That housing booms can soon develop into bubbles and become a source of great risk to the economy has been amply proved by the financial crisis. Everybody knows that the crisis started with a housing boom in the US. The Chinese government certainly believes that a similar bubble has developed in its country, which is why it has cracked down hard on its real estate sector. But how big is this bubble? How far have real estate prices gone up in China? These are the questions addressed by Jing Wu, Yongheng Deng and Joseph Gyourko.
Here are a few startling facts the researchers have unearthed. Land values, adjusted for inflation and differences in quality, have shot up by nearly 800% since the first quarter of 2003, with half that rise occurring over the past two years. House prices, after adjusting for inflation, have increased by 225% in 35 main Chinese cities, with 60% of that, or 140 percentage points, being the increase since the first quarter of 2007. What’s more, prices have increased 41% (annualized) this year. It’s no surprise then that the Chinese government is so concerned about overheating in real estate.
The authors say that the rise in home prices has, however, been less than the rise in income in cities such as Chengdu, Tianjin, Wuhan and Xian. But prices in the coastal markets and in Beijing have outpaced even the high income growth enjoyed in those places. Price to income ratios have reached their highest levels ever in Beijing, Hangzhou, Shanghai and Shenzhen. Price to rent ratios, too, have risen sharply in many cities, with the ratio rising by almost 75% in the last three years in Beijing. Prices have risen faster than rents in all major cities and the ratio is a very high 45.9 in Beijing. The reason for such a skewed ratio is that home buyers are assuming large capital gains on their purchases.
But there’s also a constant flow of migrants from the countryside to the cities, so perhaps there’s a case for assuming that demand for housing is more than the supply of new land. The researchers says that in five of the eight largest Chinese cities, “the net new number of housing units provided since 1999 is at least as large as the net increase in the number of households.” But demand exceeds supply in Beijing, Hangzhou and Shenzhen. Even so, say the authors, while upward pressure on prices is to be expected in those places, the demand-supply mismatch cannot account for the dramatic rise in home prices.
Consider also the impact that this real estate bubble could have on the banking sector. From the end of 2008, outstanding loans on residential mortgages have increased by 38% and loans to real estate developers by 50%. While Chinese house owners have higher levels of their own money in their homes than Americans, the fact remains that “even modest declines in expected appreciation would lead to large price declines of over 40% in markets such as Beijing.”
And lastly, think about how important the housing market is for China’s economy. The construction industry accounts for “5.7% of Chinese GDP; it employs 14.3% of all workers in urban areas; and it consumes about 40% of all steel and lumber produced in China.” How China manages to deflate its real estate bubble will have significant implications for commodity prices and growth not only in China, but also in the rest of the world.
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