IS THERE REALLY A BUBBLE IN THE CHINA’S REAL ESTATE MARKET?
Demand on real estate market in PRC is fueled by expectation of ever growing property prices but not on the basis of occupancy; as a result real vacancy rate is 30 to 50 percent in properties which is good indicator of existing overcapacity of buildings. What is more, property inventory in China rose to a record 6.2 billion square meters by the end of 2015. And, according to the China Index Academy, it would take at least five years to clear at the current speed of sales. Going further, the current property ownership accounts for 90 percent of the population already and the current stock could easily make it 100 percent. According to Bocom International chief China strategist Hong Hao, remaining 10 percent translates into 46 million households in need of a house. That is, because the government has ignored the obvious rental demand and the necessity of sharing due to high property prices.
For these reasons, as reasonably stated by Hong, “with the current high prices, it is hard to say the Chinese property market is not in bubble territory.” Especially since “China is going to face negative population growth within next 15 years which will further reduce the demand of houses (Paskelin & Vishwakarma 2011).” The real estate market in China will need to adapt to the inevitable decline in demand caused by demographic change (Nie & Cao 2014). The share of China’s population from 24 to 30 years old, the age group needing to purchase their first home, has decreased from 13.4 percent in 2000 to 10.7 percent in 2010. The share of the working age population in turn (15-59 years old) has decreased to 68.7 percent in 2013 after peaking at 70.1 percent in 2010 (UN Data).
Chart 21: China and India population forecast (data after year 2010 is projection using medium fertility variant)
Source: Statistic Times
4.1. Empirical tests of the existence of the bubble
The above described circumstances provide an incentive to comprehensively and empirically test the existence of real estate bubble in China’s economy. Especially, since the question of Chinese real estate bubble has special importance for policy-makers and investors due to its spillover effect on national economy then on international economy. China is a major consumer of commodities and any shock to its economy will have major implication to rest of the world. It is thus vital to accurately forecast bubble for policy makers as growing number of economists are worried that a bubble in Chinese real estate has the potential to rattle the world economy that is still struggling to recover from the shock of 2008’s global meltdown.
Much academic efforts have been devoted to the study of housing price in China. The outcomes of academic research are diversified. For instance, Ahuja et al. (2010) find that “for China as a whole, the current level of house prices does not seem significantly higher than would be justified by underlying fundamentals. However, there are signs of overvaluation in some cities’ mass-market and luxury segments.” What is more, an empirical study by Wu et al. (2011) concludes that “[although] we could not provide a definitive test with our limited data… multiple parts of the evidence… suggest the potential for substantial mispricing in Beijing and other Chinese housing markets.” Barth et al. (2014) believe that the last home price increases were mainly driven by fundamentals with an important assist from the stimulus. “It is not likely, it appears, that the Chinese economy will suffer a hard landing due to a collapse in home prices. However, despite the government’s efforts, the condition of real estate developers does merit some concern.”
Ren, Xiong and Yuan (2012) run a test of rational expectation bubble (Blanchard & Watson 1983) using annual housing investment returns of 35 Chinese cities between 1999 and 2009 and reject the bubble hypothesis. Shen (2012) defines a new measure of housing affordability in terms of permanent income with annual data from 1997 to 2009, and finds that housing price is reasonable because the affordability in China is high due to higher growth rate and low interest rates.
Recent and very reliable study by Chow & Niu (2014), in turn, discusses relative housing price in urban China utilizing data from 1987 to 2012 in a framework of demand and supply. Their theoretical framework is a standard simultaneous equations model of demand and supply for a representative urban consumer. The quantity of housing is per capita residential housing space. They treat the quantity of housing in use (not new housing) in the demand equation. The supply equation explains the same quantity variable by the same price variable and the cost of construction. The price effect is positive and the effect of construction cost is negative. “Although in China land is collectively owned and the use of land for construction is controlled by local government officials, [they] assume that the same factors affecting the supply of housing in a market economy apply to China since the construction of housing is governed by the same profit motive. The quantity variable includes both new construction and the stock of existing housing made available for sale.”
It extends the analysis of Chow and Niu (2011) using data up to 2006. Compared to other studies mentioned above, their paper has two possible contributions. First, as pointed out by the authors themselves, it studies the determination of relative housing price which has increased rapidly by 230 percent in their sample period of a long span. This increase has caused concerns of many Chinese households. Second, their structural framework not only can help determine whether the model is sufficient to explain the determination of housing price so as to rule out the existence of bubble, but also helps to illustrate how price is formed by long term effects of real income and cost through a dynamic demand and supply mechanism.
Using aggregated annual data from 1987 to 2012, as obtained from various issues of China Statistical Yearbook and the publicly available online database of China’s National Bureau of Statistics, in a simultaneous equations framework, they show that the rapid increase in the urban residential housing price can be well explained by the forces of demand and supply, with income determining demand and cost of construction affecting supply. They find the income elasticity of demand for urban housing to be about 0.9, the price elasticity of demand about -0.8, and the price elasticity of supply of the total housing stock about 0.5. Hence, estimates of income elasticity done by Chow and Niu are similar to those found in other countries and in China in the early 1930s.
“Since the observed increase in the price of urban housing in China can be explained mainly by an increase in income using a demand and supply framework without resort to an effect of speculation, we have found no evidence of a housing bubble during our sample period up to 2012. This remark applies to urban China as a whole and does not rule out a housing bubble in particular cities (Chow & Niu 2014).” What follows, the fact that interaction of demand and supply, with income determining demand and construction costs affecting supply, can explain the annual price of urban housing at the aggregate level in China very well. This in turn indicates that urban housing prices in PRC are no highly affected by speculation.
Deng, Gyourko, and Wu (2014) are much more worried about the risk in the China’s housing market. Particularly, they provide us with an evidence of a rapid increase in housing supply and housing inventory held by developers in various major cities in recent years. Fang et al. in turn (2015) take a more balanced stand between these two contrasting views.
They construct housing price indices for 120 major cities in PRC in 2003-2013 based on sequential sales of new dwellings within the same housing developments. “By using these indices and detailed information on mortgage borrowers across these cities, [they] find enormous housing price appreciation during the decade, which was accompanied by equally impressive growth in household income, except in a few first-tier cities. While bottom-income mortgage borrowers endured severe financial burdens by using price-to-income ratios over eight to buy homes, their participation in the housing market remained steady and their mortgage loans were protected by down payments commonly in excess of 35 percent.”
What follows, the housing market is unlikely to cause a severe financial crisis in China. Nevertheless, high expectations about future income growth are a real concern, because they make low-income people buying homes by undertaking substantial financial burdens especially vulnerable to future sudden slowdowns in the Chinese economy.
4.2. Threat to the Chinese banking sector
Another serious concern is whether the perils in the housing market will eventually threaten the health of China’s banking sector. As pointed out by the authors of the Milken Institute’s report which was cited above, a “special territory,” Hainan province, went through striking housing booms and busts in the early 1990s. It was selected as a pilot region for housing reform. From 1989 to 1992, housing prices in Hainan rose more than four times. The boom has come to an end when the government decided to reduce bank credit flowing into the housing sector. The bursting of the bubble put 3.6 billion dollars of nonperforming loans on the balance sheets of the four biggest commercial banks. In effect, the insolvent developers were resolved and the housing inventory in the city returned to a more sustainable level in 2006.
The very similar situation might repeat on a much larger scale, especially in first‐tier cities where housing price growth in the last decade substantially outpaced that of income growth (Over the 10‐year period from January 2003 to March 2013, the housing price index for the first‐tier cities had an average return of 15.9 percent while purchasing power grew by 6.7 percent on average. That was not the case of second- and third-tier cities: the second‐tier cities on average witnessed an average annual housing return of 13.2 percent in nominal values. In the same decade, per person GRP had a mean annual growth rate of 13.4 percent in nominal values).
The PRC’s housing market has changed greatly over the past thirty years. After successful privatization of the housing sector in the 1990s Chinese rulers have consistently advocated homeownership for the average household. Nonetheless, after years of extraordinary growth, there are concerns that this growth has not been caused by justified factors. And these concerns look rationally in the circumstances of lack of investment alternatives, real interest rates that have been negative for a long time, dubious shadow banking financing schemes promising what are really unattainable (that indicates a hidden leverage in the system), local governments using real estate development as a way to obtain funds, and a state-controlled banking system that has created lots of “fiduciary money”.
In such situation many people and media routinely ask whether Chinese real estate is a ‘bubble’ (driven by the fiscal stimulus packages and gigantic credit expansion indeed). Nevertheless, in present dissertation we did not attempt to answer that question directly, but we do provide a theoretical explanation of the key features of the gargantuan boom in this sector; an unprecedented housing price growth and hugely excessive vacancy rates. The reason is that the data necessary for any such analysis is very limited (and not very reliable) in case of China – the official government price series are of lower quality than those created by private providers. Thus, as far as the above described ‘bubble activities’ are concerned, it is not always possible to tell the difference between real “growth” and “capital consumption”.
Anyway, data used by cited economists that show rapid house price inflation and a very high price-to-rent ratio do not necessarily imply a house price bubble, especially from the perspective of the equilibrium asset-pricing approach (e.g. Chow et al. 2015). Instead, the real estate market in China is quite efficient as predicted by the equilibrium condition in this sector. The speedy house price inflation is fueled by rapid income growth and urbanization. The high price-to-rent ratio is an effect of high expected house price growth, driven by good perspectives on further urbanization, at least till 2020. This is why most of economists reject the existence of a real estate bubble at the national level but simultaneously indicate particular risks in residential housing in second- and third-tier cities like, for example, Hohhot, the capital city of the Autonomous Region of Manchuria, where – as reported by Business Daily – only 0.37 percent of total supply of newly-built homes was sold in 2014 (there is substantial heterogeneity in supply-demand imbalances across different markets in China).
The certain fact, however, is that economy in China entered a new stage of growth. The year-to-year GDP growth rate has significantly dropped from its nearly 10 percent growth of the last three decades. In 2016, the Chinese economy will grow at a rate of 6.5-7.0 percent. As economic growth decrease, the growth of disposable household income will naturally decrease too. This, in turn, will lead to a commensurate decrease of sustainable price‐to-income multiples for home buyers. Furthermore, the population of Chinese is rapidly ageing and is expected to decline beginning in 2030 (Fang et al. 2015). Using the 2000 Chinese Census micro data, Fang et al. (2015) have found that in 2030, the prime age population of buyers of homes in RPC will decline to about 62 percent of the corresponding level in 2000.
Surely, the ongoing urbanization is, as pointed out by Fang et al., likely to draw a well share of the rural population to cities, and thus for the urban housing market, the overall demographic trend may not be as important. Moreover, the one‐child policy that has been recently relaxed may decidedly increase the demand for housing in the cities. However, if the economy and income growth slow rapidly, many of credits will not be repaid and the real estate market will collapse.
Will the burst of Chinese real estate ‘bubble activities’ cause the catastrophic consequences to the rest of the world? It is immensely difficult to answer this question shortly and directly. Nonetheless, one thing is certain. It will shake fundaments of China’s economy up heavily, because the situation upon the Yellow and Blue Rivers is very specific – nearly 90 percent of housing belongs to the citizens (e.g. in the United States the figure is about 65 percent, and in Germany 53 percent). Thus, the crucial task for Chinese policymakers is to introduce some profound reforms – like the abolishment of Hukou or the unification of social insurance system – to softly diffuse described above ‘bubble activities’ without having severe societal repercussions.
Michał Wołangiewicz, prawnik, ekonomista. Absolwent studiów licencjackich ekonomii oraz studiów magisterskich prawa oraz ekonomii menedżerskiej Uniwersytetu Wrocławskiego. Student studiów LL.M. na specjalizacji Corporate and Commercial Law na the London School of Economics and Political Science (LSE). Alumn Akademii Liderów Rynku Kapitałowego (ALRK) i stypendysta Fundacji im. Lesława A. Pagi. Interesuje się rynkiem kapitałowym, chińską gospodarką, CSR oraz młodą sztuką. Fan piłki nożnej oraz kolarstwa górskiego (MTB), które od wielu lat czynnie uprawia.
 In Chow’s and Niu’s research, the Chinese urban housing market is treated as one market although prices in different cities vary substantially. In 2012, average prices of commercialized residential housing sold in different provinces and municipalities ranged from 2,982.19 to 16,553.48 yuan per square meter. Thus, the average price in China was 5,429.93 yuan per square meter. The time series is used an average across different cities. This treatment of housing price and the corresponding treatment of the quantity of housing as floor space per capita are used in estimating a demand equation for an average Chinese urban consumer across different cities.
fot. Scott Meltzer/Public domain/Wikimedia Commons