April 30, 2013 — Does the China bubble exist? This is one of the most pressing questions facing property buyers in China — and investors the world over.
The following excerpt is from the book Landed China.
Is there a bubble?
As this book went to press, many people were debating whether China was in the middle of a real estate bubble. The answer to that question is complex and a lot is riding on it. If you include the full spectrum of related activities, real estate accounts for up to one-quarter of China’s economy, shaping demand for everything from Japanese construction equipment and Chilean copper to European furniture and Chinese cement.
The argument for a China bubble…
Headlines like “Shanghai New Home Prices up 273% in 7 years” make a strong case for the existence of a China bubble. At one point in 2010, home prices in Beijing were 22 times higher than the average annual income, putting home ownership beyond many people’s reach. One survey concluded that China has 64 million empty dwellings, many of them in cities like Kangbashi, Inner Mongolia, which was built to accommodate 300,000 people but houses less than 10% of that number. Since 2010, the central government has implemented a range of costly and unpopular measures to cool the property market, a course that the Chinese leadership was not likely to take unless it believed that a bubble was forming.
…and the case against
As economists Carmen Reinhart and Kenneth Rogoff point out in their 2008 paper, “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises,” the pervasive view that ‛this time is different’ is precisely why it usually isn’t different, and catastrophe eventually strikes again.” That said, there are parts of China’s experience that — if not different — are distinctive. For example, research by CLSA indicates that in 2011, one-third of all Chinese buyers paid cash for their homes, up from 24% in 2007. Furthermore, 53% of people buying a dwelling for investment purposes paid cash. In addition, there is a 30% minimum down payment for first homes, with higher minimums for subsequent purchases, and the exotic mortgages that fueled the American sub-prime crisis are not available in China.
There is also a strong cultural bias toward repaying debt. When property prices in parts of Hong Kong fell two-thirds after the 1997 Asian financial crisis, the mortgage default rate peaked at just 1.4%.
China has an overhang of empty homes, although the size of the surplus is open to debate, with some estimates placing the number at 16.6 million. A large proportion of these empty homes are held as investments because there are few other options. The inflation-adjusted returns on bank deposits and bonds are negative, China’s stock markets are notoriously fickle and most people cannot invest overseas. As a result, holding empty apartments is often the “least worst” choice.
There is also strong demand from end-users, with 93% of buyers planing to live in the homes they purchase. McKinsey estimates that China’s cities will add some 350 inhabitants between 2005 and 2025, creating a need for 10 million new homes each year. Nearly one-third of the nation’s 225 million urban households don’t have a private kitchen or bathroom, so there is also demand from people upgrading their homes.
Luxury homes in the nation’s Tier 1 cities are undeniably expensive. But China is not a homogenous market, and a villa in a gated community in Beijing is no more representative of China than a penthouse in New York’s Central Park is typical of the United States.
Finally, there is little question of China reverting to a centrally planned economy. Deng Xiaoping’s doctrine of “socialism with Chinese characteristics” has been affirmed by China’s new leaders, and accumulated surpluses give China a significant financial cushion.
But is it the right question?
In the most dire predictions, the China bubble bursts and causes the nation’s financial system to collapse. In a worst-case scenario, the global financial system fails, too.
Like the central government, this author believes the threat of a bubble is real. But if you are an end-user who plans to live in China for the medium-to-long term and have a reasonably secure job, the patience to endure the market’s turbulence and a manageable debt load, you should be fine. There’s still the risk of losing your job in a global recession, a developer failing to complete a home bought off the plan or the insolvency of a local government.
Based on what psychologists call availability bias, I would be more concerned about documented — yet less dramatic — threats like air pollution than a housing bubble bursting, especially if you’ve done your homework and bought sensibly.
In the end, I agree with Professor Gregory M. Stein of the University of Tennessee College of Law. In his 2012 paper, “Is China’s Housing Market Heading Toward a US-Style Crash?,” Professor Stein concluded, “Anyone who claims to have a definitive answer to this question is overly confident.”