Can China Step Off Its Property Treadmill? Not Likely
(Bloomberg Opinion) -- Danny, the political theorist, aspiring lawyer and purveyor of rare herbs in the British cult film Withnail and I, understood the problem of Chinese real estate. “If you're hanging on to a rising balloon, you're presented with a difficult decision,” he observes. “Let go before it's too late or hang on and keep getting higher, posing the question: How long can you keep a grip on the rope?”
Several Chinese cities suspended land sales in recent days and weeks, after a revamped auction system failed to have the desired effect of restraining prices. It was the latest of Beijing’s periodic stop-start attempts to cool the housing market. This year, these have also included revived talk of introducing a recurrent property tax, a long-debated measure that has gained fresh impetus as President Xi Jinping places a priority on reducing inequality. Don’t expect these efforts to amount to much, at least in the short term.
More than a decade ago, the American hedge fund manager Jim Chanos said that China was on a “treadmill to hell” because of the economy’s dependence on real estate for growth. Chanos was wide of the mark in his prediction that the property bubble might burst as early as 2010. Yet in the intervening years, the imbalances have only grown more pronounced. While a collapse has been avoided, China is no closer to weaning itself off its real estate addiction. In fact, the dependency appears to have grown.
Despite Xi’s admonishment that “housing is for living in and not for speculation,” and the government’s regular entreaties to banks to scale back property lending and increase the flow of credit to small business, the share of funds directed to the industry has risen. Real estate loans have increased to more than 27% of total yuan advances, from less than 20% a decade ago, according to People’s Bank of China data. Moreover, this is certainly an understatement — at least according to the country’s head banking regulator, who ought to know. Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, wrote last year that the real share of property-related loans is more like 39%, or 70 trillion yuan ($10.8 trillion).
Floating on top of this ocean of funds is a bubble of epic proportions, one that by various metrics easily overshadows the pre-global financial crisis run-up in U.S. property values (which burst with such disastrous consequences) or the unsustainable booms in European countries such as Ireland and Spain. It stands comparison with the Japanese real estate bubble of the 1980s, which helped send the country into at least one “lost decade” when it finally burst in the early 1990s.
Two measures serve to illustrate how extended prices have become. In leading cities, prices relative to average incomes are orders of magnitude greater than in global metropolises such as London, New York or Sydney, where valuations are often viewed as unaffordable, according to Numbeo, a cost-of-living data collection website.
And rental yields are often less than half of what is available in those markets, despite China having relatively higher interest rates. The PBOC’s one-year lending rate is 4.35%, while the U.S. fed funds rate is at 0% to 0.25% and the Bank of England’s base rate is 0.1%.
Arguably, China is different because of its rapid development, fast-rising incomes and lower levels of household indebtedness — though these factors, which have helped to underpin real estate demand for the past two decades, are starting to recede to varying degrees.
Xi, who is determined to create a more egalitarian society, has good reason to want to reshape the housing market, which has contributed to China’s soaring inequality. That task would be a lot easier if valuations weren’t perched at such a precariously high level. Fundamental change would risk cascading effects through the financial system and economy that might be hard to control.
Take recurrent property taxes, which are favored in most developed countries, where they are regarded by economists as relatively fair, low-cost and efficient. China has taxes on transactions, but no regular levy on the assessed value of property, beyond trial programs in the cities of Shanghai and Chongqing that have made a negligible contribution to revenue collection since their introduction in 2011.
The widespread rollout of such a tax would have to consider the potential effect on owners and supply. With yields so low and no ongoing taxes to pay, many investors choose to keep their apartments vacant. China had more than 60 million empty dwellings as of 2017, with the biggest cities (tiers 1 to 3) having vacancy rates of 17% or more, according to a 2020 paper by Harvard University’s Kenneth Rogoff and Yuanchen Yang of Tsinghua University. Forcing investors to pay a regular tax would increase the cost of carry, giving many an incentive to sell or lease out their properties. That would boost supply, pushing down prices and rents, putting pressure on indebted developers, and potentially slowing construction activity and the economy.
Once jobs and growth are threatened, that’s likely to be a game-changer. With the delta variant now weighing on the economy, a turning point may not be too far away. China’s policy makers have long-term plans and visions, but they also respond in a pragmatic and iterative manner to changing circumstances — “crossing the river by feeling the stones,” as late paramount leader Deng Xiaoping called it. Like it or not, the government still needs an expanding real estate industry, even if it’s one that has already been defying gravity for years.
How to feel the stones when your feet are no longer on the ground, though? Then, as Danny would advise, all you can do is hold on to the rope.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Matthew Brooker is a columnist and editor with Bloomberg Opinion. He previously was a columnist, editor and bureau chief for Bloomberg News. Before joining Bloomberg, he worked for the South China Morning Post. He is a CFA charterholder.
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