“Secret buyer” of illiquid Chinese housing
With China’s economic transition from production to consumption rails, Chinese authorities are faced with the task to uphold consumer optimism, which, apart from current incomes also depends on the market value of their assets (wealth). Unlike in the US, where the stock market is a barometer of consumer confidence, economic decisions of Chinese households and firms are quite sensitive to real estate prices since for households it represents the biggest asset in their balance sheet:
Firstly, this is the result of the lack of other investment instruments and undeveloped financial markets. Secondly, the fiscal budget of China’s municipal authorities strongly relies on the proceeds from the sale of land and they use future revenues from land sale as collateral for financing by the government. Third, firms use real estate as collateral for loans, and therefore also prefer to keep it as an asset.
The government has realized the importance of stable house prices, therefore, they “inflate the bubble” from time to time, especially during the time of emergence of a strong imbalance between supply and demand. Such attempts were successful in 2011 and 2014, when another important driver of the economy, production, made up for the decline in such a component of GDP as residential investment. However, the last episode of weakness of Chinese economy which is characterized by a marked drop in production activity limits potential of past successful measures:
In the years when production activity was in the phase of expansion, the government could confidently pursue economic goals of the party by spending huge amounts of money on infrastructure and urbanization, which also supported the growth of capital investments of companies getting direct benefits from government expenditures. In the best traditions of the Keynesian idea of the government role state in maintaining growth, China built bridges, airports, roads and “ghost cities” which still miss their inhabitants:
But well, for Marxist-inspired Chinese officials, ghost cities can be simply a part of long-term government plan. The process of urbanization in China may not be fully based on market signals (i.e. prices), since the rapid increase of urban population can be a strategical goal for the government. Command methods can prevail in the block of macro-decisions, including regulation of the process of migration from villages to cities. The question is how long the state will be able to bear the burden of illiquid housing stocks.
In 2017, the number of vacant homes was 22% or 50 million, which is the highest among the major economies:
In mid-2016, the real estate bubble in China reached another peak, but then authorities managed to partially control the fall in prices, deflating the price bubble in Tier 1 cities and supporting a moderate price increase in other regions:
However, the calculation of house price inflation in China can be tricky. In addition to the notional regions’ taxonomy based on their administrative and economic importance (Tier 1, Tier 2, etc.), the urbanization process involves improvement of living conditions in a city, which creates a kind of “qualitative price inflation”. That is, if the price of a house rose 10% over the month, this does not always mean that inflation was 10%, since part of the price change fell on the growth of “intrinsic value” (improved infrastructure, newly created jobs near home etc.)
Taking into account the behavioral factors of the Chinese, investment needs, as well as speculation motive, the government attempts to stabilize real estate market which are accompanied by a strong amplitude of price fluctuations, as can be seen on the chart above. On the one hand, depriving the public of the fancy of endless price growth easily triggers a chain of panic sales, and demotivates potential buyers, including speculators (a sharp bias towards supply). On the other hand, the rise in prices as a result of artificial absorption of the supply by the government forces young buyers out of the market but begins to attract speculators. Recent decline in production activity, in turn, can be reflected in a decrease in the demand for rental housing, which can be an argument for potential rentiers to sell the house, increasing pressure on the market.
Attempts to withdraw excess supply by ordering municipal governments to buy surplus from developers lead to the price inflation outpacing other regions without government support:
Once a major buyer of housing in the province of Bengbu became the government, speculators were quick to jump in benefiting from state guarantees what drove prices up quickly. The program for buying out illiquid housing is planned to continue up to 2020 in 200 cities, but in cities with obvious speculative trends, such as in Shanghai, the right to determine prices is granted to the market.
– More than 50 million uninhabited houses and apartments in China;
– The volume of mortgage loans increased 8 times in ten years;
– Government buys surplus real estate to support the market;
– Prices in developed cities are falling, the discount from developers reaches 30%.
It is obvious that China will have to continue to bear the burden of the “principal-agent” problem, which seems to be eternal for the command economy.
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