Real estate prices fell in 64 of the 70 cities surveyed. This is the largest decline since records began in 2005. This is bad news for the global economy
I had written about the problems with Chinese real estate a few months ago. Normally I do not discuss a particular subject more than once a year, but it appears that this problem will only get worse.
When I wrote the piece, prices of Chinese real estate were still rising, perhaps at a slower pace than in years past, but rising. This is no longer true. They have now been falling for the past three months. It is not just the third and fourth tier cities that are having problems. They fell in 64 of the 70 cities surveyed. This is the largest proportion of declines since records began in 2005. The fall between June and July was .9%, the fastest decline over the three months. So the fall may be accelerating.
Housing sales are also falling. They have fallen 10.5% in this year, this figure too, is accelerating. Sales fell 16.3% in July, dow
n sharply from June. The drop has continued into August. Data from 42 large cities showed a 20 % year on year decrease in home sales in the first 17 days of August.
The falling prices are beginning to cause a bit of unrest. There was a protest at the Shanghai offices of the developer Greentown China Holdings. It dropped prices 25% in five days. Naturally the people who had purchased their properties before the price drop were a bit upset. There were also protests in Jinan, south of Beijing, when another developer also cut prices by 25%.
Falling prices are rather new phenomena in China. With the exception of a short period in 2012, housing prices have been rising. There has never been any real correction since people were first allowed to own their homes 15 years ago. Prices have increased 500% since 2008 and are some of the most expensive in the world, relative to household income.
Housing is also a major component of the Chinese economy. The construction and real estate industries make up 13% of GDP compared to just 3.2% in the US. If you include cement, steel, chemicals and furniture and other industries that impact real estate, the figure rises to 20% a full one fifth of GDP.
The real estate industry is not only a large part of China’s GDP, it is also central to local government revenues. It is estimated that land sales make up 60% of all local government income. Real estate taxes, where they exist, are only experimental programs.
There is also plenty of inventory to work through. At the end of 2013 there were 4.863 billion meters of residential housing under construction. If we assume that sales average the same number as between 2009 and 2012, an assumption that may no longer be valid, then it would take 5 years to deplete the inventory assuming no new developments after 2014. Unsold inventory in 14 large cities jumped by 30% since the beginning of 2014.
Property developers are trying to deal with the inventory in different ways. One is to hold back property from the market. The number of homes added to the market in July dropped 25% from June. They are slowing construction. New building construction dropped 18.6% in the first 5 months of 2014. They are also adding incentives. These include no down payments and guarantees to buyback properties at the sales price in five years. And as a last resort they cut prices, but in smaller cities these discounts do not increase sales.
The slow sales and large inventories have hurt developers' cash flows. Cash and cash equivalents at 137 listed mainland developers, excluding the four largest, were sufficient to cover just 74% of their short term liabilities in the first quarter.
Naturally the government is concerned with the present housing slump. They faced a similar slow down in 2011-2012. At that time the solution was to expand credit. The present slump is in part a reaction to the 2013 credit expansion. To slow the markets the government has been slowing credit. Can they reverse course and get the market moving again?
Perhaps, but it will be more difficult. China has been expanding credit since 2008. It is now more than 250% bigger than their economy.. While the absolute level of debt is not that high compared to other counties, the US has a ratio of 277%, the speed of the build up is. The US present debt levels haven’t grown that much in the past 5 years. China’s debt has expanded by 150%. Rapid build-up of debt in such a magnitude in such a short period has almost always been followed by financial turmoil in other economies.
The banks are also having trouble finding new money. They have been subject to huge outflows as competition from trust companies and new online banking offer higher interest payments. Their bad loans are rising and they have been forced to sell Rmb 90 billion ($14 billion) worth of bonds to shore up their balance sheets.
The other recent source of loans, trust companies, is drying up. Chinese regulators have issued a series of new rules that have slowed their growth. Problems with several trust companies and the increased government scrutiny have made them more cautious. There have been defaults, but these have been followed by bailouts, which may not continue.
Even President Xi Jinping’s crackdown on corruption is having a detrimental effect. Government officials make up as much as 20% of the luxury housing market. They used ill gotten gains to invest in real estate. They have stopped buying and are actively selling their houses at discounts of 5% to 10%.
To slow the rapid rise of real estate prices many towns had instituted restrictions. Thirty cities have eased these curbs, but it hasn’t helped. Buyers have realized that prices could go down and won’t take the risk.
The impact of a Chinese real estate decline will not be limited to China. There is a more direct impact than just the falling demand from a slowing Chinese economy. Asian companies have issued bonds worth $150 billion last year. They had sold $100 billion by last June. Up to half of the issues are from Chinese companies. Thanks to rock bottom interest rates, much of the demand for Asian bonds comes from the US. Chinese developers have also participated in this market. They have sold $50 billion worth since 2010.
A slowing Chinese real estate market would not be good news for the world economy. It might become far worse since the world economy already has enough problems. The Eurozone, Japan, Russia, Brazil are either slowing or in recession. The massive amounts of free money that has been swirling around the globe for the past five years have possibly created several asset bubbles, which depending on the country could include equities, bonds, and real estate. The ability of governments, specifically the Chinese government, to stimulate growth with more debt is constrained. Capitalism is a two way street. So despite the promises of central bankers the long awaited recovery might actually be something quite different.
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William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)
