China Needs to Pop Its Property Bubble
The financial woes of the giant real estate developer Evergrande, which carries an estimated debt of $300 billion, have rekindled global fears that China’s property bubble is about to burst. Such predictions have occurred repeatedly in the past, in particular since 2010, and have been fueled by the rapid rise of property prices, construction volumes, and real estate debt. Today, many analysts fear that if the property bubble collapses, the impact on the real economy will be devastating. Some expect China’s growth potential to decrease dramatically, to 4 percent per year from about 8 percent during 2010–19, or even lower. Yet the current property market turmoil originates in regulatory action to reduce financial leverage, and it may not lead to a full-fledged financial meltdown if authorities keep the situation under control. Most important, reducing the share of construction and real estate activity may slow real gross domestic product (GDP) growth in the short run but would benefit China’s transition to a more productive and sustainable growth model.
A Red-Hot Housing Market
After its liberalization in the late 1990s, China’s property market witnessed a sustained expansion with only minor corrections lasting no more than a few months. The government supported the property sector to strengthen the urban middle class and underpin growth. Banks started issuing home loans in 1997, and credit was easily accessible to both developers and households. Housing became the preferred investment vehicle for the Chinese, as bank deposit rates were kept artificially low, the stock market suffered severe crashes in 2007 and 2015, and capital controls prevented investment diversification abroad. Today the homeownership rate exceeds 90 percent (compared to 65 percent in the US) and about 70 percent of household wealth—far higher than in Western economies—is held in real estate. After the global financial crisis, the government used the property sector to spur growth via recurrent waves of easy credit. As a result, residential property prices have more than doubled during the last fifteen years alone (graph 1).
Graph 1: China Nominal Residential Property Price Index
Source: FRED and Bank for International Settlements.
The real estate bubble was fueled by a vast increase in both mortgage and developer credit. During the last decade, household mortgage loans increased almost six times, to about $6 trillion, while real estate developer’s debt almost doubled to $3.5 trillion (graph 2). Real estate debt exceeded 50 percent of GDP at the end of 2021 and contributed to the rapid buildup in China’s total debt in the economy, which in 2020 almost doubled to around 290 percent of GDP, after only two decades.
Graph 2: Housing Mortgage Loans and Developer Debt
Source: IHS Markit.
The scale of the building boom unleashed by China’s growth stimuli is impressive. The Financial Times reports that in only two years—2011 and 2012—China produced more cement than the US did in the entire twentieth century. During the last fifteen years, the volume of floor space under construction by real estate developers increased more than five times (graph 3). Today, China’s real estate activity, including construction, accounts for about 30 percent of GDP annually, compared to 15–20 percent in most developed nations. In addition, local governments depend on land sales for about a third of their fiscal revenues. The fact that about a fifth of China’s housing units are now vacant certainly points to housing oversupply and real estate malinvestment.
Article from Mises Wire