Shortly after the sales indices of 70 cities that China’s National Bureau of Statistics regularly publishes showed that residential property prices rose 15% in the 12 months to April, the government announced policy measures designed to cool the overheating. Pundits are now wondering whether real estate prices are about to come crashing down and what will happen to economic growth if they do.


The good news is that the picture might not be as scary as some observers claim. Though some circles are predicting property prices to fall by as much as 30%, others assert that such a steep dip in prices nationwide is by no means a foregone conclusion. Also up for debate is whether significant corrections will be confined to major cities, like Beijing, which have experienced remarkable housing price inflation, and whether the government’s latest property-tightening measures will have a limited impact on overall economic growth and only on particular sectors, such as construction.


Unwanted Consequences


When China’s government launched a plan to help buoy the property market during the global financial crisis in 2008, many of its measures proved highly successful in staving off dramatic damage — some might say almost too successful. As prices began rising, developers jumped on the bandwagon and construction activity picked up enough to help drive China’s GDP growth, which the World Bank estimates will reach 9.5% this year.


The boom has had unwanted consequences. For example, property markets in various tier-one cities have become bubbly. Average property prices in Beijing in the first three months of the year surged 64% from a year earlier, 39% in Shanghai and more than doubled in Shenzhen, according to UBS.


Even so, the government’s 10 new property measures unveiled in April surprised observers with their forcefulness. Among the most stringent measures, down payments for first-time buyers have been bumped up from 20% to 30% and the minimum down payment for second homes has been raised from between 30% and 40% to 50%. Meanwhile, mortgage rates have been raised. On the supply side, local authorities must now increase the amount of land available for public housing and mass-market residential properties, while accelerating construction projects for these areas.


Action and Reaction


There are signs that the policy push is making an impact. In the first week of May, home sales in 15 major cities reportedly fell nearly 40% in terms of both square feet and number of units sold, causing anxiety among some property developers. Evergrande Real Estate, for instance, anticipates a 15% decline in sales, while property mogul Pan Shiyi of Soho China has been blogging about the possibility of 15% to 20% being lopped off prices this year.


A growing number of analysts are bracing for a steep fall in prices this year, particularly in first-tier cities. Xing Weiwei of China Jianyin predicts a 30% decline in first-tier residential prices this year. One source of concern, according to Yang Qingli of Bocom International, are Beijing’s measures — such as suspending mortgages on third homes and to non-residents (wealthy Chinese not from the capital and government officials often aspire to own properties there) — and he reckons its various austerity measures will be replicated by other cities.


Some predict a dire economy-wide impact. For example, James Chanos, celebrity hedge fund manager and president of short-selling Kynikos Associates, declared in April that China is “on a treadmill to hell,” thanks to the “heroin of property development.”


The financial markets have been notably jumpy since the release of the government’s new measures. Despite soothing words from Premier Wen Jiabao, who pledged on May 15 to avoid any “negative impact” from the policies, the Shanghai Composite Index fell more than 5% two days later, which was followed by further falls and rebounds. By June 4, the index was down by 22%.


The extent to which property prices nationwide will be hit in part depends on whether the provinces fall in behind the national policy. After all, local governments have an incentive to keep prices high given that land sales account on average for at least 20% of local government revenue, according to UBS estimates.


Speaking at a real estate forum in May organized by the Penn Club of Beijing, Patrick Chovanec, a professor at Tsinghua University’s School of Economics and Management, said the government’s actions to weaken prices in first-tier cities will simply push investors to cities outside the first tier. If so, this could undermine the ability of the measures to drain capital from the property market.


“Reports of housing prices dropping quickly need to be interpreted with caution,” says Wang Tao, an economist at UBS. “The increase in low-end housing will naturally pull down average prices of new property sales, and the government has requested that the media focus on the success of the property measures,” she notes. (There are also reports that, on the government’s say-so, sales of luxury units in Beijing — defined as property selling for more than RMB 30,000 (US$4,400) per square meter – are being delayed temporarily, helping to lower the average price of property sold in the city and burnishing the success of the new policies.)


Many economists also say it’s important to be clear about what the government wants to achieve. As Wang puts it, the government’s aim is to “stabilize housing prices by restricting demand while increasing supply,” not to bring down the property sector or overall growth. A drop in property prices and housing starts may appear in the latter half of the year, but UBS does not expect price cuts to run as high as 20% throughout the country. “We do not expect a significant drop in property prices nationwide,” comments Wang.


20/20 Hindsight


What if pundits have been too sanguine? Past experience may be a useful guide. Helen Qiao, a China economist at Goldman Sachs, points out that when, in the spring of 2008, average property prices in Shanghai fell 20% year-on-year and 33% in Shenzhen, foreclosures were low, even among borrowers whose properties were in negative equity. A survey of 150 Shenzhen property owners, whose property values were worth less than their outstanding mortgages, by China Industrial Bank in August 2008 found that only one foreclosed.


Historical comparisons may be instructive in other ways. Morgan Stanley’s chief China economist Wang Qing says when the wider consequences were greater than intended after policies were tightened in 2004 and 2007, the government responded too slowly because of personnel changes in politically appointed posts. That won’t be the case today. “The timing of the current tightening, which started in early 2010, is not affected by political cycle factors and is appropriately early and pre-emptive, and thus less likely to be very harsh, in our view,” he says.


In 2004 and 2007, moreover, policy makers were taking aim at fairly high inflation and strong fixed-asset investment. Today, inflation is relatively modest and investment growth is moderating. Indeed, Wang does not see macro tightening as the main thrust of the new policies. “The primary purpose of these policy measures is to curb speculation and rein in rapid price increases,” which goes in favor of more moderate implementation, he notes.


It is true that, by dint of the higher levels of debt accrued over the past two years, households and the government are more exposed to a property correction, points out Goldman Sachs’s Qiao. However, absolute levels of household and government debt remain low, and asset levels are high.


There’s also the global context to consider. Any tightening in China will hinge on the pace of recovery of the global economy,” Wang of Morgan Stanley observes. In 2007, China’s leaders incorrectly assumed a strong global economy when designing their policies, unlike today. “We all know the global economy is improving but is still weak,” as the Greek crisis shows. “The Chinese government is unlikely to make such a low-level mistake in messing up the economy as seems to be feared by the market,” he concludes.


A Tale of Two Policies


Looking beyond short-term dynamics, most analysts see strong long-term prospects for China’s real estate. Among the reasons why: Urbanization, demand for upgrading old housing, wealth accumulation and fewer households with different generations living together. However, the pervasive concern is that a housing bubble could still have negative consequences, highlighting the importance of several new policies, including proposals to begin taxing residential properties.


Tsinghua’s Chovanec cites one local trend that a new property tax might address: “What you see in the residential sector is people using empty residential units as a store of value, like gold,” he says. And like gold, real estate does not produce anything, but in China it is a place where you can “stash your cash,” as he puts it. “People are buying multiple residential units as a form of savings…. They don’t intend to live in them; they don’t even intend to rent them out.”


China’s limited investment options is one reason why buying property is so popular, says Chovanec, and while investors have learned in recent times that the stock market does not inevitably move upwards, few have experienced a sustained downturn in real estate since private ownership of property became common in the early 1990s. New mortgage restrictions will do little to discourage individuals with ready access to funds to buy properties for investment purposes, and instead will hurt people who need loans to buy houses they will actually live in, Chovanec reckons. Meanwhile, a property tax is also seen as a way to wean local governments off land sales as a revenue source.


The idea of a tax appears to be gaining ground among policy makers. In the most recent move, at the end of May the State Council said it would gradually “push forward” property tax reform.


However, it is unclear what form a residential property tax might take. Local press have been reporting rumors and counter-rumors, with suggestions that the government is considering on the one hand a U.S.-style tax based on a property’s market value and on the other a tax modelled on the existing commercial property tax, which is based on the original price at which property was bought.


Local governments are reported to be considering property taxes of their own. Shanghai has been widely tipped to be the first to do so, but other reports suggest that Wuhan will be running a pilot, though it would only apply to state-owned property. Others have cast doubt on whether local governments can levy a tax before a central government reform is introduced. Only one thing looks relatively sure: The nationwide roll-out of a property tax is a long way off given the need to build up a large network of property assessors.


The policy that could be implemented sooner involves developing more and cheaper public housing. Among its aims, the new policy would help low-income residents purchase property. Apart from easing the housing difficulties for low-income Chinese, it could also help offset a decline in construction at the luxury end.


It is thought that previous attempts to spur public housing have failed in part because local authorities and developers collude to build lucrative high-end developments. In 2008, low-income housing’s share of total floor space sold fell from 10% in 2004 to 6.1%, according to UBS. To counter the decline, the government set a target last year to provide 3.1 million public housing units, or 11% of commodity housing starts and 12% of total sales for the year. However, only two-thirds of these were made available to residents and not all were newly built, says UBS.  

In 2010, the target for constructing new public housing has been set at three million units. As with the government’s other new measures, hitting that target will depend to a significant degree on the willingness of the regions to fall into line.