Twenty years ago, China had no real estate market to speak of. Change began when the government ordered state-owned companies to privatize the housing that had been part of the cradle-to-grave benefits they provided their urban employees. In some cases, their employees were given a shot at buying old apartments; in others, companies distributed newly built housing units to staff — all at heavily subsidized prices. Either way, much of that housing has since been sold as the new property owners sought upgrades, both for themselves and their children. Those property owners are among the lucky ones.

Since then, the property boom across China's major cities has locked out many young locals and newly arrived urban migrants, shining a spotlight on the growing income inequality within the country and leaving millions in a bind. In Shanghai, for example, the average purchase price for an upper-tier apartment is RMB 47,465 (US$7,345) per square meter and RMB 22,665 per square meter for a mid-tier apartment, up 110% and 100%, respectively, from five years ago, according to property consultants Cushman & Wakefield Shanghai. "When prices are over 20 times more than annual household income, it's not affordable," says Andy Xie, an independent economist in Shanghai.

So as China grapples with high inflation and skyrocketing property prices, the country is also trying to address its politically sensitive public housing issue. As part of what's been dubbed China's "new deal" program aimed at tackling social inequality and assisting the country's 218 million urban households, the central government has ordered local governments to build 36 million units of "affordable housing" by 2015.But it will be a stretch.

“The 36 million units target is quite ambitious because they are already behind schedule,” says James Macdonald, the Shanghai-based head of research at Savills China, a U.K. property agency. Hefty building costs and the lack of incentives for local governments and developers to be involved in the projects are just some of the hurdles of meeting Beijing’s ambitious construction schedule. And even if the units do get built, there is still much debate about how and to whom they are distributed under the shadow of rampant corruption in many parts of the country.

Locked Out

Doing nothing isn't an option, either. A new paper about China's housing market published for the National University of Singapore's East Asian Institute (EAI) cites a survey by search engine Sohu in late May in which nearly 90% of respondents said the government's new deal is failing to live up to expectations. Patience is wearing thin.

Already back in late 2009, another survey, by the Chinese Academy of Social Science, a government think tank, found about 85% of urban respondents saying they couldn't afford to buy a new flat, even with mortgages. The problem is just as severe today, according to the report's co-authors — Lu Ding, an economics professor at University of the Fraser Valley in Canada and EAI visiting senior research fellow, and Huang Yanjie, an EAI research assistant. They point out that in the country's metropolitan centers today, house prices per square meter generally amount to between 50% and 100% of average annual incomes. "To secure a flat of 90 square meters, an average working family in Beijing and Shanghai will have to work for more than 50 years to pay off their loans, compared to five to 10 years in the developed world," their paper notes.

Renting isn't necessarily any easier, say other experts. In Shanghai, the average monthly rent for an upper-tier apartment is RMB 148 per square meter and RMB 80 per square meter for a mid-tier apartment, up 20% and 18%, respectively, from five years ago, according to Cushman & Wakefield Shanghai.”

As a result, "sky-high housing prices have undermined housing affordability and caused great anxiety and resentment among the public, who are wary of the conspiracy among 'speculators' — developers and government officials in charge of real estate businesses," according to Lu and Huang.

Been There, Done That

The government has tried to address the problem before, but perhaps without the same sense of urgency as today. A paper written in 2009 by urban planning professors at University of Michigan for the U.S. Department of Housing and Urban Development described a decentralized affordable housing program in China similar to the one today, involving a combination of rental subsidies and new developmentsand requiring the proactive participation of local governments and developers. But with no enforcement mechanisms in place, it failed to gain traction. Between 1998 and 2006, only about 550,000 low-income households benefited from cheap rental and other social housing programs, producing "about 1% of the total housing units built" during that period, according to the paper.

This time around, the program is part of a bigger plan to cool off China's hot market. Over recent months, Beijing has rolled out new taxes and anti-speculative policies, such as raising down payment levels, increasing mortgage rates and limiting the number of homes a single investor can buy. China began accelerating construction of public housing units in 2008 and intends to build, or renovate, 10 million units this year. By 2015, if the government meets its target of 36 million units, social housing will be available for 20% of urban households, compared with about 7% today.

The trouble with public housing initiatives, however, often boils down to money. Despite their addiction to commercial real estate and showcase public facilities, for example, China's local governments contend they lack the means to finance social housing projects. With local government debt estimated at over RMB 14 trillion ever since China’s big splurge on recession-fighting construction in 2008, local finances are indeed strained. “No other government in the world would spend that kind of money," says Xie. "If you go to local [Chinese] cities, you will see what they spent [that money on]: Tens of millions on just trees, parks and government buildings.”

But there's a deeper cause to the problem than meets the eye. As "both a prime benefactor and beneficiary of the housing price boom," local governments are in a bind, according to Lu and Huang of the EAI. Given their own heavy investments in real estate, local governments are loathe to do anything to hurt the commercial market, particularly since as much as half of the cities' revenues comes from land sales and property taxes. There's also concern that once they do allocate land for social housing, property prices in their surrounding neighborhoods could also take a hit.

Those arguments don't wash with some experts. “In booming cities, localgovernment should never use a lack of funds as an excuse because they can always generate additional funding [through different zoning regulations] and revenues from land sales," says David Smith, founder of the Affordable Housing Institute (AHI), a Boston-based non-profit research and consulting organization. “Local governments can make tons of money on development of the market-rate housing, and so for local governments to be crying poverty is not persuasive.”

The Ministry of Housing and Urban-Rural Development (MoHURD) estimates that building 10 million units of social housing this year will cost between RMB 1.3 trillion and RMB 1.4 trillion. The central government allocated only RMB 103 billion for it in the 2011 state budget. Estimates of the amount of local government funding required range from RMB 100 billion to RMB 800 billion. One way to make up the shortfall is for local governments to issue bonds, says Tao Wang, head of China research at UBS Securities in Beijing.

Financing can also come from housing funds set up by companies and other institutions,which urban employees are generally required to contribute to as part of their social benefits packages. While companies — state-owned or private — are no longer involved in social housing since the reforms of the 1990s, these funds are run on a city-by-city basis, with employeesand employers paying varying rates into them and then drawing down fundswhen they buy a house. MoHURD said recently that any increase in these funds’net revenue should go to public housing construction. In 2010, that net revenue increase was RMB 5 billion.

Wooing Developers

Most property developers — state-owned or private — are also reluctant to be involved in social housing, a public good with low profit margins, says Wang. Only 30 out of 100 developers participated in affordable housing projects between 2007 and 2010, according to a June report on the corporate social responsibility activities of China's real estate companies by MoHURD in June.

But they may be persuaded to move in that direction if they can get easier access to credit and land, Wang notes. Given today's tightening credit and government curbs, ratings agency Standard & Poor's cut its outlook for China's developers — which include Greentown China Holdings, China Resources Land and China Overseas Land & Investment — to negative in June. Critically, developers that help local authorities by building affordable housing might be enticed by the promise of a better chance at gaining permission to build on land for future commercial residential projects. And construction companies, unlike developers, are keen on the business the social housing projects will bring. “The projects do not have to rely excessively on developers,” she says. 

So far, the mammoth municipality of Chongqing, a hilly industrial center perched above the upper stretches of the Yangtze River with a population of 28 million, has led the push toward affordable housing. Spurring that along is Bo Xilai, Chongqing’s charismatic Communist Party secretary and former commerce minister, who has sought to burnish his public service credentials through such initiatives, with an eye to an eventual top leadership position in Beijing.

Market conditions in Chongqing also are relatively favorable, with residential prices averaging RMB 30,000 per square meter, or less than one-third that of prime property in Shanghai, says Macdonald of Savills. Aiming to reach 2.4 million residents eventually, Chongqing’s program focuses on public rental housing and is restricted to individual applicants with monthly incomes of RMB 2,000 or less or family applicants with monthly incomes of RMB 3,000 or less, says Chen Jie, director of housing policy studies at Fudan University's School of Management in Shanghai.

As in other cities, previous housing schemes in Chongqing that enabled applicants to buy apartments at a discount to market prices were often abused. “BMWs were regularly seen parked outside [social housing complexes], suggesting the well-connected were getting preferential access," says Stephen Green, China economist and head of Greater China research at Standard Chartered Bank. "So Chongqing is focusing solely on public rental housing,” where occupants pay below-market rents. “The beauty of public rental housing is that occupants will rent first and after three years, they will be allowed to buy at a price that covers the construction and financing costs,” he noted in a research report titled, “Chongqing’s 2.4 Million New Renters.”

Huang Qifan, Chongqing's mayor, has estimated that land comprises only one-third the cost of commercially sold apartments, so units under the city's scheme should cost their buyers less than half the market price, according to the report. Chongqing's government claims to have built about 260,000 units of between 40 square meters and 60 square meters each, or about 13 million square meters, and intends to complete an additional 13.5 million square meters of affordable rental housing this year, and the same next year.

While experts generally applaud the design of the program, it's too soon to say whether it’s a model others should replicate. Chen also says the municipality could be taking on a worrisome level of debt — Chongqing and the central government are covering about 30% of the program’s costs, with the rest paid for with bank loans.

Downriver in Shanghai, authorities are planning to increase their focus on “economic use housing” (EUH) — that is, homes that are sold, rather than rented, at below-market prices. According to officials, EUH will comprise 40% of its overall affordable housing program in the next five years, with the remainder involving various rental schemes.

But there is a mismatch between the type of units the program is providing and what low-income locals need. With units selling for as much as RMB 8,000 per square meter and with the average apartment being 60 square meters, "it is too expensive for lower income families,” Chen says. “Many of the people who qualified for the economic use housing gave up their applications because it is too expensive for them.”

To attract more applicants, Shanghai's government has raised the monthly income threshold for the program, to RMB 3,300 for individuals or RMB 10,000 for families. But Chen says Shanghai's authorities are fudging some of the figures by including housing that's provided as compensation for tenants affected by commercial redevelopment projects, who are not necessarily low income. So far, the city has allocated 10% of its planned public housing to cheap rentals, which is far less than needed, he adds.

Carrots and Sticks

Once cities get past the debate of who pays for and builds the housing, the next difficulty is over who qualifies for it. “It is meant to solve the housing situation of the relatively poor. So the criteria should mainly be household income,” says Wang of UBS. But deterring abuse by government officials and the well-connected is hard.

In one notorious case reported last year, in the industrial town Xinzhou in central China’s Shanxi coal belt, a new complex of smart apartments called Century Garden was on the local government’s list of designated social housing.Almost all 1,578 apartments were reserved for local officials, some of whom quickly resold the apartments at considerable profit before construction was completed, says Smith of the AHI, who has been providing affordable housing advice around the world for more than 35 years. Experts reckon the Xinzhou case isjust thetip of the iceberg.

“Government officials divide the profit [of such projects] among themselves," says Xie. "If they do a project for the common people, the buildings often will be poorly built in the middle of nowhere because they do not care about the common people."

As with social housing everywhere else in the world, location and quality are big issues in China, observes Macdonald. With urban social housing developments, “you will always have poor locations, where commuting times are significantly long because the government and developers do not want to [use] prime residential locations for affordable housing that won’t make them much money,” he says.

In Shanghai, all such housing is built in its outskirts, in places like Baoshan, Songjiang and Nanhui. “We had economic housing in Shenzhen and Shanghai before, but people do not want to stay there because the apartments are so far away,” says Xie.

Will the government meet its targets? Green expects it to attain between 60% and 80% of the total 36 million planned for the next five years. In early June, the housing ministry ordered local governments to begin construction of social housing by November at the latest, pushing the deadline back by a month. By the end of May, work had begun on only 30% of this year’s planned 10 million units, according to Xinhua News Agency. 

Regardless of the reservations and hidden agendas of local officials and developers, experts say the central government will do what it can to ensure progress is made, not least because of growing concerns over social unrest as income inequality increases. Smith calls it a hot button issue. “You could get very substantial domestic unrest," he says. "Food and housing are two things that make ordinary people really angry."

There's another factor compelling the government to act, saysMacdonald. By taking care of low-income households, China may benefit the commercial real estate sector. “If you have enough social housing in the market, low-income citizens will have houses. That will allow the commercial residential market to continue to appreciate, because the low-income stratum is taken care of,” he says.