China’s Property Market

In the mid-1990s, I was frequently asked whether I thought that China would break apart into a number of separate, individual countries. That’s because China bears at the time warned that China was not one country, but many different countries, and that the bonds binding the whole lot together were thin. In their view, China was likely to split into a number of different fiefdoms, each led by their own “warlord.”

As we’ve all learned, however, China is, in fact, one country, despite its many different dialects and regional differences, and nationalism is on the rise. Rather than splitting apart like the former Soviet Union, China has gone the other way, bringing additional territories into its economic and political orbit. Hong Kong was added in 1997, Macau in 1999, and now even Taiwan is drawing closer.

In the late 1990s, financial experts worried that China’s state-owned banks would cause the Chinese economy to go off the rails when they drowned under a sea of non-performing loans. That never happened. In fact, the Western banking giants, which were thought to be bastions of sound lending and banking practices, were the ones that nearly brought down the entire global financial system. Until we see how events in Greece, Portugal, Spain and other European countries play out, they are still not out of the woods, two years after the crisis hit.

Today, many question whether China’s property market might be the Achilles heel in a red hot economy that grew at 11.9 percent in the first quarter of 2010. Certainly, anyone that’s traveled around the country has a story or two about empty office buildings, or new apartment complexes being built purely on speculation. Property speculation may be the Chinese economy’s downfall, but I wouldn’t bet on it. I’ve been surprised too many times over the years.

I can remember standing in the middle of Pudong in 1996, surrounded by newly-built, totally empty office buildings, wondering what the developers could possibly be thinking. If Pudong wasn’t the ultimate field of dreams — build it and they will come — I didn’t know what was. Yet, a year later all the buildings were filled and the rest is history. Pudong has to rank as one of the most successful real estate developments of all time.

Whenever I encounter economic issues regarding China that seem to defy logic, I turn to Andy Rothman, my good friend who is the China Macro Strategist for CLSA Asia-Pacific Markets. Andy always seems to have done his analytical homework, which enables him to provide logical explanations. Since I am getting many questions about China’s property market these days, I was thankful to read Andy’s recent article, PERMA-BEAR MIGRATION, published in Sinology, his research newsletter.

In his opening comment, Andy expresses a similar sentiment regarding the China bears:

The annual migration of China perma-bears is underway once again. In past years, the migration was triggered by a wide variety of misguided fears: pork prices, export-dependency, non-performing loans, SARS or trade war with America. This year, the perma-bears are queuing up to proclaim that China is on the precipice of a housing market collapse paralleling the recent U.S. property meltdown. One day the perma-bears will be right, and China will suffer the long-predicted economic crisis, but this isn’t coming soon, and China clearly is not suffering from the housing finance bubble that crashed the US economy.

As Andy points out:

It is a mistake to look for the old American property problems to reappear in China. … The Chinese housing market is very different from America’s because:

• The loan-to-value ratio for mortgages is very low in China, while it was very high in the US. China buyers must put at least 20% cash down, and most buyers are required to put down 30% or more.
• China has almost no securitisation, no subprime mortgages and option ARMs, and .U.S-style home equity loans are not available.
• China’s housing boom has not been accompanied by a sharp rise in debt. The ratio of consumer lending to GDP in China is 17%, in contrast to 95% in the U.S. and 72% in the U.K.
• Household leverage in China is 39%, well below the 55% level in the U.S. in 1960, and far from the U.S. peak of over 130% in 2007.

Andy also clears up a number of misconceptions, which I will only paraphrase here:

• China’s housing market is driven by owner-occupiers, not investors. Only 22% of buyers are investors.
• Housing is affordable for many middle-class Chinese.
• The market is not primarily Beijing and Shanghai. 150 cities with a population of at least 1 million account for the vast majority of sales.
• Prices are much lower outside of the four tier-1 cities of Beijing, Shanghai, Guangzhou and Shenzhen.
• Investors are not highly geared. Of the middle-class families in our study who own a second property, only 39% used a mortgage. Of those who did use a mortgage, more than one-third paid a cash down payment of 50% or more.
• Low financial sector exposure. Mortgages remain a very small part of China’s financial system. The ratio of mortgage loans to GDP is only 14%, compared to the US peak of 79% in 2007.

If you are an institutional investor, I encourage you to call CLSA and get on Andy’s list for Sinology. It’s the best research piece I know of on China and its economy. In any event, I will continue to pass along Andy’s comments as I have in the past.

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