by Jim Juback
Many aspects of China’s real-estate bubble mirror the run-up to the housing bust in the US. But there are important differences as well.
The consensus is that China has a real-estate bubble. The only argument is whether it will burst in some crash that will take down China’s economy or come in for a relatively soft landing that slows China’s economic growth but in no measure extinguishes it.
It’s tough for me to come down on either side of that debate, because most of the time the protagonists don’t bother to set out what the bursting of a real-estate bubble would look like in China. There’s a kind of unspoken vague agreement that a Chinese bust wouldn’t look like a U.S.-style one, but no real effort to put flesh on the bones of a China-style bust.
What ‘middle class’ means in China
And without fleshing out what a real-estate bust in China would be like, it’s just about impossible to decide the seriousness of that bust or the extent of its consequences.
Let me take a run at that and see if the effort helps settle the crash-versus-soft-landing debate. Or at least moves it along a bit.
I don’t think there’s any real argument about this: China is in the midst of a speculative rise in real-estate prices that can’t be sustained.
Bubble fears in China
Housing prices rose at an 11.4% annual rate in June. And that was down from a 12.4% annual rate of growth in May and a 12.8% annual rate of growth in April. New-home prices rose even faster — at an annual rate of 14.1% in June.
With prices rising at that pace, developers and speculators have rushed to build. In the first five months of 2010, investment in the property market grew 38.2% from the corresponding period of 2009. And that rate was 2 percentage points higher than in the first four months of the year.
With supply soaring, only cheap money kept the game going. Banks flooded the market with mortgage money in 2009 and into 2010. Loans for second homes. And third homes. Loans to buyers with inadequate incomes. Loans to buyers without credit checks.
Up to this point, the scenario sounds incredibly similar to the run-up to the housing bust in the United States. But there are crucial differences. Let me describe a few.
No. 1: Chinese buyers aren’t nearly as leveraged as US buyers were
Down payments in China were a high 30%; in the U.S., at the height of the frenzy, lenders were bundling two mortgages together so that a buyer could borrow the required (and much smaller) down payment as well. Homebuyers effectively were putting nothing down.
And Chinese homebuyers started off with a much larger base of savings. In 2009, the Chinese savings rate was about 40%. In the years just before the end of the U.S. boom, Americans’ savings rate had actually turned negative.
As a result of those differences, I don’t think a real-estate bust in China would set off the huge contraction of family balance sheets and consequent steep drop in consumer spending that have resulted from the bust in the United States.
No. 2: The US boom was top to bottom
Rich people in California and Florida and poor people in rural North Carolina and Detroit all got sucked into the whirlpool either through mortgages that let high-income families buy more house than they could afford or through 0% teaser financing for low-income families that couldn’t pay once the real interest rates kicked in. In China, the boom has been concentrated at the upper end of the income scale.
Speculators have built more and more luxurious apartments and houses at higher and higher prices for China’s population of the newly well-to-do. At the same time, the country is facing an extreme shortage of affordable housing for middle-class Chinese families.
That has created a strangely bifurcated market. At the upper end, huge building programs and the Beijing government’s recent moves to slow lending have created a large supply of empty luxury apartments. Prices in this part of the market have just started a drop that could easily extend to 20% or 30%. In Shanghai, the price of the average new luxury home dropped 13% from April to July, according to China Real Estate Information. (That took the average price for a luxury home down to a still very elevated $856 a square foot.)
At the other end, rapidly growing cities such as Chongqing are launching crash programs to build housing for anticipated millions of new inhabitants who have been priced out of the private real-estate market. In the case of Chongqing, projections call for 1.5 million new inhabitants over the next three years, and the city plans to build about 323 million square feet of public housing to meet the demand.
This bifurcation means China is unlikely to see the collapse in housing construction after a bust that has characterized the U.S. experience. If the high end collapses, as seems possible, taking many developers into inactivity if not actual bankruptcy, the public sector is already gearing up to take up the construction slack. And in a command-style economy such as China’s, revving up a public-housing construction program is actually easy.
(For more on some of the advantages and disadvantages of China’s command-style economy, see my July 12 column, “Can China keep its economy afloat?”)
A housing market bust in China would have less effect on national economic activity after the initial shock than the bust in the United States has had.