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Tuesday, April 15, 2014

Has China's Real Estate Bubble Finally Popped?

A lot of people have been predicting for several years that the Chinese real estate market was overbuilt and faced a collapse, yet China somehow avoided the bubble popping. Panos Mourdoukoutas, writing at Forbes, describes the basic situation:
For years, China has been enjoying robust economic growth that has turned it into the world’s second largest economy. 
The problem is, however, that China’s growth is in part driven by over investment in construction and manufacturing sectors, fueling asset bubbles that parallel those of Japan in the late 1980s. With one major difference: China’s overinvestment is directed by the systematic efforts of local governments to preserve the old system of central planning, through massive construction and manufacturing projects for the purpose of employment creation rather than for addressing genuine consumer needs.

Major Chinese cities are filled with growing numbers of new vacant buildings. They were built under government mandates to provide jobs for the hundreds of thousands of people leaving the countryside for a better life in the cities, rather than to house genuine business tenants.
 
China’s real estate bubble is proliferating like an infectious disease from the eastern cities to the inner country. It has spread beyond real estate to other sectors of the economy, from the steel industry to electronics and toys industries.  Local governments rush and race to replicate each other’s policies, especially local governments of the inner regions, where corporate managers have no direct access to overseas markets, and end up copying the policies of their peers in the coastal areas. 
We all know how the Japanese bubble ended. ...
The risk is succinctly described in this April 3 article from Quartz:
Throughout 2013, China’s housing market surged. That run may finally be over.

Q1 home sales in Beijing, Shanghai, Guangzhou and Shenzhen fell more than 40% from the same quarter in 2013. That’s scary. Real estate is a huge driver of China’s GDP growth. And since China’s property sector is funded by its credit boom, many fear a housing market slowdown could easily become a crash, dragging down China’s financial system along with it.

Whether or not it’s time to start the doomsday countdown depends on a question, though: Does China actually have a housing bubble? The answer depends on whether you think China’s soaring housing prices are due to speculation (which would mean a bubble) or a genuine lack of supply.
Gordon Chang, also writing at Forbes, thinks that the bubble may have finally popped:
The real estate market in Hangzhou looks like it has just passed an inflection point. It is not so much that fundamentals have deteriorated—they have been weak for some time—as that people’s mentality has changed.

As state-run China Central Television explained, the problems in Hangzhou, once the world’s largest city, began on February 18. Then, the North Sea Park development began offering deep discounts. Rumors that the developer had cash problems started a chain reaction across the city. It did not matter that North Sea Park issued denials. Other developers began offering either deep discounts or large incentives, but the tactics did not work. By then, there were almost no buyers.

Now, the problem of no buyers is spreading across the country. Sara Hsu notes China’s residential markets are becoming inelastic. “Once consumers stop buying,” she writes, “deep discounts are ineffective in drawing them back.” People aren’t buying because they believe prices will decline further.

According to the National Bureau of Statistics, new home prices across the country are still going up, but percentage increases have now declined for three consecutive months, signaling a peaking.

Official statistics do not seem consistent with the general trend of reports, but in any event severe problems are evidently ahead. The secondary property market has tumbled, with sales falling by more than half in Q1 2014 from the same quarter in 2013. Speculators have either left the domestic market or have sold off holdings. Rich Chinese, now interested in foreign holdings, are also shunning their home market. Foreigners, who own only an infinitesimal portion of China’s property but who are a bellwether nonetheless, are investing at the slowest pace in at least a decade. Middle class Chinese are also largely out of the market.

And that’s not all. China property trust sales plunged 49.1% in Q1 2014 from the previous quarter, from 99.7 billion yuan in Q4 2013 to 50.7 billion yuan. The precipitous fall was due in part to the failure last month of developer Zhejiang Xingrun Real Estate, which had 3.5 billion yuan of indebtedness.

Moreover, just about everyone expects more developers to close their doors. ...
He's not the only one. Jerin Mathew at the International Business Times concurs. The Malaysia Chronicle reports:
The property sector woes have kept coming: average new home price rises across the country have slackened for three straight months; property developers in big cities are offering discounts to prevent sales from plummeting; and foreign investment in China's real estate has fallen to the lowest in at least a decade. 
All this has led to Nomura economist Zhang Zhiwei citing a property market downturn as the biggest risk to the Chinese economy this year and next year. 
It has also caused more analysts to think the long-awaited correction in China's red-hot property market may be finally appearing, after several false starts over the past few years since the authorities introduced property restriction policies to cool runaway prices in mid-2010. 
The key challenge China's leadership faces is whether it can guide inflated property prices to moderate gradually. 
A sudden loss of investor confidence could cause prices to crash - particularly in smaller cities which face a supply glut due to over-construction. This, in turn, would be a drag on China's already slowing economy, to which the real estate sector is estimated to contribute 15 per cent. 
Renmin University professor Ma Guangyuan warned in a commentary in China Daily recently that China should "prepare for the popping of the property bubble". 
Beijing-based real estate researcher Zhang Yinqing echoed this: "People are more sceptical this time of a property bubble bursting because there have been at least three times in the past few years that media speculated a downturn, or even a crash, when the government imposed curbs, but prices only continued to rise. 
"But this time, it's real - rich investors are no longer speculating on China property, the government is still tightening credit, and the middle income can't afford the current high prices, so it's only a matter of time that the bubble deflates."
Bob Davis and Esther Fung at the Wall Street Journal similarly comment:
Pudong became a model for the rest of China: build it and they will come. But with so many cities competing to build cookie-cutter housing projects and industrial parks, the model may have run its course. Since the early 1990s, China’s overall return on investment has fallen by about a third, the International Monetary Fund says. The country overinvests by 10% of GDP, the IMF estimates. And each yuan of lending now produces just one-third the payoff in economic growth that it did before 2009, Fitch Ratings says.
And from Business Week:
Issuance of property-related trusts, which target wealthy investors, slid to 50.7 billion yuan ($8.16 billion) from 99.7 billion yuan in the fourth quarter, data compiled by Use Trust show. The yield on AA rated five-year bonds has climbed 175 basis points in the past year to 7.23 percent, according to Chinabond. That compares with 2.74 percent on corporate securities globally, Bank of America Merrill Lynch indexes show.

“The banking system and the shadow banking system are becoming concerned about exposure,” David Cui, China strategist at Bank of America said in an interview yesterday. “Once people refuse to provide credit to developers, their balance sheets will be under pressure, forcing them to cut prices. Once enough of them cut prices, fewer people would buy because most people buy property only when they think the price is going up. If this persists, it will turn into a vicious loop.”
See also this article from Bloomberg.

However, not everyone agrees. The Quartz article I cited above cites Rafael Halpin, an analyst at China Confidential, as to data indicating that when you subtract out substandard housing, which is being abandoned in favor of newer construction, China actually has a housing shortage.

As usual for any nation on the planet, government policies may be coming too little too late. On March 25, 2014, CNBC reported that the Chinese government was taking steps to reduce demand for real estate:
At the National People's Congress this month, Premier Li Keqiang addressed the real estate concerns of China's top officials, reporting that the government would "curb demand for housing for speculation and investment purposes."

In another report released this month, China's National Development and Reform Commission acknowledged that "housing prices in some large cities are rising too fast, and there are risks and hidden dangers in the real estate market."

China's Ministry of Finance also announced that it would accelerate legislation for a real estate tax that would discourage individuals from speculating in the property market through multiple home purchases.
Combine these disincentives to purchase property with an already declining market, and it will further compound the decline.

So what could happen? This March 19 article from Quartz explains:
“This is comparable to when the US property bubble burst, since property prices did not collapse in New York, but instead in places like Orlando and Las Vegas,” Zhang says. “In China, the true risks of a sharp correction in the property market fall in third- and fourth-tier cities, which are not on investors’ radar screens.”

If China’s housing market crashes, the ripple effect could be even more cataclysmic for its economy than the recent housing market collapses in the US and Europe were for their economies. A fifth of outstanding loans and a quarter of new loans are to property developers, says Nomura; untold billions more have been lent out off bank balance sheets. As falling prices crimp margins, small developers—like the one in the news this week—will start defaulting.

But the fallout will be bigger still, says Patrick Chovanec of Silvercrest Asset Management. “Not only is property important because it’s a key component of that investment boom, but it’s essentially the asset that underwrites all credit in the Chinese economy, whether it’s local government loans, whether it’s business loans,” Chovanec says, explaining that lenders require “hard” assets as collateral because financial accounts can easily be doctored.

This creates a circular system. “All these loans are being made on the basis of property as collateral, which then goes into property and bids up the price of property,” he explains. “And then the property price—the price of the collateral—goes up, and you can get more loans. That’s a very dangerous cycle.”

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