China's Real Estate - A Market in Crisis

After China's house prices rose dramatically through the first months of 2013, the government imposed stringent cooling measures which may have been too efficient...

After China's house prices rose dramatically through the first months of 2013, the government imposed stringent cooling measures which may have been too efficient, resulting in rapid deceleration in housing values across the country.

The government initially imposed restrictions on the purchases of second and third homes, increased the amount of deposits required on property financed by mortgages and tightened credit for property developers.

Measures to Cool Market Too Effective

In June 2014 it was reported that among 70 major cities in China, house prices dropped in 55 of them, representing the sharpest decline since December 2008. Further statistics showed a drop-off in property investment with annual growth rising by 16.8% in the first three months of 2014, down from 19.3% in the first two months.

price growth chinese housing

In order to slow price deceleration since June, more than 20 of the 49 cities that had imposed house-buying restrictions have become more flexible, allowing more people to buy multiple properties requiring lower down payments.

Increased Flexibility Immediately Increases Sales

Business magazine Caixin reported that two of the first cities to introduce spurring measures Jinan and Hohhot, have since experienced a sharp increase in property sales.

China's economy depends heavily on the contribution of the housing sector which represents between 16 and 20% of GDP growth. However, this reliance has led to the government's reluctance to completely deflate the real estate bubble, raising questions about the long-term health of the world's second-largest economy.

Property Bubble not Fuelled by Subprime Lending

Unlike other property bubbles, China's is not fuelled by subprime lending as seen in America in the mid-2000s. China is very unlikely to experience a mortgage crisis due to strict lending requirements and the unlikeliness of mortgage defaults in the event of a price drop.

housing bubble in china

There is a general reluctance to let the air out of China's housing market

Chinese economist Yukon Huang estimates that even a 30% decline in housing prices would only leave 3% of China's homeowners underwater. Economists believe that this is what provides China with flexibility in managing its housing market, acknowledging that price declines are a healthy sign for the country, considering its long-term dependence upon the sector.

Credit Levels Concern Chinese Government

The real issue for the Chinese economy is credit, which has grown from 120% to 190% of GDP in the last five years. Patrick Chovanec, economist at Silvercrest Asset Management said: "Even if people use cash to buy their homes, that cash is coming from an infusion of credit into the economy or an expansion of the money supply. And a lot of people in China use real estate as a place to stash their cash."

Strict controls by the Chinese government limit the options for the richer classes in terms of where to invest their capital. Despite a huge increase in overseas property investment, there are restrictions in place to prevent the capital flight that devastated East Asia's economy in the 1997 crash.

Lack of Domestic Investment Choices Good News for Overseas Markets

The Chinese stock market is highly volatile and prone to corruption resulting in a lack of confidence in equities, leaving real estate as the logical place to invest surplus capital. In 2010, the home ownership rate in China was 90% compared to 65% in the US.

Although a sharp downturn would not necessarily affect many Chinese homeowners, property developers would be hit very hard. Construction is highly leveraged in China, with local governments lending substantial sums to developers.

Restrictive Lending Places Stranglehold on Development

Tighter lending measures make credit increasingly difficult for developers to obtain which in turn, will lead to less investment in the new housing market with the ripple effect filtering through to commodities like cement and steel and the labour market. Ultimately, this will depress economic growth and could bring a lot of serious issues to the Chinese government.

housing starts

2014 has seen a sharp decline in housing starts

It would appear that China's attempts to extricate itself from its reliance upon the housing market, although highly responsive, has a tendency to snowball rapidly in whichever direction the government aims to drive the sector. In this climate, instability is rife and investor confidence low leading to a significant increase in Chinese investment in prime real estate markets overseas such as New York and London.

- Wednesday 06 August 2014

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