By Mark Bern
To start out let me say that I am not trying to say that a correction is imminent. I do not know when it will happen. But I do believe that understanding what could cause a tipping point is important information to consider. There is a lot of talk about a real estate bubble in China. The discussion has been going on for years. But it seems to be in the headlines more than ever these days. An article I wrote in February titled, "Is The China Real Estate Bubble Real?", was misinterpreted by some as an argument that real estate would fall soon. It was not. What I was attempting to do with that article was to start a discussion on the subject and provide some evidence that the real estate market in China was getting over priced relative to much of the rest of the world in terms of local income levels.
Something interesting came out of that discussion that I believe needs to be considered, discussed and provided to a broader audience. Seeking Alpha member, Regular Joe Investor, made some arguments as to why China real estate would fall. He posted this instablog as a result of the discussion for those who would like to view his thoughts on the matter. Several of his observations make a lot of sense from the point of view of an investor in real estate. A trait that both Joe and I share. But one point jumped right off the page at me and I just had to look deeper into it. The point was that the Chinese government is creating a national property registration that will require owners of all properties (including "land, buildings, grasslands, forest, and sea waters") to register. Officials are quoted in this article from Bloomberg Businessweek stating that the goal is to complete the registration of all such properties within three years. A new bureau, the Ministry of Land and Resources, was created earlier this year according to this article from China.com. Also in that article it was indicated that there is rampant corruption in the ranks of Chinese government officials at the local and regional levels.
"Coping with the real estate information registration will be a headache for officials who have abused their power for personal gains and own multiple homes," the official said.
"From this point of view, the unified system could help uncover corruption and expose those who bought multiple houses with illegal earnings or who abused their power to acquire several government-funded low-cost apartments," he said.
There is a limit on the number of properties one person can own imposed by the Chinese government. It is implied in the article (and others) that corrupt government officials have become wealthy by bending the rules for themselves, relatives, friends, and for bribes. This makes sense in that at 25 to 45 times the average annual income of local workers, a home or apartment is out of reach.
Family members have been known to pool together to buy an apartment for a son who moved to the city; it is true. It is also true that many Chinese either pay cash or 50 percent down for property. But the problem arises when the majority of those who can afford to buy properties and let them sit vacant for speculation are no longer able to buy more. And the problem is exacerbated when many of those who own multiple properties must hurry to sell to avoid being caught and jailed.
They may have a window of up to three years, depending upon where their properties are located and where the new agency begins to focus is registrations, but many of those officials, friends and family owned a dozen or more properties and will need to list multiple properties at a time. I confess that I do not know how big a problem that the corruption and multiple-property ownership really is in China, but it seems logical that it is widespread with the prices so high. How many average Chinese workers could afford to buy a $250,000 to $450,000 apartment on an annual salary of $10,000?
My point is that sometime over the next three years, as the new law becomes enforced broadly, there will be a dash to the exits to sell properties that violate the current law. Several officials have already been caught and jailed. An article from WSJ.com notes one example:
"In recent years, court cases of individuals owning multiple properties have also driven calls for more transparency on property ownership. In September, Gong Aiai, nicknamed "Sister House" in China, was sentenced to three years in prison for forging identification documents that allowed her to purchase 44 properties."
In another article, this time from Radio Free Asia:
"In the Uncle House scandal, a former police official in Guangzhou was sentenced to 11 years in prison for bribe-taking after he and his family were found to own 22 homes."
Also in the same article and many others I have read it is mentioned that property taxes are being piloted and are considered a potential solution to reducing speculation in real estate.
"The property tax has been promoted as a solution, but public disclosure of ownership may bring political risks for officials with unexplained sources of wealth."
And finally, from the same article, I found this quote very interesting:
"Real estate wealth is most of the wealth in China," Hufbauer said. "So, anything to do with the property sector is pretty sensitive."
So there you have it. Most of the wealth in China is invested in real estate, owned by the wealthy, a significant number of those properties may be owned illegally, and the majority of those properties will have to be sold before the Central government can complete the national registry. When does this trigger get pulled? My guess is sometime in the next three years, but probably sooner than later. How much damage will it create to the Chinese economy? It sounds to me like it could be extensive but temporary. The economy in China will be much healthier with the emphasis focused more on productive assets than speculation; one of many good outcomes of the change.
Will the damage spill over into the global economy? I cannot imagine that the rest of us will get off easy. Many of the emerging markets (and some of the developed ones) are very dependent upon natural resource exports to China (think Brazil and Australia). That will reduce demand in some very populated economies. It will reduce demand in China for finished goods, as well. That will affect Germany, Korea and Japan more than others, but will have wide-spread implications.
Of course, if the new law does not create a problem then what will happen if property taxes tests go national and get increased to fund local governments. The central government realizes that some other source of revenue will be needed in order to replace the revenue from selling/leasing land for development in the near future. Paying taxes on a vacant property that deteriorates and provides no income does not sound very lucrative to me.
But, once again, I want to be clear on one very important point. If the central government in China does not follow through with the registry the whole concept and potential timetable no longer apply. If it does follow through and stays on target, the trigger should get pulled sometime before the end of 2016. That is not exactly a forecast of imminent disaster from my point of view. The registry completion date could get postponed. Something else could go wrong in the world before that timetable runs its course. The world is just full of potential surprises!
This is just my point of view as an objective observer not directly involved in the miracle that is China. There are those who will proclaim everything I have written as useless because they are in China and know more about the subject. To those objections I merely paraphrase an old saying, "Can you see the forest for the trees?" When someone is in the middle of something and their wealth and well-being are tied directly to its continued success of that activity surrounding them it is very easy to let emotions rule over logic. People will ultimately see what they want to see. This is just what I see: a cautionary tale to be considered.
As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other's experience and knowledge.
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.