Is there really a property bubble in China?

December 9, 2013 by Timothy Beardson

The principal grounds for proposing the existence of a property bubble in China are that prices have risen substantially since the 1990s, rental yields are low and there is anecdotal evidence of high vacancy. Add to that the fact that average salary earners cannot buy the average apartment and you have an argument that the market is essentially unaffordable and thus eventually insupportable. But is the argument sustainable?
This subject is widely discussed. It carries implications for government debt, the banking system and, indeed, the overall economy, with perhaps social stability also involved.
As always in China we must recognise that the data are sparse, contradictory and often faulty. However, it seems clear that since the market really started in 1998, residential property prices have broadly tripled from maybe Yuan 196 per square foot to somewhere over 560 now, rising by about 7% compound annually. Some estimates are double that rate. However there has been an upgrading of quality, which should be noted in price changes.
Low residential property yields suggest that rental might be more attractive than purchase. Several examples are cited of principally vacant developments. Ordos in Inner Mongolia is the most colourful, where a city built for one million reputedly has only 28,000 inhabitants.
Classical measures of affordability comparing ratios of purchase prices with average salaries are used to compare Chinese cities with the world. Perhaps 4:1 might be typical internationally but in China, according to recent data, it could be 7.4 and in Beijing and Shanghai it is around 12 and in Shenzhen 16.
We might imagine market rejection of these high-priced developments and default by indebted developers leading to systemic bad debt issues for banks. This could then undermine funding for economic development and even cause riots by angry under-water mortgage holders.
Several points occur. Residential real estate prices have mostly lagged nominal GDP in the cities where the units are located. Urban wages have also generally outpaced home prices. Rapid price rises are unsurprising in a fast-growing economy. Moreover, China’s price trends have similarities with recent periods in developed countries.
There are notable areas of vacant property. However, most empty units were bought by investors – often multiple units – for capital growth. China has few attractive opportunities for personal investment. Bank deposits pay little interest, the bond markets are scarcely accessible, the stock market is unattractive and overseas investment is barred. Property thus looms larger in households’ savings mix than in those of many other countries. Furthermore, investors frequently believe that having tenants would devalue their investment.
There have been many “amateur developers” in the market. Ordos, for example, was partly developed by a group of natural resource-related enterprises. Such developers may have made tactical mistakes with their developments that have affected their purchase appeal.
It seems as if between 2000 and 2013 there were around 70m units sold in China. While doubtless a rising number through the period, this averages about 5.3m a year. When we consider that there are now 188m urban dwellers of working age and the number was not much different in 2000, far fewer than 2.5% had to buy one in any given year – as many bought more than one.
Spain has a property crisis with up to 1.5m empty (and mostly unbought) homes. If China had a proportionate problem it would perhaps have 30-45m empty and unbought homes. This is scarcely conceivable if only 60m have been built since 2000. Vacant investment properties may be widespread – there could even be 30m – but they have owners, who are not known to be in difficulty.
Developers seem to have been selling apartments above or below 1,250 square feet, whereas the average apartment provides around 315 square feet per person. It is very clear that developers have been building units almost entirely for the affluent. Their target market is the top 40% of the urban population. This also happens to be the segment with the largest amount of undeclared income above that imputed in government data. The surplus is estimated to be between 40% and 220%. When one combines the marked and growing inequality between low and high earners with the substantial unreported income, developers are targeting a market which can afford the numbers of units offered.
The developers now need to address the growing middle class. The issue here might be the supply pipeline with 43bn square feet under construction at end-2012. This equates to four years’ supply. Hopefully developers are downsizing the units to more average sizes or they may be caught in a changing market.
Another peculiarity of the Chinese housing market is that although government mandates a high down-payment for mortgages, this is usually well exceeded by buyers. Thus the resultant monthly mortgage payments become manageable. The cash is available from the wider family members who tend to support a relative who is buying. This transcends the characteristic Western affordability model.
Most academic models produce theoretical, or equilibrium, prices. In comparison actual prices appear slightly to moderately excessive. However, most models generally do not account for income distribution or unreported income.
Several developers are now, with government encouragement, aiming to build smaller apartments and thus broadening the market. Some negative trends should nonetheless emerge. The supply of uncompleted buildings could be inappropriate to future demand and larger than expected. Interest rates may get liberalised and have the double impact of increasing mortgage costs and the attractions of bank deposits. The renminbi market could be opened up, allowing investment overseas. Some developers could suffer debt problems. The number of workers will start falling. The proportionate impact of future urbanisation will reduce as over half the country is now urban.
In a country of China’s size, having had such rapid and dramatic change, we should anticipate several local property bubbles bursting with associated pain, but the overall property market is probably sustainable.

Tags: Ordos,

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