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The Chinese Real Estate Time Bomb

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Last year, China surpassed the United States as the world’s largest property market worth US$156.2 billion. The big question, is it all a giant bubble?

When the global economic crisis struck in 2008, China knew it had to deal with the problem immediately lest the country suffer the same fate as most Western economies.

Thus, the Economic Stimulus Program was introduced the same year to counteract the fallout that threatened social upheaval among the citizenry. Nearly 40% of the package was allocated for public infrastructure, which included building affordable housing and funding loans to help transform the real estate sector into a robust, dynamic market.

Three years later, numerous regulatory policies are now in place as foreign capital for various property investments continue pouring in. Now, with thousands of luxury apartments and commercial buildings standing empty as a result, property analysts are divided on whether the stimulus package helped the growth of China’s economy or triggered a housing bubble that is waiting to burst.

Low-cost Housing
Despite tighter regulations, the central Chinese government likes to think the rapid pace of building 24 real estate properties will prove more boon than eventual bust. So does the financial community.

“We believe that the large-scale construction of low-cost housing will be a major driver for the country’s economic growth,” says Jing Ulrich, chairman of global markets in China at JPMorgan Chase. Confirming her enthusiasm are the big numbers.

The central government estimates that 10 million residential units will be built this year alone, which should accommodate a third of the 30 million citizens looking for affordable housing.

The stringent policies introduced in the last 12 months were put in place to curb widespread speculation of purchase values in the property development market. These include imposing higher requirements for new purchases as well as announcing spikes in benchmark interest rates. 

“The big increase in low-cost housing will change the country’s property market format, and property developers need to quicken their transformation to adapt to this change,” said China Real Estate Association secretary general Zhu Zhongyi at a real estate summit in Beijing early this year.

The restriction on new home purchases is just one of the many regulatory measures that the government has kept a firm grip on. Last month, the state extended the restriction to lesser-tier cities.

Following the expected market reformat, industry experts believe a decline in property prices may soon happen as a result of the rapid proliferation of small apartments in major cities such as Beijing and Guangzhou. But a sharp drop is unlikely. “I don’t think the word ‘turning point’ is appropriate to describe future housing prices,” says Zhu.

Low-cost housing is not the only property that’s spreading like wildfire in smaller cities. Investments in building fixed assets—such as factories and commercial buildings—have ballooned by an average of 24% from last year, if data released last month by China’s National Bureau of Statistics (NBS) is to be believed. This despite more stringent policies by the government to curb excessive borrowing by investors.

Many of the companies and organizations responsible for the bulk of investments are owned by the state. This suggests that efforts at regulation are curbed by lax enforcement. Analysts believe that the property sector’s resilience may be a strategy orchestrated by the state itself, a subtle experiment in financial engineering executed on a grand scale.

Rapid Development
The continued construction of condominiums and commercial buildings in areas where structures are mostly vacant may be another reason. While the worst financial crisis in history since the Great Depression struck down most of the world’s major economies, China’s has weathered the storm relatively unscathed. Its real estate investments—fixed assets, in particular—accounted for two-thirds of the country’s trillion-dollar economy in 2009. Meanwhile, the United States went through a recession that was triggered by a market correction from their own housing bubble.

It was only a matter of time until someone from China would dare say the state is suffering a similar fate. “China’s property market is a massive bubble,” Shanghai-based contrarian economist Andy Xie remarked last year. Thus, as speculative investing became widespread, the state started imposing measures to avert a similar bubble, which included a revival of property tax in 2009, higher down payments for families purchasing second homes last year, and the removal of discounts for first-time estate buyers this year.

As premium land space in major cities rapidly decline, developers have looked into second- and third-tier cities for building cost-effective residences that target middle-class buyers. But the exodus of investors into these untapped areas may have had unintended consequences. Previously, China’s most valuable lots could be found in Wenzhou, Zhejiang province. One parcel of precious real estate in the prefecture-level city, in particular, was valued at 27,000 yuan (US$4,192) per square meter, the highest known price for a residential area in mainland China. But that was last year.

The record was recently broken after a local estate developer purchased tracts of land in Yiwu, a nearby city in Zhejiang, for 39,545 yuan (US$6,139) per square meter—12,500 yuan more expensive than Wenzhou.

“Recent record land sales made in second- and third-tier cities suggest that the new top prices are somehow shifting to second- and third-tier cities, especially as the major cities of Shanghai and Beijing are short on premium land,” says Lu Qilin, research director at a real estate agency in Shanghai.

Analysts worry, on the other hand, that the rise of property prices in lower-tier cities like Wenzhou and Yiwu will cause local market bubbles to form and eventually burst by year’s end. As the populace of Wenzhou and Yiwu thrive in specialized free markets and commodity trade, many newly minted entrepreneurs who can afford more than one house are being tempted by local developers into buying luxury units in nearby provinces.

Zhang Hongwei, a research director for a real estate consulting firm also based in Shanghai, believes that the status symbol attached to owning these properties has attracted investors to build more luxury apartments in second- and third-tier cities. The properties will most likely be sold from 60,000 to 100,000 yuan (US$9,315 to 15,525) per square meter, Zhang estimates.

But not everyone has rushed to buy these hot properties. The head of Wenzhou SME Development Association, Zhou Dewen, cautions that a bubble could just be around the corner if the spree of unrestrained property buying goes unchecked in the coming weeks: “In the worst scenario, after the land-bidding spree sidelines industrial production and fuels more record property prices, the bubbles in the housing market will burst and the economic boom will end with a hard landing.”

More Foreign Investments
Aside from state-funded low-cost housing and luxury properties in lower-tiered cities, foreign investments in China are also expected to rise, if the upward trend of the last five months is any indicator. According to NBS, local property developers spent US$4.1 billion in foreign capital from January to May this year. “Foreign institutional investors are particularly interested in commercial properties in China’s central and western regions,” says Grant Ji, a director at property service provider Savilis. 

Other foreign investment companies also see the potential of commercial properties sprouting in smaller cities. “Obviously, they are betting on the huge growth potential of China’s retail sector, and thus the chance of a higher yield from investment in the commercial properties,” says Lecheng Real Estate general manager Wang Zhe, whose company is now building one of the largest shopping malls in the national central city of Tianjin.

The bustling northeastern metropolis bears witness to the never-ending construction of unoccupied office buildings that will not be fully leased for the next quarter century. With zero tenants, the vacant rooms gather dust.—With reports from China Daily

Print ed: 08/11


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