Chinese Housing Bubble: Cause for Concern?

Chinese housing prices have risen in the past year for 69 of 70 of the largest Chinese cities, as tracked by the China Statistics Bureau. Furthermore, 10 of these cities have experienced housing price increases of over 10%. This general increase in prices is in part due to government policies preventing all except those who have government connections to import and export businesses and from investing outside the country. Thus, investors are left with two options: stocks and real estate. However, investments in the Chinese stock market are both risky and generally have low rates of return. Overall, the Shanghai SE composite index has declined 31.37% in the past 3 years while the bond market can also barely offer rates greater than the rate of inflation. Because of this, real estate is a far more common investment option. This has in turn created an increase in housing price driven by speculation and a real estate bubble in China.

There are those who argue that the real estate bubble is not actually a bubble and that the increase in price demonstrates a real increase in demand for housing due to increased urbanization and wage inflation. In the past year, China’s real GDP has increased 7.8% and income per capita has increased by 7.3%, reflecting inflated incomes. Furthermore, some economists believe that even if a supposed housing bubble were to burst in China, the effects would not be nearly so widespread or severe as the burst of theU.S. housing bubble due to the fact that China has a much lower residential mortgage debt than the U.S. at the time. In 2009, the U.S. had mortgage debt the size of 81.4% of its GDP while Chinese residential mortgage debt is only 15% of its GDP, as most Chinese buyers use cash for their real estate purchases.

However, the potential consequences of the rapid increase in housing prices cannot be ignored. Currently, the value of China’s residential property market is 115 trillion yuan, compared to 23 trillion for the stock market and 26 trillion for the bond market. As housing prices rise higher and higher, more and more Chinese savings are tied up in real estate. Right now, over 60% of households’ assets are in real estate and only around 20% in cash deposits. Furthermore, because housing investment now accounts for 11% of China’s total GDP, a decrease in housing prices resulting from the housing bubble’s burst would cause a significant decline in consumer spending, and this would in turn hinder China’s goal of encouraging consumption-led growth.

In addition, Premier Li Keqiang has set a 7.5% growth target for the economy this year and has stated that a growth rate below 7% would not be tolerable. Because of this, the government has still not announced any new policies regarding the regulation of real estate investment since former premier Wen Jiabo enacted a policy requiring higher down payments for second-mortgages in cities in April 2010. Continued lack of government effort in controlling the housing bubble in China could cause housing prices to plummet, as was the case in Wenzhou.

From the start of 2010 to the end of 2012, home prices in Wenzhou plummeted around 60%. This was mostly due to increased government regulations that came about October of 2010, in which restrictions on purchases were enacted and higher down payments on mortgages were required. As a result, demand for real estate dropped and a panic resulted in which investors scrambled to sell their properties. Were such a panic to happen on a large scale in the Chinese economy, households’ assets would be greatly affected, and as such, consumer spending would likely decrease. Due to this, the government is hesitant to enact more restrictive measures regarding real estate investment for fear that doing so will cause a rapid decline in housing prices and thus cause China to not meet its economic growth goal.

Certainly, there have been significant increases in housing prices in China in the last five years. However, whether this increase in real estate price signifies the presence of a housing bubble is debatable, as there are other factors pushing demand for housing to rise that are not purely speculative. Also, while the inflation of housing prices is somewhat concerning, as it creates the possibility of a panic driven real estate price tumble, at the moment it does not appear as though the Chinese government will pass policies to curb the increase in housing prices. At least for the immediate future, real estate will likely still offer the most lucrative rates of return for Chinese investors.