Real Estate Bubbles In The U.S. And China - Difference And Implications

Includes: TAO
by: Disruptive Investor

There is no doubt that there is a real estate bubble in China. I will give some charts to underscore this point in my article. However, the real focus of the article is on the difference in the real estate bubble in China and the United States and its implications for investing in China's real estate market for the long term.

At the onset, I would like to talk about the existing real estate bubble in China and it is verified by the record high ratio of house prices to annual household income for several cities in China as indicated by the chart.

The real estate bubble in China has largely been fueled by easy money resulting in a huge investment boom in the sector after the financial crisis. I would like to emphasize the investment boom and the subsequent speculative buying, which are the main reasons for the real estate bubble in China.

The point of investment boom is verified by the second chart below, which shows a surge in housing under construction during the period 2006-2012 in China. At the same time, a surge in vacant housing is indicative of speculative buying in the absence of demand from households. I am not suggesting that there is no demand for housing in China. However, the investment and construction boom in certain cities outpaced the demand significantly after 2006.

Coming to the most important point, the chart below gives the residential mortgage debt as a share of GDP in China and the U.S. during the peak of the real estate bubble.

The critical conclusion that follows is that the U.S. housing bubble was as a result of a construction boom coupled with over consumption and over borrowing from the household sector. On the other hand, the household sector in China has not played a big role in the real estate bubble with consumers not leveraged. The residential mortgage market still has a long way to go in China as compared to the United States.

Considering the low mortgage debt factor, coupled with a high savings rate (25-30%) in China, I do expect housing prices to decline in the near term and trend higher in the long term. Therefore, from an investment perspective, China's real estate is a good buy for long term on price correction in the foreseeable future. On further correction, investors can consider exposure to the Guggenheim China Real Estate ETF (NYSEARCA:TAO).

In terms of problems related to the real estate boom, the major focus will be in the banking sector and the Chinese banking sector can be avoided for the medium term. At the same time, the real estate players with significant investments over the last few years will suffer as high vacancy rates result in declining return on investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.