Beijing is in the midst of one of the most ambitious makeovers ever attempted by a city anywhere in the world. Walk around just about any neighborhood and you will see multiple cranes towering over the city. Blocks of 30-story buildings are rising seemingly overnight, taking up space once devoted to one- to four-story houses and wiping out alleyways that date back to Imperial days.

Newspapers are full of real estate advertising supplements; billboards around the city boast market developments with grand names such as Park Avenue, Central Park and Upper East Side; kids stand on street corners handing out flyers for the latest development, and mobile phone users are pounded daily with a barrage of short messages from property developers. In many cases, chunks of buildings are sold out before the building is completed.

However, some experts are concerned that the residential property market may be saturated with new properties and that the market is in for a serious correction.

Andy Xie, an independent economist, told the South China Morning Post in April that there was already a nationwide property bubble in China. In some cases, properties in China are more expensive than similar properties in the U.S., he said, adding that he suspects the number of empty apartments is piling up.

Emphasis on the New

An average of 20 million square meters of residential property has come on the market in Beijing over each of the past four years. Approximately 63 million square meters of residential property was under construction in 2006 alone. Yet the huge increases in supply have had little or no impact on the market. Prices in the city shot up 42% over the past three years, and in the first quarter of 2007, investment in property rose 26.9% to RMB 354.4 billion ($46.2 billion). Experts say 40% to 60% of residential purchases are paid for with cash.

The market has been boosted by a booming economy, rising incomes and a dearth of investment channels for cash-heavy Chinese who are hungry for investment vehicles.

Although observers suggest that speculators are involved in this phenomenon, property agents, developers and some economists argue that demand justifies the sharp rise in prices. “At present, the space is rising at a very high level,” says James Hawkey, an executive consultant with Cushman & Wakefield China, a global real estate services firm. “While there’s a lot of supply, there’s also a high level of demand. If there was a real problem, how could 20 million square meters of space sell in Beijing?” he asks. Hawkey plays down reports of high levels of speculation. “Certainly there is some speculation happening; there are a lot of small investors who own a couple of apartments. But I don’t think it’s dominating the market.” He estimates that 5% of the market is in the hands of speculators.

“Many Chinese want to buy if they can afford it,” Hawkey adds. “You have a lot more investors out there than potential renters. Everyone in China wants to be an investor, and no one wants to be a renter.” Nor do they want to buy second-hand apartments. The emphasis is on new.

According to Arthur Kroeber, director of Dragonomics Research & Advisory in Beijing, property prices have been rising rapidly in Beijing, up 10% in April year-on-year, a fact he says “is certainly not consistent with a thesis of oversupply.”

Outstripping Income

But sales have nothing to do with actual occupancy rates. And if apartments are sitting empty, is there anything more than wishful thinking among speculators, and corruption, propping up prices? Yi Xianrong, a researcher at the Institute of Banking and Finance at the Chinese Academy of Social Sciences (CASS), puts the speculation estimate at 18%, adding that many people own two or more apartments. He concedes that no one really knows how many apartments are sold but remain unlived in.

Anecdotal evidence hints at apartments sitting empty. People interviewed in the Central Building District (CBD) in Beijing report that their buildings are one-third to one-half unoccupied.

Furthermore, rents have plummeted in the last decade, an odd phenomenon in the face of record sale prices. An apartment in the bustling Sanlitun area that is home to many expatriates and diplomats went for $5,000 in 1997; it now rents for around $700. And a flood of new buildings in the city means that new units — except at the top end of the luxury market — are no longer able to command high rental prices. Luxury rentals in Beijing have fallen from $50 in the mid-1990s to around $20 today, says Hawkey, which is not consistent with strong demand.

“That’s not a problem because investors are still getting a reasonable return on rents,” according to a real estate analyst in Beijing, noting that while returns on residential property investment have fallen from 20% in the mid-1990s to about 8% today, and could drop another two percentage points, people are still making a return on their investment. He says that with prices rising 10% in 2006, even if an owner left his apartment empty, he is still chalking up a decent increase in the value of his property.

Another problem is that price rises have basically outstripped the rise in incomes, making it difficult for the average person in China to afford his or her own place. According to conventional wisdom, a property should not exceed three to six times the annual disposable income of a purchaser, but the average property price in Beijing is almost 10 times disposable incomes. The average disposable income for a family in Beijing was RMB 51,193 ($6,700) in 2005, with the average price of even a lower-end residence at RMB 480,000 ($62,600).

“People can’t afford to buy a home,” says Yi, who has become a champion of average citizens keen to purchase their own property. “The prices are so high, how could they?”

Kroeber argues that there is a “big oversupply problem” at the high end of the market. “This appears to be the most profitable sector and it’s clearly running ahead of demand,” he says. Luxury rents in Beijing started to slide in the first quarter of 2007, falling 1.9% to $18.35 per month, compared to the fourth quarter of 2006, according to a report by Cushman & Wakefield. Meanwhile, the average vacancy rate in the luxury sector for the same period increased to 21.96%, which the company attributed to new supply coming into the market, while the vacancy rate for the mid-market declined only slightly to 16.52%.

According to Yi, property price rises are not connected to real supply and demand, and prices are manipulated by developers, some of whom collude with corrupt officials to obtain prime real estate in the city. The economist has been warning Chinese not to race to buy homes as prices are artificially high. “As long as the prices keep rising, investment will continue to pour into the real estate market,” says Yi, who notes that developers have no idea about actual market demand. “They only care about how much land there is.”

In hopes of controlling the overheated property market, the Chinese government had taken some measures, including a tax on resales made within two years of purchase of a property and restrictions on foreign organizations and individuals purchasing residential properties. However, these measures -– both passed in 2006 — seem to have had only a slight effect on the market.

Pan Shiyi, a real estate tycoon in China who has several large real estate projects in key areas of the CBD, said to a local media several months ago that government measures in 2006 had some repercussions for the high end of the market, but he dismissed any possibility of a downturn in prices. “I think even in the worst scenario, there will be no drops in price or transaction volume in the near term,” he said in a press report. Pan cited continued economic growth and a shortage of land in urban areas as reasons for his confidence in the market.


Concerned Policy Makers

Despite optimism within the industry, China’s continued strong economic growth has led to fears in the market that the government will adopt more tightening measures to cool off the overheating economy, and that higher interest rates could slow property prices and deflate the property bubble. Some Chinese economists predict that property prices in major cities, such as Beijing, Shanghai and Guangzhou, will slow to single digits within the next two years.

A report earlier this year by CASS urged the government to keep interest rates high to cool down the real estate sector in order to avoid a crisis similar to the one Japan suffered in the 1990s, when rising real estate prices resulted in a huge property bubble. The report said there were “amazing similarities” between the two situations.

The People’s Bank of China last December warned of possible dangers resulting from fluctuations in the real estate sector, the first such warning to come from the central bank. In its Financial Stability Report 2006, the bank said any major price drops in the sector will devalue the mortgages in the hands of banks, which will eventually lead to further drops in housing prices. Some 15% of total bank lending is for housing loans.

In March this year, China’s Minister of Construction warned that the country’s real estate industry has become “a hotbed for power-for-money deals,” according to the state-run Xinhua News Agency. “The industry suffers institutional loopholes in preventing and combating corruption, especially the collusion between government officials and businesses,” the agency quoted Wang Guangtao as saying at a conference on building a clean and honest government.

Xinhua said that the ministry will investigate “power-for-money” deals this year and watch for malpractice in property transactions and real estate developments. It will also audit real estate developers and inspect all property projects under construction to make sure all government officials involved in illegal deals are punished in accordance with the law.

In addition, the government will investigate the availability of vacant land and push real estate developers to speed up construction and increase housing supplies for low to moderate income buyers. Whether the government will succeed is open to question. Developers are mainly interested in the more profitable high end market, and this may explain why developers have been sitting on land.

Correction Expected

Construction is also slowing down. Completed construction of residential properties jumped from 21 million in 2003 to 28 million in 2005, before then slowing to 22 million last year, a drop of around 21% from the pervious year.

“Maria Shao, a Beijing property agent with many years of experience, says it’s gotten much more difficult to sell expensive properties that costs more than RMB 20,000 ($2,600) per squre meter.

Analysts generally agree that prices will slow initially over the next year or two, but express confidence they will rise again. Hawkey says his company se