The Chinese real estate market has remained robust in 2016, with increasing price growth in all major cities and particularly in the so-called "Tier 1" urban zones (Shanghai, Beijing, Guangzhou, Shenzhen, Tianjin, Chongqing):
Beijing home prices finished the year up 28.4% from the end of 2015, Shanghai's are up 31.7%, Guangzhou's are higher by 24.3% and Shenzhen is up 23.8%. According to real-estate consultancy Knight Frank, eight out of the top 10 cities for fastest growing prices globally in Q3 2016 were in China, and 10 Chinese cities recorded annual price growth above 20%. Average new home prices in 70 major cities rose 12.4% in December from a year earlier, compared with November's record 12.6% rise, according to data from the National Bureau of Statistics.
Despite the robust uptrend, a slight cool off occurred in December 2016. Although Guangzhou reported a MOM gain of 0.7%, the remaining Tier 1 cities had decreases of 0.1% in Beijing, 0.2% in Shanghai and Chengdu, and 0.4% in Shenzhen. Overall, Tier-1 cities' prices on average showed no MOM growth in Dec 2016 compared to a 0.1% MOM increase in November. Investment in real estate has similarly continued at a brisk pace, growing 6.9% YOY in 2016, 1.1% faster than in the January-September period, and 5.9 percentage points faster than a year earlier:
While prices cooled off in Q4 2016, growth in property investment accelerated with December registering a 11.1% YOY increase from an increase of 5.7% YOY in November. New housing starts, a broadly utilized figure to gauge property developers' confidence in the market, rose 12.5% YOY in December, accelerating from November's 3.3% YOY rise. For residential properties, investment rose 6.4% YOY and the floor space of new residential construction expanded 8.7% YOY. Housing sales maintained steady growth. In terms of floor area, property sales jumped 22.5%, while in terms of value, sales rose 34.8%.
The dynamism in the housing market has been the result of 2 main factors:
1) A continuously expansionary monetary policy from the People's Bank of China (PBOC) and
2) An continued aggressive lending policy on the part of Chinese banks.
The stock of broad money M2 reached 155.01 TLN yuan as of December 2016 (up 11.3% YOY), or approximately USD $22 TLN:
This is $9 TLN more than the US M2 figure, a remarkable sum given how China's GDP is only 61% of the USA's.
The expansive monetary policy has transmigrated through the banking system. A record 12.56 TLN yuan ($1.82 TLN) of loans were extended in 2016, half of which were mortgages. By the end of December 2016, financial institutions in China had outstanding loans of 26.68 TLN yuan ($3.9 TLN) to the property sector, up 27% YOY according to PBOC data. Outstanding loans for real estate development amounted to 5.66 TLN yuan at the end of December, up 12.2% YOY, while loans for individual purchases rose 35% YOY to 19.14 TLN yuan. Residential investment now makes up more than 66% of the real estate sector's overall investment. The real estate market accounted for 14.2% of GDP in 2015, compared to 8.9% in 2006. Due to the importance of the real estate sector both to the economy and to the banking system, the Chinese government, regions and municipalities now face a balancing act - how to reign in the price increases, to avoid socially negative effects in the population, while at the same time deflate the boom in a controlled way, avoiding non-performing loans, developer bankruptcies and a collapse in construction activity.
Since the fall of 2016 about 20 Chinese cities have rolled out policies, including raising down-payment requirements and banning non-residents from purchasing a second home, all to avoid a possible housing bubble. In Shenzhen, second home buyers now have to come up with at least a 70% down payment, up from 40% before. Measures of housing affordability show real estate prices at highly inflated levels on a global and historical basis:
Furthermore, a noticeable bifurcation has appeared between the housing affordability in mega cities and that in the remainder of the country. While increasing in the latter, it has remained stubbornly low for Tier-1 cities:
While the Chinese population struggles with housing affordability, real estate investment is at the same time increasingly dependent on and sensitive to Chinese domestic investment. The total funds for real estate development enterprises in China reached 14.4 BLN yuan (about $2.1 BLN) last year, a 15.2% increase YOY, but foreign capital was reduced 52.6% as foreign investors became worried of an incipient real estate bubble. The Chinese market's capacity to finance and sustain real estate investment is becoming strained, as shown by the decline in onshore (i.e. domestic) bond issuance by property companies:
In addition, housing price growth continues to outstrip income growth. China's nationwide per capita disposable income of residents grew 6.3% in real terms in 2016, and only 5.6% for urban residents. This is merely 20% to 25% of the price rise in Tier-1 cities for 2016. Furthermore, real estate prices have a very significant influence on the overall wealth of Chinese households, as they represent 74.7% of the value of gross household assets:
As China's average home prices are forecast to rise at 4.1% in 2017, a lesser rate than 2016, the wealth effect on Chinese households will start to be less significant, with obvious implications for consumption patterns. It is relevant to remember that at the height of the US real estate boom in 2005, real estate investment constituted 6.18% of GDP. At 15.7% of Chinese GDP in 2016, the prospect of a major nationwide price downturn could wreak major havoc on the Chinese economy, if one takes the American experience as an example.
Furthermore, local governments in China depend on land development sales for roughly 2/3 of their revenues. China land auction prices were up 30% in 2016, and the top 10 Chinese cities earned a total 1.24 TLN yuan from land sales, a significant 35% YOY increase. Out of 300 major Chinese cities, 2.87 TLN yuan of land sales were transacted in 2016. In Q4 2016 major cities introduced new land auction restrictions in an effort to control surging land prices, including the setting of price caps and banning developers from buying land on credit. Despite intentions to slow down the price rise, the authorities are understandably recalcitrant to stem this flow of revenues, which would put pressure on fiscal budgets.
Of even greater concern is the issue of unsold inventories. China has 13 million empty homes and continues to add to excess supply at a rate of 2 million units annually. At the end of December 2016, 695.4 MLN square meters of property remained unsold in China. This is an increase from the 691 MLN square metres of November 2016, which were themselves down only 0.01% YOY. Inventory-Sales ratios remain especially high in Tier 3-4 cities, putting pressure on prices:
The worsening of the unsold inventory situation is even more apparent when looking at the historical data:
After remaining stable throughout the 2010s, between 2011 and 2016 the square meterage of unsold housing has essentially trebled, from about 200 MLN to 600 MLN square meters. Conclusively, there is reason to be cautious on the Chinese real estate market. Although Chinese GDP is expected to grow by 6.5% in 2017, slightly below 2016's expected 6.7% (State Information Center), cracks are appearing in the housing sector.
The trigger could be in the form of higher rates, as the PBOC begins more earnest efforts to cool the real estate market and tame inflation. On January 24th the PBOC for the first time in one year raised the interest rate on the medium-term lending facility (MLF), with the interest rate for one-year MLFs increasing by 10 basis points to 3.1%. Since October 2015 the PBOC's benchmark rate remains at an all-time low of 4.35%. Inflationary data and expectations however are on a steady uphill rise in 2016:
If the Yuan also continues to weaken vis-a-vis the USD, inflationary pressures will continue to manifest themselves and eventually lead to a more restrictive monetary policy.
In addition, it is important to remember that China only in 2013-2014 experienced a significant downturn in real estate prices. Subsequent monetary easing starting in November 2014 and continuing into 2015 put the real estate market back on track:
At the present moment, China could be facing a similar scenario. The prospect of increasing rates, against a backdrop of an oversupplied housing, increasing lack of affordability and a desire to temper the boom by authorities, could make 2017 the turning point of the Chinese real estate boom. If the 2013-2014 is to be taken as informative, the negative impact on real estate prices will likely follow a decline in transaction volumes, with a time lag of about 6 months. The latter should therefore be monitored very closely in 2017.
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Additional disclosure: www.HedgedEquity.com has no position in China real estate.