Where Is the Chinese Real Estate Bubble?

Includes: FXI, PGJ
by: Thomas Pan

Last year, one Fortune article, Chanos vs. China, caught my eye. Particularly, the story told by James is telling.

One day, at a research conference in 2009, Chanos listened to an analyst tick off numbers about the scale of China’s building boom. “He said they were building 5 billion square meters of new residential and office space — 2.6 billion square meters in new office space alone. I said to him, ‘You must have the decimal point in the wrong place.’ He said no, the numbers are right. So do the math: That’s almost 30 billion square feet of new construction. There are 1.3 billion people in China. [In terms of new office space alone] that amounts to about a five-by-five-foot cubicle for every man, woman, and child in the country. That’s when it dawned on me that China was embarking on something unprecedented.”

It looks like that in 2009 alone, China has finished 5 billion square meters of new residential and office space. Recently, on a talk show program (in Chinese) from Hong Kong Phoenix TV, I got more official numbers from one government official attending the program. In the past decade, China has built 8 billion square meters of new residential space, which is about 70 million units, most as apartment units. It is about 30% of total residential space in urban areas. On average, the annual increase is about 3% - 4%, which is NOT as dramatic as the Fortune article represents.

To judge whether there is a real estate bubble or not, it is important to look at two key metrics: average ratio of house prices to incomes and the amount of leverage in the system. The former is THE fundamental to gauge whether a real estate market is healthy or not. The latter decides how much the banking system, or even the whole economic system, relies on a healthy real estate market.

Per this article from the Economist, IMF data show that since 2001, the average ratio of house prices to incomes has stayed flat (see the graph below) while during the same period, the same ratio increased more than 20% for Hong Kong, Singapore, Australia, New Zealand, Britain, United States, and Europe. Further, in its latest 5-year plan, the Chinese government wants to increase average per capta disposable income by at least 7% annually, with a 13% yearly increase on minimum wage, which is far above 4.9% core inflation rate that we are seeing now. All in all, from the wage gauge, the China real estate market is far more healthier than developed countries and it might become even more healthier if the government DOES carry out its wage plan.

From the same Economist article:

The IMF reckons that loans to developers and mortgages accounted for under 20% of total outstanding loans in late 2009, compared with 52% in Hong Kong and 57% in America. Again, nobody should draw too much comfort from this. In a cash-driven market, liquidity can flow out of the sector quickly; mortgage debt is rising fast from a low base; and a property bust could spill over into other fields to which banks have lots of exposure. But as Western policymakers would now wearily agree, less debt means less systemic risk for the banks if and when the property cycle turns.

One CBRC official, Yan Qingmin, has confirmed that based on an internal self test that has been conducted recently, the whole Chinese banking system can easily sustain a 30% price drop in the real estate market.

Last but not least, if we further consider GDP growth and budget deficit between US and China, it is more likely to say that there is still a real estate bubble in US even based at the current price level and there is still huge systematic risk in the US banking system.