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Is Growth in Chinas Housing Sector Sustainable?

Sreevardhan Agarwal

PKU Summer Programme 2011 Introduction to Chinas Economy

Chinas Housing Sector has been the center of immense interest both within the country and outside, especially in recent years. Analysts, scholars, policymakers, speculators and ordinary Chinese homeowners are all looking towards the movements in housing prices at the same time as these movements become increasingly important to the economy as a whole. In a study titled Evaluating Conditions in Major Chinese Housing Markets, scholars from Tsinghua University, National University of Singapore and University of Pennsylvania established that land prices in Beijing increased eight fold since 2003, while between 2007 and 2010 alone, they nearly tripled. Amidst this euphoria, analyst Andy Xie ingeniously coined the Housemaid Indicator- drawing a parallel between his housemaid who asked for leave so that she could rush home to cash in on the property boom, and the shoeshine boy whose giving advice on stocks was the reason behind Joseph Kennedy selling his stock before the crash of 1929 to indicate towards what he calls the Giant Ponzi Scheme that is the Chinese property market. The Economist Intelligence Unit, in its report titled Building Rome in a Day outlined how at the current rate it would take only two weeks for China to build housing capacity equivalent to that of Rome, but justified the sustainability of this extraordinary growth on the basis of the long term urbanization trend and inherent strengths of Chinas economy. Contributing to this discussion, the goal of this paper is to understand the nature of the housing boom and whether it could be sustained over an extended period. In order to achieve this, the history of the housing sector and the origins of the present boom will be discussed. I will also draw upon generally accepted measures such as the Price to Income Ratio to understand how

current housing prices in China compare to those in other time periods and other countries. The role of the Government and State Owned Enterprises in the context of the boom will also be looked into.

History of Private Housing

At the time of the founding of the Peoples Republic of China (PRC) in 1949, Urban Housing units were nationalized. Thus, the government became the monopoly supplier of housing over the next three decades. At the time of reforms in the 1970s, a pilot programme of housing sector privatization took place in coastal cities and was subsequently expanded throughout the country. The first significant breakthrough, however, came in 1988 with the passage of the Constitutional Amendment- although the state was still the owner of urban land, individuals could now lease it for a period up to 70 years. Through the 1990s, by means of several reforms, the government encouraged residents to purchase housing from their work organizations at prices lower than market rates. Finally, in 1998, the passage of the 23rd Decree was seen as the foundation of Modern Private Housing in China- companies would now need to integrate housing benefits into employees salaries rather than develop housing units for them, and employees had to purchase or rent units directly from the private market. We should note that this relatively recent establishment of private housing in the country provides a much smaller database restricting analysis of long term trends in the sector. Over the course of this period, the contribution of the private housing sector to the fiscal revenues of local governments has increased dramatically- from 542 Billion Yuan in 2003 to 1.6 Trillion Yuan in 2009,1 thus being the largest off-budget source of income for local governments.

Wu, Deng, Gyourko, Evaluating Conditions in Major Chinese Housing Markets, 2010, page 8

This intimate relationship between the housing sector and the local government can find implications in the recent boom- as the sector becomes a larger source of income and the power of local governments increases as the monopoly supplier of urban land for housing, local governments are effectively de-incentivized from keeping land prices in check as they themselves are among the largest beneficiaries of the boom.

Origins of the Boom

The origins of the current housing boom in China can be seen around the period of 2007-2008, after the government used measures such as tightening credit flow and requiring larger down payments and mortgage requirements to cool the housing sector after the boom period of 20062007. After the onset of the Global Financial Crisis of 2008, the government set out a large stimulus package of 4 Trillion Yuan and directed a surge in new lending, with total new lending in 2009 being more than 250% of that in 2007.2 In doing so, the Peoples Bank of China adopted a method different from that of other Central Banks, using increased direct lending to stimulate economic activity, instead of reducing interest rates to near zero levels like in other countries. In addition, the floor mortgage interest rate for commercial individual housing was reduced to 70% of the benchmark interest rate and minimum down payment required for a first-time home owner was reduced from 30 to 20%. 3 A large part of this lending, however, instead of being directed towards the real economy, found its way to asset markets such as real estate and securities. This diversion of credit is illustrated by the marginal increase in the loan-deposit ratio from 65% in December 2008 to 66.6% in June 2009while during the same period new lending increased


MiljanaVujosevic, SAIS China Studies Working Paper Series, (2009) page 3 MiljanaVujosevic, SAIS China Studies Working Paper Series, (2009) page 3

tremendously. 4 It is this expansion of credit towards the sector that was seen fuelling the boom during the period of the slowdown in the global economy.

Underlying Trends
There are particularly two long term demographic trends that have been credited with being among the primary driving forces behind the sustained housing boom in China since 2003Urbanization and Migration. According to the study by Wu, Deng and Gyourko, between the years 1996 and 2005, the urbanization rate is steady at 1.4 percentage points. This translates into 15 million new people entering urban housing markets each year, with the total urban population according to official figures released being 665 Million.5Underlying this trend is the desire among the youth living in rural areas to migrate to urban (coastal) cities with much higher rates of growth and better job opportunities. These migrants contribute significantly to demand in urban areas, with 33% of new housing being purchased by migrants in 2009. 6 However, even this soaring urbanization cannot extend the boom indefinitely. At present rates, Chinas urban living space per person is 28 square meters, very high compared to other developing countries like India. Assuming the continuous growth in urbanization until levels reach around 75% of total population, we can expect another 300 Million people to enter the urban housing market. This would translate into a requirement of 8.4 Billion square meters of living space, of which, according to Andy Xies study, work-in-progress covers more than 2 billion square meters and the construction industry has present capacity of producing 1.5 billion square meters. Thus, some analysts believe that in the span of a few years, a situation of absolute

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Andy Xie, China Counts Down to the Next Bubble Burst, (2009) page 1 6 Wu, Deng, Gyourko, Evaluating Conditions in Major Chinese Housing Markets, 2010, page 7

oversupply may come about in the sector, triggering a huge decline in prices in urban areas. Another trigger could be the decline in the number of youth both as a proportion of total population as well as a decline in the absolute number of youth in China. For a ten year period beginning in 2016, Chinas population in the age group of 20-29 is expected to fall from 200 Million to 150 Million, representing a decrease of 25%.7 Taking into account that this is the segment of population that constitutes the largest proportion of migrants into urban areas, a fall in their total number may significantly affect demand and thus affect prices of urban private housing.

Price to Income Ratio

Among the most widely used metrics to understand relative prices and affordability of housing across different markets and different time periods is the Price to Income ratio. In essence, the ratio is: Average total price of housing unit / average household income. However, modifying it in order to make calculations with the available data in China: (Average housing price per square meter * average size of unit) / (average per capita income * average household size). At first on looking at the continuous and drastic increase in prices over the last few years, the housing boom seems intrinsically unsustainable. However, this metric helps paint a different picture, particularly in regions other than the largest coastal cities. Specifically in cities such as Chengdu, Tianjin, Wuhan and Xian, although housing prices have risen considerably, they have been outpaced by an increase in income of the residents. Thus, the Price to Income ratio in 2009 was the same as that 5 years ago.8 The same cannot be said of the largest coastal cities and those like Beijing. Although these cities have also enjoyed rapid increases in income levels, the rise in
7 Wu, Deng, Gyourko, Evaluating Conditions in Major Chinese Housing Markets, 2010, page 21

housing prices has been even greater, leading to an increase in the price to income ratio from 1415 to 18.5 in 2010. 9 In comparison, at the peak of the housing boom in Japan, prices peaked at 9 times income in Tokyo in 1990. 10 This inflated price-to-income ratio in Beijing has fuelled the belief that house prices are largely overvalued and are in line for a significant correction. This may also come from the fact that growth rates in the largest cities like Beijing are slowing, with higher wage prices of labour and many of the industries previously concentrated in these large coastal cities shifting to alternative regions further inland. With this shift, higher home prices will continue to be seen in relatively smaller urban hubs, while cities such as Beijing will face a correction.

Role of State Owned Enterprises

According to the State-owned Assets Supervision and Administration Commission (SASAC), at the end of 2009 there were 129 State Owned Enterprises (SOEs) owned by the Central Government. These SOEs represent some of the largest Chinese corporations, with aggregate sales in 2009 of 12.6 Trillion RMB. According to the SASAC, 94 of these 129 SOEs were involved in the real estate industry at the end of 2009. Particularly within Beijing, SOEs have an overarching presence in the housing industry, with the share of purchases of Central SOEs increasing from almo`st negligible levels to over 50% in 2010 and the total combined share of Local and Central SOEs being 71% in the same year. In addition, the average prices paid by these firms for land in Beijing were seen as being 27% higher than if the firm was not a SOE.11 A report by Reuters 2010 outlined this role, bringing to

Wu, Deng, Gyourko, Evaluating Conditions in Major Chinese Housing Markets, 2010, page 22 11 Wu, Deng, Gyourko, Evaluating Conditions in Major Chinese Housing Markets, 2010, page 14

light transactions in which SOEs paid Billions of Yuan to purchase land in the land auctions, setting record prices. Testifying to the strength of SOEs in the market, the largest private real estate developer opted out of the public land auctions, with its Chairman considering competition between private firms such as his and SOEs futile.12According to some analysts, this represents an unhealthy cycle in which State owned firms borrow from state owned banks at artificially low interest rates and then invest in the property sector, the primary proceeds of which go to the local governments. Thus, the money circulates within the pockets of the government itself. There is a widespread perception that the Chinese government sees SOEs as direct means of achieving its economic goals through making markets. Thus, as the activity of SOEs was dramatically increased in the period following the stimulus programme and the global economic crisis, after fears of overheating in the property market became widespread in 2010, the SASAC released new regulations stating that all SOEs whose core business activity was not real estate were to exit the housing market. Although this regulation covered a total of 78 corporates, the exit from the industry, in order to prevent a rapid decline in prices was done in a phased manner, with 14 firms exiting the market in 2010 and another 20 projected to exit in 2011.13 This action on the part of the central government shows that through the SASAC it still exerts significant control over movements in the sector, just as it did in 2007 when it was successful in diffusing an overheated market using measures such as increased down payment requirements for homeowners and lesser credit to the industry. As long as the largest players in the industry, namely the banks that provide credit and the SOEs that have the potential of constituting a majority of total demand are controlled by the Central Government, it will continue to possess the power of regulating movements of the sector .
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The Housing Sector in China is intimately connected to the countrys growth on several levels, thus making its sustainable rise important to the economy as a whole. Over the last few years, especially since the period of the global financial crisis, the driving force of Chinas growth has been its investment in infrastructure and fixed assets such as housing. In 2009, fixed asset investment in China contributed to 90% of economic growth when the countrys other growth engine, its exports, slowed substantially. Investment, as a proportion of GDP grew to an extraordinary 58%.14 Firstly, infrastructure spending is largely determined by local governments, for whom land sales constitutes among the most important sources of income. From the study by Deng, Gyourko and Wu, this role of land sales in providing funding for government projects during the period is easily observed. From 2003 to 2007, ratio of land-to-house value was between 30-40%. In 2008 and 2009, this jumped to over 60%. A decline in the sector, producing a fall in housing prices will significantly affect the governments ability to fund such projects in the future. In the background of another global economic slowdown, which many are projecting as a double dip recession for developed countries, this situation may lead to the first instance when China would not escape unscathed form the crisis. In addition, the sector constitutes demand for production and employment in other sectors such as construction. It also plays the crucial role of reducing fears of overcapacity in sectors such as steel and helping boost domestic demand for products like furniture and electrical appliances, essential considering consumption as a proportion of GDP in China is among the lowest in the world at 34%.


National Bureau of Statistics of China (source data at caldata/Quarterlydata/t20100301_402623502.htm).

In essence, Chinas housing sector exhibits a complex picture which involves several factors that have contributed to the boom, including a heavy role by the government, through the strong buying from SOEs and easy credit form the large public banks, strong underlying trends of urbanization and migration, and most importantly a rapid rise in income among its Tier Two cities. At the same time, the government also possesses the power of controlling an overheated market like it has shown in the past. However, with the possibility of another global slowdown, the intrinsic force of falling asset prices including securities and property, coupled with the phased exit of SOEs form the housing sector, may cause a precipitous decline in property values, especially in cities such as Beijing. With trends like urbanization and growth in population stabilizing further in the medium to long term, the fundamentals of growth in the sector do not match up to those in the previous decade. It remains to be seen whether the housemaids decision to cash in on the housing boom turns out as a prudent one. However, given the current condition of housing markets in the nation, she should certainly heed her employers advice of using maximum leverage and protecting herself from the volatility in the sector that may persist in the coming years.