Last month CBS's 60 Minutes aired a video titled "China's Real Estate Bubble." The video highlighted three ghost towns near China's cities of Zhengzhou, Shanghai, and Tianjin. Viewers could see a large number of empty apartments, vacant office buildings, and abandoned shopping malls. 60 Minutes also showed two leading Chinese developers being interviewed for the show and both of them seemed to agree that China's real estate is in dangerous territory.
After the show was aired, stocks of most of China's real estate companies listed in the U.S. market tumbled. Among them were Xinyuan Real Estate Co., Ltd (NYSE:XIN), China HGS Real Estate Inc. (NASDAQ:HGSH), Soufun Holdings Ltd (NYSE:SFUN), and E-House (NASDAQ:CHINA) Holdings Ltd. (NYSE:EJ).
I totally agree that the golden age for the Chinese real estate industry has long gone. But I firmly believe that the industry will not go bust in the next five to 10 years; rather, it will become a normal industry with average growth and profit potential.
Yes, there are quite a few ghost towns around China nowadays. As a matter of fact, in addition to the locations mentioned by 60 Minutes, there are other ghost towns located in more remote areas such as Inner Mongolia, Yunnan, and Xinjiang Provinces as well. These ghost towns are signs that there is excess and overbuilding in certain parts of China, but it does not necessarily mean that China's real estate industry as a whole is a big bubble.
Urbanization Is The Key
China is still a developing country and it is urbanizing rapidly. In 2011, China's urbanization rate surpassed 50% for the first time, compared with less than 20% in the 80s. According to OECD, China's urban population will increase by more than 300 million by 2030. Assuming there are three people in a household, this means 100 million new households will be created in the next two decades.
So overall, China still needs a lot of housing to accommodate the population inflow. That's why the government has a plan to build 36 million new housing units in the next five years.
For ghost cities near China's tier I and tier II cities with population inflow, those empty apartments, vacant office buildings, and shopping malls will eventually be filled up as the urban population grows.
Shanghai's Pudong is a case in point. In the late 1990s it was a gigantic construction site with no residents. Now it's a fully occupied modern city with close to six million residents.
Store of Value
For a lot of rich Chinese, those empty apartments in the ghost towns are a good place to store their wealth, since they lack investment alternatives. Because of currency control in China, they can only invest domestically. But, China's domestic market has few attractive investment options. The stock market has been weak for years and most stock investors are simply speculators. The bond market is shallow and inactive and interest rates offered by banks are too low to offset inflation. So, property investing has become the most attractive option. And, the huge return it has generated in the last couple of years also has reinforced this perception.
For wealthy Chinese families, it's pretty common for them to have one apartment as their primary residence and own additional housing units as investments. Due to the severe income disparity in China, some rich Chinese own three or more housing units as investments, and best of all, they pay cash and carry no mortgage.
According to a recent research report, on average Chinese consumers own 87% of equity in housing and only 13% is mortgaged. This low leverage will significantly decrease the spillover effect in the case of a housing crisis.
So what does China's ghost town story tell us? I believe it shows that there is excess and overbuilding in certain parts of the real estate industry, but it is not a sign that the overall industry is a bubble.
Ghost towns near China's Tier III cities are quite likely to continue to sit there idle for a long time. This definitely is a waste of resources and is deadweight to the society. However, ghost towns near China's Tier I and Tier II cities will turn into vibrant modern cities in the next decade as China's urbanization continues.
Nowadays governments play a critical role in both the developed world and developing countries. This is even more so in a country like China where the government calls the shots. It's not surprising that the Chinese government will continue to act as a stabilizer and insurer for the real estate industry, and it has the willingness and resources to do so.
In summary, if China's real estate is a bubble, it probably has a bit more inflating to do.