly to leave properties empty, has been introduced in Chongqing and Shanghai but is too small to have an effect.
Why not really grab the bull by the horns? The reason may be that if prices fell, construction of new projects would plunge, and GDP with it. Housing construction makes up around a sixth of China’s economy. Put another way, if building activity were to drop by a third in one year, GDP growth would halve. That would cost thousands of jobs, and put social stability - China’s bugbear - at risk.
Meanwhile, the authorities are trying to increase the supply of affordable housing. That won’t bring down prices at the top end but it does have the benefit of pacifying the unhoused poor, and may provide a boost to construction even if house prices fall.
What would really make a difference is a sharp increase in interest rates. Even with little mortgage lending, a big hike - say two percentage points - would make owners lower their expectations of future value. The problem is that it could also cause a broader economic slump. For now, the housing bubble is holding monetary policy hostage.
Who gets hurt if the bubble bursts?
The victims can be divided into three camps. First, the banks. Since most mortgages are worth less than 50 per cent of the value of the property, big lenders have plenty of security in the event of widespread default. Agricultural Bank of China, one of the big four lenders, claims a 50 per cent price drop would increase its bad loans by just 0.5 per cent, though that might be an overly rosy assessment.
Smaller lenders may be more exposed and might have to be swallowed by larger ones. But China’s banking industry has healthy capital ratios, and bad debts are currently just one per cent of the total loan book. Even if soured loans do go through the roof, China could afford to recapitalise its banks by drawing on savings elsewhere in the public sector, or tapping its US$2 trillion of foreign reserves, as it has before.
Property slump
The second set of victims would be property developers. Again, the biggest may be shielded, and some have eschewed debt financing. Others, though, are already raising funds at high rates, notably through bond issues in Hong Kong. Inventories are bloated, especially in second-tier cities such as Wuhan and Taiyuan. Officially, a quarter of loans made in 2010 were to the property sector, but the real number is no doubt higher.
The final group would be house buyers. The number of people affected by a property slump may be larger than it looks, since families often club together to buy, or borrow informally from other sources. One apartment may tie up three generations’ savings.
Faced with that outcome, Beijing may feel that the best thing to do is nothing. But that would be folly. The lesson from other property crashes is that if regulators and policymakers don’t prick bubbles, an external crisis or sudden reversal of sentiment eventually causes a much more savage sell-off. Governments that attempt to cure investment manias are damned if they do, but much more damned if they don’t.
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China: One nation, many bubbles
Home prices have been driven skyward by cheap money, middle class and city dwellers, but they need to come down
By JOHN FOLEY
06 April 2011
China’s property bubble is so big you can practically see it from space. House prices have been driven skyward by cheap money, aspiring middle classes and rising numbers of city dwellers. Taxi drivers, politicians and hedge fund managers talk of little else. The government tolerated a boom for too long, but prices need to return to earth.
Why do people say China has a housing bubble?
The speed of price rises has been dizzying. In 10 of the country’s biggest cities, the price of new mass-market houses rose more than 10 per cent in the last year. And from 2004 to 2009, prices in 35 cities doubled. As with any bubble, there is no definitive proof.
IMF’s take
The National Bureau of Statistics has abandoned its headline price indicator, saying it masked huge variations. The International Monetary Fund (IMF) has decided that, on a countrywide basis, Chinese property is not yet a bubble. But in some urban centres, it’s a different story.
Consider affordability. In most markets, a comfortable ratio of house prices to average annual household income is around four times. In a metropolis like Beijing, Shanghai or Shenzhen, the current level is more like 12. Even with wages rising rapidly, that’s excessive.
The financial conditions for a speculative bubble are also present. Broad money supply has increased 39 per cent in the past two years. Real interest rates are negative. A hoarding mentality, the result of decades of grievous shortages, looks conducive to investment manias. Investors have only three places to put their funds: in the bank, in stocks or in real estate.
New investment
What’s missing is leverage. As buyers have to put down at least 40 per cent of the purchase price in most cases, a bursting bubble would look different from the recent US housing crash. Still, the fact that prices have reached such levels in the absence of easy mortgage credit shows how much expectations of capital gain have risen.
So who owns all those empty buildings?
That’s the wrinkle: China has a supply bubble too. Rising prices have attracted new investment, but buyers and sellers can’t agree, so apartments sit empty. Ordos, a city in Inner Mongolia, shows up on Google Earth as a pristine ghost town. And a widely circulated rumour in 2010 suggested that 65 million Chinese homes had used no electricity in the previous six months.
The government has helped create this excess. Provinces depend on revenue from selling land for development. Officials at every level have tacitly welcomed building activity, since it pushes up gross domestic product (GDP), on which their success tends to be measured. Even wealthy cities such as Tianjin and Dalian boast visibly empty stretches of prime real estate.
Sellers also have no reason to cut a deal in a hurry. Rental yields, as low as 1-2 per cent, are less than the cost of depreciation, so there is little pressure to rent out properties. And since many speculative owners have little or no leverage, they often do not face cash flow pressure.
The authorities see the problem. China’s banks are being told to clamp down on property-related loans, which made up a quarter of last year’s total, and keep 20 per cent of their deposits on reserve to curb frivolous lending. That doesn’t help Ordos much, but it should ensure ghost towns don’t become a bigger feature of China’s landscape.
What can China’s leaders do about it?
So far, politicians have tried to buy time by stopping the market in its tracks. Shanghai and Beijing now limit purchases by non-residents, and third homes are taboo. That has slowed the pace of transactions, which fell 70 per cent from January to February, according to real estate website SouFun.
Speculators, though, are merely waiting for the market to thaw. An annual property tax, which makes it more costly to leave properties empty, has been introduced in Chongqing and Shanghai but is too small to have an effect.
Why not really grab the bull by the horns? The reason may be that if prices fell, construction of new projects would plunge, and GDP with it. Housing construction makes up around a sixth of China’s economy. Put another way, if building activity were to drop by a third in one year, GDP growth would halve. That would cost thousands of jobs, and put social stability - China’s bugbear - at risk.
Meanwhile, the authorities are trying to increase the supply of affordable housing. That won’t bring down prices at the top end but it does have the benefit of pacifying the unhoused poor, and may provide a boost to construction even if house prices fall.
What would really make a difference is a sharp increase in interest rates. Even with little mortgage lending, a big hike - say two percentage points - would make owners lower their expectations of future value. The problem is that it could also cause a broader economic slump. For now, the housing bubble is holding monetary policy hostage.
Who gets hurt if the bubble bursts?
The victims can be divided into three camps. First, the banks. Since most mortgages are worth less than 50 per cent of the value of the property, big lenders have plenty of security in the event of widespread default. Agricultural Bank of China, one of the big four lenders, claims a 50 per cent price drop would increase its bad loans by just 0.5 per cent, though that might be an overly rosy assessment.
Smaller lenders may be more exposed and might have to be swallowed by larger ones. But China’s banking industry has healthy capital ratios, and bad debts are currently just one per cent of the total loan book. Even if soured loans do go through the roof, China could afford to recapitalise its banks by drawing on savings elsewhere in the public sector, or tapping its US$2 trillion of foreign reserves, as it has before.
Property slump
The second set of victims would be property developers. Again, the biggest may be shielded, and some have eschewed debt financing. Others, though, are already raising funds at high rates, notably through bond issues in Hong Kong. Inventories are bloated, especially in second-tier cities such as Wuhan and Taiyuan. Officially, a quarter of loans made in 2010 were to the property sector, but the real number is no doubt higher.
The final group would be house buyers. The number of people affected by a property slump may be larger than it looks, since families often club together to buy, or borrow informally from other sources. One apartment may tie up three generations’ savings.
Faced with that outcome, Beijing may feel that the best thing to do is nothing. But that would be folly. The lesson from other property crashes is that if regulators and policymakers don’t prick bubbles, an external crisis or sudden reversal of sentiment eventually causes a much more savage sell-off. Governments that attempt to cure investment manias are damned if they do, but much more damned if they don’t.
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