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Stratfor: China's Real Estate Bubble


Stratfor has an excellent article on China’s soaring real estate prices and a potential impact:

On Sept. 10, China Overseas Land and Investment, a Hong Kong-listed company and a subsidiary of state-owned China State Construction Engineering Corp., purchased a prime piece of real estate in the Putuo district in downtown Shanghai. The company paid 7.006 billion yuan ($1.026 billion) for the undeveloped property, which will amount to an average of 22,409.3 yuan ($3,283.9) per square meter of floor space (just in land costs) once the designed residential building is constructed.

Heh. BPTP had bid just about that much – 5010 cr. or $1 billion – for a 95 acre plot in Noida, but it decided it didn’t quite want to pay that much, a little while later. Just sayin’.

The government began this [real estate] privatization process by making a private dwelling a “commodity” and granting the purchaser the right to own a newly built house for 70 years. (Likewise, the developer who buys the property on which residential or commercial buildings are to be constructed may own that property for 70 years.) Home ownership in China could now be a sound financial investment.

Thus, the residential real estate market would boom in almost every urban area in China — and particularly in the “first-tier” and “second-tier” cities (only Beijing, Shenzhen, Guangzhou and Shanghai are in the first tier, with more than 20 cities, and mostly provincial capitals or coastal ports are in the second tier). But rising land prices would eventually put housing prices out of reach for the general public. In Dongguan, a coastal second-tier city in Guangdong province, land prices averaged 4,957 yuan ($726.42) per square meter in 2007, a more than 500 percent increase from 2003, while personal disposable income increased 24 percent during the same period (from 20,526 yuan [$3,008] to 27,025 yuan [$3,960] per year).

That’s about Rs. 3000 per square foot – prices easily payable in “second tier” Indian cities of Bangalore, Pune and Hyderabad, especially in 2007.

A 2006 survey conducted by the National Development and Reform Commission showed that the average ratio between housing prices and income was approaching 12:1 in many large and middle-size cities in China (in Beijing it had reached 27:1). Twelve to one is significantly higher than the World Bank’s suggested affordability ratio of 5:1 and the United Nations’ 3:1. The problem was compounded by the fact that, of the more than 80 percent of Chinese who owned their own homes in urban areas (generally considered cities with populations of more than 20,000), 54.1 percent were making monthly mortgage payments that constituted 20 percent to 50 percent of their monthly incomes.

Er, let’s see the situation in India. For a standard 5:1 price to income rate, a person earning Rs. 12 lakh can afford a property worth Rs. 60 lakh. With 10% down and a loan of Rs. 54 lakh at 9%, the person will pay 48.5K per month, or 48.5% of his monthly income. (oh and tax will take away another 15-20%, so the person isn’t left with nearly enough)

At 12:1 people in India won’t be able to afford loans at our interest rates – China’s interest rates must be abysmally low. I’m trying to get sources of loan-to-income or price-to-income in India, but there’s not much out there that is unbiased.

As housing prices continue to rise, a parallel trend is manifesting itself — rising vacancy rates in urban areas. A 2009 report by the Shanghai Yiju Real Estate Research Institute revealed that, by the end of 2008, the average vacancy rate for “commodity housing” (as opposed to welfare housing) in Beijing was 16.64 percent, and vacancies reached as high as 30 percent in some districts. Most of these vacant houses, however, are not unsold ones. They have been purchased by investors as speculative investments. While there are fewer and fewer ordinary people who can afford to buy houses, there is still excessive demand for investment housing — pressure that continues to drive up the prices.

This closed loop in the Chinese real estate market is facilitated by the country’s political and bureaucratic system. In China, all land is initially owned by the state, and local governments have the sole authority to sell it. And income from property taxes and land sales are a primary source of revenue for local jurisdictions. According to estimates by the State Council’s Development and Research Center, tax revenue from the land in some jurisdictions accounts for 40 percent of the local budget. Moreover, net income from land sales accounts for more than 60 percent of the local governments’ extra-budgetary revenue. The soft budget and lack of accountability to the people reinforces the local governments’ incentive to expand their real estate investments without much concern for cost or impact on public services.


One typical strategy is for a developer to buy a big chunk of urban land from the local government but leave the land undeveloped, or build on only a small portion of it, thereby keeping the housing supply limited. Despite various state policies to lower land prices in order to make homes more affordable, local government officials and real estate developers control the land auctions. When a lower sale price is dictated from above, it is easy enough for the local sponsors to officially deem the auction a failure. Even when the developer does build houses on the property, a speculative investor, working hand in hand with the developer and government officials, can bribe both parties to ensure that he can buy all the houses at a low volume price and keep them off the market, thereby maintaining a limited supply and high prices.

Anecdotal evidence: This is quite the case in India as well. Mumbai’s land mafia keeps land and apartment supply limited, and there’s widespread collusion with government officials. In Gurgaon, a broker told me that a new project by a certain builder was not selling because some of his other projects in the vicinity had still some listed flats with investors looking to sell at low prices. So the builder purchased all such flats to push up the price of a “new” project – a strategy that’s useful once in a while but fails when everyone overbuilds.

With 70 percent of real estate investment in China coming from bank loans, a dramatic drop in land values could send shock waves throughout the economy. There are already signs of decline. In Shenzhen, one of China’s first-tier cities, real estate prices have been dropping for the past two years (30 percent for housing), and many developers and speculators have suffered great losses. The threat looms in other large cities such as Beijing and Shanghai and may be emerging in many second-tier cities as well.

It’s useful to keep in perspective India’s bubble as well. While real estate has been going up the last few months, and more IPOs are on the anvil, there is a significant chance that the bubble that didn’t quite burst in the last two years is on its way to a final hurrah. Like balloons, you never know how much they’ll grow before they pop – and like balloons, it’s safer to watch from a distance.


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