Mar 03, 2014 05:37 PM

The Property Market Is Headed to Heaven – and Direct the Other Way

Predictions for this year's property prices are contradictory, just as they have been in past years. Economist Andy Xie predicts an imminent collapse of the housing bubble, while real estate mogul Ren Zhiqiang continues to see that as nonsense.

Hong Kong billionaire Li Ka-shing, who does not usually come off as alarmist, has sent off confusing signals about his views of the property market. He sold some of his real estate assets on the mainland and said the prices of land were too high. The flour, Li said, was becoming more expensive than the bread.

However, he has also said he is very optimistic about the domestic property market because buying a house remains the hope of many households.

The data is equally contradictory. On the one hand, land sales last year totaled 4.1 trillion yuan, reaching an all-time high and underlying developer confidence. On the other hand, worries about housing prices taking a dive have haunted the market for days, since Industrial Bank said it tightened lending to developers.

A comprehensive analysis would show that both pessimists and optimists have reasons to back their claims.

Above all, the market obviously has some bubbles. It is absurd that it should take up to 40 years of a person's average annual income to buy a house in big cities such as Beijing and Shanghai. Robert Shiller, who won a Nobel prize in economics in 2013, said he thought the price-to-income ratio of 8 to 10 in California was already too high. Expensive home prices threaten to wipe out the capacity of the middle class to consume, making it more difficult to restructure the economy away from dependence on investment.

A monetary environment that has shown signs of tightening could cause home prices to fall. A lot of developers have been forced to finance through shadow banking options, which have high interest rates, since the government started discouraging property investment in 2010. After Li Keqiang took over as premier last year, capital costs have surged on three occasions because of a temporary liquidity shortage. Several developers in Hangzhou, the capital of the eastern province of Zhejiang, have dramatically cut their home prices, probably because they were pressed for cash.

The central government's crackdown on corruption has also put strong pressure on home prices. The era of luxury watches and top-end liquor for officials is gone. How long will it be before the housing market, which has played such an important part in corrupt officials' money-hiding schemes, sees the end of its frenzied days?

"A considerable share of the property market is meant for houses that do not need to be there at all," Wang Shi, a real estate tycoon, said recently. This is why the biggest measure the government can take to regulate the market is taking on corruption, he said.

For all that says the property market is in danger, there are always factors we cannot ignore that strongly prop up prices.

First off, the country's excess liquidity is among the worst in the world. Its M2 is more than that of the United States when converted into U.S. dollars, and it has reached twice the amount of GDP. Because the stock market has been disappointing, the property market has become the pool that absorbs excess liquidity. That is precisely what economist Wu Jinglian meant when he said: "The root cause of soaring property prices is an oversupply of money."

Also, Chinese banks' mortgage policies are more prudent than those of their U.S. counterparts. Compared with U.S. lenders, which before the 2008 financial crisis lent to home buyers even without down payments, Chinese banks are much more resilient against a fall in home prices because the down payments they require are among the highest in the world.

In addition, consider where the government stands on the issue of property prices, when data shows that the real estate sector contributes 20 percent of the country's GDP and 50 percent of local governments' incomes. While the overall economy looks set to slow further, the property market looks all the more important.

Last but not least, a dramatic fall in housing prices would trigger concerns about social unrest, as the example of Hangzhou shows. This was not the first time that people who bought homes a while back stormed a developers' sales office to protest a price cut. The protesters seem certain that the government will not stand by and watch unrest spoil the appearance of social harmony.

Taking the factors on both sides into account, the following conclusions can be drawn: 1) houses are too expensive; 2) it is unlikely that prices will fall dramatically; 3) divergence in prices between large and small cities will widen; 4) developers will continue to have liquidity problems; and 5) the government will be compelled to step in if the property market suffers a full-blown crisis.

What Charles Dickens said at the beginning of his novel The Tale of Two Cities can also be used to describe the property market in China: It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way.

The author is the deputy executive director at China Europe International Business School

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