China real estate is now like Dubai before the crash
Jonathan Woetzel and Jeffrey Towson
There has been an eerie calm in Chinese real estate for the past couple months. People have noticed that real estate developers are cutting prices. They have noticed that banks are pulling back on lending. They have noticed that China’s first bond defaults since 1997 have occurred. It’s like everyone has stopped (or at least slowed) the real estate game they have been happily playing for the past decade and are quietly re-assessing the situation.
In October 2008, those of us in Dubai noticed a similar calm. For six years, we had enjoyed a housing boom. And we had all become well-versed in the rationalizations for why the housing bubble wouldn’t collapse (i.e., “it hasn’t crashed so far”, “the government wouldn’t allow it”). That had all ended the month before when housing prices unexpectedly began to fall. And what followed was a similar eerie quiet, like everyone was rethinking and holding their breath.
By December 2008, prices for new Dubai developments had dropped 40%. Real estate stock prices were in free fall. And publications such as the Economist were leading with headlines like “Has the Bubble Burst?” The calm was over and everyone was starting to take action.
In January 2009, foreigners began to leave the country in droves, abandoning their leased cars at the airport by the thousands. State-backed real estate companies began to realize they were facing massive lay-offs. Many real estate developers realized they weren’t going to be able to survive their debts at current housing prices. And the overall government debt at 150% of GDP suddenly went from a theoretical to a very real problem.
By July 2009, Dubai was a ghost town. The roads were no longer congested. It no longer took an hour to get across town. The restaurants and malls were spooky-quiet. Hotels were 50% cheaper than the year before. And apartment prices continued to drop by a cumulative total of 60% over the next year. The city would subsequently spend the next 3-4 years working out its debt and housing supply situations.
China today has some important similarities to that initial calm period in Dubai in October 2008.
First, everyone is re-thinking the situation – and market psychology matters.
People have now accepted that the Chinese real estate market, or at least parts of it, could actually collapse. It’s no longer a theoretical idea. Commercial banks have woken up to the fact that they could be stuck with non-performing loans. Developers are slowing their land acquisitions. Home owners are realizing they could lose money. And the overhang in construction is likely to plague the building trades with overcapacity for years to come.
Psychology is a big part of what is going on right now. Irrational exuberance can easily tip into fear in moments like this. And if people become too afraid to buy it will cause real decreases in home pricing. Whether people slow down versus run for the door, like Dubai, is going to matter.
Second, this is mostly about Dubai-like second-tier cities
Dubai collapsed but Abu Dhabi, Doha and Riyadh did not. It was a real estate bubble in a specific second-tier city. China’s situation is mostly the same. The housing markets of specific second tier cities could collapse due to oversupply relative to local demand. But Shanghai, Beijing and the overall country-wide market are less likely to be greatly impacted. Much of China’s housing problem is a demand and supply imbalance in certain isolated and unsexy second tier cities.
China is not “Dubai times 1,000” as some have claimed. China is a huge country with 10-20 potential Dubai’s in it.
Third, the quasi-sovereign guarantee for debt is being curtailed.
One of the problems with state capitalism is that it creates the belief that commercial projects enjoy quasi-sovereign guarantees. Investors, banks and others assume that if things go wrong the government will help them out. This is usually through state-owned companies, banks, and local governments. That expectations problem exists in both Dubai and China.
In China, the line between commercial and government debt is being re-clarified. This is similar to Abu Dhabi’s response to Dubai’s 2008-2009 crisis. In both cases, the government publicly withdrew the implicit guarantee on debt, if ever there was one.
The ultimate difference between China and Dubai is Dubai had debts that exceeded their cash. The real estate problem did not have to trigger a Lehman-type financial freeze. The real estate debt was enough to bankrupt the city on its own and Dubai had to go to Abu Dhabi for a bail-out. China, in contrast, has a closed capital account with trillions in cash.
In the press, there has been ongoing speculation that China has finally reached its “Lehman Brothers moment”. But the right analogy is that many second-tier Chinese cities are reaching their “Dubai moment”.