Will China's Real Estate Bubble Pop the Global "Recovery"? (December 30, 2009)
China's real estate market, built almost entirely on speculative demand, is a reflated bubble. When it pops, it could trigger a global rout in both speculative equities and real estate.
My ever-insightful blogging colleague Maoxian (who blogs from Beijing) kindly gave me permission to reprint this chart:
The chart plots a real estate-based stock index (red line) and an index of property prices (white line). Clearly, the stock index leads the property index; the stock index topped out a few months before property prices plummeted.
Rather ominously for China real estate speculators, the stock index topped out in July 2009 and is carving out a lower high.
China's real estate market is different from the North American market in several fundamental ways.
1. As correspondent Mike D. (writing from Harbin) recently reminded me, home ownership in China (85%) is much higher than it is in the U.S. (69% and falling). The reason is simple: the Central Government transferred ownership of most occupied dwellings to their occupants a generation ago, when the leadership chose a path of State-controlled "command capitalism with Chinese features."
Occupants paid a small sum for their home, and thus they were given instant equity.
The Central State retains ownership of all land in China; everyone gets a 99-year lease.
2. As Mike D. noted, such a gigantic transfer of equity and property from a Central State to its citizenry is unprecedented, and thus any attempt to forecast the long-term consequences has little historic precedent for guidance.
3. As a result of this transfer of ownership, most Chinese families had a very low-cost ownership stake. This enabled families with multiple wage earners and/or middle-class incomes to save (by Western standards) an extraordinarily large percentage of their net income.
4. Until recently, most Chinese paid no income tax, and even now, only high-income citizens are expected to pay (how many actually do is unknown/questionable).
5. There are no property taxes in China, so the cost of owning an empty house or condo is very low. Our friends own a spacious condo in Suzhou, about 90 minutes west of Shanghai, and their monthly condo maintenance fees are around $20 per month--a far cry from the $300 to $400/month (and up) paid by U.S. condo owners.
6. Many Chinese lost money in the insane Chinese stock market bubble which popped in 2007, an experience that was akin to the Nasdaq dot-com bubble and decimation in the early 2000s. Since stock ownership was restricted for decades, this "first taste" reinforced the view that stocks were highly risky and undoubtedly manipulated. Real estate is thus widely viewed as a "safe" investment.
7. Even though real estate cratered along with stocks in the global financial meltdown, Central Government stimulus and "quantitative easing" (flooding the country with easy to borrow money) has engineered a rebound, fueling a complacent sense that "real estate never goes down."
8. The re-sale market in China is very thin; there are few sales of "used" (existing) homes because the supply of brand-new homes is vast. Also, since people buy condos as long-term investments akin to savings, there is little "flipping" for short-term gain.
Add these factors up and you get exactly what you see everywhere in China: a massive over-building of luxury dwellings and households owning multiple high-end dwellings as investments. Many (if not most) are empty because the costs of ownership are so low and finding renters is either not "worth the hassle" or difficult due to the huge oversupply of luxury units and feeble demand from high-income renters.
Contrary to received wisdom, there is little unmet "organic" demand for housing in China, especially the luxury market. The demand for millions of luxury units is mostly speculative and has virtually nothing to do with "organic demand," i.e. people who want a place to live.
The past 20 years of rapid growth has convinced many residents that the boom in property values will never stop, i.e. it is a permanent feature of the Chinese economy that you can buy a luxury condo today and it will be worth a lot more in five years. This appreciation is basically "guaranteed" by easy credit, ever-rising wealth, etc. etc. etc.
But Chinese leaders recognize the real estate market, driven by speculation and massive State injections of credit, is vulnerable to crashing. For instance, here is a report from a China-based analyst: China Acts to Calm Its Overheated Real Estate Sector - and Misdiagnoses the Problem.
The situation has all the ingredients of a classic speculative bubble:
1. a complacent belief that the "investment" can never go down for long
2. a speculative market supported by cheap, easy credit and government policy
3. an oversupply of product generated to meet speculative rather than organic demand
4. a thin re-sale market which will plummet once selling begins
5. unsustainably rapid appreciation of assets due to speculative demand
This is how you get new unoccupied cities with thousands of units which have been sold as investments, as seen in this report: the empty chinese city
Can central planners somehow cool China's real estate market without popping what is clearly a stupendous speculative bubble? Has this feat ever been accomplished in the long history of asset/credit bubbles? The answer is no, so there is little to support the claim that "this time it will be different," and Maoxian's chart is offering up a warning to those who believe "real estate never goes down in China."
There is a wild-card in all this which no one ever mentions: a building is not electronic data or a gold coin. Buildings fall apart unless they're lived in and maintained; you can't leave a house or building, even a concrete one, sitting in the desert for 5 years and expect them to remain habitable just because they're "still new."
The unspoken reality which only those who live in China know is that buildings there are rarely well-maintained. For the past 30 years, every building built 15 or 20 years ago has been torn down and replaced with something much grander. Thus maintenance has seemed superfluous; why bother when we all know this building will be torn down and replaced in a few years?
So what happens when the decades-long cycle of demolition and construction runs down? Millions of supposedly valuable long-empty dwellings will have little value as actual residences for two reasons: there will be an oversupply of luxury units and the wear-and-tear of weather and time will have reduced the livability of these buildings to near-zero.
But that is all a few years away. What China faces now is a massive imbalance between organic demand for luxury dwellings--people who can buy $600,000 condos in Shanghai to live there--and speculative, investment demand. History suggests all such speculative asset/credit bubbles pop. Given that the world looks to China for "growth," then we can safely predict that if China's real estate market sneezes, the entire world will catch a cold.
Here is the single best report on China I have read in years:
China's investment boom: the great leap into the unknown (PDF).
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