The consensus is that China has a real estate bubble. The only argument is whether it will burst in some crash that will take down China’s economy or come in for a relatively soft landing that slows China’s economic growth but in no measure extinguishes it.
It’s tough for me to come down on one side of that debate or the other because most of the time the protagonists don’t bother to set out what the bursting of a real estate bubble would look like in China. There’s a kind of unspoken vague agreement that a Chinese bust wouldn’t look like a U.S.-style bust, but no real effort to put real flesh on the bones of a China-style bust.
And without fleshing out what a real estate bust in China would be like, it’s just about impossible to decide the seriousness of that bust or the extent of its consequences.
Let me take a run at that and see if the effort helps settle the crash vs. soft landing debate. Or at least moves it along a bit.
I don’t think there’s any real argument about this: China is in the midst of a speculative rise in real estate prices that can’t be sustained.
Housing prices rose at an 11.4% annual rate in June. And that was down from a 12.4% annual rate of growth in May and a 12.8% annual rate of growth in April. New home prices rose even faster—at an annual rate of at an annual rate of 14.1% in June.
With prices rising at that pace developers and speculators have rushed to build. In the first five months of 2010 investment in the property market grew by 38.2% from the same period in 2009. And that rate was two percentage points higher than in the first four months of the year.
With supply soaring only cheap money kept the game going. Banks flooded the market with mortgage money in 2009 and into 2010. Loans for second homes. And third homes. Loans to buyers with inadequate incomes. Loans to buyers without credit checks.
Up to this point, the scenario sounds incredibly similar to the run up to the housing bust in the United States.
But there are crucial differences.
First, Chinese buyers never got nearly as leveraged as those in the United States. Down payments in China were a high 30%.; in the U.S. at the height of the frenzy lenders were bundling two mortgages together so that a buyer could borrow the required (and much smaller) down payment as well. Effectively home buyers were putting nothing down. And Chinese home buyers started off with a much larger base of savings. In 2009 the Chinese savings rate was around 40%. In the years just before the end of the boom in the United States the savings rate had actually turned negative.
As a result of those differences I don’t think a real estate bust in China would set off the huge contraction of family balance sheets and consequent steep drop in consumer spending that has resulted from the bust in the United States.
Second, the U.S. boom was a top to bottom boom: rich people in California and Florida and poor people in rural North Carolina and Detroit all got sucked into the whirlpool either through mortgages that let high income families buy more house than even they could afford or through 0% rate teaser refinancing for low income families that couldn’t pay the freight once the real interest rate kicked in. In China the boom has been concentrated at the upper end of the income scale. Speculators have built more and more luxurious apartments and houses at higher and higher prices for China’s population of newly well-to-do. At the same time the country is facing am extreme shortage of affordable housing even the average middle-class Chinese family.
Which has created a strangely bifurcated market. At the upper end huge building programs and the Beijing government’s recent moves to slow lending have created a large supply of empty luxury apartments. Prices in this part of the market have just started a drop that could easily extend to 20% or 30%. In Shanghai the price of the average new luxury home dropped by 13% from April to July, according to China Real Estate Information. (That took the average price for a luxury home down to a still very elevated $9,212 per square meter.)
At the other end rapidly growing cities such as Chongqing are launching crash programs to build housing for anticipated millions of new inhabitants who have been priced out of the private real estate market. In the case of Chongqing projections called for 1.5 million new inhabitants over the next there years and the city is planning to build 30 million square meters of public housing to meet the demand.
This bifurcation means that China is unlikely to see the collapse in housing construction after a bust that has characterized the U.S. experience. If the high-end collapses, as seems quite possible, taking many developers into inactivity if not actual bankruptcy, the public sector is already gearing up to take up the construction slack. And in a command-style economy such as China’s revving up a public housing construction program is actually an easy task. (For more on some of the advantages and disadvantages of China’s command-style economy see my post So remind me–why are we so worried that China’s economy will slow big time? ) A housing market bust in China would have less effect on national economic activity after the initial shock than the bust in the United States has had.
Third, while the commercial real estate bust followed after the housing bust in the United States—and remained largely a problem for regional U.S. banks, in China commercial real estate could actually lead the crisis and create bigger problems for property development companies that their lenders. It’s hard to get national statistics on vacancy rates for commercial buildings in China, but from anecdotal evidence the problem is huge in hot cities such as Beijing and Shanghai.
Beijing had an office vacancy rate of 22.4% in the third quarter of 2009, according to CB Richard Ellis. In the eastern part of the city the vacancy rate at the huge Central Business Development is 35% but plans call for doubling the size of the project. In all 13 million feet of new office space are scheduled to enter the market in 2010.
Fourth, the list of who’s on the hook in the two busts is radically different. In the United States the damage started with the banks who had made the initial mortgages—such mortgage lenders as Household, Countrywide, and Washington Mutual are no longer with us—but it quickly spread through the markets for mortgage-backed securities and derivatives based on those securities to financial institutions such as insurance companies (American International Group), investment banks (Lehman Bros. and Bear Stearns), and then overseas to financial institutions that had bought some of the paper backed, ultimately, by the power of U.S. homeowners to pay their mortgages. That meant the U.S. housing bust took down institutions such as Dutch insurer ING (ING).
In China, first on the hook at the property development companies such as China Vanke, China’s largest developer by market value, Poly Real Estate, China’s second-largest developer, and Gemdale, the fourth largest.
Second are China’s local governments, which are among the biggest lenders and the biggest investors in many real estate projects. Local governments in China are constantly strapped for revenue since they have little ability to raise funds. The real estate boom must have seemed like a perfect solution. Local governments would organize land sales to developers, often using the coercive powers of government to get the land at a low price, and then collect fees from the sale. Often the local government would become a partner in the project. And if financing was a problem, local officials would either lean on a bank for a loan or arrange a loan through an investment company set up by the local government for the purpose of funneling loans to developers. (So what that local governments couldn’t legally set up such businesses?)
Now the local governments are facing two big problems. First, with the slowdown in property development, they’ve lost a major source of revenue. A city such as Tianjin, located east of Beijing, got 41% of its revenue from selling land in 2009. Second, local governments are faced with bad loans and failing projects.  Estimates say investment companies run by local governments had extended $1.7 trillion in loans as of the end of 2009. (For more on how deeply in hock local governments are see my post Despite those huge reserves, China could be, gasp, broke.)
Third, of course, are China’s banks. Beijing is sufficiently worried about the amount of bad loans that these banks have made to real estate developers that the People’s Bank has told banks to increase the reserves they keep with the central bank and also to raise new capital in Hong Kong and Shanghai to the tune of more than $40 billion. (For more on this scheme to raise reserve requirements and at the same time to raise capital, see my post Move over Charles Ponzi and Bernie Madoff–China is running history’s largest financial scam.)
Fourth, and finally, as in the United States, there’s the national government. But even here China follows its own solutions. Instead of putting tax payer capital at risk by direction investments or guarantees to troubled financial institutions, China’s government prefers to rearrange the players and redistribute the liabilities. Its solution to the bad bank loans that followed from the 1997 Asian currency crisis was to set up new off-balance sheet investment companies that took bad loans off bank books and effectively buried them. I suspect that if push came to shove and the People’s Bank plan to recapitalize China’s big banks didn’t work, Beijing would work a similar plan in this crisis.
And fifth, as a result of the first four differences, I think a real estate bust in China would inflict more limited damage. Although a real estate bust in China would knock the Shanghai and Hong Kong stock markets for a loop—since both exchanges have heavy exposure to property development companies—I don’t see it creating the kind of multi-year, lingering economic downturn that the real estate bust has created in the United States. The leverage of the financial system and consumers to the boom and bust isn’t as great as it was in the United States, the bust won’t send the entire construction sector into a near depression, and the government has unique tools that let it bury bad debt in the financial sector very efficiently.
A real estate bust in China would be very bad news for China’s stock markets but the damage to China’s economy—and global economy—would be far more limited than the effects of the U.S. housing bust has been.
Of course, the above doesn’t decide between the bust and soft-landing arguments. But at least it fills in some of the details of what we’re arguing about.
peterspain: As far as Chinese stock market, it has already crashed. October 2007 peak is way above the current tradings. However, I was talking about the real estate market. The current understanding of it in China is absolutely identical to the one in Japan in 80’s.
you are right you only have to change it to the following ANY market WILL crash every 3, 7, 15 or 50 years that is an given, to compare Japan from 1980 with China from 2010 is not logical the P/E values in 1980 Japan were 30 to 50 times with a growth of a few percent China has currently (the A market) P/E average of 18 or less and a growth of 8%+ I will be invested in China for the next few years, hoping to be out before the crash or social unrest materialize
amtrend10,
I agree. And who says I’m leaving?
hailog,
Sorry about that. I have to figure out how to turn off comment moderation. I am still learning WordPress.
Chinese real estate market WILL crash. It is just a matter of time. All bubbles burst, and this one is not an exception.
While some people argue that China’s story is different, I do not believe that. The same things were said about Japan in late 80-s, and … you can go back in time as long as you wish to find more examples of crashes.
Having said that this crash will come, I have no idea when it will happen. In theory, Chinese government has enough resources to sustain this bubble for quite some time. However, the US government is not predictable, and it is hard to expect more predictability from Chinese.
”rapidly growing cities such as Chongqing are launching crash programs to build housing for anticipated millions of new inhabitants who have been priced out of the private real estate market. In the case of Chongqing projections called for 1.5 million new inhabitants over the next there years”
Chonqqing has more than 30 million inhabitants (figure of 2007) that places this comment in a different perspective, beside of that Chinees people pay cash or partly cash for there house, in general Jim Jubaks view about China are not suported by JPMorgan Golman Sach etc etc Obviously there are problems with local goverment, you will see bridges to nowhere or massive airports with 3 or 4 flights a day (Dali Yunnan) like in Japan or many other countries.
and there are dubieus lons and yes there will be problems like in any other country, but for a crash in hong kong or china stockmarket you have to wait a few years growth figures of 8% plus helps to support a lot
Ed,
That’s great! Good luck!
I visited the blog and posted a comment, but for some reason it got listed and then disappeared. You may want to check.
Hope to see you in both places soon.
I appreciate Jim’s objective and pragmatic approach to the markets of the world.
On the other hand I do not care to read about any other reader’s portfolio or personal opinion. We are all in different positions and can utilize Jim’s observations for our own stratagies but to follow one person’s opinions (and not form your own) is a very dangerous way to invest.
Goodby Ed and the best of luck to you.
Way too many comments for me to respond to (although I did read them all), so I will respond in general.
First, I decided to go the blog route. Feel free to come and visit and comment:
http://edstalkingstock.wordpress.com/
Second, I will continue to comment here, but I will try to stay on topic as much as possible. (that should make a few of you happy)
Finally, thanks for all of your supportive comments, and even your criticisms. 🙂
I agree with the majority of the posts here supporting Ed. I enjoy his insights (but not always his politics:).
Earlier this year some of Ed’s naysayers got nasty and Ed responded aggressively. Later Jim came on and basically said play nice. While I totally respect and enjoy Ed’s post’s, I would want Jim’s thoughts regarding Ed’s proposal. I, like the the overwhelming rest of you, have too much respect for Jim not to have his input regarding Ed’s proposal.
ED, everyone
I mostly read Jim’s articles for advice on the market directions and sometimes go straight to the comments to see what you all say about it and get a better understanding about what I will read about. Thanks to all for the education I am getting reading comments from Jim, ED and others.
10 light years from home.
On a second thought, maybe we can create, say, a yahoo group for the off topic discussions???
Ed,
Even though I enjoy reading your posts, I feel sometimes your posts are off Jim’s topics, and sometimes make it difficult for people to comment on Jim’s pieces. Would it possible for you to provide a link in your post for any off topic discussion? I am sure I will visit that forum. Just my 2c.
Jim,
I am visiting China. One of my friend told me that Chinese bought houses for themselves, and they also bought houses for their kids because they are afraid that their kids won’t be able to buy houses with this kind of fast price appreciation. Once housing price appreciate in Asia, it will be difficult to come down. Examples abund; just look at Tokyo, Hong Kong, Taipei, etc…
However, my friend is not sure how many are bought by Chinese for themselves…
Ed: I read Jim for education and information and that includes postings from everyone else. That being said, if I’m in a hurry on a particular day, I scroll down to specifically find your posts and just read them. Don’t stop.
Chuck
Jim, Ed, and all – I second the opinion of artifactr and a few others that creating a forums section on this site would be a nice alternative, and would allow many different topics, subtopics, and threads to be created and discussions could flourish on-topic in these threads. These would be archived by default and people could go back to these threads by topic and look for info later (if they want). The fact that these topics would be archived would be particularly suited for folks wishing to learn about financial topics.
For example, Ed could write an educational post on shorting the euro (or shorting in general), and post it to the “Shorting” topic and anyone interested in learning about that or discussing or asking a question on shorting can click that and dive right in.
I’ve been on a few other sites (non-financial) that have a forums section and it seems to work very well. I think a forums section would make this already excellent site even better and even more helpful.
creativekev
Ed,
Would prefer you post your thoughts not all of your transactions. If jubakpicks adds a user forum section then a thread for your transactions would seem appropriate. If you post your transactions maybe one summary post at the end of the day would be sufficient. I can definitely see the comments sections devolving into a back and forth about your transaction. If you post your transactions as frequently as you make them input from folks posting about Jim’s article could easily become lost in the noise.
Cheers,
Robb
if china’s growth was primarily driven by privatising chinese real estate and exports, why would china be so integral to world economy? Other than buying raw materials, what fuel are they providing to world economy?
Jim:
Thanks so much for a thorough and convincing article!
While the argument of whether China’s real estate will crash is an important one, it misses a broader issue of the China economy, regardless of the housing market crash or not. The issue, which can find parallel in US economy as well, is, after a nearly two decades of stellar growth, the forces propelling its growth are expected to have much less effects. China’s economy took off in 1993 when it depreciated the currency 40%, thus hugely improved the export. Then it entered into the so-called golden 10 years in late 90’s by privatizing real estate (as well as education and health service). Now, these two propelling factors (export and real estate) are not expected to generate the growth China had experienced in the past decades (you can find parallel in Ireland too). And we know China needs to maintain a high growth, and we know growth propelled by fiscal stimulus as it did in 2009 and lasted till now can’t sustain.
So your article basically says even if there might be some crash in China’s high-end real estate market, it won’t be a crash for the whole China economy. I think your argument is very convincing. But some relevant questions are: to try to maintain the >10% growth China enjoyed in most of the last ten years, where future growth will come from? If not, will China economy slow and to what extent, <10%, <8%? And how that will affect the raw material market and countries like Brazil, and in the end, economy of the US and the whole world – I would say China play a 30%-50% role in pulling the world out of the 2008 recession.
Ed,
Yes, please start your own blog and get off Jim’s.
In my view, these comments sections are open forums. Nothing wrong with that; the more the merrier. But ed, I don’t think you fairly characterized your exchange with semievolved.
Following a post on emc’s earnings you made an off topic remark about a paperless dentist’s office which quickly devolved into gratuitous potshots at the obama administration (nothing new there).
In my view all semievolved was doing was tweaking you for your boasting about being short the euro (a profitable trade and a good call for several weeks)because you were basically attacking him for having the audacity to point out that the health reform bill pledged money to put medical records online- a topic you initiated. I don’t think he was “complaining” that you weren’t posting your trades in real time.
Do what you want; it’s a free country. If you want to post your trades so you can share with others your joy or pain, all the power to ya.
If you must chime in with political banter, have thick skin and don’t take or make it personal. That is a general comment not directed at ed.
Ed,
You are one of several posters here that I look for. However, while I would be interested in specific trades I don’t feel that this blog should be for that. I am perfectly willing to take a person’s word as to when they entered and exited a position if their overall comments show an intelligent and interesting take on either the topic Jim has started or something relevant to the entire field.
China’s Banks See Loan Risks:
http://www.bloomberg.com/news/2010-07-23/china-banks-said-to-see-risks-in-23-of-1-1-trillion-public-project-loans.html
JIM –
have you considered creating a ‘forums’ section of the site that would allow users to have open discusion on topics following your posts or specific stock picks? This would also allow users like EdMcGon to create a thread and/or profile with recent buy/sell activity with separate discussion areas for such topics.
I’ve been following Jim since wayyy back in the MSN days and this site is a wonderful format. Adding a forums section would really make it the ultimatet in IMHO. Thanks for all you do! and you too Ed! Keep the posts coming (although a blog would be great too)
Thanks,
-Artifactr
Ed,
When I consider your question of posting or not, the axiom “Everything is relative” comes to mind. I’m specifically thinking about the length of the discussion (i.e. number of back-and-forth posts, etc) regarding something you post on, for example, a trade you just made. If there are not more than, say, 15 to 20 subsequent posts discussing this, then it doesn’t seem excessive. But if there are, say, 30 or more subsequent posts in response to a single post you made, then it can be somewhat of a chore to sift through the comments for the on-topic ones, or comments where the investing view is longer-term.
I’m NOT giving a vote of ‘don’t post’. Not at all. I’m just suggesting that if and when you (or anyone else) see that there are many posts and the sheer numbers have taken over the comments section for what Jim has posted, then you might call a ‘cease-fire’ and possibly continue to discuss that topic at another more suited online location – a blog, maybe? Just my thoughts.
Respectfully,
creativekev
ed,
i used you be annoyed with how often you posted, but have noticed a difference and appreciate your insights when they are relevant to 1) the article topic or 2) others questions/comments.
If you want to put all your trades out there you should start your own blog.
Jim:
Very good article! Really appreciate it. I wonder if we should wait for this bubble to bust before buying China. As you said, when the bubble busts, it will take the Chinese stock market down with it even if for a short time. Shall we wait out the storm before jumping in?
Ed… certainly keep posting and mentioning stocks/ETFs that have piqued your interest for whatever reason. I think we all do that and helps make the site more robust.
I would prefer not to see every transaction. It is easy to skip over one poster, if someone wanted. However, if you do every transaction that will lead to back and forth on the board with other posters which is mostly off-topic and can be frustrating to wade through.
My $0.02
Ed,
When I look at the comments, I look for your name. Now I am off to do a google of Ed McGon and see what I find.
I also assume that Jim should decide if you could promote your future blog here on a “one off” occasion so we can follow you too.
Perhaps Jim should employ you.
Thanks for all your comments.
EdMcGon
Please post as you desire. I too am in a learning situation here so I consider what Jim posts and what others comment to as additional learning.
Besides, I believe each post has a name to it so anyone could always skip posts they do not want to read.
Ed,
Definitely enjoy/appreciate your comments and you sharing your ideas. Please keep them coming:). As to weather or not you should post all trades, is up to you.Personally, I don’t think you owe anyone that accountability.