More On China’s Frothy-Looking Housing Market

We put up a post in late December which keyed off a discussion by Patrick Chovanec . Chovanec argued that real estate was increasingly serving as a vehicle for speculation, with many units kept vacant by investors:

In China, however, “flipping” is not the problem. Some people may be engaged in short-term ”flipping,” but as I’ve described in my FEER article “China’s Real Estate Riddle,” a lot more are buying residences — in many cases multiple units — and holding them vacant indefinitely as an unproductive ”store of value,” like gold. As I mentioned in my article, the Financial Times estimates that there are 587 million meters of apartment space that buyers have purchased over the past five years only to leave lying empty (for a concrete notion of what this statistic means, take a look at Al Jazeera’s report on Ordos). This puzzling phenomemon is due to the fact that Chinese citizens have relatively few investment options, and China’s real estate sector (unlike its stock market) has never experienced a sustained downturn since the country converted to private home ownership in the mid-1990s. The fact that China has no annual holding tax on property means there is little penalty for letting property lie idle, in the hope that it will appreciate or at least retain its value. The result is an inflated market where the demand for property as a pure investment vehicle far outstrips the demand for affordable, usable space.

If people were trying to “flip” their properties, that might actually be a good thing. At the very least, it would mean those residences would have to be brought onto the secondary market and priced. What we see in China, though, is an extremely weak secondary market. In the U.S., the ratio of secondary to primary residential property transactions for the first half of 2009 was 13.45; in Hong Kong it was 7.25. In China as a whole, that ratio was 0.26 (four times as many new home purchases as secondary sales). Even in China’s most developed markets the ratios were just 1.30 for Beijing, 1.56 for Shanghai, and 1.35 for Shenzhen. [Keep in mind that an immense quantity of existing housing stock was privatized in the 1990s, at nominal prices, so the explanation cannot be simply that China is a “new” market — China actually has a higher rate of established home ownership (80%) than the U.S. (70%)].

Chovanec got some pushback, and has offered some further commentary on his blog (hat tip reader Michael):

One of the comments posted on SeekingAlpha framed the first argument, about leverage (or lack thereof), quite well:

If they are buying and holding long term without using it (as a store of value), then they must not be taking on loans to do so.

If that is the case, then it is not an asset bubble. Bubbles are fueled by cheap debt. If they are paying in full, then they can just sit on them forever without problem, if that is their preference. They aren’t hurting anyone by doing so. Eventually, their economy will grow to the point that they will sell their holdings (so long as their government continues to liberalize their economy). Until then, there isn’t really a problem.

I don’t mean to pick on the reader by citing him here — quite the contrary, he offered a very succinct and articulate summation of an argument I hear quite a lot, both outside and inside China.

Yves here. The idea that asset bubbles depend on leverage is inaccurate. In the dot-com mania in the US, borrowing played a trivial role (there was an increase in margin debt, which occurs in most bull markets, but it remained a very small percentage of market capitalization). Cheap lending makes asset bubbles more likely, and also makes their unwind fare more destructive (as in not only does the investor/borrower lose, but in many cases the lender loses too, and since most lenders are pretty highly geared, the damage can blow back and impair the banking sector. Chovanec, addresses this longer-form, with more examples and more detail, but the premise hold. His discussion of how leverage works in the Chinese real estate market was very interesting:

China’s property markets are leveraged….

Chinese developers must use their own capital to secure land. Once they do so, banks will lend them 65% of the money they need for construction and related development costs, with the land pledged as collateral. But saying developers must use “their own capital” to buy the land is a bit misleading…. By taking on loans at multiple layers of holding companies, a developer can leverage up considerably to cover his “capital” commitment to the banks.

In today’s hot residential property market, developers usually pre-sell all their units well before they complete the project. …..there’s a huge pipeline of residential projects for which land has been purchased or construction is underway but pre-sale proceeds have yet to exceed construction loans. If a crash were to take place, the junior creditors would be left holding the bag. It’s very hard to quantify the extent of this exposure, due to the indirect way many of these loans were raised and channeled into real estate.

According to the latest statistics I’ve seen, approximately 50% of all residential purchases in China today are financed with mortgages, which are mainly provided by the big state banks. That’s a sharp increase from just a few years ago, when nearly all such purchases were made in cash. In theory, the rules allow 30-year mortgages, but anything longer than 20 years is rare, and the presence of high prepayment penalties tend to push buyers towards mortgages with even shorter terms (our own mortgage was, believe it or not, 3 years, which is more like an installment plan!). The terms for buying a second or third place are much steeper than buying a first home, and my impression is that the vast majority of mortgages being issued are going to people who actually intend to live in their unit, whereas people buying multiple units as investments are mostly paying cash. And by the way, the banks don’t securitize the mortgages (at least not yet, there’s some talk of pilot projects in this regard), but hold them on their balance sheets.

Obviously the investors paying cash don’t present a credit risk — in that sense, the people using real estate as a store of value, a place to stash their cash, are helping to deleverage the developers. And to the extent they’re buying units pre-sale, it’s a pretty rapid deleveraging process (of course, in this market, the developers are just releveraging back up again to build the next project). So what about the mortgaged buyers? Well, the fact that they live in their units reduces the risk — they’re likely to pay up to avoid losing their homes. But the fact that they’re stretching themselves so thin to buy into such a high-flying market, in competition with investors, on accelerated repayment terms is some cause for concern. In the TV show “Dwelling Narrowness” — which encapsulated middle-class distress at rising housing prices in China — the main characters’ mortgage payments end up amounting to 2/3 of their combined monthly income. That may be on the high side, but it’s not too far outside the mainstream. ….The good news, however, is that China’s mortgage market is relatively small — about 10% of GDP, compared to 48% for Hong Kong. But it is growing rapidly, and the second half of 2009 saw a big push in mortgage lending from the banks, as part of the stimulus effort.

Ahem, this does not look pretty….

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  1. Rahul Deodhar

    Chinense and for that matter many other real estate companies create a web of subsidiaries to obfuscate the real cash flows. Many analysts don’t even have a foggiest idea what goes on inside the statements. The leverage is higher and more destructive than what seems and eventually the home buyers is left carrying the bag. I expect more delays (that has already started since 2008 Dec) in pre-sold projects while new projects keep getting launched.

    In India this phenomenon has been repeated in a 10-13 year cycle for quite sometime yet the lessons are long forgotten by the time next crisis comes along. (haven’t we heard it many times on this blog!)

    1. Brain

      People need a place to live? The article makes it pretty clear that a large amount of those units are purchased as investment and never occupied.

  2. David

    Some Chinese are quite rich. Some pool family money, after all they have been saving for years. This is what they spend on.

    The leverage story is actually quite unthreatening. Half-built projects that are not pre-sold are leveraged. If the market were to go down a lot, some developers would blow up and some of those might projects not be finished, which is fine for the property values of existing finished apartments. Banks would feel more pain than real estate would.

    Everything else is held by strong hands: investors owning for cash (and paying low property taxes and maintenance fees, not like the high carrying costs in USA) or owners with relatively short-term mortgages.

    The facts discussed in the article look fine. Yves, why do you say it doesn’t look pretty?

    The only concerns I have are matters not discussed in this article: the value to income ratio, and the related fact that rents are low relative to purchase prices. If the younger generation someday decides to keep living with their parents, the market could crash. But for now, people need a place to live.

    1. Brain

      (Dammit, I replied to the wrong comment)
      People need a place to live? The article makes it pretty clear that a large amount of those units are purchased as investment and never occupied.

      1. attempter

        Yes, I couldn’t help focusing on this

        If they are paying in full, then they can just sit on them forever without problem, if that is their preference. They aren’t hurting anyone by doing so.

        in the comment cited in the OP.

        I understand that alot of people are psychopaths who think it’s morally OK to hoard and speculate on a scarce necessity, driving up the price for those who do in fact want to use it. (Although it’s truly pathetic how high a percentage of them are losers who will never have speculation money themselves, and their sick attitudes are only attacks on themselves and their own families. It just goes to show how stupid they are.)

        Well, like I said I see how common the psychopathy is, but what’s most idiotic about it is how many are so brainwashed and/or cowardly that they’ll not only make that immoral assertion, but feel the need to add the lie that it doesn’t hurt anybody, when it obviously hurts every non-rich person who actually wants to use a residence to live in.

        Why are they such cowards about that? I guess to admit the truth would show up the fundamental lie of all economic “libertarianism”, that it is indeed intended to justify hurting others, very aggressively.

        There’s no spare capacity on the planet anymore. All the space and resources have to be spoken for.

        That means speculation in and hoarding of any necessity can no longer be tolerated. It’s a crime.

        1. Dan Duncan

          Attempter, thee doth Project too much.

          What an odd comment. Psychopaths!?

          The most disturbing part, though, is the concluding sentence: “That means speculation in and hoarding of any necessity can no longer be tolerated. It’s a crime.”

          If one disagrees with economic “libertarianism”, OK, fine. But is this your alternative??

          Seriously, (and I swear–I’m not being sarcastic) you’ve got to follow up on this line of thinking. Maybe Yves could let you write a guest post?

          1. If so, how would your society define “speculation in and hoarding of”?

          2. How would it define “necessity”? [Would necessity be a static concept?]

          3. Now for the most interesting parts: Who would do the defining in #1 and #2? The Government!?


          4. How would the “tolerance” part be enforced?

          This stuff has “Manifesto” written all over it.

          1. Toby

            Dan Duncan,

            them is important questions, your implication being state control cannot work. Do you think “free market” liberal economics can work beyond the carrying capacity of the planet? Does the planet have a finite carrying capacity and will we sorry animals, economically addicted to perpetual growth as we are, soon run into the hard-hitting wall of that capacity?

            My thinking on this is that NO system predicated on scarcity and the subsequent price-based distribution of goods and services can function healthily any more. We have two serious problems to deal with. The first I mentioned in my opening para (Mother Earth), the second is the effect of ongoing technological development on our current economics, which is essentially a “science” for dealing with the problem of unlimited wants versus limited resources. This second problem, the tech problem, comes in two flavours:

            1. scarcity is solvable in various ways
            2. technological unemployment

            The long-term solution to the problems I highlight may well be a resource-based economy where the need for trade is transcended (or rendered redundant) by overcoming scarcity and producing abundance. That abundance might be the solution to an ecosystem struggling to support us humans most likely seems at first blush the stuff of lunacy, but properly seen scarcity fosters greedy and hoarding behaviours, the need for money and stores of value to protect against future want, and an incredibly complex and unwieldy socio-political infrastructure that is now out of our control. We flesh and blood beasts simply can’t keep up any more. We can’t run the show. It’s too big.

            Transcending scarcity would be accomplished both technically (via deliberate and global focus on renewable energies, new house/city/transportation designs etc) and through refreshing/updating our understanding of, and relationship to it. Marshall Sahlins is helpful here (The Orginial Affluent Society is available online) as is an article by Sam Vaknin called “The Misconception of Scarcity.” We have a deep problem in which our total systemic dependency on “growth” and monetary evaluations of wealth, are directly contrary to a healthy relationship with the planet upon which we actually depend. Overcoming this will take a massive rethink, way beyond what is offered by the capitalism and socialism variants we know today. To progress beyond this point we need to pursue a new direction, not introduce a new law or tax band. Tinkering isn’t going to cut it.

            As to who makes the decisions, who, or what, makes them today? Money is my answer. If a solution or plan does not make financial sense, it won’t get implemented. Is that wise? Is that sustainable?

            That’s my way of seeing this anyway. You kindasorta asked.


          2. attempter


            The psychopathy of today’s economic actors is well established. It’s a truism I repeated.

            As for my society, it doesn’t need the all the complex regulations that detractors claim.

            Rational, fair marginal tax rates, along with draconian penalties for fraud, embezzlement, looting, and extortion, would clean up the problem of patholgical wealth accumulation nicely, so that we wouldn’t have to worry about oh-so-“innovative” people with too much idle time and money on their hands.

            As for casino gambling, simply restore the good old bucket laws and such. There’s no reason any derivative which isn’t bought by someone actually making or taking physical delivery should have legal status at all.

            Let the gamblers go back to the old numbers rackets if they so badly need to gamble.

            (Since you get such a rush out of my comments I’m surprised you don’t check out my blog. Lots of pinko stuff there. Your head would explode, you’d be so enraged. :) )

  3. GA

    Since leverage is generally measured as a percentage or multiple of the equity, and real estate markets depend most significantly on the most recent valuation to determine the amount of acceptable leverage (for bank lending purposes), leverage if measured over other measures would be much, much higher in a market that is growing rapidly.

    Leverage should really be measured compared to cash flows (see Minsky). The old commercial property measure of cap yield attempts to capture this cash flow – hard to see how you apply to places sitting empty (probably correct for expected amounts of empty space).

    These comments do not prove anything about China, but I will add that in markets where developers and governments make related non-cash deals based on notional valuations, the issue of value and leverage gets even more problematic – and likely existing notions are just plain wrong.

    From experience in other similar markets (Russia in particular), I can say two things that are almost certain to be true in China as well: 1) Banks ALWAYS have far more exposure to real estate than they think (usually because they were lending based on collateral value, which is likely overstated), and 2) Systemically, borrowers frequently have far more exposure to cash flow risk (hence leverage) than anyone thinks (usually because their ability to service real estate debt is dependent on a whole bunch of other counterparties who are deriving cash flow from real estate).

    For the second point, remember multipliers: everyone who has a job or business turnover to the construction sector will be hit if it collapses.

    Also from experience in Russia and other countries: comparisons based on the amount of mortgage lending compared to GDP are useless. Everyone in Russia would say there was no issue in real estate because bank/mortgage lending was very low compared to the West, ignoring that it was even lower in e.g. Kazakhstan (which suffered a massive collapse in real estate prices).

    Again, this doesn’t prove anything about China, and not my area of expertise. But I’ve seen this film before, and it always ends badly.

    On the positive side, borrowing in China is in own currency, compared to Eastern Europe, where borrowing was either explicitly in foreign currency, or dependent on an explicit currency peg.

  4. Samuel Morales Jr.

    I think the Chinese are using housing as a way to get out of the US dollar. Using it as a long term investment. The amount of liquidity should be measured. The housing bubble in the USA had extreme liquidity. Credit is being used to build these things. China said this explicitly not long ago. Also to note, China has savings, and because of savings they go on the housing binge. There is much vacancy in China, but doesn’t seem to have the same behavior like the red hot liquidity of the US housing bubble. Sure it is a bubble at some level, but I don’t think no where the size of other infamous housing bubbles like that US had.

    1. DownSouth


      I think you’re on to something there.

      I live in Mexico, where the latest statistics I’ve seen indicate about 6% of homeowners have mortgages, the other 94% owning their houses outright.

      Money, dollars or pesos for instance, are the quintessential social construct. Houses are of course much more of a social construct than raw land, but not nearly so much as money.

      In Mexico revolutions come and go. Governments come and go. Currencies come and go and also experience wild fluctuations. Mexicans therefore look much more favorably upon something real—like land or houses—than they do pesos or securities. The logic is this: governments and currencies and corporations can come and go, but if you own a piece of land the land or a house (no mortgage) and can hang onto it, at least you’ve still got something.

      I suppose one could criticize this as being a feudal attitude. However, it is the mentality that develops when the stable conditions for a modern economy don’t exist. And I suspect that the Chinese might be correct in their assessment that the conditions for a modern economy are no longer all that solid in the United States. Or maybe their attraction to real estate is a vote of no confidence in their own government.

  5. pigeon

    If the facts in the article are correct I find that very encouraging. It would contribute to some elasticity of the chinese economy. Unlike the west where the economy is blown up through leverage, the opposite seems to be the case in parts of Chinas real estate market. Since credit is growth brought forward this could provide room for future real growth in the chinese economy. The demand for housing in chinese urban areas will certainly rise some time in the future. When that happens the government can simply employ high property taxes to bring these withheld units to the market and in doing so put a cap on price appreciation.

  6. mxq

    FT’s China bureau chief wrote up a piece last night that cited Chovanec (aside: that’s the first time they’ve cited him, i have a feeling Yves earlier post got a his attention) — here’s a scary anecdote he cites:

    “Indeed, there is a whiff of Dubai about the Chinese property market at the moment. In Tianjin, a city two hours from Beijing, a developer is starting work on a vast project of luxury villas, built in clusters named after continents, which form the shape of a world map. If that does not sound familiar, nothing screams Dubai more than the 7-star hotel and indoor ski slope that are also part of the plans. (In defence of the skiing, it was -11°C in Tianjin on Wednesday, compared to Dubai’s 23°C.)”

  7. MyLessThanPrimeBeef

    That Beijing project with villas which form the shape of a world map – that’s not trying to imitate Dubai.

    No, Chinese Exceptionalism would not allow that.

    That’s probably, and I could be wrong, an imitation of the tomb of Shihuangdi (he was the First Emperor, as opposed to the Last Emperor Puyi, who was the last Manchu emperor, i.e. of the Imaperial Kanto Army controlled Manchuko, but really not the last Chinese Emperor since that honor went to Shikai Yuan).

    Inside Shihuandi’s tomb, as yet unexcavated, there is, supposedly, a map of the world carved on the tomb floor, with mercury-filled rivers and the sky, i.e. the ceiling, filled with shining precious stones.

    There you have – Chinese Exceptionalism.

    I hope, unlike 2,200 or 2,300 years ago, not only dead people will visit that project.

    But then, Chinese Exceptionalism probably dictates they are different and only dead people will go.

    That’s Chinese Exceptionalism for you – the whole world is in depression but they are different, they are immune, they are better, they are stronger than the rest of us…they invented toilet paper.

    Welcome to Chinese Exceptionalism.

    (Don’t forget you heard it here first).

  8. purple

    Hoarding is incompatible with healthy capitalism. Read Marx on India (re: gold), or China (re: silver) . The antidote seems to be large state directed investment, but I would argue that it doesn’t fully replace private sector investment if a community wants to integrate within the world capitalist system.

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