China’s real estate market freefalls: so what?

by Editor

The Chinese real estate market has historically been a bit of a mystery. At its height, it contributed 25% of the country’s overall economic output. And despite making only one-fourth as much money as American buyers, people in Beijing and Shanghai are paying home prices that are comparable to those in San Francisco and New York.

Many now think the Chinese real estate market is set to see a dramatic recession. The government intends to step in to stop speculation and control the “three high” crisis, which it refers to as high debt, high financialization, and high pricing. The strategy has been dramatic in every way. Property developer financing has collapsed. Property sales earlier this year decreased by up to 30%, developments that are now under construction are not being finished, and citizens have taken to the streets to cease mortgage payments on these projects in protest.

The largest Chinese real estate developers frequently default on their payments. Even the surviving are in a liquidity crisis and are starved for cash. There is a chance that the housing market crisis may drag down the overall economy, harming suppliers, small and medium-sized construction businesses, as well as consumer spending. Furthermore, it is risky that the banking system has at least 25% of its assets in real estate.

Currently, a backstop is required to prevent the crisis from becoming self-fulfilling: the fear that real estate developers would go bankrupt causes buyers to put off their purchases and finance to become scarce. A planned bailout package is unlikely to make a difference, and some monetary easing and relaxation in the mortgage market are insufficient to stimulate demand. The issue cannot be resolved by reducing mortgage lending standards. Property developers would require considerably greater assistance from the government notwithstanding their prior dishonest behaviour. The government will need to convey a much stronger message and foster trust in order to break the pattern.

Although there is immediate pressure on the Chinese economy, a catastrophic housing crisis is not imminent in China. For starters, Chinese households have historically had quite high savings rates, so they should be able to handle interest payments very easily. There were no severely indebted homeowners unable to make their minimum payments in the US or Europe in 2008.

Additionally, there is still a pent-up demand for housing due to factors like rising urbanisation and the fact that bachelors are more “eligible” to marry in a society where marriage is fiercely competitive for men.

A full-blown financial crisis is also unlikely. Major banks are owned by the government and cannot fail. The western banking system does not involve long, opaque lines of intermediation. Foreign creditors to Chinese real estate developers will have to take a significant haircut, but the impact on the global economy is probably not as significant. Foreign investors currently hold fewer than 5% of all Chinese stocks and bonds, limiting their overall exposure to Chinese assets. Contrary to mortgage-backed securities, which were publicly traded prior to the 2008 financial crisis, this is not the case.

The current real estate market cycle is the third significant one to occur in the previous ten years. The state has good reason to get in; giving the middle class more accessible homes is the first step in capturing their hearts. Financial stability is likewise threatened by a hot sector. In the past, greedy real estate firms have diversified into unrelated industries, while many other businesses have chosen to invest in real estate as opposed to concentrating on their core competencies.

However, drastic and hasty measures to chill the market would backfire. The structural nature of the housing market’s issue necessitates a long-term solution. China’s banking system is one of these issues. Property investing has historically outperformed the market as a whole. Around 80% of people are property owners, and a startlingly large fraction of them — apparently over 20% in metropolitan areas, and I’ve read figures as high as 40% overall — are multi-property owners.

“Mayor economy” is another issue. Land is sold by the local government to generate cash, and it is also used as security for large-scale borrowing. The construction of residential housing by developers frequently results in the investment in infrastructure, the creation of retail space, the provision of services, and the creation of jobs. This explains why, as a quicker approach to boost local GDP, local governments’ enthusiasm in the past ten years has quickly shifted from industrialization to huge urbanisation. Additionally, this has given developers carte blanche to take on more debt, stockpile land, and overexpand.

The state wants the property sector to shift from being “rarely cold and mostly hot” to the opposite. Not merely strict restrictions are needed for this; the economic structure of the country must be fundamentally altered. Few governments have shown to be particularly adept at weaning the economy off property in an orderly fashion; this takes competent navigation and a lighter thumb on the reins.

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