JAMES CHANOS: Well, again, the perception seems to be that China will grow into this real estate problem. But there’s a problem with that argument, and that is the real estate that’s being built is not being built for the masses. This is not affordable housing for the middle-class. This is high-end condos in major urban areas and high-end office buildings.
Just to give you an idea, right now construction costs in China are starting to hit $100 to $150 in some of the cities. That doesn’t sound a lot by western standard — per square foot, by the way. The typical Chinese condo is 100 square meters, about 1,100 square feet.
So that means a condominium that is basically presented to you with no floors, no walls, no appliances, costs the average Chinese two-income couple $100 to $150 U.S. Now, that Chinese two-income couple in their 30s probably makes combined $7,000 or $8,000 a year.
Now, you do the math. Incomes are about $3,500 per capita in China, urban areas slightly higher. Even if they were making $10,000 to $15,000 a year, you couldn’t carry a $150,000 condo. This is very similar to someone making $40,000 in the U.S. at the height of our bubble and buying an $800,000 house. And we know how that ended.
Chanos, the founder of Kynikos Associates Ltd, has a terrific track-record. He makes some compelling points, especially about commercial office and retail real estate. However, I am not convinced by his bearishness about residential property, and I think he is making a mistake by looking at China as one unified real estate market. There are significant variances between cities, and I think Chanos is underestimating the poor quality of current housing (has he spent a night in local Beijing housing yet?), the pent up demand to upgrade, and the increasing urbanization of rural suburbs.
In the case of Beijing, residential real estate (disclosure: I have property inside the Third Ring Road) may be getting ahead of itself but not yet be a bubble. That said, I would not be a buyer right now given the policy risk. Here is why I think Beijing may not yet be in a crazy bubble:
1. Beijing is the capital city of the largest country in the world with the fastest growing major economy;
2. Beijing’s housing market is really a nationwide housing market. Every person with means in China wants to buy in Beijing. Beijing is the center of power, it has the best education system in the country and it has the best health system; UPDATE2: This point may not hold much water for a while, as new rules limit purchases of non-residents–never underestimate policy risk in China.
3. As the capital of China Beijing attracts rich buyers from the global Chinese diaspora;
4. As I wrote recently, the skyrocketing relocation compensation costs within central Beijing’s make any new constructive extremely expensive. UPDATE1: News reports today state that the relocation compensation for the Tongzhou New City exceeds 15,000 RMB/m;
5. Prime developments inside the Third Ring Road are still less than $1000 square foot equivalent; compare to similar locations in New York, Tokyo or London;
6. Using official statistics to calculate average Beijing income to show that real estate is overpriced is misleading. Rich people from all over China buy here, and the official income statistics understate how much money Beijingers have at their disposal;
7. Beijing’s population just hit 22 million, a number it was supposed to reach in 2020;
8. We are starting to see the emergence of a Greater Beijing Metropolitan Area, along the lines of the Greater Tokyo Area, stretching east, north and south into Hebei and Tianjin. The eastern expansion of CBD and the Tongzhou New City (video here, in Chinese but with lots of pictures) are just two examples of this sprawl, a trend that will likely make central Beijing property even more desirable and expensive. The government is massively upgrading the public transportation network (see a map of the planned subway expansion) as part of this expansion of Greater Beijing.
The rising prices in Beijing are very painful for many Beijingers. But I think we are watching Beijing evolve into a truly world-class city, along the lines of New York, Tokyo or London. How many New Yorkers or Londoners or Tokyo residents can afford to live in the city center as opposed to commuting in from a suburb? The same dynamic is at play in Beijing.
There are professional investors who are not as worried as Chanos about a China real estate bubble. In December 2009 Pimco issued a report comparing Japan’s experiences with China’s-The Chinese Real Estate Market: A Comparison with Japan’s Bubble. The author does not believe that real estate market in China is anything like Japan’s was near the height of the Japanese bubble, though he points out that there may be future risks:
Overall, the basic economic conditions in present-day China are substantially different from those of late-1980s Japan or the post-bubble U.S. (Chart 6).
…We see little risk in the foreseeable future that increases in loans to the real estate sector will pose a threat to the financial system. That said, a rapid increase in lending could lead to a rise in bad debt in the future, a risk of which Chinese regulators seem well aware.
An expansion in mass-market housing is vital for China to realize growth powered by domestic demand. A high percentage of home purchases in China are carried out in cash (down payments are generally around half of the purchase value), and the amount of home mortgages remains relatively small. This is related to the nation’s high savings rate, but as middle-class housing becomes more available, the younger generations may rely more on loans. Increased demand for homes and durable goods may help promote a healthy cycle in domestic demand as a reduction in the savings rate may lead to higher personal consumption.
Given China’s potential growth, its real estate market has plenty of room for enlargement over the long term, which stands in clear contrast to Japan’s real estate bubble. That said, the current situation seems to have some characteristics of a future asset bubble. A key theme in the months ahead will likely be whether and how the Chinese government is able to contain the potential overheating in the market and shift the focus of housing supply towards the mass market.
On April 12 US Global Investors issued a more sanguine report titled “No Housing Bubble in China“. The US Global Investors analysts believe that the relatively low amount of debt to disposable income and the government’s efforts to rein in excessive speculation should keep China’s real estate market from blowing into a full scale bubble:
Leverage is also an important indicator in judging how susceptible a housing market is to growing into a bubble. The chart below, also from BCA Research, shows debt as a percentage of disposable income in China and in a number of developed-market countries. More than half of the developed countries had debt in excess of income, with Denmark and Ireland pushing 200 percent.
China is at the far other end, with debt totaling just 44 percent of disposable income. Furthermore, homebuyers in China put down at least 20 percent as a down payment (30 percent for a first-time buyer and 40 percent for a second-home buyer to damp down speculation). These buyers rarely fall behind on their mortgage payments.
It’s obviously true that there has been rapid price appreciation in major cities like Shanghai and Beijing. Prices have risen above the affordability level for most families in these cities, and that is why the government is acting to let some air out of those markets before dangerous bubbles form…
Where does the China housing market go from here? Home inventories are low in major cities – at the current sales pace, there are only a few months worth of inventory in Shanghai, and the situation isn’t much better in Beijing or Shenzhen.
But demand is still strong. A recent survey by the Hong Kong-based brokerage CLSA found that 56 percent of China’s middle-class families are considering buying a new home – despite the higher prices many families can pay a 30 percent down payment because of their higher savings.
Our own research shows that property developers, coming off a good 2009, are expanding into second- and third-tier cities, where housing markets are also growing and prices are more affordable.
This widening of opportunity, combined with the government’s early recognition that decisive measures were needed, together will raise the probability that it will achieve its goal of slowing down home price increases without causing the market to collapse.
Who is right? It may take a while to find out. The stock market at least seems to have made an early judgement, as Maoxian has pointed out at his excellent blog, where he compares year-over-year changes in Chinese property prices (not yet updated to include the March 2010 11.7% rise) with an index of Chinese real estate stocks.
In the meantime, China should should show it is still a socialist country and build more affordable housing, as an article in Xinhua yesterday suggests: China to boost low-income housing building: housing authorities. UPDATE3: The government announced more measures Saturday, detailed here, that contributed to a 4% drop in the Shanghai stock market Monday.
I assume Jim Chanos must be hoping the government will be unable to rein in a potential bubble in time to ward off a full-scale crash.
Please tell me what you think in the comments.
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