Is The Housing Bubble In China About To Burst?

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by: Mingdong Wu

Over the past five years, housing prices in major cities throughout China went up tremendously. Beijing is the capital of China. The rapid increase in housing prices in Beijing represents the trend in all major population centers in China. According to data published by the National Real Estate Market Data Center, the average price per square meter in Beijing was $5,760, or about $530 per square foot, in July 2013. This implies that a three-bed-room 2,000 square foot apartment in Beijing would cost over one million US dollars. Please note Beijing is one of the biggest cities in the world. This average price includes lower housing prices at many remote suburban locations in Beijing with no access to rapid public transportation such as subway. For apartments near city center in Beijing, the market price for a 2,000 square foot apartment could easily reach three million US dollars. So, there is indeed a housing bubble in China.

A popular thesis among local economists is that this once-in-a-lifetime bubble in housing is about to burst. Their arguments are often centered on very logical reasoning. Such analysis was mostly based on:

● The average disposable income in China is still very low. For example, according to Beijing Statistics Bureau, the average annual disposable income in Beijing in 2012 is about $6,000. Such low level of disposable income cannot sustain the current housing price. Or,

● The rental yield is typically less than 2% in Beijing. If someone holds housing for rental income, the rental yield is much lower than one-year fixed deposit rate (approximately 3% per annum) at major banks. Or,

● As a direct result of overbuild, there are several well-documented ghost towns (residential buildings with almost no residents) in parts of China. The resale price at those ghost towns has already dropped well below the initial price paid for those units by investors.

All of the above are true. However, all of the above do not foretell correctly the future direction of the housing price in China.

The Chinese government has tried to cool down the housing price with various austerity measures, such as price control and very restrictive buyer qualification process, over the past three years. The government also increased its enforcement on collecting twenty percent capital gain taxes on sellers early in 2013. However, the housing price increase shows no sign of retreating. Why is this obvious bubble in China not ready to burst?

When analyzing housing price, people often forget that housing is also an alternative investable asset much like gold. For an asset to become an investment alternative, it needs to show three key characteristics: commonly accepted form, low transaction cost, low carrying cost. When the US Fed started quantitative ease in 2008, the Chinese central bank also started to increase its money supply significantly, which caused the asset prices to inflate. Such sudden increase in paper wealth mostly benefited the rich people, or people with capital to investment. Just as in the United States, excess money supply benefits working class very little because the cost of living increase often exceeds wage increase. Because of extremely low carrying cost, housing in China has become a very important, or perhaps the most important, investment alternative.

In China, there is no property tax. The annual management fee for an apartment is typically very low due to cheap labor in China. Therefore, the ongoing cost of maintaining an apartment is very affordable and many wealthy families hold multiple apartment units as a significant part of their investment portfolio. As urbanization continues at rapid speed in China, more and more capital will flow to housing in large population centers where the infrastructure such as healthcare and education is superior. Therefore, as long as the carrying cost for owning a house is kept low and the Chinese central bank continues to adopt loose monetary policy, housing prices in major population centers in China will continue to increase for many years to come.

As an US investor who wishes to take advantage of this trend, you may consider investing in some of the top real estate developers in China listed on the Hong Kong Stock Exchange, such as Wanke (1036.HK).

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.