By Jacob Lee
Introduction
There is a saying that you should not put all of your eggs in one basket. It means that you need to prepare for a case when the basket gets damaged and all of the eggs inside go unused, accordingly. In this context, diversification is regarded as a rule of thumb in financial investment. However, this does not seem to be the case for Chinese. The aggregate household asset distribution in China shows that real-estate accounts for 78% while financial assets only account for 12%. This is a very high concentration on the real-estate. A crash in the real-estate market can lead to an enormous impact on households and the economy of China.[i]
Since housing prices have rapidly increased starting from the 2000s,[ii] investment in real-estate has been regarded as a golden ticket for being rich in China. The housing reform in 1998 terminated the socialist housing distribution system. Rapid growth followed in the Chinese housing market.[iii] Although there were minor drops in housing value, the general trend was upward sloping for the past 20 years. Under the rapid growth of the Chinese economy, the housing market bubble was viewed as unavoidable costs.
Households, local governments, and real-estate developers in China have supplied excessive liquidity into the real-estate market through financial institutions. The collapse of the housing market will directly affect the financial market. In fact, we all saw this from the financial crisis in 2008, which was initially caused by a housing market crisis in the United States.
The global economy has faced slow growth after the financial crisis, affecting Chinese economic growth as well. The Chinese economy’s rapid growth, which was 14.2%, in 2007 has decreased since then – 6.9% growth in 2017. However, housing prices have kept rising regardless of the economic trend. Many experts started to warn a housing bubble burst in China. Will the housing price meltdown occur, which would give enormous pressure on the Chinese banking system? Will the current policies suffice to avoid the meltdown? What are the preemptive measures?
- The housing bubble in China
1.1 Both Chinese and Foreigners are aware of the bubble in China
According to well-respected news outlets, such as Bloomberg, the New York Times, and Forbes, which compared the housing market in China to pre-2008 America’s, it is generally accepted that there is a bubble in the Chinese housing market.[iv] Not only Western media warned of the housing bubble in China, but also the highest government official of China also acknowledged the housing bubble.
Xi Jinping, General Secretary of the Communist Party of China, also stated that “Houses are built to be inhabited, not for speculation” at the 19th Party Congress in 2017.[v] Given the importance of the Party Congress, it would be fair to say that the Chinese government is also aware of the housing bubble.
Quantitatively, Bloomberg also cited the Soufun holdings Ltd’ 100 City Price Index. The Index rose 31 percent from 2015 to 2017. Compared to the average square foot cost in the United States, where the average income is more than seven times higher than the average income in China, the Chinese per square foot price is 38 percent higher than that of the U.S.[vi]
However, housing is different from other commodities. Because buildings are non-movable commodities, the value of housing varies greatly by region. In China, there exists the Chinese city tier system. In general, consumer behavior, income level, population size, consumer sophistication, infrastructure, talent pool, and business opportunities are reflected in the City Tier System. Although this city tier system is not recognized by Chinese officials, it is widely used in the market.[vii]
For example, the Tier-1 includes Beijing, Guangzhou, Shanghai, Shenzhen, and Tianjin. The Tier-2 includes Changchun, Changsha, Chengdu, Chongqing and so on. Other small cities are categorized into the Tier-3 and Tier-4. The Tier-1 cities’ housing price is generally higher than that of the Tier-2 cities.
Price to Income Ratio (PIR) is used to measure the basic affordability for housing in a given area. The range between 3 and 6 is regarded as the affordable and reasonable range. However, both Beijing and Shanghai showed very high numbers – 25.5 for Beijing and 23.5 for Shanghai. To put it into words, this means that it takes 25.5 years for an average household to purchase one unit of housing without spending a penny on other things.
Looking at the Tier-2 cities’ trend. Things get complicated. For example, Chengdu, one of the Tier-2 cities, showed a 5.2 PIR, which falls into the affordable range.[viii] However, some Tier-2 cities show that their average housing sale prices are equivalent to that of Guangzhou, a Tier-1 city. These cities include: Xiamen, Nanjing, Hangzhou, Ningbo, and Suzhou.[ix]
1.2 Who contributes to the housing bubble?
It is crucial to understand that housing in China was provided through a socialist housing distribution system before 1998. With the housing reform in 1998, Chinese banks finally started issuing home loans. In addition, the export-oriented economy brought lots of capital inflow into the current account, and it was even more accelerated with China joining the WTO in 2001. As a result, there has been lots of liquidity in the market. Especially, there are mainly three factors contributing to the housing bubble: Households, local governments, and real-estate developers
Household
The Chinese have held a remarkably strong attachment to their property. According to a HSBC survey which took place in 2017, 70% of China’s millennials (aged 19-36) are already proud property owners, and 94% of Chinese millennials plan to buy property in the next five years.[x]
There are several reasons for this desire. To name a few, growing desire to upgrade to modernity, limited investment channels available in China, investment security, traditionally strong homeownership aspirations, essential marriage criteria, face culture, and social status are listed as reasons for homeownership.[xi]
Then, how do Chinese afford to purchase such expensive houses, continuously? Here are some reasons. During the 1998 reform, people were allowed to purchase their previously government-owned homes at favorable rates. With the housing market boom, they could sell these old houses and buy new houses at their discretion.
Secondly, it is not just individuals but the inner-circle of individuals buying housings. Because owning a house is deeply intertwined with social status especially for the marriage market, parents and relatives help individuals with a big portion of payment or, at least, down payment.
Thirdly, Chinese save a lot. They generally save 30% of their income as a saving. Due to this high saving attitude, gross saving in 2017 hit 47% of GDP. It helps them maintain a relatively low mortgage rate. Just 18% of Chinese household have mortgages, compared with half of all homeowners in the U.S.[xii]
Local government
While property tax is a major source of tax revenue in many of developed countries, China does not have a property tax nationwide. Only Shanghai and Chongqing are testing property taxes on a limited scale.[xiii]
In 1994, there was a major fiscal reform of public finance. As a result of the reform, a large share of fiscal revenues moved from local governments to the central government. The problem is that, unlike the revenues, the central government did not substantially transfer local governments’ expenditure. Following the reform, local governments were responsible for only 46 percent of revenues when they were also responsible for 77 percent of public expenditures at the same time.[xiv]
In order to fill this gap between expenditures and revenues, local governments started to use the conversion of land from rural use to urban use. By re-zoning a land from a cheap agricultural one to an expensive commercial one, the local governments were able to sell the land at a much high price to developers. They continuously readjusted land use at their discretion. The difference in land value provided revenue to the local governments.
Development in local areas generally increases the local GDP as well. This incentivizes local officials to re-zone the land use more and more because a political reward is closely aligned with regional economic development in the Communist party of China.
Furthermore, local governments had been banned from taking loans or issuing bonds directly in China. Therefore, local governments made quasi-fiscal entities called Local Government Financing Vehicles (LGFVs). Local government transfers land parcels to LGFVs for equity.[xv] Then, LGFVs put local governments’ land as collateral to take loans. With the borrowed money, LGFVs finance large infrastructure projects and affordable housing projects in local regions. In fact, the central government also implicitly approved local government to tap into LGFVs to achieve its policies. For example, the central government required that local governments fund 2.8 trillion RMB (70%) of the 4-Trillon RMB package.[xvi]
The problem stems from a severe maturity mismatch. The LGFVs has not only taken short term loans from commercial banks but also from “shadow banking.” These loans have been invested for long term projects. The gain from projects come in the long term while repayment schedules are on a short-term. When China was growing fast, its economic growth allowed the short-term loans to be repaid with other short-term loans. However, things changed as China has faced slowdown for the past few years. Now, the debt repayment pressure threatens local government financial stability.[xvii]
Real-estate developer
Because a local government is a sole entity to sell a land use right in the region, the competition to get the land use right between real estate developers makes the price of land go up rapidly. This was the revenue for the local governments, as real-estate developers had to borrow money from the Chinese financial market as well as “shadow banking” on the short term to pay for land use right.
Although they could transfer this cost to consumers with higher housing price in the market, the economic slowdown has changed this structural cycle. Now, developers struggle to repay their debts, and cities are left with 65 million unoccupied apartments.[xviii]
(To be continued on the part 2)
[i] Newspim, “돈 생기면 집부터…중국 가계 자산 중 부동산 비중 78%,” Last Modified January 23, 2019 http://www.newspim.com/news/view/20190123000355
[ii] ibid
[iii] Lincoln Institute of Land Policy, “China’s housing reform and outcomes,”
Click to access china-housing-reform-and-outcomes-chp.pdf
[iv] Charlie Chen, “Waiting for China’s Precarious Housing Bubble to Burst,” Last Modified October 8, 2018, http://thepolitic.org/waiting-for-chinas-precarious-housing-bubble-to-burst/
[v] Bloomberg News, “Housing Should Be for Living In, Not for Speculation, Xi Says,” Last Modified October 18, 2017 https://www.bloomberg.com/news/articles/2017-10-18/xi-renews-call-housing-should-be-for-living-in-not-speculation
[vi] Charlie Chen, “Waiting for China’s Precarious Housing Bubble to Burst,” Last Modified October 8, 2018, http://thepolitic.org/waiting-for-chinas-precarious-housing-bubble-to-burst/
[vii] Global Web Index, “Chinese Tier Classification,” https://knowledge.globalwebindex.net/hc/en-us/articles/212633345-Chinese-Tier-Classification
[viii] Korea Institute for International Economic Policy, “중국 부동산시장 현황 및 2018년 정책 방향,” Last Modified March 30, 2018, http://www.kiep.go.kr/sub/view.do?bbsId=kiepBeijOffBri&nttId=200701
[ix] ibid
[x] Juwai, “Why are Chinese so obsessed with buying property?” Last Modified June 26, 2017 https://list.juwai.com/news/2017/06/why-are-chinese-so-obsessed-with-buying-property
[xi] ibid
[xii] Wade Shepard, “How people in China afford their outrageously expensive homes,” Last Modified March 30, 2016, https://www.forbes.com/sites/wadeshepard/2016/03/30/how-people-in-china-afford-their-outrageously-expensive-homes/#23cdf61ea3ce
[xiii] The Real Deal, “China moves closer to implementing a game-changer: a property tax,” Last Modified March 07, 2018, https://therealdeal.com/2018/03/07/china-moves-closer-to-implementing-a-game-changer-a-property-tax/
[xiv] Lincoln Institute of Land Policy, “China’s local public finance in transition,” https://www.lincolninst.edu/sites/default/files/pubfiles/chinas-local-public-finance-in-transition-chp.pdf
[xv] Brent et al, “Understanding the Risk of China’s Local Government Debts and Its Linkage with Property Markets,” https://www.researchgate.net/publication/315487928_Understanding_the_Risk_of_China’s_Local_Government_Debts_and_its_Linkage_with_Property_Markets
[xvi] ibid
[xvii] Andrew Sheng, “Why we shouldn’t worry about China’s “ghost towns,” Last Modified September 22, 2014, https://www.weforum.org/agenda/2014/09/china-ghost-towns-lgfv-debt/
[xviii] Kenji Kawase, “China’s housing glut casts pall over the economy,” Last Modified February 13, 2019, https://asia.nikkei.com/Spotlight/Cover-Story/China-s-housing-glut-casts-pall-over-the-economy
[iv] Charlie Chen, “Waiting for China’s Precarious Housing Bubble to Burst,” Last Modified October 8, 2018, http://thepolitic.org/waiting-for-chinas-precarious-housing-bubble-to-burst/
[v] Bloomberg News, “Housing Should Be for Living In, Not for Speculation, Xi Says,” Last Modified October 18, 2017 https://www.bloomberg.com/news/articles/2017-10-18/xi-renews-call-housing-should-be-for-living-in-not-speculation
[vi] Charlie Chen, “Waiting for China’s Precarious Housing Bubble to Burst,” Last Modified October 8, 2018, http://thepolitic.org/waiting-for-chinas-precarious-housing-bubble-to-burst/
[vii] Global Web Index, “Chinese Tier Classification,” https://knowledge.globalwebindex.net/hc/en-us/articles/212633345-Chinese-Tier-Classification
[viii] Korea Institute for International Economic Policy, “중국 부동산시장 현황 및 2018년 정책 방향,” Last Modified March 30, 2018, http://www.kiep.go.kr/sub/view.do?bbsId=kiepBeijOffBri&nttId=200701
[ix] ibid
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