Alarm bells are ringing on China's property bubble

China’s biggest real estate developer believes his country’s housing construction frenzy has reached its peak. Now it's just a question of how big the correction will be.

Before the burst of the Japanese real estate bubble in 1990, Tokyo's total land value was about $US4.1 trillion, or 63.3 per cent of US GDP. When Hong Kong’s apartment prices crashed in 1997 the land value for the city was about $US5.7 trillion, or 66.3 per cent of US GDP.

Guess what? Beijing’s land value in 2012 was about $US10 trillion, or 61.6 per cent of US GDP. Do you see the scary parallel now? The vice-president of China’s largest property developer Vanke, Mao Daqing, certainly does. In a leaked speech that is still causing ripples in China he said Beijing’s land value was a very scary number indeed (What keeps China’s biggest property developer up at night 7 May 2014).

“Multiple pieces of evidence suggest that the Chinese property market in 2013 shared many characteristics with that of Japan and Hong Kong before the bursts of their asset bubbles,” Mao said last week at a closed door industry forum. “From the perspectives of the percentage of income that a household spends on housing expenditures, the rapid growth in Beijing and Shanghai is approaching Tokyo and Hong Kong levels before they went bust,”

Analysts and commentators are shifting their attention to the next weakest link in the Chinese economy -- the property sector -- which accounts for 16 per cent of GDP and 33 per cent of fixed asset investments. Wang Tao, the chief China economist for UBS, sees it as the biggest risk to the Chinese economy. Zhang Zhiwei of Nomura believes the sector is facing a major correction and it is no longer a question of if and when, but how much.

However, it is Mao’s penetrating analysis that offers the most worrying insight into the sector. On Wednesday, China Spectator wrote about the rapid build-up of inventory and the high level of leverage of property developers in China, according to the leaked speech.

Mao is putting China’s over-investment in the property sector into a global perspective. In a mature and stable market, an average family owns 1.1 houses and each person occupies 1.1 rooms. If we apply this standard to China, Beijing is still facing a shortage of housing but many other cities are more adequately supplied if we include existing inventories, he says.

Mao uses standard industry measurements such as ‘new units under construction per thousand people’ to illustrate the dire state of over-investment. Between 2009 and 2011, China built 1.85 billion square metres of floor space or 16.27 million residential units. It works out to be 12 new units per thousand people.

That number is about the peak construction level in many developed countries. Mao says though that this number is acceptable but has more or less reached the peak -- and this does not even include other houses under construction that are not built by commercial developers.

If he was to include other housing projects apart from commercial development, China’s housing units constructed yearly per thousand was more like 35 units in 2011. This far exceeds anything we have seen even during the boom years of Japanese and Korean construction, which didn’t exceed 14 units.

“That was a peak without precedent in human history,” Mao said according to the leaked transcript of the meeting.

Like many other things, it is dangerous to overgeneralise in China. First-tier cities like Beijing, Shanghai, Guangzhou and Shenzhen still face an under-supply of housing, and there are signs of sluggish demand recently due to a generally gloomy outlook for the sector.

Third- and fourth-tier cities, which account for 67 per cent of total construction, are roughly building at the national average rate. Mao is most concerned about second tier cities -- mostly provincial capitals -- which account for nearly one third of total construction in China.

Housing units under construction per thousand was 30 in 2011, more than double the international average during their peak development period.  For example, the figure for Hohhot, the Inner Mongolian capital, was 70 for the last three years, while it was 49 for Shenyang, a major provincial capital city in the northeast, and 38 for Xi’an.

“In the past three years, housing construction frenzy has reached its highest peak in human history. For cities that can attract new migrants, it is safe to be building between 20 and 25 new units per thousand people,” he said.  

“But some second-tier cities are building 30 or even 40 units per thousand people every year and we must pay attention to that.”

In summary, Mao believes the level of housing construction has reached its upper limit. He still sees potential in third- and fourth-tier cities in coastal provinces, where living standards are approaching industrialised countries.

However, he is pessimistic about cities with a high level of inventory and can’t see room for any price increases for at least the next few years. Even for the first-tier mega cities like Beijing and Shanghai, prices are among the most expensive in the world. They’re even more dear than Tokyo and New York, two of the most expensive cities in the world.

“We think housing prices are quite reasonable in New York,” he said. This rare insight from one of China’s most influential property sector executives should serve as an alarm bell to people who are concerned about the health of the Chinese property sector.   

This is part two of China Spectator’s coverage of the Mao Daqing leaked speech that has caused shockwaves throughout the country. China Spectator will publish part three of this series on Monday. Read part one here.