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China’s government is engaged in mortal combat to control rapidly-rising real estate prices ... or so you would believe from reading the newspapers and listening to all the economic commentary. But it’s not entirely true. The reality is, China’s government is trying to navigate a tricky path between the interests of current homeowners and those who’ve yet to join the housing ladder.

For anyone seeking to make money investing in Chinese real estate companies like Xinyuan Real Estate Co., Ltd. (XIN) , SOHO China Limited (SOHOF.PK), Sino-Ocean Land Holdings Limited (SIOLF.PK) and Central China Real Estate Limited (0832.HK), it is important to bear this contradiction in mind: Ever-rising prices cause social instability, but falling or even flat prices are no less of a headache for the country’s leaders. Goldilocks is providing the policy guidance now for China’s real estate market.

Current homeowners, of course, are perfectly happy for prices to keep rising. In today’s China, homeowners are one-and-the-same with the country’s most important political constituency. When I first came to China in 1981, this country was, both in its rhetoric and policy, still a nation of and for “workers and peasants."These “have-not” groups enjoyed preferential access to housing, jobs and higher education.

Today, most power belongs to society’s haves, the urban and educated population that creates and captures the benefits of China’s remarkable economic growth. The leaders of the China government, made up overwhelmingly of the people drawn from the same strata of society, seek to keep this group content. The easiest way to do this, of course, is to create policies and conditions where personal incomes continue to rise. Since most personal savings is tied up in housing and the stock market, the government must focus heavily, in ways perhaps no other government in the world does, on measures that produce favorable outcomes for people with money tied up in property or shares.

Overall, China’s government has been consistently successful doing this. With housing prices, it's perhaps been a little too successful, since the policy mix has created a situation where prices continue to rise by over 50% on an annualized basis and are now often higher, per square meter, than they are in most of the US and Europe. For the tens of millions who have owned property for more than six months, this translates into very significant increases in personal wealth.

In short, for every person currently priced out of the housing market, there may be three or four who are feeling flusher than they ever have. That means, if you could measure such things, greater net happiness in China when property prices are rising.

China’s government, if it wanted to, has the power to drive down housing prices in a hurry. It owns all the land in China. By releasing more of it for residential development, the certain outcome would be to lower or even roll back the growth of housing prices. Yet doing so will also have wealth effects on those who already own.

The other policy levers at the government’s disposal – introducing property taxes, restricting people from buying more than one residential property, raising minimum down-payments, – can have some impact. These are the main tools the government is now using to moderate housing price inflation. But all evidence is that these steps aren’t having a major impact. Property prices continue to rise, if less explosively than they did in 2009 and 2010.

Most of the talk from government is about increasing affordable housing, especially in cities. But, the policy mix is still designed in such a way that prices should continue to move upward.

Hong Kong is a constructive example. There, too, property prices are high and moving higher, and the government is tinkering with policy changes to slow rapid increases. But, high property prices have been a fixture of Hong Kong life for a generation.

The Hong Kong government owns most of the undeveloped land. It tightly controls the amount of new land auctioned each year. This maximizes the government’s profits from land sales, while sustaining upward pressure on property prices overall. This makes all current owners, from large developers like Li Ka-shing’s Hutchinson Whampoa and Cheung Kong Holdings, happy as well as the two-thirds of Hong Kong citizens who own their own homes.

Home ownership in China is not quite as high overall, but is likely just as high, if not higher, among the large fraction of China’s population whose political and economic clout is greatest. China is wise to want to extend to more people the benefits of home ownership. But, the next time you hear that China’s property prices are rapidly rising, the meaning is: The country’s very many haves now have very much more.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Real Estate Prices in China: For Many, Higher Means Happier