China's Property Bubble is Still Growing

China is awash with cash, even if it is concentrated among a relatively small percentage of professionals and business owners. The buying power generated by all that money has been inflating a Chinese property bubble, which some believe is primed to burst.

A recent report by the Chinese real estate services company E-House China shows new home prices in 288 Chinese cities rose 10.5% over the past year ending in October, growing faster than the previous month’s annual rise of 10.4%.

Four years of Chinese government efforts to keep property prices under control have failed. With average prices well beyond the reach of average Chinese families, experts are sounding the alarm. Is China’s housing market facing an imminent collapse? Or are underlying market forces strong enough to keep feeding the bubble for years to come?

Two Reasons for an Imminent Burst

Another report issued by China Real Estate Index System (CREIS) similarly revealed alarming price increases. Home values in the 100 largest centers grew for the 17^th month in a row, up 1.2% in October alone, higher than September’s 1.1% increase. Yearly increases in these cities reached an 11% annual gain in October, higher than September’s 9.5% annual rise.

Increases were even worse in the 10 largest cities, where home prices rose 2% in October, 16% higher than a year prior. In the nation’s two largest cities of Beijing and Shanghai, annual prices rose by 20.6% and 20.4% respectively.

What makes it so much worse is that most new projects seem to be targeting the wealthy, where builders can charge a heftier premium. “Some developers have launched more middle and high-end home projects in October to pursue high profit margins, pushing up home prices,” Reuters cites the CREIS report.

Yet it seems builders have tripped over themselves chasing after the upper classes, as rows upon rows of vacant housing line the streets of many cities. One ground reporter verified to Forbes the grossly disproportionate amount of vacant housing, which in some urban centers averages 1 vacant home per 4 citizens.

The glut of empty housing is only one sign that the property market may be running out of buyers and is due for a severe correction. A second sign is revealed by the Chinese government’s own report showing a home ownership rate of over 90%, compared with the global average rate of 63% and America’s 65%. The report also shows that Chinese home owners are overextending themselves, with 15% of home owners owning two homes or more.

This smells like saturation and is prompting many experts to voice their concern, including Jim Chanos, founder of hedge fund Kynikos Associates, who called China’s housing market a bubble that keeps getting “bigger and bigger and bigger,” quotes the Financial Times.

Liu Li-Gang, a Hong Kong-based economist at Australia & New Zealand Banking Group, couldn’t be any clearer when he warned to Bloomberg, “Home prices, especially in big cities, are a bit out of control. China’s facing an increasing risk of a property bubble.”

Three Reasons Against an Imminent Burst

Contenders, however, counter with three rather convincing arguments of their own downplaying the risk of a housing implosion in China.

Firstly, wages are on the rise. Where in 2005 it took the average Chinese household 10.5 years to pay off its home, by 2012 families could accomplish the feat in just 7.6 years. Permitting these wage increases is the nation’s still robust commercial activity, its foreign exchange reserves growing by $163 billion just this past third quarter alone.

Secondly, most of the “ghost towns” of unsold housing are concentrated in the deep interior of the country, closer toward Inner Mongolia where employment is not as abundant. Closer to the industrial centers along the coast, however, the demand is meeting the supply.

The main factor distinguishing these two faces of the Chinese housing market seems to be the availability of employment, where jobs are more plentiful and wages are higher on the industrialized coast than deeper inland. Slow home sales inland should not be taken as a sign that the dramatically rising prices on the coast are unsustainable. China is vast enough and its population is large enough for the co-existence of two separate and distinct housing markets, each with its own subset of support drivers.

The third argument contra an imminent housing implosion is the government’s own urbanization plan as unveiled by Premier Li Keqiang this past March. More than 657 million Chinese, or some 49% of China’s population, live in rural regions and are effectively out of the commercial loop. Imagine the impact on the nation’s domestic economy if just half of that group – the equivalent of the entire population of the United States – were integrated into the broader urban consumer marketplace.

That’s what the Chinese government wants to achieve over the next 30 years – moving half of its rural population into cities at a rate of some 10 million persons per year. That is going to require at least 2.5 million new city homes annually. Although the housing program may be a little off in determining precisely where that need will be concentrated, any housing gluts will be filled in due course.

Stepping Up the Supply

The government, therefore, has two major incentives to keep the construction of new homes going at full steam – it will keep increasing the supply of new homes to bring prices down and to keep pace with its plan to urbanize its rural citizenry.

And this is what Chinese President Xi Jinping promised last week: to increase the supply of new homes and subsidize affordable housing projects to cool home prices down.

Recognizing that free enterprising builders will naturally cater to the upper classes to improve their profits, the government is stepping in to fill the void for middle-class housing. “A new category of housing for the middle-income will be introduced,” an official of the Beijing Municipal Commission of Housing and Urban-Rural Development informed Reuters.

The project will construct 70,000 homes this year and next at 30% below the average housing prices, exclusively for migrant families that fulfill the government’s criteria.

“We are making this move to further balance the supply of homes, support demand for owner-occupied apartments and stabilize market sentiment,” the Beijing housing commission posted on its website.

The government will also be upholding its law prohibiting any individual from owning more than two homes in an effort to curb property speculators from gobbling up housing. Remember that China now has the largest number of millionaires among any nation in the world, who could easily turn the Chinese housing market into their very own Monopoly game.

Affirming its pledge to prevent real estate speculation, the Beijing housing authority warned, “We will provide guidance for property developers to set prices reasonably. For those that set their prices too high or do not accept government guidance, their sales will be suspended,” quoted the state news agency Xinhua, as cited by Reuters.

Despite the alarms raised by many, don’t expect China’s property bubble to burst any time soon. It still has enormous inflows of cash, it still has rising wages, and it still has growing urban populations. All the ingredients are there to keep property prices rising higher and higher for decades to come.

If you as an investor want to participate in the growth of China’s housing sector, you will find it rather impossible to own Chinese property directly. There are, however, numerous real estate trusts which are available on the Hong Kong stock exchange. Just be certain to closely examine each REIT’s holdings to ensure it has a larger concentration of properties in the growing coastal regions rather than in the over-saturated inland market.

Joseph Cafariello

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