BIZMOLOGY — You don’t have to be an economist to know that China’s property bubble is approaching — to be kind — an inflection point.
Tales of unoccupied ghost cities have been legion for years. Vacant residential and office space has been documented from remote Ordos in Inner Mongolia to the Yangtze Delta and first-tier urban hubs like Tianjin.
But for the first time since the property market was born in 1997 (when mortgage financing was liberalized), prices are slipping despite efforts by local governments to backtrack on earlier administrative controls. Until recently, sales were repressed by controls such as limits on wealthy Chinese making multiple home purchases.
Average residential property prices have only just begun to slide. For the last three months in a row, prices were down a cumulative 2% at the end of July.
Unsold inventories are bloated: China’s top 20 cities had more than 23 months of inventory in June. Tier-two city Hangzhou, located in the heart of the Yangtze Delta, had 20 months of inventory.
This is a consequence of a supply overhang of unsold homes, which has grown to 1.3 billion sq. meters since the start of 2011. That means China’s construction frenzy has resulted in about 37 sq. meters of residential floor space per person compared to 8 sq. meters in 1978, according to China’s National Statistics Bureau.
Household balance sheets can withstand a correction, thanks to high historic ratios of cash buying. But the flow diagram of what a market crash could bring to an economy used to idiot-proof housing investment is scary.
Real estate and construction accounted for 16% of GDP in 2013. Linked sectors such as steel, cement, and household goods put this ratio over 20%. And developer finances, local government finances, land sales, construction, and bank balance sheets are in a dangerous embrace of mutual dependence.
Prices are often unaffordable for median-income earners, yet they have broadly kept step with disposable income since 2011. Much of the population still lives in prereform housing. But against this are high inventory levels and a context of reduced speculative demand for the high-end apartments that the boom has driven.
Chasing such negative factors are Chinese President Xi Jinping’s new sweeping anticorruption efforts that should stall the common practice of officials buying dozens of flats with the fruits of graft and elite Chinese citizens’ appetite for property in Australia or California, not at home.
China’s banks are also looking to defend their capital base from credit risks in a string of heavy industrial sectors, and Basel III requirements due by 2018 require boosts to capital. Accordingly, banks are not eager to grant more mortgage financing. Meanwhile, yields in commercial real estate have been lower than the cost of capital for years.
Optimistic talk of 2020 urbanization targets or the Beijing-Tianjin-Hebei “economic circle” ring hollow: It is such top-down targets that led to supply gluts in the first place.
The end of controls on home purchasing in most of China’s biggest cities may help. Everybody will be watching credit availability for mortgages in the fourth quarter. The head of China’s real estate industry association denied the market was “on the edge of collapse” at an industry forum in August.
However, the imbalances will take years to work off. It is not just a 1-2 percentage point drag on economic growth over a few quarters, but a switch in the growth model.
Together with demographic factors and other heavy industrial excesses, a weaker property market will shift China’s potential growth rate down from 7%-8% to 5%-7%.
A quieter real estate market with lower volumes and losses kept unrealized, back-door bailouts, and judicious accounting may help forestall a financial crisis, but the impact will be negative, substantial, and increasingly visible into 2015.