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The Chinese Real Estate Bubble- Fact Or Fiction?

Welcome to our first weekly edition of I'll usually publish the weekly edition on Saturday. Every week I'll recap any noteworthy or unusual activity in the stocks in the portfolio, and provide unique information on issues making news in China that effect the investing landscape.

On a quick recap note- this first week I've been focused on commodity stocks- specifically Pork, Coal, and one unique situation with a Bromine producer. The mid week surprise: the interest rate increase  by China, cooled the off the streaking China stocks. However, I believe this will be temporary. The pullbacks have been on light volume, suggesting a little buy side volume will give us back the roughly 2% losses from the back half of the week. If you're wondering why I like the coal sector so much, consider this commentary on Friday from the Gerson Lehman Group, a research service for institutional investors:  

Energy consumption growth (both primary and end-user) is expected to stay well above 10 percent for 2010, even with central government's desperate efforts to improve energy efficiencies and cap emissions. Coal consumption is mainly boosted by strong electricity demand, which is expected to increase by 14 percent for 2010, and enormous coal chemical projects. 

The interest rate move this past week simply serves as proof there's some inflation in China's economy, that's why we're in coal stocks. Demand is outpacing supply, and pricing power means more profits for these companies.

I'm not terribly concerned about the inflation issue. A lot has been made of a pending "Residential Real Estate Bubble". Today's topic is the perceived residential real estate bubble, and what the Chinese government is doing to prevent any environment even remotely close to the real estate market melt down we experienced in the United States in 2008- painfully, still persisting today.

The China Surprise

As I chronicled earlier in the week, the Chinese government surprised the world this week by raising interest rates. Interest rates were raised by 25 basis points to 2.5% for deposits, and 5.56% for loans.

The Chinese government has come under global pressure of late to allow the RMB to strengthen, thereby more accurately reflecting the strong state of the Chinese economy. So far, the Chinese have resisted, and believe the issue is more political than substantive in the United States. A weaker RMB has the effect of making China exports cheaper, and correspondingly imports into China more expensive. The US would like to sell more stuff to China, so hence our attempt to cram a stronger RMB down their throat. The stronger their currency, the cheaper our stuff. The Chinese do buy plenty from us- $870 Billion in Treasuries to be exact.

A lot has been made of the perceived Chinese Real Estate Bubble- Many comparisons have been made to the '08 US real estate implosion and mortgage melt down. While the price of residential real estate has risen rapidly in China, comparisons to our melt down are simply a bunch of hooey- it's not going to happen.

US investors are suffering from "Post Traumatic Stock Syndrome" (yes, I made that one up). We all lived through a once in a century melt down, and we're now as paranoid as a crystal meth addict. Paranoid investors don't believe they can ever make money in the market again. Strikes me as the perfect time to have equities faith.

The Chinese are plenty smart enough to learn from the mistakes of others. Rising prices in the Chinese residential real estate market are being fueled by a number of factors. First and foremost, there is a whole new generation of wealthy investors hatching in China, pulling profits out of highly successful businesses. The nuevo riche Chinese are looking to invest, and their choices are limited. It's their domestic stock market (Shanghai or Chendu only), real estate, or gold. That's about it. In 2009 there were 1,000 RMB billionaires in China- today there are 1363. 95% of the newly created wealth is coming from companies serving the Chinese consumer, not exporters.

There's also the high savings rate. The Chinese save approximately 40% of their income. The savings habit has been driven by preparation for future health care expenses- few Chinese have health insurance, so they tend to save for catastrophic illness or injury. The government has earmarked billions for health care coverage in both the rural and urban areas, leading many to believe they don't need to save as much. That money is looking for a new home- as both a place to live and an investment.

The Chinese are taking extreme measures to stave off any sort of real estate bubble. The Government wants to encourage their new urban generation towards home ownership, and rising housing prices could take buyers out of the market.

They also don't want to see the kind of wealth destruction we are living through in the good old US of A. They know our economy is a mess, and don't want to follow our lead. Here's a few of the measures implemented to keep China from being Deja Vu all over again aka the US:

  • Down payments on 1st homes are required to be 30%
  • 3rd Home buyers are not permitted to get mortgages in Beijing, Shanghai, Hangzhou and Shenzhen
  • 2nd Home buyers are required to put down 50%
  • Developers must develop properties within one year, or they are not permitted to bid on other properties (creates more supply; lower prices)
  • Tax exemptions are being providing to rental property developers for lower income renters
  • When purchase limits are being strictly enforced in Shenzhen, and October home sales nose dived by 30%
  • The recent rate hike is targeted at both developers and residential real estate buyers
Suppose the US had implemented these requirements 6 years ago, and never securitized mortgages? Would we be in the mess we are in today? If you're concerned about an overheated China real estate market, you just don't have the facts. You are simply suffering from Post Traumatic Stock Syndrome. Consider these measures, and put your common sense hat on.

Disclosure: N/A