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Print Edition> Business
UPDATED: August 16, 2010 NO. 33 AUGUST 19, 2010
Observer: Vacant But Not for Sale

ANYBODY HOME?: An apartment complex in Pudong District, Shanghai, was ready for buyers in April 2010. It's estimated that tens of millions of apartments in China are now empty as buyers hold them as investment rather than homes (CHEN FEI)

Housing market speculation in previous years has resulted in an "empty apartment" phenomenon—houses and apartments are purchased as investments but left unoccupied. Various Chinese media outlets reported that about 64.5 million urban electricity meters read zero in the first six months of this year in empty apartments across the country. Andy Xie, an independent economist based in Shanghai, said the huge number of empty apartments foreshadows a bubble burst in an article recently published on Century WeeklyEdited excerpts follow:

Property bubbles can be divided into two kinds—quantity bubbles (too much supply) and price bubbles (too expensive). China, however, is facing a combination of the two.

The Chinese property bubble is different from that of other countries since it has a huge supply while prices also run high.

China's urban housing stock is mainly composed of housing built by enterprises or government organizations for their employees, and some 60 million private housing units built over the past 10 years. Property developers are now building about 20 million private apartments, and local government-owned land reserves may be enough for another 20 million to 30 million.

Even if the stock of empty apartments is less than 64.5 million, the number would still be equivalent to 20 percent of the total urban housing supply, which is higher than Taiwan's vacancy rate at the peak of its bubble at the end of the 1980s. Moreover, as credit policies are loosened, the stock could rise to more than 30 percent.

In mature markets, the property price is usually twice that of a person's monthly income. In many Chinese cities, the per-square-meter property price is five to 10 times the average monthly income for local residents—a clear indicator that bubbles are forming.

A price bubble can damage the economy in three ways. First, it usually leads to a banking crisis. As the market trades at higher and higher prices, buyers borrow more against the same property. Banks that maintain the same lending cushion with, say, a 30-percent down-payment rule, suffer losses when prices fall below that level. A banking system in crisis cannot function properly, and the economy suffers collateral damage due to this dysfunctional banking.

Second, the wealth effect—increased spending due to an increase in perceived wealth—leads to excessive consumption during a bubble. The backlash weakens an economy for several years.

And third, bubble-induced demand distorts supply. When inflated industries plummet after a bubble burst, it takes time for other industries to take their place.

Unique in China

I think the vacancy rate for the country's private and commercial housing stock is between 25-30 percent, nearly double that of a normal market. But price hikes along with a high vacancy rate are inexplicable.

China's phenomenon is unique for at least four reasons.

A sustained negative real interest rate has led to a falling demand for money and a rising appetite for speculation. Inflation fears and greed are working together to form unprecedented speculative demand for property.

Second, a massive amount of "gray" income is seeking a safe haven. This "gray" income could be around 10 percent of GDP. Due to rising inflation and a depreciating dollar, a currency that used to be a traditional safe haven, the booming property market has become the place of choice to hoard money.

Third, few people in China have experienced a property bubble. The property crash in the 1990s only touched a small segment of society, mainly foreigners and state-owned enterprises. Geographically, it was restricted to the country's developed regions including Hainan, Guangdong and Shanghai. Most people don't have a firm understanding of what a property crash is, and this ignorance has led to a lack of fear for runaway speculation.

Fourth, speculators are confident that the government won't let property prices drop. They surmise that local governments rely on property deals for revenue and do all they can to prop up prices. But their faith in the government is misplaced. The government can delay, but not deter, a bubble burst. Nevertheless, faith in the government is stronger than fears, and speculative demand will continue to grow as long as credit is available.

Government dilemma

Right now, tight credit is holding the market back, and supply is piling up. The government's tightening measures are squeezing out buyers looking for second and third homes, and transaction volumes across the country have collapsed.

When the policy is relaxed—as most expect—speculation will probably revive and lead to a doubling in the total value of speculative inventory.

In some cities, banks are loosening credit a bit. Why? Because local governments have a lot of debt—commonly five times more debt than revenue—and could find themselves in financial trouble without a decent level of property transactions.

Local governments have depended on real estate transactions for revenue and could default if the market falls too far. Thus, the Central Government may loosen its policies to help the local governments. Such a change of attitude would ease short-term government difficulties but double the trouble down the road before the property bubble bursts.

Market solutions

At this point, an interest rate hike would be the best option. Raising interest rates would cool speculative demand gradually, and at the same time avoid market disruptions. A delay in raising interest rates would only cause a surge for the stock of empty apartments.

In the long run, local governments must find ways to increase sources of non-property revenues or simply limit expenditures. The investment-led growth strategy adopted by all local governments will inevitably lead to maximized revenues from land sales, but unless limits are put on this strategy, the property market cannot function normally.

Property taxes could be a new and better source of revenue. In many countries, property taxes constitute a big proportion of local governments' revenue and finance public services. China should adopt the same model, coupled with cuts in government expenditures.

What happened to the U.S. economy now serves as a good lesson for Chinese decision makers. Policymakers should act now to alleviate the housing problem, since a crash in the real estate industry could bring down the whole economy. In my opinion, it is very likely the Chinese property market would collapse much like the United States did in 2008.

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