Chinese property bubble trouble?

Concern is growing among investors about the health of the real estate sector in China, and there’s plenty of evidence to weigh up on whether a major correction is imminent.

Graph for Chinese property bubble trouble?

Li Ka-shing, the richest man in Asia and one of the shrewdest property investors in the world, has been selling down real estate assets in China -- including Oriental Financial Centre, which is at the heart of Shanghai’s glitzy financial district. In 2013, he offloaded 20 billion yuan's worth of property in China.

Li, who is known as the “superman” in Hong Kong, is shifting his investment focus from mainland China and Hong Kong to Europe, and especially Britain. Some investors and property developers in China see Li’s move as a sign of his weakened confidence in the world’s second largest economy.

Wang Shi, the chairman of China’s largest property developer, Vanke, said: "The shrewd Mr Li is selling his assets in Beijing and Shanghai, and this is a sign that we must be careful".

Wang’s comment is part of a growing concern among investors about the health of the real estate sector in China, which is one of the most important growth engines and revenue sources for the government.

Nomura’s chief China economist Zhang Zhiwei believes a potential downturn in the real estate sector poses the greatest risk to the Chinese economy in 2014 and 2015. He argues that real estate sector risk is more grave than either shadow banking or the local government debt problem.

The real estate sector makes up 16 per cent of GDP, 33 per cent of fixed asset investment, 20 per cent of outstanding loans, 26 per cent of new loans and 39 per cent of government revenues in 2013. "If it slows sharply, we see obvious replacement to support growth," says Zhang in his research report.

But people have been predicting the collapse of the Chinese property sector for years. Andy Xie, a noted former Morgan Stanley chief Asia economist, has been saying that for as long as people can remember, and it has become somewhat of a running joke among economists and investors.

At a time when people are getting increasingly jittery over other looming signs of crisis in the country’s shadow banking sector and ever-expanding local government debt, the question must be asked: Is 2014 going to be different?

This year has already started off on a bad note. House prices in 70 large and medium cities have only increased 0.27 per cent in February. That’s an incredibly slow pace compared to the same period last year. Even more worrying is the fact that developers in second, third and fourth tier cities have started reducing prices to sell apartments.

This is a far cry from previous years, when Beijing had to step in to impose draconian policies to restrict people from buying property in a bid to put a lid on skyrocketing house prices. There are ominous signs that bubbles are quickly developing in China’s third- and fourth-tier cities.

Zhang from Nomura argues that foreign and Chinese investors are often misled by soaring prices in major cities like Beijing, Shanghai, Guangzhou and Shenzhen. In fact, they only account for 5 per cent of housing under construction.

Twenty-four second-tier cities -- mostly provincial capitals -- account for 28 per cent of housing under construction. On the other hand, the mostly overlooked third- and fourth-tier cities account or 67 per cent of housing under construction, 69 per cent of sales, and 57 per cent of housing investment.

Zhang argues that the fast-emerging risk comes from the overlooked third- and fourth-tier cities. The rapid expansion in the sector has contributed to a large over-supply of housing stocks in many smaller cities dotted around the country.

Between 2000 and 2013, China’s residential property supply increased 423 per cent. On a per head basis, an average Chinese person enjoyed about 23.4 square metres back in 2009, a figure comparable to Russia, but far below other developed countries.

However, as a result of rapid expansion, the average residential floor space increased 31 per cent to 30.6 square metres in 2013, a level that is comparable to developed countries like Japan and Britain.

Let's use Guiyang as an example. Guiyang is a small mountainous city in southern China with a population of four million people. The five largest real estate projects in the city are building 74.2 million square metres of new apartments, enough to house two million people.

The head of forecasting at the state information centre, Zhu Baoliang, says the situation in Guiyang was “madness”.

“The planned new city is several times larger than the old town,” he told the Southern Weekend newspaper.

Some of China’s largest and well-financed property developers are shifting their focus away from third- and fourth-tier cities and are moving back to major metropolises like Beijing and Shanghai, despite soaring land prices.

How bad are the problems in these smaller cities that account for a majority of new housing construction in China? Can we expect a major correction in the sector that could lead to a sharp downturn in the Chinese economy?

China Spectator will look at these problems in a series of articles over the following weeks.

The second article in this series looks at Nobel Laureate Robert Schiller's diagnosis of China's property market. Read it here.