The Biggest Myth of China’s Economy: Why Doesn’t the Real Estate Bubble Pop?
Simone Gao: Hello everyone! Welcome to Zooming In China. I’m Simone Gao.
Would you enter a lottery where the grand prize was a chance for you to spend $1.5 million? Or pay an extra $30,000 at closing, without protest or pause, when the seller suddenly raises the asking price? Would you risk it all on real estate knowing it would take 40 years to pay off a 750 square foot apartment?
The answer for those living in China’s premier cities, including real estate hotspots in Beijing, Shanghai, Shenzhen and Guangzhou, is yes.
In Shenzhen, 288 apartments offered in a new property development sold out online within 8 minutes. Another new real estate development led 9,000 people to put down a deposit of one million yuan just to qualify to buy the apartments.
In the same city, in 2019, average house prices are 35 times of a family’s gross annual income.
The real estate market in China is hot. Too hot. It’s a market condition that cannot hold. But in China, it must.
It must hold, because 78% of the country’s wealth is tied up in real estate. It must hold, because, as China analyst Nigel Vinson recently said: “The economic fallout of a bursting property market bubble would be catastrophic. A burst would lead to a sharp decline in property values, which would then send shockwaves through the financial industry as millions of Chinese investors trigger mass mortgage defaults. Additionally, China’s emerging middle class would be disproportionately affected, dealing a solid blow to a fragile Chinese economy.”
But while financial experts and fintech analysts keep their eyes on the sharp rise and expected dive in China’s property values, it is not the property that will keep the bubble from its catastrophic burst. It is the land beneath it.
That land is owned by the Chinese government.
They took possession of all lands within China’s borders after the 1949 creation of the People’s Republic of China and following a bloody “land reform movement” in the countryside. That movement encouraged the laborers to take possession of landowners’ lands by any means necessary, including violence. Those revolts led to an estimated 2 million landlords killed and up to 4.5 million total deaths. In the end, though, it was not the laborers but the PRC who claimed the lands as their own.
They secured permanent possession of that land in the 1982 Constitution, writing that “the land in the city belongs to the state. The land in the countryside and the suburbs of the city, except for the state owned by the law, is owned by the collective.” That means the land is owned by a group of people within the community or belongs to certain community organizations.
However, the central government or the local government has the authority to requisition such collectively owned land for use that serves the interest of the country. A lot of times, such interest falls into the category of urbanization. After the countryside is urbanized, the land would be rented out by local government to real estate developers. On top of that, the leaders of such rural communities are all Communist members. They decide how the land should be used.
It is not an exaggeration to say that the CCP is now the sole landlord in China. There is a sale not of the land itself but of the right to build on that land. For commercial use, the lease is 40 years, for residential use, it is 70 years.
The CCP control the supply of buildings because they control the land beneath those buildings. And because they are the only actor in this game of land ownership, they also own the market, control the supply, and can manipulate the rise and fall of housing prices. And with the CCP in control, no matter how strong the economy may be, housing prices can fall; no matter how weak the economy has become, housing prices can rise.
Thomas Orlik, author of China: The Bubble That Never Pops, wrote that “for China’s government, real estate is the ballast that keeps the economic ship afloat.” In the past, that has often led the CCP to insist on building more real estate at any sign of the economy slowing down. And for outsiders, that move may look like a benevolent government trying to protect its citizens by offering more property in order to drive down real estate prices. More supply means less demand for the available supply, leading to more manageable costs. And that would be a reasonable assumption in a democratic society.
In the case of the CCP, though, their interest is self-preservation, and their ballast is the land transfer fees, or the costs the Chinese people pay to rent the land they live on. Those fees are a sizeable portion of the CCP’s fiscal revenue. In 2020, a full 44% of the local government’s revenue came from land transfer fees.
But now that ballast is faltering. The pandemic stripped the economic foundation of many Chinese citizens, the kind of foundation needed to support a booming real estate market. Average Chinese families are left with debt outpacing their income, raising the risks of defaults on home loans. And rigid controls on overseas investments, paired with fears about the stability of local stock markets, have pushed wealthier Chinese citizens to invest their money in real estate, further reducing the supply of housing and driving up costs on what is still available. In fact, real estate investment is the only viable investment option left for the rich Chinese people.
A crisis is approaching. And the CCP knows it.
In March, Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, revealed his concern over the “bubble” in Chinese real-estate prices and unveiled steps the government would be taking to stabilize the market. His first concern was the purchase of properties as investments rather than as homes. But one concern is even more critical, according to Guo: the likelihood of a sharp drop in home prices leading to economic instability in Chinese banks.
Based on China’s central bank data, roughly 1/5 of all loans at China’s banks are home loans and the majority of bank credit was granted based on real estate collateral. Because of that, the financial stability of China lies in stable property prices, and skyrocketing prices have already led to serious financial industry impacts. Guo told reporters that in 2020, Chinese banks had to dispose of $470 billion dollars in bad debt. That followed a $1.36 trillion disposal of debt between 2017 and 2020, a total equal to the 12 previous years combined.
The government has developed new tactics in their attempt to control the rise in property costs, a battle best seen in the southern city of Shenzhen where a modest apartment now costs more than one million dollars. Their first tactic is the most aggressive, and it targets the banks and their lending practices.
In February, the Chinese government set new standards for banks to follow when reviewing mortgage applications. In Shenzhen, the banks received an 84-page document listing maximum prices for more than 3,500 city real estate developments. While buyers could pay more if they chose, they would have to come in their down payment and not in funding from the bank.
While these measures by the Central Government of the Communist Party of China suggest an effort to suppress the sharp rise in housing prices, it is not a sincere move towards bettering this housing situation for millions of China’s citizens or the economic viability of the developers funding the construction projects.
However, experts say the CCP government would likely drive the real estate prices up again once they need to stimulate a slowing down economy. After all, real estate remains the backbone and the most powerful engine of China’s economy.
That is to say, as long as the Chinese Communist Party continues to own all the land, continues to charge fees for its citizens to live on that land, and continues to rely on that income to fund its regime, the Chinese economy will remain in danger of a catastrophic burst of the real estate bubble.
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