The rapidly cooling Chinese property sector is one of the most polarising issues for analysts who try to make sense of an industry that is responsible for 20 per cent of total investment in the world’s second largest economy.
An increasingly large number of analysts are beginning to view 2014 as a tipping point that could put an end to China’s miraculous run over the past three decades. In yesterday’s article (Fears of a Chinese property crash are overblown, October 15), China Spectator drew attention to the arguments of Dr Li-Gang Liu, ANZ’s chief economist for Greater China, about the fundamentals that help support the health of the Chinese property sector.
Dr Liu cites high-quality mortgage assets, large-scale urbanisation, high saving rates and historically strong demand for housing as some of the most important factors that support the country’s housing sector. In the same policy brief for the Peterson Institute for International Economics, he also outlines some of the risks.
Risks to China’s property sector
There are emerging signs of a bubble in the sector. The country’s property prices have increased 64 per cent over the past 10 years, outpacing most of its Asian neighbours. Though growth in per capita household income at a national level has tracked property price increases, income gains in the big cities have not been able to keep pace with skyrocketing house prices.
The relatively safe picture painted by Chinese property data at a national aggregate level masks significant regional variations, with some areas experiencing significant over-supply problems. For example, regional capitals like Kunming and Changsha saw property investment surge 20 per cent each year over the past decade, while population growth was limited to three per cent a year over the same period.
The greatest risk to China’s property sector lies in the third- and fourth-tier cities. As Liu notes, “In the current property market slowdown, property prices in these cities could experience significant downward adjustment absent policy changes to phase out property curbs and hukou restrictions.”
Another significant downside risk to the property sector is its link to the country’s banking system. Liu estimates Chinese property developers source 40 per cent of their funding from trust companies, an important part of the shadow banking sector which has total assets of close to 12 trillion yuan, or $2.2 trillion.
Trust companies typically charge an interest rate of at least 12 per cent a year, twice the country’s benchmark rate. This was not a problem when property prices were surging but, “a sluggish property market with rising inventories could lead to payment difficulties for weak developers, causing financial stress in China’s companies as well,” Liu argues.
Having weighed up the risks, Liu’s diagnosis is relatively upbeat. He argues that recent policy measures aimed at curbing demand and putting a lid on prices have distorted prices. For the past four years, local governments have prevented people from buying multiple properties and put barriers in the way of non-residents looking to buy homes in cities in which they don’t reside permanently.
The ANZ economist argues that this pent-up demand will support a healthy property sector once local governments begin to relax these policy settings.
However, 66 out the 70 cities that introduced these measures have already lifted their restrictions and we’re yet to see any noticeable uptick in demand or prices. So, early evidence is casting some doubt on Liu’s prediction.
Liu, a former economist at Hong Kong Monetary Authority as well as the World Bank, argues the sector is simply going through its third cyclical downturn. “Like stock prices, price corrections after a sharp price increase are inevitable and necessary,” he says.
Chinese property developers, mostly private owned and controlled, have gone through a rapid deleveraging over the past few years. The debt-to-asset ratio for listed developers has dropped from 90 per cent in early 2009 to 50 per cent. In addition, they still enjoy strong profit margins, in fact, some of the highest among Chinese listed companies.
The ANZ economist has also provide a useful summary of policy tools available to Beijing to help support the sector. Apart from the obvious blunt tools like cutting interest rates or lowering the capital reserve that banks are required to hold, there are a range of policy options available to Beijing.
For example, they can allow banks to issue covered bonds or securities their mortgages to manage the maturity mismatch of the banks’ mortgage portfolios. At the moment, Chinese banks still have to hold all mortgage loans on their balance sheets, which is a huge drag on their capital base. The maturity mismatch between short-term deposits and long term mortgages is a considerable risk for the Chinese banking system.
One of the major policy impediments to China’s urbanisation process is residential registration system. Though Beijing has announced its intention to abolish it eventually, the country still has some 170 million migrant workers waiting to receive residential permits in the cities.
The Chinese government can and should build more public infrastructures to accommodate more rural migrants as well as phase out the discriminatory residential permit system. “These migrants’ potential demand for houses, either owning or renting, remains huge if they can find jobs in nearby cities where they can also gain equal access to public services,” Liu says.
Though we need to be vigilant about the considerable risk in the Chinese real estate sector, it is too simplistic to draw parallels between the US housing crash and the current situation in China. There is no evidence of widespread default or irresponsible lending, if anything, the quality of Chinese mortgages is rock solid, which requires a minimum of a 30 to 40 per cent down-payment before home buyers can qualify for a loan.
Beijing still retains a considerable range of policy tools to combat any potential collapse, and more importantly, strong fundamentals such as urbanisation support a more bullish perspective on China’s housing sector.