Property market corrections will benefit end users and real economy

Winston Mok says inevitable corrections to China's property market will direct capital to places where there is genuine need for property developments and to other business sectors

PUBLISHED : Wednesday, 30 July, 2014, 6:23pm
UPDATED : Thursday, 31 July, 2014, 4:18am

The zillion dollar question today is what will happen to China's real estate market. With price corrections spreading from Hangzhou to Beijing, there is little doubt that China is bracing itself for a market downturn. The issues are how widespread, how severe and for how long.

Some pundits are saying the downturn will be more severe in tier-three and -four cities, while top-tier cities like Beijing and Shanghai will be less affected. The reality is perhaps a bit more nuanced and complex.

There is a world of difference between small, resource-based inland cities suffering from chronic oversupply and inflated prices and small Hebei cities near Beijing that will benefit from Greater Beijing integration. Prices in outlying areas of Beijing are coming down, while prime properties in central Beijing are still seeing record prices.

China's real estate markets will become increasingly differentiated.

Central locations and some satellite cities in dynamic economic regions should do fine in the long term. Hyped projects unsupported by underlying economic activities will not fare well. It is ultimately the real economy that will drive the real estate market - not the other way around.

More importantly, the pause from market frenzy presents the opportunity to reflect on, and hopefully begin to address, the deep imbalances in China's housing market.

While many have multiple apartments and the wealthy sometimes dozens, most working class people in major cities are struggling to find down payments for their first flats. Many luxury apartments remain vacant, while some college graduates stay as "ant tribes" in basement cubicles in Beijing. Without support from wealthy parents, most graduates from its top universities cannot afford to buy apartments in Beijing for many years after graduation.

The overall supply and demand of housing in China nationwide may not seem that much out of whack. But many apartments were built in the wrong places. There is significant oversupply in some smaller cities while grave shortages of housing remain in Beijing and Shanghai.

Many new flats in Beijing and Shanghai have price tags of more than 10 million yuan (HK$12.6 million), putting them beyond the reach of ordinary people. But for social or affordable housing in Beijing, there are often more than 10 applicants, sometimes 50, for each available flat.

The current market corrections may help to address some imbalances through reallocation of development projects to meet end-user demand, redirection of capital to productive industries and reduction of reliance on land-based financing.

A significant portion of China's gross domestic product is "wasted" in building empty apartments in ghost towns. Market corrections will direct capital to develop property projects in cities where there are genuine end-users needs.

The healthy development of Zhejiang's economy has been distracted by the "easy money" in real estate - as may be seen in the significant oversupply in Hangzhou and surrounding areas. Now real estate is less of a sure bet, capital will start flowing back to productive industries. A real estate downturn may help in the restructuring and upgrading of the real economy.

Many local governments have been relying on ever increasing land prices to finance a significant proportion of their budgets. Land-financed infrastructure in turn drives land prices higher, forming a cycle of enterprising bootstrapping. The current downturn, breaking such a chain, will force many local governments to look for other, more sustainable forms, of fiscal income.

Thus, in the longer term, the current real estate market corrections may be good for China in many ways. Economic growth may suffer for a few years. But corrections will enable quality growth.

Real estate is by nature a cyclical industry, given the long development lead time. As much as high prices in the past led to the current oversupply, subdued prices today will restrain supply tomorrow - leading to market recovery. Reducing purchase restrictions can lower the barriers for the market to find a new balance. The lower the restrictions, the faster the market can correct itself.

However, while the downturn may make housing more affordable for smaller cities, the market - even with significant corrections - just cannot provide enough housing for ordinary workers in top-tier cities. The government may need to consider other forms of intervention than restricting purchases. If purchase restrictions are lifted for the luxury sector, the ensuing increases in prices and volumes will lead to higher land revenues. A good proportion of such revenues may be deployed to build social housing.

Perhaps the management of supply, rather than demand, is where the government may more effectively focus its efforts. Instead of the market, perhaps it is the common people whose housing needs are not met by the market that require "rescue" by the state.

Winston Mok is a private investor, a former private equity investor and McKinsey consultant. An MIT alumnus, he studied under three Nobel laureates in economics