December 13, 2011 8:19 pm
Chinese property: a lofty ceiling
In a showroom built to resemble an ancien régime palace, a platoon of salespeople stands idle on the frontline of a looming Chinese property bust.
The luxury apartments of Versailles Residentiel de Luxe La Grand Maison, located next to a polluted river in the third-tier coastal city of Wenzhou, have not yet been built but are already on sale for as much as Rmb70,000 ($11,000) a square metre. That is more than double the annual income of the average Wenzhou resident, who would have to save every penny for 350 years to buy a 150 sq m home in this development.
But even the few who can afford it seem to be having second thoughts. “We have been told to say publicly that everything is going very well and our apartments are selling even though none of the other developments in the city can sell theirs,” says one sales assistant who asks not to be named for fear of losing his job.
Prospective owners have paid deposits on only a dozen or so of the 198 apartments on sale at La Grand Maison. “Prices are dropping fast and everyone is waiting for them to fall further before they think about buying,” says the sales assistant.
Across the country, from the big cities of Beijing and Shanghai to the smallest regional towns, countless such complexes have sprung up in recent years as developers and local governments have rushed to capitalise on the frenzy for property. But now, following a decade-long boom and nearly two years of attempts by the central government to cool the overheated sector, the market appears to have turned. Sales volumes have slid and prices are falling as developers try to tempt reluctant buyers with discounts.
“China’s property bubble is bursting,” says Andy Xie, an independent economist. From their current elevated levels, “prices may fall by as much as 25 per cent soon and by another similar amount in the following two to three years”.
The downturn comes just as the market expects a wave of new supply, particularly in smaller cities such as Wenzhou, on China’s prosperous eastern seaboard. The country’s 80,000 property developers own enough land to build nearly 100m apartments. Add this to vacant apartments for sale, according to estimates by Credit Suisse analysts, and China already has the capacity to satisfy housing demand for up to 20 years.
The consequences of a crash would be dire for the wider Chinese economy and for the economies of many other countries that rely on China to fuel their own growth.
Last year, property construction accounted for 13 per cent of gross domestic product, and for more than one-quarter of all investment in what is the most investment-dependent economy in history. Property directly accounts for 40 per cent of Chinese steel use; the country itself produces more steel than the next 10 producing countries combined, making it by far the most important buyer of inputs such as iron ore.
Construction in China is also important for a host of other industries, from copper, cement and coal to power generation equipment. The sector “matters to an extraordinary degree for overall Chinese growth, for commodity demand, household expenditures, external trade and underlying heavy industrial profitability,” says Jonathan Anderson of UBS. He calls it “the single most important sector in the entire global economy, in terms of its impact on the rest of the world”.
The increasing prospect that this sector could come to a screeching halt has serious implications for the global economy at a time of deepening gloom and uncertainty. It is especially important for commodity exporters that have seen their economies boom on the back of Chinese demand for raw materials.
“The growth model China has followed for the last few years, which has involved a whole lot of property construction, is running out of steam,” says Mark Williams of Capital Economics. “People have not priced in the coming rebalancing of China away from commodity-intensive development and this has to be bad for economies like Australia, Brazil and Chile.”
Chinese housing prices have soared so high and so fast that the dream of owning an apartment is now out of reach for almost anyone who does not already have one. Growing public dissatisfaction prompted the government early last year to start introducing increasingly tough restrictions, such as higher deposit requirements and outright bans in some cities on the purchase of more than one apartment. But the measures have started to work only in recent months.
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According to government figures, which most analysts believe understate the reality, average housing prices more than doubled in the last four years nationwide, while in Beijing and some other regions the price increase was more like 150 per cent. Data are incomplete but analysts say the price of an average apartment in a Chinese city is now about 8-10 times the average annual income nationwide; in cities like Beijing and Shanghai the ratio is closer to 30 times.
Even at the height of the US real estate bubble in 2005, the price-to-income ratio for the whole of America peaked at about 5.1, while cities such as Las Vegas, where the bubble was biggest, saw the ratio reach 5.6, according to Zillow, a real estate information company. Historically, US home prices have tended to be about three times average annual incomes and they are close to that level again now, six years after the bubble burst. In the UK, the ratio peaked at about 5.8 in 2007, according to Halifax, the mortgage lender.
Government policy over the last decade set up perverse incentives that almost seem designed to create a bubble, say Chinese analysts and economists. To start with, all land belongs to the state and local government officials have monopoly power over its supply. In an autocratic, opaque and corrupt system, that gives them enormous authority to decide who gets to use that land and how.
Faced with chronic revenue shortfalls but forbidden to run deficits, local governments have come to rely on land sales (the “sales” are actually only of land-use rights of up to 70 years) for up to 40 per cent of their income. Analysts say the tax system encourages real estate speculation by wealthy Chinese who have few other investment alternatives and face negative real interest rates if they deposit their money in the bank.
Apart from pilot projects in Shanghai and in Chongqing to the west of the country, nowhere is an annual property tax levied and the property transaction tax that exists is derisory.
“Right now the high housing price is not due to limited supply – it is because of endemic speculation but the government doesn’t combat speculation because high prices keep GDP growth and revenues high,” says Yi Xianrong, a professor at China Academy of Social Sciences, a government think-tank. “China’s real estate bubble is undeniably the biggest in history but our property taxes are lower than Zimbabwe’s; the situation is laughable.”
China’s domestic financial system, which sailed through the global financial crisis mostly unscathed, is also vulnerable. When Beijing unleashed an enormous stimulus package in late 2008 to combat the effects of the crisis, much of the money went into construction.
The government says developers and mortgage borrowers account for about 20 per cent of all loans but senior regulatory officials admit that figure probably significantly understates the true exposure of the broader financial system to a downturn in the sector.
A banking stress test conducted this year by China’s biggest banks concluded that non-performing loans would tick up only slightly if real estate prices halved. But analysts say the test did not take into account a steep fall in transaction volumes that has already hit much of the country or recognise how falling prices would affect the wider economy when construction inevitably slowed down. Nor did the test try to estimate how falling land sales and prices would affect the value of bank collateral, even though the vast majority of collateral in the system is land or property.
In Wenzhou, often seen as a bellwether for the wider economy, house prices fell 5.2 per cent in October from the same time a year earlier and dropped 4.6 per cent from a month earlier. Prices have not yet fallen as much elsewhere – but transactions across the country were down 11.6 per cent from a year earlier in October, compared with a 7 per cent fall in September, and in the 15 largest cities the drop was 39 per cent.
“The volume of land transactions has also dropped sharply as developers hold off on new projects and will probably continue to weaken as homebuyer sentiment falls further,” says Du Jinsong, China property analyst at Credit Suisse.
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So far, the government has stood firm on its commitment to bring down property prices and has refused to roll back any of its restrictions. This year it unveiled a plan to build 36m subsidised housing units for low-income families in just three years, in the hope that this would make up for the slowdown in commercial housebuilding.
But there is some evidence this plan is already faltering, because of opposition from developers and local governments who are expected to build and pay for units on land they would have otherwise been able to earn big profits from.
“The subsidised housing is all very poor quality and in terrible locations,” says Cao Jianhai, a real estate expert at the China Academy of Social Sciences. “Local governments are not willing to build affordable housing that can compete with commercial residential developments.”
Given the importance of the sector to the overall economy, most analysts believe that if prices drop too far, Beijing will step in to save the market by lifting purchase restrictions and pumping more credit into the economy.
But others warn that saving the property sector would require another flood of liquidity into the system and would only re-inflate the bubble, leading to higher inflation and an even bigger crash in the future.
“The government is in a very difficult position,” says Tao Ran, an economics professor at Renmin university in Beijing. “If they relax macroeconomic policy the bubble will get worse. But if they don’t relax policy then the bubble will pop and the economy will stall.”
It is an eventuality that may already be confronting the backers of the faux French development in Wenzhou.
In 1996, when Li Fuan was asked by his bosses at China’s central bank to translate an American banking examination manual into Chinese, he stumbled on a problem in chapter 17.
“I couldn’t find a translation for ‘mortgage loan’; we just didn’t have a word for it in any of the dictionaries,” says Mr Li, now a senior official in the China Banking Regulatory Commission.
Eventually he tracked down an English-Chinese dictionary printed outside the People’s Republic and used the word he found there – anjie – to describe a personal bank loan for the purpose of buying a house.
“At the time there was no such thing as a mortgage loan in China and some of my superiors thought we should just leave that chapter out of the book altogether,” Mr Li says. “In the end we kept it in but clearly marked it as ‘reference only’.”
Before 1998 China did not have a residential real estate market to speak of and there was no need for such exotic financial products. In urban areas, all housing was built and allocated by the state through the ubiquitous “work unit”. In the countryside, peasant farmers built their own homes on land allotted to them by the state or the collective.
The real estate market that now plays such an important part in China’s overall economy was born when the Communist party decided in the late 1990s to begin transferring ownership of the vast majority of housing to individuals. The first home mortgages were extended soon after that.
It is easy to forget that the market is just over a decade old and, apart from a brief dip in the midst of the 2008 financial crisis when transactions dried up, most Chinese have only seen prices double every couple of years and never seen them fall.
Many regulators believe that the sector’s short history and a lack of other investment options has led to irrational exuberance. And that in a country where speculative bubbles have been a constant phenomenon since market-based reforms picked up pace in the 1980s.
Copyright The Financial Times Limited 2011