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Slowing, Not Crashing

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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). 

Little speculation

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).


One of the most frightening stories about China’s property market is that the country is full of ‘ghost cities’ of empty apartment buildings and tumbleweed, with Lon Chaney, Jr. lurking around the corner.  These stories are widely believed, but are plagued by the absence of hard data and a misunderstanding of the Chinese market.  There certainly are some failed projects, but the ‘ghost city’ story is greatly exaggerated. 

I visited recently a new residential project in the city of Changzhou, which has an urban population of 3.2m (larger than Chicago).  This project did appear ghostly:  none of the apartments were occupied, although about 40% of them had been sold.  But a conversation with the sales manager and then a tour of the project revealed that this was because interior construction was still underway and none of the apartments had been turned over to the buyers.  Without going inside, however, it would be easy to mistake this for a ‘ghost city’.

It is important to understand how China’s property market differs from that in developed countries.  For example, about 80% of new apartments are sold on a pre-sale basis, which means the contract is signed from one to two years before the building will be completed.  And most new apartments are sold unfinished, which means the owner takes possession of a bare concrete shell.  Finishing the apartment — everything from floors to kitchens and bathrooms — can take another 3 to 6 months.

Another unique factor is that most new apartments are being built outside of city centers, because the traditional downtown area is too congested and land is either unavailable or too expensive.  The government is encouraging developers to focus on these new areas by building infrastructure — everything from subways to and hospitals and schools — and many buyers don’t move in until these are finished.

The one detailed study of ‘ghost cities’ we’ve read was published in May by CLSA, the Hong Kong-based brokerage, based on a study of 609 residential projects in 12 cities, covering over 800,000 apartments.  CLSA’s conclusion was that although it takes time for new projects to fill up, three years after completion the average vacancy rate was 15%, similar to the 14% vacancy rate for US housing units.

Today’s market

Today the market is soft, but it is far from the collapse that many are writing about.  Full-year sales volume is likely to be down significantly YoY, compared to a rise of 18% last year.  Median new home prices are softening, but are still up YoY and are up strongly over the last eight years.

It is inevitable that China’s economy will, on average, grow a bit more slowly every year for the foreseeable future.  This applies to the residential property market as well.  This is a natural consequence of a maturing market, changing demographic trends and the base effect.

But, slower growth, or even declining YoY changes, does not signal impending doom.

Fundamental demand for housing remains healthy.  There are about 13m marriages every year, and new couples account for about one-third of new home sales.  There are about 13m births a year and the urban population increases by about 21m annually.  Income continues to rise at a healthy pace, and household savings increased by 346% over the last 10 years to more than US$8tn, greater than the combined GDPs of Russia, Brazil and India.

The boom days of China’s property market, however, are over.  The peak in new home sales is approaching, and it is highly unlikely that prices will continue to rise at an average pace of 9%.  But even if sales volume declines by 9% this year, that still means sales of about 10m new urban apartments. 

It is sensible to look closely at sales volumes and average selling prices and competitive pressures, but scary stories about bursting bubbles and ghost cities should be told around campfires, not investment committee meetings.


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