Monday, June 10, 2013

Chinese Housing Bubble

The chart below may explain the reason for seemingly contradictory reports of housing shortages vs. reports of ghost cities of empty new apartments in China. The chart, published on , shows a long-term misallocation of capital towards construction of luxury apartments, whereas affordable housing is in short supply.

In my previous post two years ago on the Beijing housing shortage, , I had spoken to a recent college graduate who described how 6 to 8 recent graduates would have to share one apartment because of the lack of affordability, yet there also media reports, including Leslie Stahl’s 60 Minutes visit to China and interview of Wang Shi, China’s biggest real estate developer, indicating thousands of empty condos in places such as Zhengzhou, Urdos and Tianjin. One memorable irony of this 60 Minutes episode was the sight of poor villagers in Zhengzhou salvaging bricks from the rubble of their modest homes, razed to build new condo towers, while empty condo towers loomed in the background. It was explained that these villagers couldn’t possibly afford the newly built high-rise residences.

In the U.S.A., the sight of so many empty condo towers was the precursor to the bankruptcy of such lenders as IndyMac Bank, whereas it is surprising to learn that in China, these empty towers are actually sold out to small investors. Middle class Chinese investors have very few investment options:

1. Put the money in the bank and earn a very low interest rate.
2. Invest in Chinese stocks traded on the Shanghai and Shenzhen exchanges, in companies that Chinese investors consider to be dodgy and dishonest. (They are restricted from investing in Chinese companies listed on the Hong Kong exchange, which are more trusted because they have to meet higher financial and reporting standards.)
3. Invest in real estate, which has always gone up in value in their lifetime.

This has led to massive investment in residential real estate, and the Chinese government has already taken steps to curb speculative demand for housing with restrictions on loan-to-value ratios for investor-owned housing and the number of units that can be owned.

Nevertheless, when so much money is sitting in empty homes with no renters, the fundamental economic law of supply and demand ultimately forces home prices lower.
Future investors will be dissuaded from investing in these homes with no prospect of income, and sales prices will decrease as a result. This is an inexorable economic law, much as the physical law of gravity, which no society can escape.

The potential result is that millions of middle class Chinese families will lose much of their wealth in an inescapable housing crash, similar to events that have already transpired in places such as the U.S., Spain and Ireland.


RES said...

I'm impressed, I must say. Very rarely do I come across a blog that's both informative and entertaining, and let me tell you, you've hit the nail on the head.

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