A worker walks past a billboard advertising a new real estate project in Shanghai. China is likely to introduce a property tax on residential housing in the first half of the year as part of its attempts to curb spiralling real estate prices, state media reported on April 26, 2010. (Philippe Lopez/AFP/Getty Images)A worker walks past a billboard advertising a new real estate project in Shanghai. China is likely to introduce a property tax on residential housing in the first half of the year as part of its attempts to curb spiralling real estate prices, state media reported on April 26, 2010. (Philippe Lopez/AFP/Getty Images)

Chinese borrowed almost $100 billion just in August to buy houses. Roughly 70 percent of new loans are mortgages. Prices in Shenzhen and Shanghai are up more than 30 percent over the year, and most analysts are calling for the burst of the second China real estate bubble since 2014.


However, between the vertical price increases, the leveraging of the Chinese consumer, the build-up of ghost cities, and Chinese officials scrambling to quench their citizens’ desire for prime real estate, there is a positive takeaway.

“Property is at the intersection of some critical reforms, including liberalizing the capital account, granting more rights to urban migrants and promoting mortgage finance as a new engine of growth. How these complex reforms play out, especially on the demand side of the housing market, will help determine the pace and breadth of China’s economic slowdown,” writes Diana Choyleva, chief economist at Enodo Economics in a recent report.


She says it’s perfectly rational for Chinese to use their $9 trillion in savings to buy houses, even if some of them are empty. Even though Chinese try their best to funnel some of the money out of the country to buy property in London, Sydney, and New York, stringent capital controls still prevent most ordinary citizens from doing so.

As of mid-2015, the stock market is not an alternative for investment any longer, and bank savings have a notoriously low-interest rate, often negative in real terms. Also Chinese just love to buy everything that’s going up, whether it’s stocks or Bitcoin.

So is the Chinese housing market a bubble? In spite of mortgages making up 35 percent of all new loans in the first half of the year, the majority of Chinese house buyers still pay cash for their property, much different from the 100 percent debt financed excesses of the subprime mortgage bubble in the United States. If the buyers decide to borrow, the loan often only makes up 60 percent of the value of the house.


The Institute of International Finance

“Household debt remains very low by global standards and stringent down payment requirements … We would have to see a significant fall in prices before homeowners found themselves underwater,” research firm Capital Economics writes in a note to clients.

Of course, it would not be China if there weren’t some people who are borrowing money from friends or underground banks to finance their down-payment to get a loan from the bank or find other ways to get around the down payment. Al Jazeera showed in a recent documentary that a developer offered to overvalue the house to get a higher loan, so the would-be buyers don’t have to pay much of a down payment.

“If an apartment is worth $300,000, and I value it at $400,000, then with a 70 percent loan, you can get $280,000 from the bank,” he says in a video recorded with a hidden camera. Because of the illegality of these practices—different from U.S. subprime—hard data on these shady loans is hard to come by. According to an earlier report by the Wall Street Journal, shady lenders funded $143 million in down-payments in January, a trivial sum compared to the billions in loans taken out. 


Different Boom

This property boom, however, is different from the previous Chinese real-estate bubble that burst in 2014, where it was developers and local government-backed companies investing in real estate and taking on massive amounts of debt. As a result, one of the biggest developers Evergrande Real Estate Group had to be bailed out by top Chinese banks in 2015. Chinese households were largely unaffected. Instead, they lost a lot of money margin trading on the Chinese stock market in 2015—a real consumer bubble.

Choyleva argues that the regime’s directive to let migrant workers from the countryside settle in cities is part of the relaxation of the rigid household registration system called “hukou.”


“In the past, migrants have not been keen to settle down because they were barred from many of the benefits of urban life, including welfare schemes and access to schools. But as the restrictions of the hukou household registration system are relaxed, attitudes are changing, and pent-up demand for affordable housing is being released.”

With price-to-income ratios for average units in places like Shenzhen approaching 70 according to research by Longview Economics (it’s 16 in London), affordable housing is key to work off the excess inventory. This is why the State Council supported the construction of 7.72 million affordable apartments in urban areas and lending to affordable projects made up 30 percent of total property lending in the second quarter of 2016, according to research by the Institute of International Finance (IIF).

However, there is still a huge mismatch between supply and demand, with around 29 percent of urban dwellings empty compared to just 13 percent in the United States, according to an estimate by RBC Capital Markets. There is also a mismatch in supply and demand at different locations, leading to record price-income ratios in Shenzhen, Shanghai, and Beijing.


“Prices are rising in the big cities where there is much less oversupply, if any, in some of the big ones. The majority of the oversupply is in the 2 and 3-tier cities and migrants, and rural residents are encouraged to move there to buy owner-occupied housing. The investment demand is in the big cities,” Diana Choyleva writes in an email.

As to how to solve these imbalances, despite her less pessimistic view on the housing bubble, Choyleva says a solution will be similar to rebalancing the whole Chinese economy. “There is no easy way; there is no way it’s going to be without pain.”

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Customers and real estate agents look at several building models at a real estate exhibition in Jiashan, Zhejiang province, in a file photo. (AFP/AFP/Getty Images)Customers and real estate agents look at several building models at a real estate exhibition in Jiashan, Zhejiang province, in a file photo. (AFP/AFP/Getty Images)

When China’s richest man and its most successful real estate developer calls the country’s overheating property market “the biggest bubble in history,” it’s probably not a good sign.

But that’s exactly what Wang Jianlin, billionaire owner of Dalian Wanda Group and Communist Party insider, said in an interview with CNN last week. “The government has come up with all sorts of measures—limiting purchase or credit—but none have worked,” he told CNN.

Average new housing prices across China increased 1.3 percent in August from July, according to state data, which was the 17th consecutive monthly jump. September was also the biggest one month increase since early 2011.

The Shanghai Composite Index has declined 15 percent since Jan. 1. If the trend continues, 2016 would be the biggest drop in five years. But volume on the exchange is also down—to the lowest level in two years—signaling that investors are pouring their money elsewhere after the scare of last year’s market crash.

In 2016, China’s property sector has been the biggest beneficiary.

At a macro level, Chinese retail investors are akin to children at a soccer match; they’ll simply swarm to where the action is. And over the last several years, the action mostly seesawed between equities and real estate, with an occasional interest in commodities.

Real estate is the hot market right now, to the point where experts—inside and outside China—are sounding the alarm.  

Ma Jun, chief economist at the People’s Bank of China’s research arm, recently called the property market a bubble in an interview earlier this month with Yicai.com.

People’s Daily, the Chinese Communist regime’s mouthpiece, published an editorial last week expressing deep concern about the frothing property market. “Looking at the current average price [of real estate] and personal income in Shenzhen, it would take an average person more than 1,200 months—that is, 100 years—of not eating or drinking to afford a 90 square-meter house,” wrote investor Tang Jun, regarding the unaffordability of Shenzhen real estate.

“China has become an economic power, but the real estate market is a landmine, and the most frightening is that no one knows when it will detonate.”

Dangerous Business Model

Low interest rates mean that even cash-strapped developers can leverage up by way of the relatively cheap onshore bond market. And property developers have been aggressive, putting little thought into their land purchases.

Economists at Deutsche Bank AG pointed out that a “clear sign of a bubble” rests in the fact that land auction prices have become so inflated that the business models of new developments only make economic sense if property prices keep rising at today’s pace.

It’s a line of thinking prevalent amongst investors before the U.S. mortgage crisis a decade ago, where lenders disregarded risks of default or foreclosure by assuming the ever-rising housing prices would cover any losses.


Price sensitivity of recent land auctions in top 10 Chinese cities. (Deutsche Bank)

After studying recent land auction prices at ten major cities, Deutsche Bank analysts believe that if real estate prices remain flat from today, half of current developments would lose money. Zhang Ziwei, Deutsche’s chief China economist, thinks a severe correction could arrive in 2018.

Regime Ambivalence

But the Chinese Communist regime has been halfhearted, at best, when trying to tame the market.

Local and regional governments instituted tightening measures at the transactional level such as capping prices, limiting the number of properties per household, and restricting non-local buyers from purchasing by closely examining residence (“hukou”) records.

Localities have taken different approaches. Shanghai, for example, decided to suspend land auctions. Other cities, such as Guangzhou, chose to cap prices. The tactics largely backfired as determined buyers found other channels to secure real estate.

The issue is that authorities have been reluctant to address a main cause of rising housing prices—easy money.

Much of the easy credit has been tied up in the real estate market. State data showed that in August, 71 percent of new bank loans went to household mortgages, instead of to the small to medium-sized businesses whom Beijing hopes would drive the economy.

Authorities have been reluctant to address a main cause of rising housing prices—easy money.

But it’s too simple to lay the blame on rate and regulatory policy nationally—China is increasingly a country with two divergent economies.

Much of the talk regarding a real estate bubble is in regards to Tier-1/Tier-2 cities and China’s coastal regions where real estate is perceived as safer, relative to other onshore investments.

Elsewhere in China, there is excess inventory and the housing market is mired in a years-long slump. This is especially true in Northern and Northeastern China where the economy—reliant upon coal and steel industries—has been in decline.

After years of overbuilding, provinces of Inner Mongolia, Liaoning, and Jilin all have supply-to-sales ratios of more than four years, according to London-based Lombard Street Research. That means it would take more than four years to sell the number of available homes, at current rate, assuming no new properties would be built. That same metric in the United States is 4.6 months as of August, according to data from the St. Louis Fed.


China real estate supply-to-sales ratios by province. (Lombard Street Research)

“Provinces with severe overbuilding (with an excess supply-to-sales ratio of more than three years) accounted for 20% of total residential investment over the past five years,” wrote Michelle Lam of Lombard in a research note.

“Housing construction in those provinces has already shrunk over the last two years and will continue to contract for another couple of years, acting as a significant drag on overall residential investment growth.”

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