Just how risky are China’s housing markets?

Complementing today’s piece on the Chinese property bubble, a cross-post from VoxEU, with some graphical depictions of how wild the bubble has become. The NYT article referenced in the piece is here – RS.

By Yongheng Deng, Professor of Real Estate and Finance at the National University of Singapore, Joseph Gyourko, Professor of Real Estate, Finance and Business and Public Policy at the University of Pennsylvania, and Jing Wu, Assistant Research Rellow at the Institute of Real Estate Studies, Tsinghua University.

Reinhart and Rogoff’s recent influential study of financial crises finds a recurring root – the country’s property markets. This column argues that a similar housing bubble may be developing in China. Urgent research is needed to determine the risk of a full blown crisis.

China is experiencing spectacularly fast growth – so fast that many fear it is driven by a bubble – a property bubble to be precise. Recent memories of what happened when the US housing market bubble burst make the possibility of a Chinese housing bubble a critical concern for the world economy. So, is there a bubble or is it simply hot air?

Financial bubbles are governed by something like the economic equivalent of physics Heisenberg’s uncertainty principle. It is impossible to observe a bubble with certainty without actually altering the bubble itself. If people knew it was a bubble, it wouldn’t be a bubble – it would have already collapsed. It would not, however, be impossible to envision “diagnostic tests” that would provide a probabilistic identification of a bubble. Unfortunately the state of economics does not provide such a procedure (see Flood and Hodrick 1990 for an early analysis of what would be required to determine convincingly whether or not a speculative bubble exists).

The problem is particularly acute in the case of Chinese housing. Data limitations arise from the fact that there was no real private market in land or housing units in China until the late 1990s, so it is only possible to compare current conditions to little more than a decade of previous data. It is not hard to find highly respected professional investors with opinions on both sides of the question over China’s bubble (see the article by Barboza 2010 in The New York Times for a discussion).

New evidence on a Chinese housing bubble

Our look at the available data strongly suggests that prices are quite risky at current levels, and that it would take little more than a modest decline in expected appreciation to engender sharp drops in prices. The first foundation of this conclusion is that home prices in China are at their all time highs, and have been appreciating at especially high rates recently. This is documented in Figure 1 which plots real and nominal price indexes developed at the Tsinghua University for newly constructed homes in 35 major cities.

Real prices more than doubled over the past decade, with appreciation rates escalating at the beginning of 2007 and then again in early 2009. The most recent data show a record 41% (annualized) growth rate for the first quarter of 2010.

Figure 1. Constant quality price index for newly-built private housing in 35 major Chinese cities, 2000-2010

Source: Wu, Gyourko and Deng (2010). The underlying data source is the Institute of Real Estate Studies, Tsinghua University. See the discussion in Wu, Gyourko and Deng (2010) for more on how these indexes are created.

But it was not high price levels alone that convinced Case and Shiller (2003) and Shiller (2005) that US house prices had become unsustainable – it was the all-time high price-to-rent and price-to-income ratios.

Information on price-to-rent ratios is less widely available for Chinese markets. Figure 2 plots them since early 2007 for eight major Chinese cities. Price-to-income ratios are then plotted in Figure 3 for these same markets, using data back to 1999. For those unfamiliar with these markets, they are listed on the map in Figure 4. Each is among the largest markets in China, with none having a population below 8 million.

  • Price-to-rent ratios have increased by at least 30% over the past 3 or so years in each of these cities.
  • The jump was very large in Beijing, rising by almost three-quarters from 26.4 in 2007 to 45.9 in the first quarter of 2010.
  • Hangzhou, Shanghai and Shenzhen also have seen their price-to-rent ratios rise sharply to over 40.

Even though income growth has been strong in urban China, price-to-income ratios also have been increasing in these same markets.

  • Income growth did keep pace with house price appreciation in the other large markets, so housing has not become less affordable everywhere, according to this metric.

Figure 2. Price-to-rent ratio in eight major Chinese cities, 2007-2010

Source: Wu, Gyourko and Deng (2010). The underlying data were collected by the Institute of Real Estate Studies, Tsinghua University. See the discussion Wu, Gyourko and Deng (2010) for more on the creation of these ratios.

Figure 3. Price-to-income ratios in eight major Chinese markets, 1999-2010

From Wu, Gyourko and Deng (2010). See that article for more on the creation of these ratios.

Figure 4. Map of the eight major Chinese cities

Chinese government data indicate that these price rises are underpinned by rapidly escalating land values. Because the Chinese government still owns all the land in urban areas and leases its use for long periods of time, we can observe land prices independently from home sales (which include the land plus the structure). We collected data on all the residential land parcel auctions in Beijing dating back to Q1 2003, and created a constant quality price index for Beijing residential land, controlling for a number of location and site quality variables that are described in Wu et al. (2010).

Figure 5 shows that real, constant quality land values increased by over 750% since 2003 in the Chinese capital, with more than half of that rise occurring over the past two years. Additional regression analysis showed that state-owned enterprises controlled by the central government played a meaningful role in this increase, as prices were 27% higher on the parcels they won at auction compared to otherwise equivalent land sites purchased by other investors.

Figure 5. Real constant quality residential land price index for Beijing, 2003-2010.

From Wu, Gyourko and Deng (2010). See that article for more on the creation of the index.

Suspicions if not proof

While it is impossible to conduct a formal test of whether there is any fundamental mispricing in Chinese land and housing markets with these limited data, there certainly is much to make one more than a little suspicious that prices are unsustainable.

  • The magnitude of the increase in land values over the past 2-3 years in Beijing is, to our knowledge, unprecedented.
  • These increases post-date the Summer Olympics and the recent price surge in early 2010 suggests a relationship to the Chinese stimulus package which itself is temporary.

The role of state-owned enterprises also is potentially worrisome. It could be that these entities are superior investors and are purchasing sites that are of especially high quality in ways that we cannot control for in our empirical analysis. However, it also could be that moral hazard is at work here, as these entities are thought to have access to low cost capital from state-owned banks and may believe they are too big to fail. If this is the driving force, then prices are being bid up as one arm of the government buys from another.

More broadly, the sharp rises in price-to-rent ratios in Beijing and the other large markets look to be very difficult to explain fundamentally.

  • Most true fundamentals just do not change so discretely or in such magnitudes as to be able to explain these changes.
  • The standard economic model of home valuation indicates that owners must be expecting very high rates of price appreciation for these price-to-rent ratios to be sustainable.

That people might believe in such high appreciation is not incredible given the recent history of Chinese house prices. However, this sort of backward looking expectation formation is a classic element of bubble psychology. Moreover that history is quite limited and tells us that prices never go up forever – much less at the extremely high rates experienced over the past few years.

What happens if the bubble bursts?

To provide some insight into just how risky prices and price-to-rent ratios are at these levels, we calculated what would happen if people began to expect that their homes would grow in value by only 4% per year. For Beijing, prices would fall by over 40%, absent offsetting rent increases or other countervailing factors. While a 4% rate of appreciation is lower than what has been experienced in the capital city over the past few quarters, house prices did grow by less than that for five consecutive years from 1999-2003. Indeed, 4% is not an especially low rate of appreciation in the broad scheme of things. If it were to continue for a decade, prices would be 48% higher; over 20 years, prices would more than double (+119%).

Reinhart and Rogoff’s recent study of financial crises often finds the genesis in the country’s property markets (see Reinhart 2008 on this site). Recent data indicate there is reason to suspect a similar predicament in China’s housing sector. Whether it leads to a full blown crisis is another matter, of course, that depends upon the amount of leverage in the system and the safety and soundness of the regulatory environment, among other factors. Those clearly are matters in need of urgent research if we are to fully understand the potential fallout from a meaningful drop in Chinese house prices.


Barboza, David (2010), “Contrarian Investor Sees Economic Crash in China”, The New York Times.

Case, Karl and Robert Shiller. “Is there a Bubble in the Housing Market?” Brookings Papers on Economic Activity, No. 2 (2003): 299-362.

Flood, Robert and Robert Hodrick (1990), “On Testing for Speculative Bubbles”, Journal of Economic Perspectives, 4(2):85-101.

Reinhart, Carmen and Kenneth Rogoff (2009), This Time Is Different: Eight Centuries of Financial Folly. Princeton University Press.

Reinhart, Carmen (2008), “Eight hundred years of financial folly”, VoxEU.org, 19 April.

Shiller, Robert. Irrational Exuberance (2nd edition), Princeton: Princeton University Press, 2005.

Wu, Jing, Joseph Gyourko and Yongheng Deng. “Evaluating Conditions in Major Chinese Housing Markets”, NBER Working Paper 16189, July 2010.

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  1. liberal

    Reinhart and Rogoff’s recent study of financial crises often finds the genesis in the country’s property markets (see Reinhart 2008 on this site).

    Why? Because people like free money (i.e., collecting economic rent).

  2. But What Do I Know?

    “Prices are being bid up as one arm of the government buys from another”

    Bravo! Why didn’t we think of that? Now they just need to find a bagholder. . .

  3. Vangel

    In 1996 I took a short vacation during the Chinese New Year period when I wound up in a hotel at the border with Burma. The hotel was quite nice but was located in an empty new town that was a few kilometers away from a perfectly good older town that was bustling with activity. When I got back home to Xi’an I started to look around and count construction cranes and was shocked that there were so many more than what one would find in the Toronto area, which was comparable in population and experiencing an influx in population that was making the need for new housing units obvious. Over the next year of travel within China I began to look for construction activity. In Beijing, Shenzhen, Shanghai, and Wuhan I noticed entire blocks being torn down so that newer apartment units could be erected in the same place. I noticed that many small towns were booming as construction crews were building new factories, shops, houses and condominiums. I also noticed the protests by people upset that their housing was not built as promised. And heard ordinary people talking about buying an extra apartment or two that they could rent out.

    At that time I was as certain as one could be that China was in a huge housing bubble and if forced to place I bet I would have felt as comfortable being short housing as I would have going long. In this I was not alone because analysts like Andy Xie and others were calling for a housing downturn and pointing to observations that were similar to mine as evidence of a huge bubble.

    The current housing bears may be correct and we could see housing in some if not most areas decline sharply. But there may be other outcomes not being considered. For one, we could be seeing the Chinese saver hedging against the obvious inflation in the region. From where I stand savers are worried about a collapse in the fiat currency and few options in alternative investments. The Chinese stock markets have not been a good alternative because they managed to lose money for investors even as China was booming. Savings accounts have not been a good idea because they have hurt depositors by yielding less in interest than the loss of purchasing power due to inflation. While gold is an option at this time, China only opened up the bullion market recently and skeptical buyers are worried about fake bars that contain far more tungsten than gold.

    Sadly, the lack of options tends to leave most Chinese investors with real estate as their primary hedging vehicle and that is likely to lead to a bubble. But given the fact that down payments are large and that Chinese are usually willing to make sacrifices and look to the long term the collapse may not be as dire as that in the US. And if there is a loss in fiat currencies purchasers who bought housing units may turn out to have done very well. I know that my friends, who ignored my skepticism and bought apartments in 1996 are looking at massive gains and are now living better than I am.

    1. DownSouth


      Wouldn’t the overall mortgage (debt) situation have a great deal to do with it?

      If someone buys a house or apartment and pays cash for it, that’s a very different story than someone like Richard in his earlier post described: “He borrowed from family and friends to meet mortgage payments twice as big as his take-home pay.”

      In the United States something like 2/3 of homeowners have a mortgage on their home. In Mexico, only 6% have a mortgage.

      This is a purely anecdotal observation, but it seems to me that in high equity environments like Mexico, housing prices tend to be more resilient and not quite as volatile.

    2. Richard Smith Post author

      Agree with DS. Look at the price to income ratio graph – I’d be amazed (and very, very relieved) if that trend isn’t being assisted by some sort of leverage.

      Deploying all your savings on interest payments in the hope that the profits appear before the saving run out may look like an extreme example, but, for instance, Option ARM mortgage deals were that sort of wheeze too, and there were plenty enough of those.

      People do that sort of thing (especially when it seems to be the only game in town).

    3. i on the ball patriot

      Some thoughts on the Chinese real estate privatization propaganda cluster bombs …


      “So why are western media so eager to promote land privatization as a cure, even though it is a “cure” more deadly than the disease? Luke Erickson, a long term observer and researcher of rural issues around the world, suggested [2] that these reports have drawn upon the policy analyses of the U.S.-based conservative think tank Cato Institute and Rural Development Institute(RDI), which have long supported land privatization in China and elsewhere, touting it as the solution to poverty and social unrest3.

      As neoliberal ideology has dominated Chinese intellectual scene for the last quarter century, there is no shortage of Cato Institute and RDI followers among Chinese intellectuals. Many of them have joined forces to push for land privatization. While much of such “advocacy” is under the pretense of peasant interests, it really serves the interest of China’s ruling elites. Li Changping, a former rural official who made his name in 1990s by boldly speaking rural crisis to the former Prime Minister Zhu Rongji, recently pointed that if the state should adopt a policy allowing privatization of land, many cadres will become big landlords overnight whereas many peasants will soon be rendered landless4, “the rural community in China today collectively are heavily in debt totaling several hundred billion Yuans. The creditors who make loans to individual peasants or local governments are primarily members of the officialdom and their relatives or friends. If land privatization is carried out nationwide, then much of the land will be surrendered to pay for the loans they have made. What will be left then for the peasants’ families?”
      However, despite of such dire warnings, there is massive and well-coordinated media effort both domestically and internationally to lobby for land privatization. In October 2008, a party conference communique received a great deal of press attention. It acknowledged many problems created by the ultra small family farms, and outlined rules for internal transfer (within village) of land usage right. In reality, there is nothing new about the document: such internal transfer are common practice throughout much of the countryside, and have been codified into Chinese law since 2002; the ‘new’ measures that emerged from the recent party document were word-for-word the same as the old 2002 law. However, many analysts see it as a step further towards land privatization. And there is growing chorus urging Chinese government to liberalize land ownership for the sake of increasing production and pulling hundreds of millions of peasants into the more prosperous urban economy. One such example is a report titled “China to Create Market for Land Rights In Effort to Boost Farmers’ Prosperity” appeared on Wall Street Journal on October 20, 2008. International Fund for China Environment, a business funded environmental group based in Washington DC, went as far as claiming carbon mitigation credit for advancing land privatization5. Meanwhile, South China Press Corporation, a neoliberal news outlet nicknamed “the CNN China branch” by more and more Chinese readers, carried many articles along similar lines to drum up the support for land privatization.
      Are these views based on simple misunderstandings of China’s rural situation, or are they disguised advocacy for the entrenched interest of the ruling elites? While there are always some well-intentioned do-gooders who might be misguided, the latter cannot be ruled out. During a rural development conference in the summer of 2008, I met a Chinese historian whose major work is to document the co-op history of Chinese peasantry in the last century. He complained bitterly about the media bias against peasants self organization: When President Hu Jintao visited rural villages in his province, he emphasized in length the need for peasants to develop co-ops and build collective economy (which this historian heard by his own ears), yet the President’s speeches were never reported by the newspapers. A later google search reveals that maybe he is exaggerating a bit: sometimes such contents were reported, but usually only in passing with a couple of phases, and never elaborated. It is quite a stark contrast compared to the media enthusiasm on the October communique. If the mainstream media really cares about peasant welfare as they often claim, why are they so indifferent to or even silently against peasants co-ops? This is a revealing example of power dynamics of current China: even the President cannot get himself heard or taken seriously when he talks about the need for cooperative economy. It exposes how much the Chinese government and the media are being hijacked by the entrenched interests. So one cannot help to suspect that the whole media frenzy about land privatization is to test the water, to manufacture “consensus” to further push the neoliberal agenda.”

      More here …


      Sheesh — those Chicago boys are everywhere! Do we see the big formula?

      Deception is the strongest political force on the planet.

  4. i on the ball patriot

    The rolling thunder of intentional debt trap bubble bombs can be heard echoing throughout the Chinese mainland.

    The bunker busting financial derivative bombs can also be heard, shaking the ground and further softening up the terrain as the after shocks of the scamerican debt trap bubble bomb attacks come rolling in and shrink demand for Chinese goods further conditioning the battlefield.

    General Bernanke, General Greenspan, and their newly acquired Chinese gangster sell out counterparts smile as they survey the battlefield.

    The global perpetual conflict now spreads to the Chinese front as the prudent are again pitted against the not so prudent in a wearying struggle that is designed to shrink their resource consumption and consume them in the process. The global propaganda bombs rain down and nebulous bull shit bombs of over-credentialized voodoo economists further soften up the now battle scarred terrain. The global perpetual conflict of the masses is now fully ignited as the battalions of propagandists drop austerity bombs into the already destroyed economies. In time they will also be dropped in China. The formula of attack is repetitive.

    The amount of leverage in the Chinese battlefield is being pumped to the max and the safety and soundness of the regulatory environment, like that in scamerica, has already been infiltrated and destroyed in preliminary skirmishes.

    Nixon, Reagan, and Lemuel Ricketts Boulware, smile in their graves.

    The wealthy ruling global elite are happy with their war of noble lies.

    Deception is the strongest political force on the planet.

  5. Mista B

    I disagree with the premise that spotting a bubble is similar to the Heisenberg Uncertainty Principle. More specifically, it depends on the author’s definition of the word “people”. If he’s referring to the population at large, then his assertion is closer to being true. For example, by the time most people in the U.S. realized there was a housing bubble, it was already deflating–though it is still in a bubble since prices are too high. If, however, the author meant any people, then the assertion is clearly wrong. Many individuals recognized the bubble even when it was in its formative stages.

    The really difficult thing to predict is when a bubble will end. All bubbles have to end, for any growth rate above the population rate will at some point in the future result (due to compounding) in such a number that is unsustainably separated. You can’t have 20% annual growth rates indefinitely in housing. You can’t even have 5%. The only difference is the time it takes to get to an unsustainable level.

    And what is the key to unsustainable prices? When the debt to finance such prices decreases (it never just levels out). The key has always been debt. So long as people can keep borrowing more, prices can keep rising. Typically, though, the super-high annual growth rates (of say 20% annually) mark the end of the trend. I recall very vividly seeing growth rates of 25% for both 2004 and 2005 for Sarasota, FL, which is a wealthy town but far from a metropolis. Same thing was happening in all the bubble states. The massive surge came from the classic madness of the crowd all pushing in at the last moment.

    Many Canadians and Aussies still deny their own bubbles (though quite a few see the writing on the wall). In the same breath they’ll say there is no bubble, only grumbling from people who missed out and are now priced out of the market. It’s like saying prices are affordable and unaffordable at the same time. Both places saw a recent surge in prices, yet sales are now dropping. The same thing happened in the U.S. You aren’t going to see higher prices with fewer sales. Sooner or later, sellers who want to get out will lower their prices, then the downslaught will begin.

  6. Jacob W

    Playing devil’s advocate for a moment, the most striking piece of this analysis from my perspective is the relative stability of price-income ratios for most of the cities in the sample. Conceivably there is no bubble at all by this metric; only Shenzhen looks really dislocated from a historical perspective, and given the pace of development there it’s unsurprising that the city’s real estate has become more desirable over the past decade.

    Beijing and Shanghai saw relatively large increases in price-income ratios during development campaigns in the run-up to the Olympics and Expo, respectively. If this resulted in a genuine improvement in the quality of the housing stock, why should it be a temporary increase? Both cities were significantly enhanced by this development.

    It’s tempting to see a bubble in absolute price increases or the price-rent ratio, but if the price increases are proportional to income gains, you’d have to believe Chinese wages are too high (quite the opposite of recent trends!) for there to be a bubble by an income metric.

    So the question I would put to all the people who think the sky is falling is why is price-rent a better metric here?

  7. Innocent Bystander

    “Financial bubbles are governed by something like the economic equivalent of physics Heisenberg’s uncertainty principle. It is impossible to observe a bubble with certainty without actually altering the bubble itself. If people knew it was a bubble, it wouldn’t be a bubble – it would have already collapsed.”

    You would think this is obviously true, but amazingly it’s probably not. There is a quite well-developed concept of “rational expectation bubbles” in the economic literature. See for example


    and references therein.

    The literature on “The limits of arbitrage” also helps to explain why bubbles do not pop.

    By the way your check for a valid email address is buggy.

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