The big question for economists, analysts, and investors about China’s economy has been not whether China’s enormous real estate bubble will burst, but when. Recent data suggests the time is fast approaching.
According to China’s Bureau of National Statistics, in October, in 70 large and mid-size cities, there are more cities whose real estate prices have moved down than cities whose prices have moved up, for both newly built apartments and existing ones.
Price Movements for Existing Apartments
In 70 Large and Mid-Size Cities
Source: China's Bureau of National Statistics
October: The Turning PointOctober demarcates the turning point for China’s housing market. The September data for existing houses in 70 cities still shows that prices were modestly rising in about 35 percent of the cities. Another 35 percent or so were declining slightly, though a couple of cities had declined for a couple of months since July. Prices for the remaining cities basically remained unchanged. There was no clear price trend.
However, the October data depicts a very different picture. Housing prices for the country as a whole turned negative. Prices of existing and newly built houses in many of the first- and second-tier cities were declining. Discounts between 5 percent and 20 percent were reported in first-tier cities, such as Beijing, Shanghai, Shenzhen, Guangzhou, Foshan, Chongqing, and Hangzhou. Prices were also down in some second-tier cities as well.
This negative price trend is a continuation of the movement that began at the turn of 2011, when the market was at its highest. As the graph shows, in January 2001, there was 86 percent, or 60 cities, whose property prices rose versus only three cities whose prices moved down.
However, in October, the number of cities whose prices moved up dropped to only 13 cities (19 percent), while those whose prices went down rose to 38 cities (54 percent).
The market change has been even more dramatic in transactions than in prices. Let’s take Beijing as an example. September and October are usually said to be the golden and silver months for the housing market. However, transactions for September and October declined 46 percent in Beijing from their level 12 months ago.
According to a Financial Times report, data from China’s Bureau of National Statistics shows housing transactions in the top 15 cities dropped 39 percent in October from 12 months ago. For the country as a whole, October’s transactions were down 15 percent, a larger decline than September’s transactions, which were down 7 percent from 12 months ago.
The slowdown in the housing market can also be seen in developers’ rising housing stock. For instance, in Tongzhou, east of Beijing, there are 13,000 apartments, a total of 1.6 million square meters (1,722 million square feet) for sale. It would take 24 months to sell the available apartments, given that in September only 546 apartments were sold.Many real estate companies have started to sell properties at 5 percent to 20 percent discounts.
In Shenzhen, there are over a hundred real estate companies, with over 5,000 offices. In 2010, the monthly average transactions were 12,000 apartments, but now only slightly more than 2,000 apartments are being sold. In other words, it takes 2.5 months for an office to sell an apartment now.
The slowdown in the housing market is pushing many players out of the market. According to China’s Daily Economy News, Centralline Property is closing down 60 offices, laying off 1,000 employees in Shenzhen alone. Shihua Real Estate was reported to have closed about 100 offices in Shenzhen, and Vanda Real Estate was to close 30 to 60 offices.
This all shows that China’s real estate market is changing direction.
Why Now?The second shoe is now finally hitting the floor. Analysts have long said that China’s real estate is just too expensive. The turn in the market has been expected.
After experiencing almost double-digit appreciation in the largest cities in the past few years, China’s housing prices for the top 100 cities in September 2011 reached a valuation of 8,877 yuan per square meter, or $130 per square foot. That is at a level similar to or even higher than most developed countries. China’s property prices are well beyond what most Chinese can afford.
In addition, the Chinese state has been taking measures to try to deflate the real estate bubble. Since April 2010, new policies have been implemented, such as raising the amount of the down payment, increasing the interest rates on mortgages, and adopting other measures for controlling the purchase of houses.
Also, in the face of rising inflation, the People’s Bank of China has further tightened monetary policy, with higher interest rates and higher bank reserve-requirement ratios, giving another blow to the housing market.
Recently, the government has required land developers to make full cash payments for land purchases, forcing developers who buy large tracts of land to pay cash, even as housing demand declines.The regime is caught in a dilemma and has to choose its poison.
Faced with the full money payment requirement, declining housing demand, and higher interest rates, many developers are having liquidity issues. From the third quarter reports of 131 listed land developers, housing stocks are piling up, sales volumes are declining, and operating income is turning into negative territory.
At the end of the third quarter, their inventory went up 44.9 percent from the same period last year to 98.3 billion yuan (US$15.4 billion). Among the 131 developers, 80 had negative cash flows.
Faced with weaker demand and a liquidity shortage, real estate companies can only survive by cutting housing prices.
Inflaming Social TensionsMany real estate companies have started to sell properties at 5 percent to 20 percent discounts, or even at a 30 percent discount. This shows that they are already facing financial difficulties. Wanke, one of China’s largest real estate developers, says China’s real estate will remain in a downturn for quite some time.
In China’s economy, if any real estate developer goes under, banks will be seriously affected. Governments will be affected as well, since 30 percent to 50 percent of local governments’ revenue comes from land sales. As the real estate market enters into a recession, the revenues of local governments will be significantly reduced.
Adding to the difficulties, the falling of real estate prices is causing protests.
For instance, on Oct. 19, Zhonghai Real Estate offered over 370 apartments in Pudong, Shanghai, on sale at 16,000 to 17,000 yuan per square meter ($234–$248 per square foot), about 30 percent lower than the selling prices of apartments with comparable features in the same location. This caused over 400 people who had recently bought similar apartments to protest against the seller, Zhonghai Real Estate.
Due to the drop in prices, some owners could have incurred losses of several hundred thousand yuan (100,000 yuan equals US$15,716). Due to large percentage drops in Shanghai’s housing prices, similar protests also occurred in the Jiading District of Shanghai.
Due to the wide income inequality and the forced demolition of homes by local governments, China is already full of conflicts. The bursting of the real estate bubble, as it begins to be felt across the country, may lead to further social conflict.
Since June, many land developers have felt the constraint in liquidity. With the declining sales, rumors spread that restrictive housing policies will be loosened. Some even say that the control measures for real estate will be aborted.
I think such rumors are partly due to the fact that selling land has become a major revenue source for local governments. Local governments do not want to see their revenue drop, so they are calling for an end to the control measures.
After climbing by nearly double digits for several years, housing prices in Beijing, Shanghai, and other first-tier cities are comparable to those in Manhattan. A three-bedroom apartment in Shanghai can be sold for US$1.3 million.
In Tongzhou, a district east of Beijing, a single house normally sells at over 5 million yuan, equivalent to US$786,000, about three times as high as an average single house in the United States. Yet, according to the IMF’s data, China’s nominal per capita income in 2010 was US$4,382, only 9.4 percent that of the United States.
The regime is caught in a dilemma and has to choose its poison. If the current restrictive policies on the housing market are relaxed, then the real estate bubble will continue to grow, and inflation will spiral upward. If the measures are kept in place, the bubble will burst.
Premier Wen Jiabao re-emphasized in early November: “A series of control measures for real estate must not be shaken. Our goal is to make housing prices return to reasonable levels.”
Therefore, in the short run, I do not think the Chinese state will reverse the control measures on real estate. The housing market is edging down. I think this trend will continue.
Tianlun Jian, Ph.D., writes regularly on the Chinese economy.