Chinese residential property: Will the bubble burst?
In the second half of 2020, property prices soared in Chinese tier-1 cities, i.e., the four most developed and populous cities including Beijing, Guangzhou, Shanghai and Shenzhen. On a year-over-year basis, the average prices in these cities rose by about 10% in 2020, with even stronger price momentum in these cities’ premium properties.
From the perspective of affordability, Chinese tier-1 cities’ residences are the most expensive among the world’s largest cities. In the four cities, the ratio ranges from 31 to 44 times for a median apartment price to median family disposable annual income, only lower than Hong Kong.
Moreover, leverage keeps accumulating in the market. According to the People’s Bank of China, new bank loans issued to Chinese households reached RMB7.9trillion in 2020 (up 6% year-over-year), 75.6% of which were long-term loans mainly for home purchase. There is also some evidence that short-term consumer loans and small business loans were directed for purchases of residential property.
Both the worsening affordability and rising leverage point to a bubble risk. However, an immediate bubble burst seems unlikely. Despite the tremendous hike in the past two decades, Chinese property prices have not deviated significantly from economic fundamentals in two aspects.
First, from 2000 to 2020, tier-1 property prices increased 10 fold, which is in line with the change in Chinese nominal GDP. Second, during the two decades, Chinese M2 supply increased at a compound annual growth rate of 15.6%, while the rate was 12.1% for average property prices in tier-1 cities and 8.5% for the nationwide average.
The above factors, particularly the simultaneous hike in money supply and property prices, suggest that real estate has a strong attribute as an asset class in China. The wealth from the whole country was pursuing tier-1 properties as a way to share the dividend of economic growth. Hence, price to income ratio might remain high when the economy keeps growing and money supply continues expanding.
That said, property prices might enter a stage for slower increases, when China enters an era of secular economic slowdown and policy normalization. The price differentiation might also enlarge between large and small cities, as large cities are usually more resilient and attractive to investors even during an economic slowdown.
Such a prospect has alerted policy makers, and regulations have been tightened to cool down the market before things get worse. Tighter mortgage conditions and more land supplies for residential construction, as well as control to purchase, have been adopted, particularly in tier-1 and tier-2 cities, to curb the price momentum and limit market liquidity. As long as China’s economic growth can sustain, these measures might help to achieve a soft landing in the property market.
Residential properties in Chinese tier-1 cities are the most expensive among the world’s major cities in terms of affordability
EXHIBIT 1: HOME PRICE TO INCOME RATIOS FOR MAJOR CITIES AROUND THE GLOBE
Real estate is an important growth driver. In 2020, real estate development accounted for 27.3% of fixed asset investment, playing a key role in economic recovery after the COVID-19 outbreak. In addition, local governments rely heavily on land sales, which contributed 44.3% of local fiscal funding in 2020.
Property is also the most important asset class for Chinese households. According to a survey in 2019 by the People’s Bank of China, properties accounted for 59.1% of urban household assets. To purchase residential property, 76.8% of the households borrowed mortgage loans, and the average debt was RMB389thousand for each family.
Therefore, there will be profound implications in various aspects of the economy and markets if a correction happens.
The tightening credit conditions for developers might lead to slower investment growth this year, which might be a headwind to the demand and prices of raw materials, despite the current price hike in the market.
Moreover, in bond markets, there might be more defaults and higher volatility, as developers with high leverage are facing mounting pressure in cash flows. Some sector leaders have beefed up their balance sheets and reduced land reserves in anticipation of tighter policy, while smaller developers might have less room for adjustments. This might lead to accelerated mergers and acquisitions among developers, and those strong ones with sound financial conditions could benefit.
There might be structural changes in consumer markets. In the past, along with strong home sales, strong trends were also seen in the sale of household appliances, furniture and decoration materials. If property sales stabilize, consumers’ demand might shift to other consumer goods and services.
With higher uncertainties and declining returns in the property market, households might have to diversify their investments. This makes the equity market a potential beneficiary, particularly since the market has become deeper and more efficient after reforms in the past a few years.