China’s housing market is one of the most important parts of its economy, and also one of the most misunderstood. This sector is important because residential real estate together with construction last year accounted directly for about 10% of GDP, 18% of fixed-asset investment, 10% of urban employment and more than 15% of bank loans. IT is also misunderstood because few observers appear to grasp the structure of China’s residential market.
In the beginning
The development of China’s commercial housing market is one of the world’s greatest and least recognized privatization success stories, as the Communist Party allowed most workers to buy their government housing at a steep discount to market value. As a result, the homeownership rate in China is now among the highest in the world: 89% compared to 66% in the US.
But this high homeownership rate may not mean the appetite for new homes has been sated. A large share of homes are substandard, so demand for upgrading is significant. Many families still have to use shared toilet and kitchen facilities, and as of 2012, about 30% of households had a per capita living space of less than 20sqm, or 215 sqft (the 2005 average per person in the US was 916 sqft).
One of the biggest misconceptions about China’s property market is that most buyers are speculators. In fact, the residential market is driven by owner-occupiers. Data collected from sales managers across the country reveal that during the last three years the share of buyers who were investors was only 7-12%.
Beyond Shanghai and Beijing
Another common misunderstanding is the view that China is Shanghai and Beijing. But this is akin to assuming that the property markets in San Francisco and London are representative of the entire US and UK markets.
The four tier-one cities of Beijing, Shanghai, Guangzhou and Shenzhen last year accounted for only 10% of China’s urban population and 5% of total residential property sales (by floor space). There are more than 150 other Chinese cities with a population of at least one million, and they account for the vast majority of the nation’s property sales. (The US has only nine cities and 50 metro areas of over one million people.)
Last year, for example, new residential sales in Hefei (the capital of Anhui Province) were greater, by volume, than sales in Beijing. Prices in smaller tier-three cities, which account for 65% of total sales (and 58% of the urban population), were 73% below tier-one prices.
Prices rising in line with income
China’s 9% average annual growth in residential property prices over the past eight years may appear to be the hallmark of a bubble, but that was accompanied by 13% average annual nominal urban income growth.
Unprecedented income growth not only supports China’s remarkable consumption story, it also underpins a healthy property market. Over the past decade, inflation-adjusted urban income rose by 7% or more every year, while real rural income increased by 7% or more during each of the past eight years. In contrast, over the past decade real income rose at an average annual pace of 1% in the US and 0.3% in the UK.
Homeowner leverage is very low
In my view, an important precondition for a bubble in any asset class is a high level of leverage, because in the absence of high leverage, the consequences of a sharp price decline are limited. In China there is extremely low leverage among homebuyers because about 15% of buyers over the past three years paid all cash, while for those using mortgages a minimum cash downpayment of 30% is required.
Chinese banks have not been permitted to offer subprime mortgages, there are few asset-backed securities and almost no secondary securitization (such as the CDOs and CLOs that created havoc in the US system).