Sticking a pin to the housing bubble theory

Although it is less of a popular topic now than it was 12 months ago, any discussion about the Chinese real estate market eventually seems to end with a debate over the existence of a housing bubble.  Those who think it exists tend to focus on Shanghai and the key Guangzhou cities of Shenzhen and Guangdong, pointing at annual increases in average housing prices that have reached 50% or greater.  Price growth in tier I cities has decreased since the government released new policies targeting speculation in the residential real estate market, but nonetheless the growth is substantial across China, at least in the tier I cities and those tier II cities where I have worked (Shenyang, Qingdao, Dalian, Hangzhou, and Chengdu primarily).   

My response to the housing bubble question is always an adamant “no” and a recent opinion article in the Economist agreed, pointing at several factors that I have also previously relied on for support.  One key when evaluating the existence of a bubble is to put the key residential growth indicators into the context of the overall economy and the unprecedented growth across the country in key indicators such as GDP, disposable incomes, and per capita expenditures.  It becomes apparent that although there is some purely speculative investment, much of the demand for housing is fuelled by increasing wealth and widespread desire to simply improve living conditions – this type of demand will continue to grow.  The economist article sums up this relationship between incomes and real estate consumption very convincingly: 

“Across the globe, studies show that in the long term the main driver of house prices is income. The ratio of average house prices to average incomes is currently flashing red in America, Britain, Spain and quite a few other developed countries where it has soared to record highs—ie, above levels that preceded previous crashes.In China, in contrast, average nationwide house prices have risen much more slowly than incomes. According to a report in the latest China Economic Quarterly, the ratio of house prices to disposable income has fallen by 25% since 1999. Even in Shanghai house prices have barely outrun incomes. A study by Bank Credit Analyst, a Canadian financial-research firm, concludes that, based on the long-run relationship between house prices and GDP per head, China is one of the most undervalued markets among those that it studied.

What did concern me about the rampant increase in housing prices in 2005 and 2006 was that some buyers, especially in Shanghai, were throwing their money into projects without first thoroughly evaluating the development.  Their short-sighted plan was obviously to get in and out quickly and make some easy money in the process and for those that timed the market well, this approach was a huge success.  For many, however, they ended up either stuck with residential units in horrible locations that nobody wanted to buy or lease or else they ended up investing in poorly planned and funded projects that in some situations never reached completion.  Indiscrete speculation creates considerable bubble potential but fortunately this type of behaviour is very limited, especially outside of Shanghai and Guangdong.

A recommendation to developers – play it safe and focus on genuine quality throughout the project.  Even though this approach often reduces profit potential, it also dramatically reduces risk and can in and of itself be the project’s greatest differentiator.  And for buyers, do your research and fully evaluate the plethora of residential options on the market.  Not only is location critical, but it is also very important to scrutinize the developer and their track record – if you find that sales staff are not forthcoming with key details of the project including the number of units sold, and the launch price, be wary. 

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