The Economy of Real Estate in China - Essay Example

The Economy of Real Estate in China Introduction Real estate may be termed as property comprising of land and all the improvements on it including buildings, immovable property and natural resources. Natural resources include minerals, water and uncultivated flora and fauna. Basing on the use, real estate can broadly be categorized into industrial, commercial and residential. In the case of China, state-owned, private and public enterprises manage and develop real estate, which went through tremendous growth in the first decade of the 21st century. Historically, there were no mortgages for individuals and government employees were given residential homes at subsidized prices. The current situation of real estate market in China is strongly linked to changes implemented in government policies. Regulators have also suggested that the short history of the real estate market in the country and the absence of investment options have resulted in the irrational enthusiasm currently witnessed. Prior to 1998, the government controlled the distribution of property while the real estate market itself participated only in secondary roles in “dual tracks” systems involving both market mechanics and government control (Shen & Liu 121). However, the rapid growth in the 21st century was also accompanied by numerous underlying problems, prompting the central government to implement measures that imposed restrictions such as checking interest rates and increasing deposits, especially in the commercial and residential categories. The current situation is characterized by high prices of housing, which is made worse by the sustained growth of the fundamentals of economics. This paper will analyze the economic issues in China and specifically focus on the real estate market. Overview of China’s Real Estate Market China shifted from a state-controlled to a market-centered economy in the 1980s. That move placed the country on a highly unprecedented economic growth path. This further led to more momentum in the 1990s after the privatization of the housing industry and the coming into existence of the property market and elimination of the work unit system. The scale of this change and the ensuing repercussions are key factors in the analysis of the economic growth in China. Further, data from the International Monetary Fund (IMF) reports that while real estate contributed only five percent of China’s GDP in 2000, it had grown to the current 15% by 2012 (Wang, Zan & Hongyu 44). Economists and analysts are still having split opinions on whether the real estate bubble being experienced in China will stabilize slowly or burst but in reality, the real estate market is losing momentum (Wang, Zan & Hongyu 44). However, most of them are in agreement that the real estate market is in dire need of correction. The response from builders was to reduce the prices of homes while the people, rather than buying homes to invest, are only buying to occupy. There have also been efforts by the government to inject stimulus into the economy in response to the globally experienced financial crisis. With acknowledgement that China’s growth has prominently been driven by the real estate market, decreasing prices have the potential to lead investors to cash in their losses while buyers will hold off purchases (Liu & Chen 207). History of Real Estate in China The current situation of real estate market in China can be attributed to changes implemented in government policies. Regulators have opined that the short history of the real estate market in the country and the lack of investment options have resulted in the irrational enthusiasm currently witnessed. Prior to 1998, the distribution of property was controlled by the government while the real estate market itself participated only in secondary roles in a system refered to as “dual tracks”, involving both market mechanics and government control (Shen & Liu 121). In the absence of both mortgage arrangements and a market for residential real estate at the time, housing units in urban areas were built by the state and allocated via the omnipresent work unit. On the other hand, peasant farmers in the rural areas used land allocated by the collective or state to put up their own homes (Anderlini 1). However, following the commercialization of real estate in 1998, programs were established by local governments in which individuals could buy real estate. This was as opposed to receiving houses under the arrangement of employment benefits. While consumers had previously perceived real estate as an aspect of practical value, the reforms in government policies changed the perception to one of an investment channel. However, there was still a period of delay and hesitation between the commercialization of the market and actual investing by the people. For instance, for the five-year period between 1998 and 2003, the prices of real estate increased marginally by three percent per year (Ahuja, Cheung & Zhang 93). On the other hand, there was a growth of nine percent per year in personal per capita income but people only started investing actively in real estate after 2003. The rush towards the real estate market was occasioned by the limited investment options in China. For example, the country’s stock market capitalization viewed as the GDP’s percentage has been consistently below the world average between 1998 and 2006 (Kaklauskas, Kelpsiene & Zavadskas 281). However, according to further studies conducted by Kaklauskas, Kelpsiene and Zavadskas (28), the percentage of market capitalization to the GDP almost tripled between 2006 and 2009 from 34.6% to 89.3%. Logically, investors could invest in either the stock market or real estate and even though there was dramatic growth in the stock market between 2006 and 2007, there were no significant drops in the real estate for the same period. The Shenzhen Stock Exchange and Shanghai Stock Exchange both started operations in 1990 and grew rapidly for a decade but after initially peaking, the market reversed for five years starting 2000 (Liu & Chen 210). However, the downturn in the overall market was happening at a time when the real estate was growing furiously. This was attributed to the 1990’s bull market ending in 2000 and investors seeking alternative investments and the perception change created by the new policies in 1998 finally endeared them to invest heavily in real estate (Shen & Liu 119). Current Situation of Real Estate Market in China Although the Chinese real estate market has been undergoing development for almost 20 years, citizens and economists have recently raised concerns about the escalating price of housing. Presently, the significance of the real estate market in China cannot be overlooked because it accounts for 15% of the country’s GDP (Liu & Chen 203). Essentially, this means it also affects other giant sectors directly, such as construction and banking. However, the best way to analyze the present situation is through the housing sector, which is not what it was one decade ago (Wang, Zan & Hongyu 46). It is not doubted by investors, economists and analysts that a housing crisis will have repercussions felt beyond China, but they generally agree that comparatively, the Chinese situation is not as grim as the US subprime mortgage crisis. Rather, the levels of household debts are lower in China than what has been seen in the US. According to an IMF report, Chinese banks, unlike their US counterparts, enter housing loans on their financial statements rather than packaging and selling them as collateralized debt obligations (Wang, Zan & Hongyu 46). However, the Chinese situation is unique in that while it seems safer than the situation in the US its real estate market is made problematic by oversupply and affordability. Houses have been built for nearly China’s entire urban population, a situation that has narrowed down the demand for new homes. The gap created between demand and supply is unrealistically high that some second and third tier Chinese cities are virtually empty as homes do not have occupants. Citizens have not shown much interest to reside in some of the said cities, which leaves almost all of the constructed homes vacant. Affordability, or the lack of it, has been a key contributory factor towards low demand and lower prices as well as a supply mismatch, as explained by the following statistics. Statistics have shown that Chinese citizens living in urban cities earn an average annual disposable income of $4,390 while buying a square meter of an apartment in Shanghai or Beijing varies between $4,720 and $8.800 (Hiang & Webb 84). A report by the National Bureau of Statistics (NBS), on the other hand, showed that China’s real estate investment dropped in 2014 to a five-year low, representing a 9.3% drop from 2013. Apart from the drop, there were also several other significant indicators of a downward trend in the real estate investment including the 10.7% drop in new construction from 2013 to 2014 while the sales of houses remained stagnant. Even property developers bought less land in 2014 than they did in 2013 and, according to the same NBS report, economic expansion in China was at its lowest in 24 years in 2014. The rapid construction growth and falling sales that characterized the Chinese real estate market are responsible for the discrepancy currently being experienced. Not only are residential homes remaining unoccupied, but unsold commercial area has risen to more than 130 million square meters between 2013 and 2014 (Wang, Yang & Liu 44). However, the World Bank has noted the broad-based nature of the Chinese property market’s weakness and acknowledged that the central government is adjusting policies towards tighter credit and reduced supply mismatches (Koetter & Poghosyan 1131). By 2010, the central government officially ended the welfare housing system and in the same year, the real estate market in China was larger than any other country in the world as housing prices had tripled between 2005 and 2009 (Wang, Yang & Liu 43). This occurrence was fueled by cultural attitudes and government policies. Currently, the high price-to-rent and price-to-income ratios for property are linked to the extraordinarily large number of unoccupied residential homes and commercial units, and this situation is perceived as evidence of the real estate market’s bubble. Statistics have shown that there are more than 64 million housing apartments standing empty throughout the country. According to reports by the BBC, Inner Mongolia and Ordos are the cities with the highest number of unoccupied houses and commercial units (Gianakopulos 112). When the situation is analyzed critically, it can be seen that the standard of mortgage lending, trends of growing urbanization and rising incomes are evidence that the high prices of property can still be justified. In response to the situation and complaints that middle-class citizens could not afford housing in cities, Government policies slowed down the growth of the bubble in 2011 (Kaklauskas, Kelpsiene & Zavadskas 286). This deflation of the bubble in the property industry, according to analysts, is the fundamental cause of the declining growth of the economy that began in 2012. Another observation by economists is that the development of housing in the country is not only highly oversupplied but also overvalued, which creates a bubble that may burst with devastating consequences. Reasons for the High Prices in the Real Estate Market of China Before offering an explanation, it is first imperative to acknowledge that the prices are indeed as high as shown by studies. As of 2014, studies by the IMF found that housing in China was the most unaffordable in the world (Gianakopulos 112). Over 58% of the 20,000 Chinese citizens surveyed in 2014 by the People’s Bank of China argued that house prices were too high even with a 0.7% drop from the previous quarter (Gianakopulos 116). The central government’s efforts to curb inflation are counterproductive and contributing towards the increasing cost of housing. For instance, the measures to prevent the property bubble being witnessed in larger cities such as Shanghai pushed money to cities in the lower tier. This, coupled with the lack of premium land in larger cities, effectively drove up the cost of property in such cities. Conspicuous consumption was common among the newly rich citizens, but that habit also contributed to the rising cost of property in the lower-tier cities commonly occupied by poorer communities. Further, there were no investment options that the citizens could turn to and the property market was the most welcoming one. According to the World Bank, buying restrictions seen in the major cities also played a part in pushing speculators to lower-tier cities. Even after authorities loosened purchase controls, mortgage regulations and interest rates, prices for residential units were still beyond the reach of middle-class citizens. The result was that citizens who opted to save their earnings in bank accounts outnumbered those who were willing to invest in the real estate market by 45%, as prices doubled from 2006 to 2010. According to the NBS, more than 70 cities increased housing prices by at least 31% between 2006 and 2010 (Liu & Chen 204). This prompted the central government to intervene and raise mortgage interest rates as well as tighten loan-to-value ratios. Although there were significant drops in rent-to-price ratios as the global financial crisis set in, the increase soon resumed after credit conditions were eased towards the end of 2008 aiming at favoring first-time buyers of homes. This led to the highest price-to-rent ratios ever seen in the country and, once again, the most affected cities were Shenzhen and Shanghai, this time also including Beijing. That period also saw housing prices increasing faster within the mass market than they did in the luxury sector as was largely witnessed in Shanghai. Relative to costs of renting, a Chinese average residential unit presently costs more than a similar unit in all countries that comparative studies were conducted (Wang, Zan & Hongyu 46). Both supply and demand have led to the current high cost of housing in China (Koetter & Poghosyan 1129). Although the high cost is a reflection of high demand, an analysis of the market also shows that it is an indication of restrictions on the housing supply. The existing gap between construction and housing price is caused by restrictions on the land supply, which is also characterized by intrinsically high prices. From that perspective, it may be understood that the demand for land is high but due to its limited nature, the prices of housing must inevitably rise (Koetter & Poghosyan 1133). From the very basic line of thinking, the increasing cost of land may be attributed to the policy of high land prices implemented by the government. However, it may also be viewed as a result of government regulations such as zoning and planning aimed at restrictions on building. Therefore, property prices are increasing because the regulation on new properties has created artificial restrictions on construction. The concept of artificial restrictions have been explained by Gianakopulos (102) in terms of the numerous parcels of land occupied as training facilities and residential quarters by the police force and reservoirs to protect against water shortages. For instance, the meager capacities of the reservoirs offer so little protection from water shortages to be justified, which make it worth mentioning that such barriers to building have created the large gap between construction and housing prices (Koetter & Poghosyan 1136). This gap can be attributed to the regulation tax and land value, whereby regulation tax comprises overcoming bureaucratic inertia and political resistance and the cost of acquiring land as well as the permission to plan and build (Wang, Zan & Hongyu 51). This can also be linked to the failure to convert the use of commercial land. For example, it would not be economically sensible to build 60 storeys on a 500,000 square foot plot and 30 storeys on a one million square foot so as to efficiently develop usable space of 60 million in high-rise settings (Ahuja, Cheung & Zhang 107). As explained by Ahuja, Cheung and Zhang (107), it would be more logical to build 40 storeys on each plot to yield the same usable space. This implies that in free-market situations, housing units completed at the same time or when prevailing market conditions are the same would have similar plot ratios so as to maximize the total value of land. As the Chinese urban economy grew in prosperity over time, the increasing property demand led to increasing plot ratios so that the demand could be met. However, as a consequence, if the regulation tax remained small, the gap between construction and housing prices would not have widened so significantly. On the contrary, high tax regulation led to different plot ratios in urban high-rise settings as the role of land increasingly became less important. According to Ahuja, Cheung and Zhang (110), the government’s failure to rezone industrial land efficiently after manufacturers left was a contributory factor to the changing environment in housing supply. If the government had taken more bold measures in the effort to convert formerly industrial land to residential and commercial use, there could have been faster redevelopment of land. Instead, it embarked on case-specific conversion negotiations that were cumbersome and did not appropriately address the urgent need to reorganize land resources into more viable alternatives following the high-paced structural changes (Qiao 88). Up to the early 1990s, housing prices were kept low by the old Town Planning Ordinance which essentially maintained a narrow gap between prices for housing and construction. Further the ordinance was designed for development because it supported an environment in which lower transactions costs characterized the real estate market. However, the new ordinance resulted in increasing transactional costs albeit the fact that it was designed to improve the older one with claims that it would protect the rights of owners of property in a better way. Critics have pointed out that the new ordinance offers additional rights to property owners that they had not paid for under the previous one. However, it also has a negative aspect because the cost of delays in development will be placed on the society. Essentially, the new ordinance disproportionately benefits existing owners of property at the expense of prospective buyers hence it acts as a form of protectionism for those who already have gained wealth (Gianakopulos 117). Recommendations on How to Improve the Situation The most significant step towards addressing the problem must focus on reducing the gap between supply and demand (Qiao 100). This can be supported by a report according to economists suggesting that the real estate market stops constructing properties for at least two years and allow the demand to catch up and match the supply. Essentially, this means that the central government must allow the growth rate to drop if it is to be sustainable. Policymakers should consider introducing a property tax in an effort to avoid the possibility of a crisis in the property market. The property tax, and especially its design, will be a critical factor towards reducing the looming short-term panic in the market and ensure long-term speculative investment is effectively reduced. The central government must raise the interest rates and implement monetary policies to control demand or face the risk of negative interest rates and the lack of viable options sending more speculation in the real estate market (Qiao 99). It may also be recommended that the government announces premiums on all properties basing on rules and updated and current rating values because that would make the conversion premiums for property public information. Further, allowing the premiums to be paid as a new constituent of land rent rather than as a lump sum at the beginning can be explored. This would enable home buyers to pay over a spread period of time affordably (Qiao 101). Conclusion It has been shown that China’s economy has experienced rapid growth for almost two decades while, comparatively, the developed countries’ economies appeared relatively stagnant. This followed the shift from a state-controlled to a market-centered economy in the 1980s. During that growth period, Chinese assets attracted foreign investors who generated a speculative wave of foreign capital into the country, fuelling the increase of prices in the real estate market that especially affected the housing industry. The Chinese real estate market was affected just like many others around the world by the global financial crisis, but its resilience convinced investors that it held attractive opportunities for investment. At the same time, while economists and analysts have not reached a consensus as per the country’s future fate of the real estate market, housing prices in cities such as Shanghai and Beijing are growing faster than citizens’ disposable income. The economists are also in agreement that the real estate market needs urgent correction. Builders responded by reducing home of prices while the people, rather than buying homes to invest, are only buying only for occupation purposes. The government has also attempted to inject stimulus into the economy in response to the globally experienced financial crisis. However, this is in acknowledgement that China’s growth has prominently been driven by the real estate market and decreasing prices can potentially lead investors to cash in their losses while buyers will hold off purchases. Cultural attitudes led to the government officially ending the welfare housing system in 2010 at a time when the country’s real estate market was the largest in the world. Suggested recommendations to correct the current situation are focused on narrowing the gap between supply and demand, raising the interest rates and implementing monetary policies to control demand. This will alleviate the risk of negative interest rates and the lack of viable options sending more speculation in the real estate market. Works Cited Ahuja, Ashvin, Cheung, Lillian & Zhang, Wenlang. Are House Prices Rising Too Fast in China? New York: International Monetary Fund, 2014. Print. Anderlini, Jamil. “Chinese Property: A Lofty Ceiling.” The Financial Times. . 2011. Web. Gianakopulos, J. Solving the Present Crisis and Managing the Leverage Cycle. New Haven: Yale University, 2014. Print. Hiang, Kim & Webb, James. “Common Factors in International Securitized Real Estate Markets.” Review of Financial Economics, 18.2 (2012): 80-89. Print. Kaklauskas, A., Kelpsiene, L., & Zavadskas, K. “Crisis Management in Construction and Real Estate: Conceptual Modeling at the Micro-, Meso- and Macro-levels. Land Use Policy, 28.1 (2011): 280-293. Print. Koetter, Michael & Poghosyan, Tigran. “Real Estate Prices and Bank Stability.” Journal of Banking & Finance, 34.6 (2013): 1129-1138. Print. Liu, Zilei & Chen, Li. “Research on Chinese Real Estate Development and Future Trends.” Asian Social Science, 7.1 (2013): 202-211. Print. Qiao, Xiao. A Review of the Chinese Real Estate market. 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