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Chinese property

When a bubble is not a bubble

A severe imbalance in land supply fuels China s wild property market

Oct 15th 2016 | SHANGHAI

ESTATE agents in China, as elsewhere in the world, are normally a

smooth-talking, self-assured bunch. But Liu Zhendong, a salesman at a large

development in the northern reaches of Shanghai, is afflicted by doubts. He had

expected business to be solid and steady this year. Instead, it has been manic,

with clients jostling to see show apartments. Some had hoped to wait for the

market to cool, but capitulated and bought as prices climbed higher week after

week. Flats in the area, the once-rural village of Malu, still dotted with

fields and scruffy wholesale food markets, now cost 90% more than a year ago.

It feels a bit like a bubble, he says.

Mr Liu is in good company. Even the head of the central bank s research bureau,

usually cautious in his choice of language, has said a property bubble must be

stopped before it gets too big. House prices have climbed by 16% nationwide

over the past year, and double or even triple that in big cities. So in the

past two weeks more than 20 municipalities have tried to calm the market down

for example, by requiring higher down-payments or limiting purchases by

residents of other cities.

As the past decade has shown, the ups and down of China s housing market are of

global significance. Totting up the property sector s impact on investment and

consumption (all the furniture and gizmos that fill new homes), it accounts for

about a quarter of Chinese GDP. So this year s rebound has prompted both hope

and dread. It has helped GDP growth stabilise at about 6.7%, faster than most

analysts forecast in January (third-quarter data will be released on October

19th). Stronger demand for iron ore and copper has given beleaguered miners a

measure of relief.

Optimism, however, has been tempered by concerns about the nature of the

revival. Surveys indicate that about one-fifth of buyers are investors rather

than owner-occupiers. CEBM, a research firm, estimates that this share rises to

up to 60% in core districts of mid-sized cities. Even more worrying has been

the increase in property developers borrowing. Zhang Zhiwei of Deutsche Bank

says they face a prisoner s dilemma: if too conservative, they will get

squeezed out of the market; so they choose to be aggressive. They have driven

up land prices by 66% this year, according to an index of 100 leading cities.

Mr Zhang examined 252 of these land auctions and concluded that two-fifths of

winning bidders will lose money if house prices level out, let alone decline.

The sharp rise in house prices also seems out of kilter with the broader

economic picture. Income growth is slowing as the economy matures, making homes

steadily less affordable. That helps explain the frenzy in the market. During a

holiday week at the start of October, huge crowds swamped sales centres when

new properties were put on the market. In Shanghai, divorces have spiked as

people take advantage of a loophole in regulations. Couples can get a

preferential mortgage rate only on their first home. Divorced spouses can

benefit by buying homes separately and then remarrying.

Such behaviour smacks of irrational exuberance, but caution is in order before

delivering that verdict. Investors, analysts and the press have been predicting

Chinese real-estate Armageddon for the better part of a decade. But there has

been no nationwide crash. Prices have weakened for a time, typically when the

government clamps down on buying, only to take off again every few years.

For all the signs of excess, officials have in fact done well to guard against

the biggest potential vulnerability: over-borrowing by homebuyers. Despite a

recent surge in mortgage lending, household balance-sheets are on the whole in

good shape. Moreover, strict down-payment rules mean that buyers typically put

up cash for as much as half the price of the home. Even if prices fall, they

are unlikely to walk away from their mortgage debt. This helps insure against

the downward spiral of foreclosures and falling prices that has wreaked havoc

in other countries.

This is not to deny that the Chinese property market faces serious problems.

But bubble may be a misdiagnosis. The real pathology is a severe imbalance in

land supply, argues Larry Hu of Macquarie Securities. Smaller cities have

plenty of land for building but shrinking populations. Big cities, where people

actually want to live and work, are sitting on large land banks but releasing

only small plots. Shanghai has about 1,800 sq km of farmland but sold only five

sq km for home-building last year. The result, predictably, has been soaring

home prices.

Why not sell much more land in big cities? Doing so would fundamentally alter

the rules of the game, causing pain for lots of important players, Mr Hu

argues. Governments in big cities count on incremental land sales as a source

of revenue; governments in small cities hope the restrictions will eventually

send people their way. This is, in other words, a political problem as much as

an economic one.

Mr Liu, the agent at the Malu development, knows both sides of the property

market. A few years ago he bought a flat in his home town of Jiuhuashan, a

five-hour drive to the south-west. It now gathers dust, empty except for a week

during the Chinese New Year holiday, when he returns home. Still young, he has

no intention of moving back to Jiuhuashan permanently. The mountains there are

stunning but the economy sleepy. Rather, Mr Liu hopes to buy a home in Shanghai

eventually and has started saving up for it. The booming prices of the past

year have kept him busy at work, but pushed his dream ever further into the

distance.