What bubble? Experts say extreme distortions in supply-demand are driving up home prices in Beijing and Shanghai

Beyond all the talk of cooling down the credit-driven housing bubble in China, experts say the situation in the nation’s largest cities still comes down to basic supply-and-demand mathematics.

Beijing and Shanghai, cities which have seen a massive population influx, exhibit the biggest distortion in terms of supply and demand for urban land, according to official data.

“The strong home-price rally is by no means a national phenomenon. Instead of thinking of the whole market as a big bubble, it is more accurate to view it as a supply-demand mismatch,” said Larry Hu, head of China economics for Macquarie Securities.

Beijing’s land supply allocation for this year is 4,100 hectares, of which 1,200 hectares is designated for residential use, according to the city’s urban land supply plan published in April. The 4,100 hectare quota itself has been declining for six consecutive years.

Even so, year to date Beijing’s government has only sold 10 parcels, or 108 hectares of land, according to data compiled by China Index Academy.

Excluding subsidised homes and ancillary properties, actual land area available for private homes is 44 hectares, which converts to roughly 12,200 new homes, compared to 94,921 new home sales in the same period in the city, according to fangdd.com.

The huge gap means Beijing is doomed to fail in reaching its annual target, analysts said. A review of the implementation reports issued by the city since 2011 show that except for 2013, Beijing failed to meet its residential land supply targets every year.

The restricted supply is due to Chinese government’s intention to control the size of its first-tier cities, while developing small and medium-sized cities, say analysts. Beijing’s land authority said this year’s plan was in line with President Xi Jinping’s instruction to “simplify the functions, control the population, and downsize the land supply” of the capital.

To discourage “land kings” – developers that bid record prices for land parcels – the city did not sell a single plot of residential land from early June to September 12, an unusually quiet period that contrasted starkly with Shanghai which saw several land parcels snapped up at record prices, generating national publicity.

Since the end of September, though, Beijing accelerated its pace of land sales with five plots for public auction with a total area of 34.9 hectares. At the same time, the capital led the nation by introducing a raft of cooling policies, which included raising down payment requirements.

However, local authorities set stringent limits on bidders. Of the five plots available, one was reserved for subsidised housing, while a ceiling price was set on the other four. When biding reached the ceiling – as it was sure to do – the developer that promised the largest share of public rental homes would be awarded the plot. They were also required to reserve at least 70 per cent of the area for homes smaller than 90 square metre, a long abandoned policy that has now been re-introduced.

On October 28, Beijing went a step further by setting a price ceiling on the homes to be built on the four parcels. For the three parcels in the Haidian district, authorities stipulated the average price of properties cannot exceed 53,400 yuan per square metre, with the maximum price of any one home being 56,100 yuan. For the parcel of land in Daxing, the cap for average cost was set at 55,800 yuan per square metre and 58,500 yuan for the highest priced home.

The strict requirements, with the goal to lower the market’s price expectations, effectively stripped developers of their market autonomy. Developers could only pin their hopes of earning profits on the commercial block adjacent to the residential block, analyst said.

In Shanghai, despite the frequent appearance of “land kings”, the local government in the first nine months only put 2.72 million square metres of residential land up for sale, down 39 per cent from the same period in 2015, according to China Index Academy. However, price per square metre jumped to 23,966 yuan from 10,532 yuan in the same period.

Contrary to most people’s perception, the highly-industrialised, urbanised metropolis of Shanghai still has half of its land devoted to agricultural use – which only generates 0.4 per cent of the city’s economic output – while 28 per cent of urban land is industrial, leaving only 36 per cent for residential use. Even then, residential density is kept artificially low, with the plot ratio capped at 2.5 times compared to around 5 to 10 times in other international cities such as Hong Kong and New York, according to a recent report by Macquarie Securities.

“If Shanghai sells only one parcel of land in a year, the price of the land must be extremely high. This is not a bubble; this is a shortage of supply,” said Hu of Macquarie Securities.

Shanghai municipality in October approved a draft plan that vowed to keep its population within 25 million, and its urban area within 3,200 square kilometres by 2040 – which means new land availability will not increase, rather it will decline from the current level.

Ouyang Jie, vice president of Shanghai-based developer Future Land Holdings, said the fundamental shortfall in land means Shanghai’s home prices will only rise in the long-term. “What’s the point of Shanghai having so much farmland? Does China’s agriculture rely on Shanghai?” he asked.