What to expect as China’s residential property market seeks a soft landing

Worsening affordability measures and rising debt levels are signs of an inflating housing bubble. However, an immediate burst seems unlikely
City prices are likely to remain high and real estate an attractive long-term asset but bond defaults may rise as developers face cash flow stresses

Chaoping Zhu

Published: 2:30pm, 4 Jun, 2021

Why you can trust SCMP

The recent surge in property prices and debt levels in China, and policymakers’ response in tightening regulations, has sparked much speculation about the real estate market and its future.

In the second half of last year, average property prices in China’s top-tier cities of Beijing, Shanghai, Shenzhen and Guangzhou rose 10 per cent year on year. For premium properties, the price momentum is even stronger. Already, the four cities are among the most expensive globally, and their housing price-to-income ratios range from 31-44 times, below only Hong Kong’s.

Moreover, credit risk keeps accumulating in the market. According to the People’s Bank of China, new bank loans issued to Chinese households reached 7.9 trillion yuan last year (up 6 per cent from 2019), 75.6 per cent of which were long-term loans mainly for home purchases. There is also evidence that short-term consumer loans and small-business loans were used to buy residential property.

The worsening affordability measures and rising debt levels are signs of an inflating housing bubble. However, an immediate burst seems unlikely. Despite the tremendous increase over the past two decades, Chinese property prices have not (yet) deviated significantly from economic fundamentals in two aspects.

First, from 2000-2020, property prices in tier-1 cities have increased 10-fold, in line with the rise in China’s nominal gross domestic product. Second, in these two decades, China’s overall M2 supply (that is, the money supply sloshing around in the economy) increased at a compound annual rate of 15.6 per cent. Meanwhile, that same rate was 12.1 per cent for average property prices in tier-1 cities and 8.5 per cent nationwide.

08:07

Cheap housing but few economic opportunities for young Chinese in city along Russian border

All this, particularly the simultaneous rise in money supply and property prices, suggests the long-term staying power of China’s real estate as an attractive asset class, buoyed by a strong economy. Hence, the housing price-to-income ratios might remain high as the economy keeps powering ahead and money supply continues to expand.

That said, the recent price surge may have run out of steam for now as China has entered an era of policy normalisation. The housing price gap between large and small cities may also widen further, as large cities are more resilient and attractive to investors, even in an economic slowdown.

Policymakers are not blind to these looming risks. They have moved to tighten regulations with the hope of cooling the property market before things get worse. Measures adopted include tighter mortgage conditions, more land supply for residential construction, and stricter purchase controls, particularly in top- and second-tier cities. These policies are designed to curb price momentum and limit market liquidity.

As long as China’s economic growth continues to chug along steadily, these measures could help the property market secure a soft landing.

02:01

China’s economy expands record 18.3 per cent in the first quarter of 2021

Real estate has been an important driver of China’s economic growth. Last year, property development accounted for 27.3 per cent of fixed asset investment, playing a key role in the post-pandemic recovery. In addition, local governments rely heavily on land sales, which contributed 44.3 per cent of local fiscal funding in 2020.

Property is also the most important asset class for Chinese households. According to a 2019 survey by the People’s Bank of China, properties accounted for 59.1 per cent of urban household assets. Given the huge importance of this asset class, there will still be profound economic and market implications in the case of a soft landing.

Tightening credit conditions for developers could lead to slower investment growth this year. That might dampen demand for raw materials over time and bring down prices.

Why China is asking banks to sacrifice profits

Moreover, we could see more defaults and higher volatility in the bond market, as highly indebted developers face mounting cash flow pressures.

Some sector leaders have strengthened their balance sheets and reduced land reserves in anticipation of tighter policies but smaller developers may have less room for adjustment. This might lead to accelerated mergers and acquisitions among developers, which would benefit the strongest players.

Significant structural changes in the consumer market could be another symptom. The demand for household appliances, furniture and decoration materials is likely to fall as property sales stabilise.

As households look to diversify their investments amid higher uncertainties and declining property market returns, the equity market could potentially benefit, particularly as it has become more efficient after reforms in recent years.

Chaoping Zhu is a Shanghai-based global market strategist at JP Morgan Asset Management

This article appeared in the South China Morning Post print edition as: Why China’s inflating housing bubble might not burst just yet