Thoughts on China’s Real Estate Crisis
After three years, China remains mired in a deep
housing and real estate slump. According
to a March 21, 2024 report from the leading global investment firm KKR, this housing recession may not be ending anytime soon. Based on a comparison to the housing bubbles
in the US, Japan and Spain, KKR concludes that the Chinese “housing market
correction may be just halfway complete.”
If true, this is very bad news, as it comes on the
heels of an already sharp contraction in China’s real estate sector. In a June 25th Financial Times editorial, highly respected China economic observer,
Chen Long, summarizes the fall in Chinese housing activity. Basing his calculations on official Chinese
Government data, Chen notes that on a rolling 12-month basis, home sales in
China have dropped to 850 million square meters, or roughly 8.5 million
apartments, which is half the level of three years ago. He further notes that the floor space of
construction starts have gone down to 620 million square meters, or two-thirds
below its early 2021 peak. The share of
real estate and construction activities in China’s economy has fallen to its
lowest level since 2009. Last but
certainly not least, housing prices have fallen by nearly 20% across the
country, although this figures masks considerable regional variation across
cities (more on those differences later in the blog post). Chen is hardly exaggerating when he writes, “we
have witnessed one of the greatest housing market corrections in economic
history.”
This real estate meltdown was initially triggered by government
efforts in late 2020 to cool down the property market. That is when President Xi, concerned about
speculation in the housing market and excessive leverage by developers
associated with their debt-driven model of home building, initiated a liquidity
squeeze on real estate firms. That
squeeze consisted of his now infamous “three red lines.” Under these new rules, liabilities could not
exceed 70% of assets (excluding advance proceeds from projects sold on
contract), net debt could not exceed 100% of equity, and money reserves had to equal
at least 100% of short-term debt. This
move quickly set off a chain reaction leading to the bankruptcy of dozens of big and smaller heavily leveraged private developers, including industry giants
like Evergrande, Country Garden, and China Vanke.
Unable to access easy credit, these firms ceased
construction of unfinished apartment complexes.
Since it is the norm for Chinese homebuyers to purchase their apartments
before they are finished, those who bought pre-sold units in such partially completed
projects and made down payments and took out mortgages on them were left in the
lurch. These so-called “烂尾楼
(Làn wĕi lóu),” or “rotten tail” projects, generated understandable anger among
these ordinary homebuyers, who felt they had been duped by developers. By 2022, these people took to the streetsacross China in protest—besides distressed developers, they directed
their ire toward banks for failing to safeguard their money.
Those protests, the ongoing importance of the real
industry, which accounted for around a quarter of China’s economy in 2021, combined with the double-whammy inflicted by the effort to pop the property
bubble and negative impact of Covid and attendant lockdowns, led Chinese
governmental authorities to ditch the “three red lines” framework. Starting in late 2023, housing policy in
Beijing and local governments shifted dramatically from tightening to
easing. As Chen observes in his Financial
Times editorial, “housing policies are now at the loosest of all time in
most parts of China.”
Thus, after the July 2023 Politburo meeting in which
top decision-makers recognized the need to prop up the real estate sector,
measures aimed at doing that, in the words of China’s leading financial
publication, Caixin, “sprouted like mushrooms after it rains” in
cities across the country. These
included the first-tier mega metropolises of Beijing, Shanghai, Guangzhou, and
Shenzhen, which had previously sought to limit speculative property purchases,
a policy that echoed President Xi’s admonition that “houses are for living, not
for speculation.” The definition of
first-time homebuyers was relaxed to allow more of them to qualify for lower
down payments and mortgage rates. As Caixin
notes, this marked the first time in three years that lending curbs in China’s
four first-tier cities had been loosened.
At the same time, the central bank, the People’s Bank of China (PBoC)
and National Administration of Finance cut the minimum down payments for mortgages to 20% for first-time buyers and 30% for second-time buyers
nationwide. Other steps to revive the housing market included the biggest ever reduction in mortgage rates, as
well as trial programs to get residents to trade in old apartments and buy new
ones.
As the figures on the ongoing slump in China’s
property market noted earlier make clear, none of these measures moved the
needle in a positive direction. This
failure led national and local governmental authorities to introduce further
stimulus measures in May of this year. China’s four first-tier megacities once
again slashed downpayment requirements and allowed room for cheaper home loans.
The PBoC announced it would
facilitate $138 billion in extra funding for property and further ease mortgage
rules, while local governments were directed to buy “some apartments.” This last measure has been touted as “historic,”
and the New York Times reports that $41.5 billion has been
committed to help fund loans for state-owned companies, who have been
instructed by local governments to start buying unwanted flats. According to Vice Premier He Lifeng, these
units would be used to provide affordable housing for less affluent Chinese.
The plan to have governmental entities to get into the
housing business by purchasing unsold housing units raises a number of thorny
issues. A Shanghai-based developer
quoted anonymously on this move in a May 17th Reuters article on the latest housing rescue package states, “Psychologically, it’d
let investors think the government is ‘paying the bill,’ and it is shifting the
risks from property developers to banks and local governments.” By letting property developers off the hook
for reckless overexpansion, it raises the issue of moral hazard: these actors will be tempted keep taking
unwarranted risks in the expectation of being bailed out by a third party down
the road. Another more fundamental
issue, however, is whether local governments are really capable of buying all
of the unsold apartments and their ability to find buyers for them. The New York Times article on this
scheme notes that estimates of what the government would need to spend to get
the unwanted flats off of the market amounts to between $280-560 billion, well
above the sum that has been allocated to do this. Moreover, due to their reliance on revenue
from land sales, which has sharply contracted during the housing crisis,
Chinese local municipal governments are very short of funds. Some have even sought to reduce medical benefits for seniors, which sparked widespread protests across
China. I am skeptical about their
ability to fulfill even the modest scale of purchases envisaged in the plan to
take unsold apartments off the market, let alone perform the real heavy lifting
necessary to do that.
The vast sums of money involved in this herculean task
underscores the basic problem underlying all of the short-term Chinese
Government fixes for the real estate slump.
That problem is China’s massive oversupply of housing stock. While the numbers here vary a lot, they are
all pretty eye-watering. According to Bloomberg Economics, as of June, China had 60 million unsold apartments, which
will take more than four years to sell off without government
intervention. An August 22, 2023 New
York Times article cited a similar figure, putting the
number of unwanted housing units at 65-80 million. In February, Nikkei put the
number of Chinese who could be housed in their country’s excess housing stock
at 150 million. Former deputy head of
the Chinese National Statistical bureau, He Keng, argues that that figure
should be much higher. In a display of
candor unusual for a Chinese government official, even one in retirement, He claimed in a September 2023 forum held in the southern city of Dongguan
that China’s 1.4 billion people “probably can’t fill” all of its vacant
flats. It also bears noting here that
according to the New York Times article on the government plan to
purchases unsold apartments, China still has 10 million “烂尾楼
(Làn wĕi lóu),” “rotten tail” projects.
China’s dreadful demography will make cleaning out
this huge inventory of excess housing all the more difficult. The rapid aging of China has led to the
hollowing out of its young and middle-aged adult population—precisely the
people who are the prime homebuyers. According
to Nicholas Eberstadt, holder of the Henry Wendt Chair in political
economy at the American Enterprise Institute Washington think tank, between
2015-2040, the number of Chinese aged 30-49 will shrink by 25%, or well over
100 million men and women. At the same
time, the pace of urbanization in China, which had previously fueled
high demand for housing in the cities, is slowing and by 2035, this process
will have run its course, putting further downward pressure on housing demand. The IMF therefore projects that real estate
investment will likely fall between 30 to 60% from its 2022 level, rebounding
only very gradually.
Source: Henry
Hoyle and Sonali Jain-Chandra, “China’s Real Estate Sector: Managing the Medium Term Slowdown,” International
Monetary Fund News, February 2, 2024.
As noted at the start of this blog, while housing
prices have contracted throughout China, this decline has varied across different
cities. That is especially true when it
comes to upper- vs. lower-tier metropolises.
For those unfamiliar with the different tiers for ranking Chinse cities,
tier 1 cities comprise the most developed and desirable metropolises,
especially for foreign investment, such as Beijing, Shanghai, and
Guangzhou. Tier 2 cities are ones with
lower GDPs than their tier 1 counterparts, but are still attractive investment
destinations, such as Chengdu and Qingdao.
Tier 3 cities consist of poorer provincial capitals and ones of more
limited political and economic significance with large populations. Fourth tier cities are ones with low GDPs,
but are still developing and urbanizing, while those falling into tier 5 tier
comprise China’s poorest urban areas. Metropolises
falling into the tier 3 or below category have been most heavily impacted by China’s real estate slump.
The picturesque town and tourist hotspot of Dali in
Yunnan Province in Southwest China exemplifies the property woes of lower-tier Chinese cities. Housing prices
there had been declining since mid-2021, before making a very modest rebound
over the last year, while investment in real estate development plunged by 43%
through April 2023. As is the case with
other lower-tier cities, a main driver of the Dali’s real estate squeeze is its
declining population. During the
2010-2020 decade, the number of people in the Dali prefecture shrank by 120,000.
Over this same period, the growing housing surplus was further fueled by
long-time overinvestment and overbuilding.
Disclosure alert: during my
decade-plus years of living in China, I spent about a week in Dali and
thoroughly enjoyed my time there (and even wrote an article about it in High
Above, the in-flight magazine of Hainan Airlines). One memory of the trip was wandering about a
housing development outside the old town of Dali, whose ancient walls are still
intact, consisting of brand-spanking new high-end villas. When I asked a couple of locals about that
complex, they said that all of the units were vacant and doubted if they would
be occupied anytime soon.
Lower-tier cities like Dali have the largest
oversupply of housing in China. In a
September 2022 International Monetary Fund Occasional Paper, Harvard
economist Kenneth Rogoff and Yang Yuanchen estimated that the aggregate total
housing stock in tier 1-3 Chinese cities rose from 39 billion to 56 billion
square meters between 2010-2021. They
note that tier 3 cities accounted for 78% of the growth in the housing stock
over that decade, despite being home to 66% of Chinese urban residents. Rogoff and Yang estimate that between now and
2035, real estate construction in such places will have to shrink by roughly
30%.
A key factor encouraging developers to overbuild in
lower-tier cities has been misguided Chinese government efforts to encourage
“balanced” urbanization. Authorities
have sought to redirect the flow of people away from upper-tier metropolises,
especially the big megacities, to smaller urban centers. This can be seen in the modest 2014 reform of
the so-called 户口 (hùkŏu) household registration
system. Under this framework, Chinese
born in rural villages receive rural hùkŏus and can only access government
health insurance, welfare, and pension schemes for rural residents, which are
much less generous than those given to city-dwellers with urban hùkŏus. The 2014 hùkŏu reform made it
easiest for villagers to exchange their rural for urban hùkŏus when they moved
to the lowest-tier towns and set forth progressively stricter standards for
doing this in upper-tier metropolises (next to impossible in places like
Beijing, Shanghai, and Guangzhou). However,
ordinary Chinese have been voting with their feet, opting to relocate to top-tier
cities, which offer greater economic opportunity. Besides the hùkŏu reform, Chinese policymakers
sought to boost smaller cities in interior provinces by giving them more land
quotas for real estate development—in China, all land is still owned by the
state—compared to their upper-tier counterparts. These measures incentivized property developers to build more housing in such places in anticipation of
higher demand for it.
I also saw first-hand the housing glut in lower-tier Chinese cities while making frequent visits to the drab fourth-tier metropolis of Panjin in Liaoning Province in northeast China. I was working as a “corporate trainer” for the Great Wall Drilling Company, which is a subsidiary of one of China’s two flagship state-owned oil companies, the China National Petroleum Company (CNPC). The managers of the training center at the Beijing headquarters of the firm sent me and the other foreigner working there, a Canadian fellow, up to Panjin to provide engineers with basic English instruction before they were sent to work on CNPC projects outside of China. While walking about and being driven around Panjin, I was struck by all the shiny new apartment towers that were sprouting up around the city like weeds. One time as I was being driven to the Panjin train station to go back to Beijing and passed by a cluster of high-rise apartment blocks, I asked my driver about all that construction. He told me that those particular structures had not only failed to find buyers and were all vacant, but they were likely going to be torn down, citing extremely shoddy construction work. Yet another example of what the Chinese call 豆腐工程 (dòufu gōngchéng), or “tofu engineering.” This story, I might add, occurred in 2013 or early 2014, years before the Chinese real estate bubble popped.
To sum up, lower-tier Chinese cities are facing now
and into the future a triple whammy when it comes to housing. Besides being significantly overbuilt and
home to the bulk of China’s excess housing stock, demand will be squeezed by
two adverse population trends. The first
is the overall fall in the young to middle-aged adult population who are the
biggest homebuyers. The second is the
pattern of internal migration in China.
As noted above, when rural Chinese leave their villages to head to
cities, they do not go to lower-tier urban centers, but instead head to
upper-tier metropolises offering better economic prospects. The same holds true for city-to-city migration. Housing demand in
lower-tier cities will be hammered not just by China’s overall bad demography,
but by the out-migration of their residents to higher-tier metropolises. All of this means that the effort to have
local government authorities purchase vacant apartments in lower-tier cities,
where the oversupply of housing is the greatest, is bound to fail. Given future trends in the demand for housing
in such places, local governments will be hard-pressed to find buyers for the
vacant housing units acquired under this scheme. In short, there is little prospect in the
near or long-term future for a housing market rebound in lower-tier Chinese
cities.
The bleak prospects for housing markets in these
metropolises does not bode well for the economic future of China. Some 70% of Chinese live in these cities and even as the number of their residents shrinks, due to out-migration to
higher-tier urban centers, they will remain home to a huge chunk of the
country’s population. As is true for
ordinary Chinese in general, homes are the only real store of wealth for
lower-tier city dwellers. Government
“financial repression”—the suppression of interest rates on bank savings
deposits—dodginess of Chinese equity markets and other investment products, and
capital controls limiting the ability to invest abroad make buying a home the one
path for accumulating wealth for those in the middle-class. Rather than having a store of value,
middle-class Chinese residing in lower-tier cities will be stuck with a
depreciating asset and will consequently feel poorer. That, in turn, will make them less inclined
to buy goods and services, further hindering efforts to rebalance the Chinese
economy toward consumption. Lastly, as
these homeowners age and need to move out of the flats they own—assuming their
children have moved to other cities in search of better jobs and cannot move
into these vacated units—they will struggle to find buyers for their properties,
necessitating unloading them at fire sale prices. All of this will have interesting
implications for China’s political and social stability and legitimacy of the
ruling Communist Party.
The outlook for housing demand in upper-tier Chinese
cities is, at first glance, much less dire than is the case for their
lower-tier counterparts. Rather than
stagnating or even declining, the population of upper tier cities will continue
to expand as most of the 1 in 3 Chinese still living in the countryside choose
to move to these metropolises when leaving their villages. However, as Chen Long observes in his Financial
Times editorial, the pace of urbanization in China has significantly
slowed, with average annual increase in the city population averaging 10
million in 2020-2021, or half the level of the previous quarter century. While new apartments will be have to be built
to provide housing for the still rising number of urban-dwellers, that need
will be significantly lower than it was during the previous two and a half
decades. That need will be further
diminished by the large number of vacant apartments in top-tier cities. Chen notes that the slowdown in
rural-to-urban migration translates into a 400 million square meter drop in new
housing demand, down from 900 million square meters during the period of rapid
urbanization (again most of this new housing demand will be in upper-tier metropolises). He concludes that real estate in top-tier urban
markets may begin to rebound late this year or next year, but that rebound will
be relatively modest. This view is
echoed by Lynn Song, chief economist for Greater China, Hong Kong, who, after
the mid-July release of government economic data on 2nd quarter
growth in 2024, stated in a Reuters article, “we saw some
stabilization (of housing prices) in some key tier 1 and 2 cities.”
But even as more people relocate to upper-tier Chinese
cities to prop up the demand for housing in such places, another major issue is
whether these new residents can afford to buy flats in such places. While apartment prices in these metropolises
have come down some during the recent property slump, they remain relatively
high. Measured in price-to-income ratios,
a commonly used yardstick measuring housing affordability, Chin’s four tier-1 metropolises
of Beijing, Guangzhou, Shanghai, and Shenzhen are now among the cities with the
least affordable housing in the world. This affordablity crunch exists despite large
number of vacant flats in cities like Beijing.
The August 22, 2023 New York Times article cited earlier in this
blog post notes that affluent upper-tier city resident bought apartments as
investments to rent out and thereby accumulate wealth. As more apartments were built toward the
tail-end of the real estate bubble, their value as rental properties declined,
leaving those who bought them with units whose rent did not pay for their
mortgages. Annual rents amounted to 1.5%
or less of a flat’s purchase price vs. the 5-6% share claimed by mortgage
interest costs. Since Chinese flats are typically
delivered by builders as hollow concrete shells without amenities like sinks,
or even basics such as flooring, with rents so low, many investor buyers have
refrained from finishing apartments in the hope of flipping them for higher
prices at a later date. According to the
Times, this behavior has been a major factor driving up the vacant
housing stock in upper-tier cities.
Fundamentally reforming or doing away altogether with
the hùkŏu system could help enable those relocating to upper-tier cities buy
housing in their new hometowns. In her
important recent book, Social Protection Under Authoritarianism: Health Politics and Policy in China, Rutgers
University Professor Huang Xian extensively details how under China’s highly
localized and fragmented social welfare system, a wide gap exists not just
between rural and urban areas, but across cities as well. Among the latter, China’s social safety net
is most threadbare in lower-tier metropolises, especially those outside the
wealthier coastal provinces. As noted
earlier, the 2014 hùkŏu reform enabled rural villagers to exchange their rural
for urban hùkŏu only if they moved to the lowest tier cities. These strictures also applied to individuals
wanting to replace hùkŏus from their old lower-tier hometowns with ones from
upper-tier cities after relocating to the latter. Scrapping these rules would give migrants from
rural villages and other cities access to the more generous social welfare
benefits offered in top-tier Chinese cities, as well as free primary through
middle-school education for their children and greater employment
opportunities. These individuals could
then have more money available to purchase apartments in the upper-tier
metropolises they now call home.
Unfortunately, little has been done by Chinese governmental
authorities to fundamentally alter the hùkŏu system. The latest changes outlined in 2022 merely nibbled at the edges of existing hùkŏu rules. Upper-tier cities remain reluctant to allow migrants from rural areas and other cities to exchange their old
hùkŏus for ones in their new places of residence. Despite their relative affluence, these
cities fear they will be unable to afford doing that, and those fears have been
accentuated by the squeeze on local finances caused by declining revenue from land sales stemming from China’s real estate slump. I also strongly suspect that further opening
the door to migrants might not sit well with long-time residents in cities like
Beijing and Shanghai. During my 11 years
of living in Beijing, one thing I head time and time again from the locals was “北京人态度了
(Bějīng Rén tài duōle),” or “too many people in Beijing!” These individuals, I might add, were
typically lucky duckies who by dint or being born in the capital or good
fortune, possessed the coveted Beijing hùkŏus.
Even in the highly unlikely event that the Chinese
government quickly enacts policies boosting the incomes migrants to top-tier
cities, the long-term outlook for real estate in these metropolises is far from
rosy. Their day of reckoning will come
in the mid-2030s. By that time, rural to
city migration with have run its course; as is currently the case among
advanced economies in Asia, North America, and Europe, 80-90% of China’s
population will live in urban areas.
While top-tier cities will continue to receive in-migration from
lower-tier cities, it is unlikely that this will come close to offsetting the
loss of rural migrants.
This loss of rural migrants matters a lot because
while China’s overall demography is bad, it is absolutely terrible in its
top-tier cities. The fertility rate, or
number of children a woman will give birth to in her lifetime, among Chinese women
has now fallen to 1.15 births, well under the replacement rate of
2.1 needed for a country to sustain its population. Fertility rates among women in top-tier
cities are even lower, with the rate among women in Shanghai coming in at 0.70 in 2022. In a February 21st
Guardian article on the high costs of raising children
in China, prominent writer Zhang Lijia, who has explored changing attitudes
toward marriage and motherhood among Chinese women, observes, “Many women I
interviewed simply couldn’t afford to have two to three children. Some can manage one; others don’t even want
to bother with one.” In a comment
clearly referring to professional ladies living in top-tier cities, she adds,
“Many urban educated women no longer see motherhood as the necessary passage in
life or the necessary ingredient for happiness.” In the absence then of the buffer provided by
in-migration, the population of top-tier Chinese cities can be expected to
contract sharply following 2035, leading to a steep fall in the demand for
housing. Once that happens, the housing
markets in these metropolises will increasingly resemble the situation now
prevailing in tier 3-5 urban centers.
Before this occurs, for the next decade at least, the Chinese
real estate and housing market will be a tale of two sets of cities, top-tier
metropolises and their lower-tier counterparts.
In the long run, however, there is little chance in either of these
cases of this story ending happily.
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