How lack of a property tax left China open to a housing bubble

Local governments’ reliance on a hot property market to sell land and cheap, available credit have been blamed for the bubble, but other factors have been at play
Even a property tax as low as 0.5 to 1 per cent could have helped prevent the bubble that is disrupting China’s economy from forming

Joe Zhang

Published: 6:45am, 28 Aug 2022

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Now that the property bubble has burst in China, it is time to examine why the bubble formed and grew to such an enormous size in the first place.

Analysts often mention three factors – the reliance of local governments on a hot property market to sell land, cheap credit, and the availability of credit. However, I feel a more relevant factor is the zero holding cost, or the absence of a property tax. Let’s look at these four factors in turn.

First, local governments. While it is true that local governments across the country might want to create and maintain a hot property market to sell land, collect taxes and create jobs, there is nothing they can do at a macro level. They have no levers to pull.

But, at the national level, a clampdown on high property prices has been in place for about a decade. For example, the government has effectively banned property “flipping” in many big cities. These cities have also imposed price ceilings, stopped non-residents from entering the market and prevented residents from buying second homes. Where second homes are allowed, heavy penalties have been imposed.

Second, there is the cheap credit for builders and homebuyers. In the past decade, mortgage interest rates have generally stayed in the 4 to 6 per cent range against an average inflation rate of 2 to 3 per cent. Given low default ratios, these interest rates should be regarded as broadly fair. Builders generally pay 5 to 8 per cent to banks, and it is hard to say these rates are outrageously low.

Delivery riders arrive outside a Bank of China branch in Beijing on August 22. China has cut benchmark loan rates in an attempt to revive its flagging economy. Photo: EPA-EFE

Moreover, these rates do not seem unfair against a one-year fixed-term bank deposit interest rate of around 3 per cent and the banking sector’s interest margin. Apart from bank deposit interest rates, all other interest rates in China have long been liberalised and are therefore market driven.

Even deposit interest rates have been constantly challenged by a wide range of money market funds and wealth management products. Therefore, these rates should be seen as competitively determined.

Third, there is the availability of credit. While it is easy to obtain a mortgage, Chinese banks have kept their loan-to-value (LTV) ratio far below 70 to 80 per cent. In practice, many mortgages are just half, or less than half, of property purchase prices. Unlike elsewhere in the world, you do not see 90 per cent or even 85 per cent LTV ratios on the mainland.

Property developers have not provided homebuyers with top-up financing. Although builders have invented various clever schemes to get funding from financial institutions and capital markets, that should have boosted property supply and dampened rather than fuelled a bubble.

That leaves the only other suspect: the zero holding cost of property. Christopher Wood argued in his 1992 book The Bubble Economy that the nearly-zero landholding cost until 1991 was partly responsible for Japan’s giant property bubble.

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The same argument is perhaps applicable to China today. By the same token, property management fees are negligible across the country, and that has also provided a boost to the net asset value of housing stocks. For a housing market where rental yields can be as low as 1 to 2 per cent per year, any meaningful property tax of, say, 0.5 to 1 per cent would have prevented a bubble from forming in the first place.

Mainland China’s property market has a short history. In less than 30 years, it has achieved a home ownership ratio of about 90 per cent, far higher than in the West. For example, the ratio is about 65 per cent in England and 66 per cent in the United States.

This is despite the fact that hundreds of millions of Chinese citizens have moved to cities from the countryside in the interim. In 1990, around a quarter of the population lived in cities. Today, that ratio has surged to around 65 per cent.

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This phenomenal transformation must have a cultural underpinning. After 1949, home ownership and property rights were, in general, denied and condemned. Perversely, that episode made Chinese people crave ownership of something.

When they were allowed to own their own homes, the proverbial volcano erupted. The public’s love affair with real estate should be seen in this context. Even today, after the bubble has burst, China’s household sector is still not terribly stretched compared to other countries, although there are pockets of distress.

Beijing knows the power of a property tax, but officials are too afraid of pricking the bubble. That is why the pilot programme of property tax collection in Shanghai and Chongqing has not been extended to the rest of the country. Given the meltdown of the property sector in the past year, don’t hold your breath for a nationwide property tax any time soon.

Joe Zhang is co-chair of SBI China Capital in Hong Kong