In the article Is China a "Colossus" or a Giant "House of Cards"?, we discussed China’s long-term plan to place an additional 400 million people in cities over the next 20 years. Clearly with the stroke of a pen that plan creates a massive housing deficit. One would think that that would be sufficient to keep all known builders busy. An article in Foreign Affairs by Patrick Chovanec tells us that the focus of the real estate market has been elsewhere: China’s Real Estate Bubble May Have Just Popped.
China has experienced an enormous housing boom driven not by the demands of people needing a place to live, but by investors speculating on the assumption that housing prices will continue to rise. Does that sound familiar? Investors are buying multiple units at a time with no intention of actually using them. Rather, the plan is hold them and resell at a later time when demand drives the price up. Why would investors fall into this classic trap?
The national government has been complicit in fueling this bubble.
Local governments also participated. They had become dependent on the funds gained from selling public land to developers, and the real estate activity showed up as contributing to the GDP growth demanded by their superiors.
The rapidly rising prices were putting these dwellings out of the reach of people who might actually wish to live in them. This concerned the central government and attempts were made to slow down the building by making it harder for speculators to get credit and buy multiple units, but never having lived through a bubble before, the builders kept on building—or rather, they kept on borrowing and building. Eventually sales slowed and inventory built up.
These unsold dwellings come at a cost to the builders. Since they borrowed to build, they had a need to keep borrowing to maintain them.
Where does this leave the market and the country?
"Shanghai homeowners are hardly the only ones getting nervous. Sudden, steep price reductions are upending real estate markets across China. According to the property agency Homelink, new home prices in Beijing dropped 35 percent in November alone. And the free fall may continue for some time. Centaline, another leading property agency, estimates that developers have built up 22 months' worth of unsold inventory in Beijing and 21 months' worth in Shanghai. Everyone from local landowners to Chinese speculators and international investors are now worrying that these discounts indicate that ‘the biggest bubble of the century,’ as it was called earlier this year, has just popped, with serious consequences not only for one of the world's most promising economies -- but internationally as well."
"In a few cities, such as coastal Wenzhou and coal-rich Ordos, the collapse in property prices has sparked a full-blown credit crisis, with reports of ruined businessmen leaping off building rooftops; some are fleeing the country."
Most of the speculators seem to have made their acquisitions with cash, and—so far—have been waiting this out. If they decide it is time to cut their losses and put their property on the market it could be disastrous.
Many countries have made money out of this housing bubble by selling China materials and equipment to support it. The Chinese will not be the only ones who will suffer consequences if this situation is not brought under control.
In principle, the government could just provide the cheap loans that the builders need to maintain their inventory, but that only stabilizes the situation. The builders can’t move their product unless investors are convinced that prices are going to keep rising—which brings us back to inflating the bubble some more.
Stay tuned. As always, there are few dull moments for China watchers.
PATRICK CHOVANEC is Associate Professor of Practice at the School of Economics and Management at Tsinghua University.