Shanghai has submitted a plan to begin China’s first property tax on residential real estate to the Beijing government for review. The plan is rumored to include a tax on people without residence permits and on those who haven’t filed an income tax return in three years. (For more on Shanghai’s plans to impose a tax on real estate and its effects see my post https://jubakpicks.com/2010/05/25/forget-war-in-korea-its-a-possibile-real-estate-tax-in-shanghai-thats-hurting-stocks-there-today/ )
The central government itself has approved the National Development and Reform Commission’s gradual national reform of property taxes. Developers don’t know exactly how strict that policy will be—although the consensus is that Shanghai’s plans, if approved, would be more stringent—or how quickly they will be implemented.
The effect of this uncertainty over national and local real estate taxes has been to freeze the real estate market. Property sales in Beijing and Shanghai fell by about 70% in May as developers have delayed pricing properties until they see what taxes they face.
Not surprisingly shares of real estate developers have plunged. After a 1.4% drop today, an index on the Shanghai stock exchange that tracks 34 real estate companies is down 30% for 2010.
And the drop in real estate stocks isn’t doing anything good for the wider stock market.
The Shanghai Composite Index dropped almost 1% to close at 2,568, its lowest level since May 20.
I don’t think this marks the bottom for China’s stocks. The real estate market is still overheated. Manufacturing growth slowed in May. And economic growth as a whole looks like it’s slowing.
If you’re been waiting for a buying opportunity in Chinese stock markets, I think it pays to wait a while longer. Bad news is still getting louder but we haven’t heard the climax yet.
georic,
1. If they have stock in the U.S. markets, they play by the SEC rules.
2. Good point. Obviously the Chinese version of “Home Depot” wouldn’t do well in such a situation.
EdMac,
1. balance sheet: value of properties depends on how they are marked, to market or purchasing price; I don’t know what is the rule in PRC.
2. Depends also on what impact this bubble burst would have on their customers and economic environment, access to credit and what not.
Let me throw a hypothetical out to you folks, based on the following question: How does a real estate bubble burst effect the following Chinese company?
Let’s say you have a Chinese manufacturer, “China Acme Products” (Wile E. Coyote’s favorite Chinese company). We’ll call them “CAP” for short.
CAP owns and leases several sites in China where they have their manufacturing operations. They have no mortgages directly. The company is pretty liquid, even having extra cash, and no debt.
As I see it, such a company would have a good and bad side to a real estate bubble burst. The properties they own would be worth less (perhaps a LOT less) on their balance sheet. On the other hand, the properties they leased could actually cost them less when they renegotiate their leases, thereby decreasing their monthly expenses.
Feel free to correct me if any of you see any other side effects I’m missing. However, it seems to me that highly liquid companies will not be as hard hit as highly indebted companies. Companies won’t shut down just because the property they are on is suddenly worth less, and people won’t stop coming to work because their homes are suddenly worth less.
Mind you, I am only talking about companies in the highly populated cities of China. If you find a company out in one of the rural areas, they may not even see any effect from this real estate issue.
In summary, when we go to look at Chinese companies, we have one of two minimal requirements: Either very liquid, or located away from the real estate problems.
Waiting a bit longer for opportunities to develop in China makes sense.
But the bubble is in the capital markets, not the property markets. Chinese families will be able to buy many of the houses coming on line eventually (mainly because the family operates as a cost avoidance tool in China – amazing what you can save when Grandma provides free babysitting at home, rather than the cost of putting her in an assisted living facility).
Chinese workers have extremely restricted credit access – no bubble can inflate until that changes. Chinese companies, however, can access global credit markets quite easily (so many foreigners expect dollar and euro collapses that they’ll buy the cheapest, stupidest, least profitable Chinese junk…hoping it will be converted into gold).
There is affordable housing out there, even in the big cities, but the conditions are pretty bad. It’s amazing to see first rate apartment complexes, complete with gates and guards, right next to what could only be described as shanty-towns. This low end real estate can’t be easily acquired/torn down due to government regulations. In any case, the situation is very different from the U.S., so it’s hard to predict the results, other than knowing that prices can’t continue to inflate at the rate they’ve been going forever. It’s interesting how the China real estate issue has gained so much urgency in the last 6 months. Seems like there was very little media coverage on this prior to that. Seems the issue has gotten the Party’s attention in a big way now. Good luck to the technocrats in Beijing. The world is depending on them now.
Brilliant insight.
Many people seem to forget about China’s one child policy. Since you have one child, all your savings and effort are put into that one child. There are a total of six possible wage earners for each child. That also means a total of six possible savings that can be used to help for a down payment on an apartment. For a young married couple, this number becomes a possible of 12 savings that can be used to help this family of two begin their life.
On top of that savings, most local governments have a policy that mandatory takes out a certain percentage of the salary and requires the employer to match that percentage. In Suzhou, it is 12%-22% of the employee’s salary for housing. The employer must match that percentage. This money will be used for a future down payment or as part of the monthly payment. With a married couple, these funds are added together for the down payment and monthly mortgage payment.
All these added together leads to a big down payment and not much debt being carried. One can clearly understand how an educated worker making from 3000 to 4000 RMB per month can afford a $100,000-$150,000 apartment.
As China becomes a consumer society like the US, the 12 sets of savings used to help a couple will diminish. When this event happens, there will be a big real estate bubble if it is not controlled. The government has to balance cooling the real estate market sufficiently as buying power rises to offset the loss of savings. In any case, I feel that we are seeing a correction, not a bubble.
Where there is a problem is the lack of low income housing for the “average earner” mentioned above. Hopefully this issue is addressed in the future and affordable housing is made for this “average earner”.
“different, and our way of analysis does nto hold.”
Didn’t they say that about internet and dotcom stocks? They’re different, they deserve to sell for 200 times revenues on no profit.
bsdgv:
Very appropriate quote! But then we are talking of Chanos – and here is a rebuttal –
http://www.forbes.com/2010/01/11/china-bubble-chanos-leadership-managing-rein.html
The flaw in Chanos’ article is that he is presuming that “average” earner is buying $150,000 condo. The very fact that average earner earns so little and still condo’s are selling with 20-30% downpayment (in cash!) and with restriction that they cannot be “flipped” for 2 years – says that it is not average Joe buying them.
In any case, the point is that using “average” couple with average income of 7,000 to 8,000 is not appropriate in China (or for that matter India and other such developing nations) The whole concept of “income” is very different than here.
Though, I am not claiming that there is no bubble – yes, it could be one and yes, it could burst and hurt a lot – but still China, etc. are different and our way of analysis does not hold.
@SPDTANI quoting chanos from bizweek:
“but it means a condominium basically presented to you with no floors, no walls, no appliances costs the average Chinese two-income couple $100,000 to $150,000 U.S. That Chinese two-income couple in their 30s probably makes combined $7,000 or $8,000 a year.”
It’s ok, they have a sub-prime mortgage.
I thought I read somewhere recently that there was another issue with Chinese real estate “ownership”. The right only lasts like 75 years. And there had not been thought on how a transfer before that ending period works. Sorry, I don’t recall where I read this and would certainly value any input on whether this is correct.
@SPDTANI:
Jim Chanos says:
“The perception seems to be that China will grow out of this situation. But the problem with that argument is the real estate being built is not for the masses. This is not affordable housing for the middle class. This is high-end condos in major urban areas and high-end office buildings. Just to give you an idea, right now construction costs in China are starting to hit $100 to $150 per square foot in some cities. That doesn’t sound like a lot by Western standards, but it means a condominium basically presented to you with no floors, no walls, no appliances costs the average Chinese two-income couple $100,000 to $150,000 U.S. That Chinese two-income couple in their 30s probably makes combined $7,000 or $8,000 a year. You do the math. Even if they were making $10,000 to $15,000 a year, they couldn’t carry a $150,000 condo. This is very similar to someone making $40,000 in the U.S. at the height of our bubble buying a $600,000 or $800,000 house. We know how that ended.”
http://www.businessweek.com/magazine/content/10_16/b4174010646611.htm
We are missing one important point: Honda workers are not buying apartments, average “earner” is not buying either. It is the owners of honda part suppliers, wholesalers, warehouse operators, shipping agents…. (get the idea) – “entrepreneurs” who are starting new companies and newly minted rich (lots of them there) are buying. And dont forget, there is a pent-up demand. People did not own apartments (forget about a house) 25 years back. We cannot compare with US or other developed economies. It is a totally strangely different world out there.
You’ve hit the bubble pin right on the head southof8. Depending on the numbers you get, and on the accuracy, housing in China is somewhere around 10x income. Compare that to about 3x in the US right now (minus some low rate affordability quotient) after a 25% drop, or so. It didn’t take 5X for US to burst, but China is holding 10+? Yeah.
To give the other side some due, Chinese wages are rising and more are entering the urban economy. A 20% wage increase makes that mortgage payment easier.
What (or who) forms the backbone of the Chinese residential real estate market? Sure isn’t the average worker at Honda, making $280 a month, which is double the nation’s minimum wage of $140 a month. The super large electronics manufacturer that employs 800,000 people and makes everything from the Ipod to a laptop pays its employees minimum wage. They all kill themselves (literally) working overtime to boost their pay to $220 a month. I.e., they work almost twice the number of hours required to make $140.
There are 22 days in a month. At that rate, each Honda factory worker makes $12.75 a day. He’s not buying a condo anywhere.
I saw something last week on a new lux building in Bejing where the apartments go for half a mil, and 40% of buyers pay cash. Where is a chinese buyer getting half a mil in cash if Honda is paying less than 13 bucks a day and minimum wage is less than $6.50?
And this is the feared to be the world’s most powerful and dynamic economy? How does a country grow a middle class with labor rates under seven bucks a day?
It’s time for China to put some real estate tax in place, though I hope they waive homestead. Real estate taxes should provide revenues for local governments, so they don’t have to go out speculate.
Thanks, Jim. I agree with you it’s too early to buy. Please let us know when it’s time to buy. I’ve got “dry powder” ready.