China Property

2 September 2011

Michael Collins, investment commentator at Fidelity

Evidence of the burst housing bubbles in western countries such as Ireland and the US is often shown as rows of empty, sometimes half-built, homes. Similar footage from China has prompted speculation that China’s housing boom will end as badly too.

Judging whether the Chinese housing market is a bubble is among the crucial issues facing investors today. Building is a big driver of China’s economy, developers and banks depend on rising housing prices and sales, and local governments rely on selling land to developers for much of their revenue. If the housing market dives, so too could China’s economic growth. The effects of that would be felt by commodity producers such as Australia.

While China’s housing market contains risks and a lack of transparency and information makes analysis more difficult, the market is not necessarily in a bubble because it operates differently from western property markets.

It’s easy, though, to find plenty to worry about when looking at China’s housing market – and plenty of pessimists to fan concerns. Large numbers of empty or half-built apartment complexes, even cities according to many reports, dot the country. Gillem Tulloch of Forensic Asia, a Hong Kong-based research consultancy, recently told SBS’s Dateline program that there are about 65 million empty apartments in China and the bubble and its aftermath will make the one in the US “pale in comparison”.1

Housing prices have soared in recent years – annual increases topped more than 100% in certain areas – and higher prices have put housing beyond the reach of most. Across China, average house prices are 10-times annual household incomes, according to the Financial Times, whereas three-times is considered the normal ratio for developed countries while the ratio is higher in Asia – say five to seven times.2 China’s ratio may be lower, many argue according to the paper, because China’s figures don’t account for illegal income that could account for a quarter of reported earnings.

To add to concerns about housing, Standard & Poor’s in June lowered the outlook for Chinese developers to “negative” while predicting that government curbs may reduce house prices by 10% over the next 12 months. Two months earlier, Moody’s Investors Service reduced its outlook for China’s property sector to “negative” from “stable” due to worries that residential sales could drop by as much as 30% as government measures to control property prices bite.3

Housing prices are already falling according to the latest figures from China’s National Bureau of Statistics.4 Prices for existing homes in May fell in 23 of the 70 cities it monitors, whereas in April prices dropped in 16 cities, the bureau said. Existing home prices in Beijing fell 0.2% in May from April while those in Shanghai rose 0.2%.

The brighter news

The stall in house price gains comes after several years when residential property prices in most Chinese cities climbed enough to stretch affordability. Because of the public angst caused, authorities last year imposed measures to cool demand, including unprecedented controls in some cities on buying multiple homes and on purchases by non-residents. These steps have removed much of the short-term speculative money from the housing market.

These moves come on top of those that Chinese authorities have taken to control inflation in general, and property prices in particular, such as four rate increases since October and nine hikes in bank reserve ratios since November that reduce the amount of money banks have to lend. As well, the government has embarked on an ambitious social (or affordable) housing program (36 million housing units over the next five years) that, by adding to supply, should ease price pressures on housing.

Our Chinese investment team has seen the alarming reports on China’s property market, including those that suggest there are several empty cities in China full of unaffordable housing. Our team’s view is that this may indeed be the case but the Chinese often build infrastructure ahead of when it is needed and the team expects most of the vacant cities to fill up in time.

These alarmist reports also suggest there are as many as 65 million empty apartments. Fidelity’s analysts are unable to confirm a source for this figure, while the research they have seen suggests numbers significantly lower than this. There are no official statistics on the number of empty apartments.

Whatever the number, these empty properties are mostly owned by individuals who choose not to live in them, according to our analysts. The best indicator of this is that there is not a huge backlog of unsold apartments owned by developers.

The key question as to whether housing prices crash in China depends on whether owners try to sell if – as looks likely – housing prices gently decline later this year. Our analysts think that most people will hold on to their homes, seeing property as a longer-term investment rather than a short-term speculation play. The mortgage debt against these properties is generally not high so people are unlikely to be forced sellers – many people in China pay cash for their properties or put down a deposit of at least 20% (plus there is almost no securitisation in China and banks tend to hold onto the mortgages until their full maturity).

According to our analysts, housing prices in China are likely to prove resilient because incomes are rising, banks are still lending and people hold high expectations for future values due to the limited number of other investment opportunities in China. Cash and shares are the only alternatives for most. At the moment, bank deposits offer less than inflation and China’s share markets have struggled since the government took steps to rein in price rises.

The long-term demand picture for residential housing is still favourable in China. There’s no shortage of demand for housing in a country where many families live in single rooms with communal cooking and shared toilet facilities.

China’s property prices have peaked

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