According to International Monetary Funds, China sector is facing a real estate oversupply problem that threatens the overall economy. This article has the details.
If you build it they will come. Eventually. That’s been the mantra of Chinese real estate developers and their lenders who have been throwing them buckets filled with yuan for the past several years. Now, an oversupply problem in second and third tier cities promises to derail the economy by as much as one percentage point, the International Monetary Fund has warned.
How important is real estate to the Chinese economy? In the year 2000, real estate accounted for around 5% of China’s GDP. By 2012 it rose three times to 15%, according to the IMF's calculations. It certainly did not decline in 2013 and 2014, despite Beijing working overtime in forcing a market correction. The IMF did not have data for the last two years.
The real estate market appears to be undergoing a correction. While a slowing of investment and construction by as much as 10% would definitely reduce growth from 7.5% to 6.5%, an orderly adjustment is still factored into the IMF’s baseline scenario.
Women look at new residential developments in Chongqing China. The International Monetary Fund says the sector is facing an oversupply problem that threatens the overall economy. Women look at new residential developments in Chongqing China. The International Monetary Fund says the sector is facing an oversupply problem that threatens the overall economy.
The IMF said in a report released on Friday that oversupply was already a big problem in the industrial northeast and in coastal cities in the north.
China’s real estate bubble is different from the price inflation that took out the U.S. economy in 2008. There is no subprime or foreclosure crisis in China. And there is not the additional worry of a mortgage backed securities bubble in the works either.
But despite those two key differences, China housing has undergone a major growth spurt in the last decade. Rich Chinese are buying up second homes as investments. And local municipalities have been funding local builders to erect housing in order to create jobs. The problem is, Chinese urbanization trends have not sped up enough to account for the new high-rises, many of which are not fully sold. Unsold properties mean less money for developers who in turn have less revenue to pay off debts. For now, many municipal lenders have been either forgiving or rolling over those debts to extend the life of the loans. Like many economists elsewhere, the IMF says the trend is unsustainable.
Impact of Market Correction
Together with construction, real estate directly accounted for 15% of 2012 GDP, a quarter of fixed-asset investment, 14% of total urban employment, and nearly 20% of bank loans, according to the IMF.
China’s real estate market has close links to several upstream and downstream industries — from cement and steel makers, to heavy equipment leasing companies.
Local governments rely on land sales to developers as an important source of funding. Like in the U.S., real estate is used as collateral for corporate sector borrowing, adding to leverage risks. Such a decline in real estate investment could significantly disrupt financial and real economic activity in China as governments will have less in their coffers and companies will have less assets to borrow against.
Changes in borrowing on account of lackluster real estate markets will first be felt in the smaller cities. Several regions are in oversupply. Residential real estate inventories have increased sharply in Tier III and IV cities, including once-hot coastal cities like Hangzhou, Dalian, Fuzhou and Wenzhou.
China’s commercial real estate also appears to be in oversupply across most regions.
In terms of residential price dynamics, Tier II and Tier III/IV cities have performed the weakest, with prices in the latter group falling on month-on-month basis recently. The hardest-hit geographical areas include the industrial northeast and the coast. To make matters worse, developers have been reluctant to cut prices because it may lead new buyers to stay on the sidelines, thinking prices will depreciate in the short term. It would also cause problems for investors, many of whom purchased properties as part of a limited liability corporation and have used those properties as leverage against other assets.
“The market is distorted by local governments’ reliance on land sales to finance spending,” the IMF report stated.
On the demand side, the market is prone to speculation since housing has shown the biggest returns over the last decade. China investors don’t have many options. The foreign markets are closed to them. Local equities have underperformed over the past five years, and interest rates are only a tad higher than they are here in the U.S., making deposit accounts and money markets unattractive.
In major urban areas throughout Shanghai and Beijing, prices appear to be overvalued and price-to-income ratios remain high—even though, thanks to rapid income growth among the wealthiest Chinese, affordability indicators have generally been improving, albeit in a skewed manner.
As of May, average residential price growth started to turn slightly negative. Transactions fell by 10% and housing starts fell 12%.
Real growth in investment fell, too, from a 20% growth rate in 2012 and 2013 to around 10% by May 2014.
The IMF said that previous downturns, such as 2008 and 2012, were driven by policies to cool the market, but this current one has come without a direct tightening of real estate policies and appears driven by overcapacity and concerns about future capital gains on behalf of investors. As a result, many Chinese home buyers are turning to overseas markets, making oversupply a greater issue than before.
The IMF’s baseline scenario assumes investment in China’s real estate market slows to around 5% this year, a 50% reduction, then outright stalls in 2015 before gradually recovering in 2016. Such a scenario takes into consideration the low, average leverage of homeowners, underlying housing demand fundamentals due to urbanization trends, and Beijing’s ability to support developers if need be. The central government can also take other measures such as financial easing for lenders, as well as removing restrictions on second and third home purchases.
On the other hand, risk of large drop in investor demand for property has increased even if underlying, medium-term home ownership demand is sound.
A mantra for China developers and their lenders is in order. It may not ring is nicely, but surely will ring true: if you build it, they might not come.
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| Having Two Homes In China Is Not Enough For the truly affluent Chinese, of which there are hundreds of thousands these days, having a home in Shanghai and one in Hong Kong is passé. You've made your neighbors jealous if you have a home in Malibu. In fact, according to the National Realtors Association, Chinese buyers accounted for 12% of all the non-American buyers of California real estate in March of 2013. That puts them only behind the Canadians, which accounted for 23%. Here's the kicker: China's home buyers spent more than twice what the Canadians spent, dishing out upwards of $425,000 for a piece of the California Dream. Forbes spoke with Andrew Taylor, the Aussie CEO of Juwai.com, China's biggest real estate source for those looking to buy overseas or connect to those who are on the prowl for property. Here's Juwai's top 10 most searched for destinations, along with comments from Taylor. Sales data not included. | Image Source: .forbes.com |
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