- Plummet in property prices would knock Chinese economy into very hard landing
- Massive inventory build-up is about to meet reality of demographics
- Easing policies boosted the market but a mis-step could trigger panic selling
Sky-high in China. Property market bubble poses major risk. Photo: iStock
China’s headline problems are daunting: high debt, “zombie” state enterprises and a shrinking workforce. But the more immediate risk of a sudden and steep downturn in the economy comes from the threatened bursting of the property market bubble.
And a bubble it is. Much like the run-up in China’s stock market, the real question for investors is when and what will pop the bubble?
Headline numbers disguise the underlying risk. In the first eight months of this year, new home sales in China rose 25.6% year-on-year in terms of gross floor area and a breathtaking 40.1% y-o-y in value terms. But sales growth has been slowing – from 28.6% y-o-y in the first half of the year and 26.7% y-o-y in the first seven months – even as home prices in the bigger cities, have surged.
The bulk of the demand pushing up prices, in our view, comes from speculators. Lack of investment opportunities on the mainland, particularly since the dramatic crash in the stock market last year, has channeled capital towards brick and mortar. And the recent tightening of exchange controls has kept capital onshore looking for a home.
The government has also been encouraging the revival in property prices through a series of easing policies since last year, including interest-rate cuts, lowering of the required reserved ratio for banks, a reduced mortgage requirement for second-home buyers and continuous credit support for property developers.
The government declared its backing for a revival of the market in December following a meeting of the party Politburo: “We must destock property inventories, by turning migrant workers into urban citizens in a faster pace and pressing ahead housing reform to meet demand from these new urban residents.”
But the risk in China’s property sector is not just some cyclical downturn. The real threat to the market is structural: the gaping mismatch between supply and possible end-user demand as determined by demographics.
Let’s start with demand. Before China opened up to the outside world in the 1980s, its urban workers were housed by their employment units and its rural workers lived on the farm. Since then, demand for housing has come from urban families trading up and from young couples buying a home to start married life. (Though 289 million people have left their farms to work in the cities, these former peasants are not entitled to settle down permanently in urban areas.)
China has added an average of seven million people to its population a year each year over the past decade. The nation’s demand for housing is ultimately constrained by this number and by the pace of growth in the earning power of this group.
Official data shows that gross floor area of new residential housing sold in 2015 hit a high of some 1.124 billion square metres. Assuming a standard average of 33 square metres living space per person, developers offloaded housing for about 33.72 million people, or three times the net increase in the population over the past year. And that is not counting unsold residential units. They added up 453 million square metres, or the size of New York’s Long Island, in 2015 and 432 million square metres in the first seven months of this year.
But it is not just one year’s anomaly. From 2006 to 2015, about 8.86 billion square metres of new residential housing flooded the market. Allowing for the rebuilding and re-sale of old homes, the nation is looking at enough standard accommodation for 24 million people, or more than three times the net increase in the population during this period.
Shanghai shopping street. Chinese property market about to meet
the reality of demographics. Photo: iStock
Then there is affordability. Banks and state-owned enterprises, which typically pay better than other sectors, are cutting staff and cutting costs. SOE profits tumbled 6.5% in the first seven months of the year compared with the year-ago period, and the state companies have been slashing salaries. As for banks, profits were essentially flat in the first half of the year as lenders struggled with shrinking net interest margins and rising bad loans. China’s listed banks have shed about 35,000 employees this year and cut average salaries as they seek to reduce costs amid stagnant revenue growth.
The Chinese Academy of Social Sciences, a government think-tank, predicts that as many as one-third of all shopping centres in China will close their doors during the next five years. And in an earlier report, it has warned that property prices and real estate investment are poised for slower growth even as home sales may rise. Its report forecasts a "short-term adjustment period" in the real estate market with price increases and investment slowing down in the second half of 2016 and the first half of 2017.
Very real risk
The mismatch has not yet caught widespread attention because of the two-speed growth trajectory of housing prices in big and smaller cities. The national market is experiencing simultaneous supply shortages and surpluses depending on the region. And the media have mostly focused on the growth.
But the divergence between the bigger and smaller cities has created an intractable market duality that has made any uniform property policy difficult to implement. Any mis-step in attempting to cool house prices in the first-tier cities could spark a wave of selling that would push down prices that would in turn set off more selloffs in a fast downward spiral.
The current boom in prices in the first-tier cities will buy time. And local governments have a vested interest in ensuring that the property market does not collapse. Taxes on real estate and land-related transactions accounted for 16% of Chinese government revenue in the first quarter, according to a report by Mingtiandi, a real estate news portal in China.
But the bursting of the price bubble, in our view, is a very real risk.
Given the close ties between the property sector, local government borrowing and bank loans (on or off the books), a substantial fall in house prices could set the dominos falling. Developers would default. Off-book local government borrowing would be hit because much of the debt raised by their financing arms relies on property for collateral. Fitch ratings agency estimates that loans secured by property now make up 40% of total loans at the Chinese banks it rates. Residential mortgages and corporate loans backed by property have increased 400% since end-2008, compared with 260% for loans overall.
And it’s not just property developers and local government financing vehicles. The use of property collateral is increasingly common among corporate and small-enterprise borrowers. Fitch says that while residential mortgages have more than tripled since end-2008, corporate loans secured with property have increased almost five-fold in the same period.
Investors are advised to keep a very close eye on shifts in property prices in the coming months.
Chinese residential area. The dominos could be about to fall. Photo: iStock
— Edited by John Acher