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Reining in China’s property frenzy

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Employees set up model apartments as they prepare a real estate exhibition in Hangzhou, Zhejiang province, China, 17 May 2012. (Photo: Reuters/Lang Lang).

In Brief

The Chinese property market is surging. In the year to August 2016, house prices in Beijing, Shanghai, Guangzhou and Shenzhen, four first-tier cities, all rose by over 20 per cent. House prices in Xiamen, a second-tier city, grew by 44.3 per cent


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, the highest year on year growth rate in China. The heat wave in the housing market has even spread to smaller cities.

This robust recovery in home prices can be traced back to a flurry of government stimulus measures in the first half of 2016. Local governments implemented policies aimed at reducing the number of unsold homes after President Xi Jinping and Premier Li Keqiang signalled that this would be necessary to run down the high housing inventory and maintain stable economic growth.

These policies were effective but had unintended consequences: housing inventory in third- and fourth-tier cities were still high while that in first- and second-tier cities was nearly fully digested. House prices in these cities skyrocketed.

The government is wary of potential bubbles. Faced with the hike in prices, local governments have issued various cooling measures including raising the minimum down payment to purchase price ratio and restricting households of non-local hukou migrants from purchasing a second property. This pattern of the real estate market expanding under stimulus policies and contracting under stringent ones is familiar to the public.

In early 2016, the city of Hangzhou announced that it would give migrant families local household permits to encourage them to buy homes. As a result, housing prices rose 22 per cent in the year to August. But at the end of September, Hangzhou announced that it would suspend this housing policy and increased the minimum down payment to purchase price ratio by 10 per cent for second-time home-buyers with unpaid housing loans. With these contractionary policies taking effect, potential buyers are hesitating to make purchases in anticipation of lower prices in the future.

The real estate sector has been a key contributor to economic growth. Real estate investment grew rapidly from about 4 per cent of GDP in 1997 to 15 per cent in 2014. Land sales have been a major source of local government revenue and have helped finance government expenditures on infrastructure, social security and education. But this has created the belief that the government will not let the real estate sector collapse.

Returns to investment in real estate are thought to be safe, especially as the search for new sources of growth is ongoing and economic conditions are uncertain. And recent efforts by the People’s Bank of China to stem capital outflows from China has added to the attractiveness of the domestic real estate market.

The first half of 2016 saw a dramatic drop in private investment growth. But the rapid growth of real estate and infrastructure investment offset the deceleration in the growth of total investment. Given the importance of investment in real estate to China’s GDP growth, recent cooling measures may hinder growth performance in the future.

A drop in housing prices may also generate a negative wealth effect. Chinese households own about 60 per cent of their wealth in real estate. Given current weak economic conditions, a drop in housing wealth will deal a blow to households’ lifetime resources and to consumer confidence, which could slow the transition towards consumption-led growth.

Another risk associated with a downturn in housing prices is the possibility of destabilising the financial market. Although it is estimated that the loan-to-value ratio is as low as 30 per cent for housing, down payments are increasingly financed by riskier peer-to-peer lending instead of household saving, which not only contributes to a rising debt burden in the economy but also enlarges the risk of debt default if housing prices drop.

The government’s hands-on approach in preventing housing prices from going too high or too low reinforces the expectation that housing prices will not fall. This induces more investment into real estate and leaves less available for other productivity-enhancing activities such as research and development for new products and investment in new industries.

To get around this, the government should further develop capital markets to help diversify investment opportunities away from real estate and towards business activities with high growth prospects, lowering financial risks from the credit-fuelled investment in real estate. This will be necessary to achieve the government’s goal of nurturing innovation and entrepreneurship for long run growth.

Yixiao Zhou is a Lecturer in Economics at the Curtin Business School, Curtin University.

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