What will happen to China’s property bubble? Maley

Worries that Beijing could be about to launch a new crackdown on property market speculation have battered Chinese sharemarkets in recent days, with Chinese banks and property developers bearing the brunt of the pain.

Recent data showing a rebound in real estate sales in major Chinese cities in August has stirred fears that Beijing might take further action to cool its property market, including stopping all lending to developers, and banning third-home purchasers.

Investors have also been troubled by media reports in recent days that suggested that Beijing will collect information about housing vacancies as part of the population census now underway. These worries were exacerbated by comments from Liu Mingkang, the head of China’s banking regulator, who warned that Chinese banks should focus on the quality of their loans, rather than on increasing their lending.

Andy Xie, the former Morgan Stanley chief Asian economist, points out that China has become fascinated with estimating the size of the property bubble by measuring it against the number of vacant flats. Recent media reports claimed that 64.5 million urban electricity meters registered no electricity usage over the past six months, which suggested that China has enough empty flats to house around 200 million people, although China’s electricity authority subsequently denied the figure.

In a recent article in China International Business, Xie argues that the Chinese property bubble is different from most property bubbles. Usually, he says, property bubbles start building due to a shortage of supply – caused by factors such as restrictions on building height and density, or a lack of infrastructure.

But China doesn’t have any constraints on supply. As a result, he says, “the stock of empty flats measures the size of the quantity bubble.”

According to Xie, “While the data is not accurate, we can confidently conclude that China doesn’t have an absolute housing shortage and the per capita space is above the level in Europe and Japan. Indeed, if we adopt Japan’s standard, China already has sufficient urban housing space for everyone in the country, i.e., there is housing for every person in the countryside to move into the cities.”

Even more importantly, he says, “is the quantity of empty flats held for speculation and no other purpose… Although the Chinese government doesn’t publish vacancy data, Xie estimates vacancy rate for commercial housing stock is between 25 to 30%, at least 100% above what a normal market requires.

“The difference can be viewed as speculative inventory – people are hoarding flats just as people hoard copper for price appreciation. The value of this speculative inventory is probably around 15% of GDP.”

Xie argues there is a possibility that a massive speculative inventory could form in 2010-11. Beijing’s recent moves to squeeze people buying their second and third home has resulted in falling real estate sales. As a result, property developers are building up huge inventories of unsold inventories. But, he says, if policy is loosened again, this will likely trigger a new wave of speculation. “It could cause speculative inventory to double in value”, he says.

Xie estimates there’s a high likelihood that Beijing will relent on its measures to curb property speculators. Local governments are hugely dependent on property transactions for revenue, and many debt-laden local governments be at risk of defaulting on their loans if their revenue collapses. But a change of heart from Beijing could set the stage for even more trouble down the track when China’s property bubble finally bursts.

It’s important to remember commercial property developers aren’t the only ones with property stock. Others – particularly people who are in advantageous position or those who have connections, such as suburban farmers and the employees of the companies that build their own housing – also have important holdings. And while these property owners aren’t competing when it comes to property sales, they do compete when it comes to rents.

According to Xie, “Even if China’s empty urban flats are less than 64.5 million, it could be half as many as defined by international standards. That would still be equivalent to 20% of the urban households… Moreover, if the property tightening is loosened, the rate could rise above 30% of urban households.”

Xie argues that to date, Chinese moves to clamp down on property market speculation appear to be something of an improvisation. A much better way to cool speculative demand would be to raise interest rates. Delaying an interest rate rise, he says, will only result in a surge in the stock of empty flats, and make an eventual property market collapse inevitable.

“China urgently needs a coherent property strategy, not periodic but unsustainable crackdowns on speculation. The massive overhang of empty flats should goad policymakers into taking action as it is a sure sign of trouble to come. The time to act is now.”

This article first appeared on Business Spectator.