(I researched and wrote this article last weekend. It was not published by Seeking Alpha. For multiple reasons, I am not going to revise it and resubmit it for publication. I hope some of you find it useful.)
There has been a great deal of talk lately regarding China’s supposed or actual housing price bubble. Four key questions should be answered and, then, monitored regarding this topic.
1) Does China have a housing price bubble?
2) If yes, what is the nature and extent of the bubble?
3) Will the bubble be eased down or will it burst?
4) What will be the impact of the easing down or bursting?
In December of 2010, the International Monetary Fund (NYSE:IMF) release a Working Paper entitled “Are House Prices Rising Too Fast in China?”. Multiple information sources were used in constructing this paper. This paper affords us with an excellent opportunity to acquire an accurate understanding of the Chinese housing market through mid-2010.
Per the IMF Working Paper:
- “First, on degree of price misalignment, we find that, as of mid-2010, house prices are not significantly overvalued in China as a whole. However, the mass-market segment in a number of coastal cities—but most clearly in Shanghai and Shenzhen—as well as a few inland cities may be in the early stages of excessive price growth. Early signs of price misalignment can also be detected in the luxury segment in Beijing and Nanjing.”
- “Second, we find that over the past decade, when misalignments in house prices have occurred, they have been corrected relatively quickly.” “This constant correction of house prices is unlike the behavior observed in several industrial economies before 2008—especially the U.S., New Zealand, and France—where deviations from benchmark prices tended to persist far longer, allowing for an accumulation in vulnerabilities, ending in a large and abrupt adjustment.”
- “Third, the policy measures taken by the Chinese government in April 2010 appear to have had some impact on price growth. The gaps between market and fundamentals implied prices have become smaller in a few cities. However, in a few cities, these market and policy measures do not seem to have been very effective in bringing prices back toward fundamentals. In particular, prices in the mass market segments in Guangzhou, Tianjin, and Shenzhen recently seem to have remained persistently misaligned.”
- “Given the awareness of China’s authorities of the risks excessive property price growth poses and their experience in containing them, the likelihood of financial instability precipitated by a housing price bust seems small.”
What has happened since mid-2010?
The National Bureau of Statistics of China (NBS) provides monthly updates on housing price increases or decreases. There was well-founded criticism of the accuracy of these statistics. Recently, these statistics were improved via better and wider data collection techniques and cross-checking. Further improvements will be made this year.
(You should avoid jumping to high regarding this statistical accuracy issue. Remember, China is still a developing nation. More of these kinds of issues exist in developing nations. Also, even well developed nations like the U.S. produce some faulty statistics. For example, the U.S. Unemployment Rate greatly understates the actual unemployment situation, and there is no significant movement toward improving this statistic. The point here is not to belittle the U.S. The point is to get people to view China’s statistical issues, where such statistical issues actually do exist, in proper context.)
New Housing Prices:
“Comparing with the same month of last year, the sales price of 68 cities in 70 large and medium-sized cities went up, that of 2 cities went down. Of the total, that of 10 cities grew more than 10%.”
Existing Housing Prices:
“The sales price of 65 cities in 70 large and medium-sized cities went up, that of 5 cities declined. Of which, 6 cities rose above 10% comparing with the same month last year.”
There is no mention of an inflation adjustment in regard to these statistics. They appear to be unadjusted for inflation. Also, in viewing these statistics, it is important to keep in mind that sales of new homes far outnumber sales of existing homes in China.
The IMF Working Paper named six specific markets about which there was a concern—Shenzhen, Shanghai, Guangzhou, Tianjin, Beijing luxury, and Nanjing luxury. In this most-recent NBS data, Beijing had a general (not just luxury) year-over-year new housing price increase of 6.8%. All of the other market-of-concern cities had year-over-year housing price increases of less than 6.8%.
China has a housing price bubble forming in certain markets; and those forming bubbles are in the process of being combated by the Chinese government. In the last year, China has taken numerous steps to address, or that will serve to address, the forming bubbles. These steps included:
- Raising down payment requirements.
- Limiting purchases of first, second, and third homes.
- Introducing trial property taxes in Shanghai and Chongqing that can serve as a model for a wider introduction of property taxes.
- Raising bank reserve requirements eight times.
- Raising the benchmark interest rate three times.
- Increasing the foreign exchange rate value of the Yuan on multiple occasions.
Additionally: “China will build 10 million affordable homes in 2011, as part of a plan to build 36 million properties for low-income families during the 12th Five-Year Plan period (2011-2015). The total investment this year will be 1.3 trillion Yuan ($196.9 billion), said Qi Ji, vice-minister of housing and urban-rural development... ‘The government will provide affordable housing projects with land for free, which we didn't include in the costs’, said Qi.” “Qi said the government will provide 500 billion Yuan for the investment and the rest will be raised from the markets by non-governmental organizations.” “Construction of 5.9 million government-subsidized homes began in 2010, and 3.7 million have been finished, according to the ministry.” (Source)
This will also serve to hold down or reduce housing prices in China.
There are other factors in play here as well.
- There are limited other-than-housing investment options in China. Investment options for Chinese citizens are slowly increasing over time, so this issue is in the process of being slowly addressed.
- Chinese citizens have a high savings rate and are less prone to spend. (Investing in a home is a form of saving.) This will become less true as China strengthens its social safety net, which it plans to do, and encourages more consumption, which it has already begun to do.
- Incomes are increasing more in China. Per a February 28, 2011 report from the NBS: “In 2010, the annual per capita net income of rural households was 5,919 Yuan, or a real increase of 10.9% over the previous year when the factors of price increase were deducted. The annual per capita disposable income of urban households was 19,109 Yuan, or a real increase of 7.8%.” From 2005 to 2010, price-factor-adjusted per capita disposable urban income rose at a rate of 9.7% per annum. (Source) The rising incomes serve to make higher housing prices more affordable.
- The availability of mortgage financing is increasing. Medium and long-term, if not short-term, this trend should continue; and it should continue to exert upward pressure on housing prices.
What is the extent of China’s and the world’s financial exposure?
It appears that China’s forming housing price bubble in certain markets is going to be eased or smacked down, versus bursting. China has been taking quality proactive measured steps to address the housing price situation for almost a year now. Also, China has a history of successfully correcting housing price misalignments.
The extent of potential harm is not as great as many people fear. Two reasons for this are:
- Down payment requirements in China are high. The first home down payment rate is now 30%. The second home down payment rate is now 60%. (About a year ago, these figures were 20% and 40% respectively.)
- There are little or no associated derivatives.
On the concerning side, local Chinese governments depend on property sales for some of their revenues. Some of these property sales are for commercial, versus residential, development though.
Per the IMF working paper, “real estate investment now accounts for…around 9 percent of (China’s) GDP”. This 9% figure should include both residential and non-residential real estate investment. A turndown in housing sales and prices in certain Chinese markets will only be detrimental to a limited extent.