In some Chinese cities, whole neighborhoods can seem to change beyond recognition almost overnight thanks to the rapid rate of construction. Now, China’s entire property market appears to be undergoing rapid transformation.


In 2008, a domestic economic slowdown in China preceded the impact of the financial crisis, as the government took steps to cool the economy. Property prices began to tumble in December in year-on-year terms, on the back of monetary tightening and other measures. This year has seen a dramatic turnaround.


While housing sales in many parts of the world remain lethargic, sales volumes in China have rebounded strongly: Growth in floor space sold rose 39% year on year in April, up from almost zero growth in December of last year. The pace of sales in some cities has been frenetic. In Guangzhou, first-hand residential transactions rose 108.2% in April over year-earlier figures. In Shanghai, meanwhile, overall sales rose 65.5% in April, which included a growth of 77.8% in residential sales. While the average price of housing in 70 major cities continued to fall by 1.1% year on year in April, it increased 0.4% over March.


Developers, who last year struggled under a tight monetary regime have seen their prospects improve dramatically as that policy has loosened up. Just as the government engineered the slowdown last year, the newest government policies are driving the current reversal. Once it became obvious that China’s exports would face weakening demand from the U.S. and Europe, the government introduced policies (since the end of 2008) designed to stimulate the economy. The government introduced a range of specific measures to breathe life back into real estate markets, particularly at the low-middle end.


Is the revival for real, though? Rebounding transaction volumes have been dismissed by some economists as mere bottom fishing, as buyers pick up bargains. Many analysts initially attributed swollen sales figures to the release of pent up demand by buyers who avoided the market while confidence was low. Housing in China remains relatively unaffordable, they say. During 2003-2008, housing prices were eight to nine times incomes, according to a Morgan Stanley report; the international norm ranges from a multiple of three to six.


These arguments have looked weaker as the recovery has gained strength. True, the recovery could be bumpy, particularly in first-tier cities. But the government’s strong policy commitment to the sector, which has improved property developers’ positions and contributed to greater affordability, in concert with other drivers, make it increasingly likely that the recovery will be sustainable.


Strong Policy Support


The strength of policy support for the property sector reflects its crucial role in the Chinese economy, and hopes for a broader recovery. Real estate attracts one quarter of China’s fixed-asset investment. Given the sector’s long supply chain, ripples from a property recovery will permeate the economy. Property construction consumes half of the steel used in China, for instance, as UBS’s China economist Wang Tao observed in a recent research note. A rebound in the lackluster demand for steel, as well as other construction materials, therefore, partly depends on a warm-up in building construction.


A buoyant property market also supports private consumption. Property-related sales of items like furniture and decoration materials, an important constituent of overall retail sales, have rebounded strongly following the recovery in property sales, note Morgan Stanley economists Wang Qing and Steven Zhang.


Moreover, local governments and the private sector are expected to cough up 70% of the four trillion Yuan stimulus plan. While this will be supported by the credit tidal wave that has been unleashed in recent months, much of the capital local governments are pouring into infrastructure spending, which is the main focus of the stimulus, comes from land sales, as Jing Ulrich, head of China equities at JP Morgan, has pointed out. Land sales recently have been sluggish, and they depend in turn on a recovery in end-user property markets.


All of this explains the government’s continued strong support for the sector. On the demand side, the government has taken additional measures, most notably lowering down payment thresholds, discounting mortgage rates, and cutting taxes. And on May 27 the state council cut the minimum capital requirement for “ordinary” residential developments (in contrast with luxury buildings, although the precise definition varies greatly by locality) from 35% of the total project cost to 20%.


Developing Recovery


This has helped turn around what, for property developers, was a dire situation in 2008. In the wake of government efforts to cool the economy, lending to property developers grew 28% year on year in December 2007, but fell to around 7% a year later, according to Morgan Stanley economists Wang Qing and Steven Zhang. It has since rebounded.


Whether developers will begin building more properties for consumers to buy, however, will partly depend on their stock of already completed buildings. Here, there is some room for optimism. Nationwide, Wang and Zhang believe the number of vacant buildings has stopped growing, while at the same time sales have picked up. Even in major cities inventory has begun to decline fairly quickly, they say. This leads them to conclude that developers will eventually start putting up more buildings.


“As inventory stops rising and even starts to decline, the significant pick-up in sales will eventually translate into a significant recovery in new projects launched,” say Morgan Stanley’s Wang and Zhang. Since it typically takes around six months for new projects started to respond to sales, the current contraction in floor space started will begin to be reversed in the second half of this year.


In the meantime, developers have responded to increasing sales volumes by raising prices. By mid-May there were reports that some developers in Shanghai were hiking prices by as much as 30%, while the local subsidiary of Vanke, China’s top ranking real estate developer, reached its May sales target on May 20. This led it to delay the opening of two new projects, with an eye towards raising prices by 10-15% more than previously budgeted, according to JLM Pacific Epoch, a research firm.


Affordability and Sustainability


But will consumers pay these higher prices? Increasingly, the answer seems to be, “Yes,” albeit with regional variations.


For one thing, the psychology of demand may also have been altered by the strong support for developers. Cash flow difficulties led developers to slash prices in order to kick start sales. This, Wang and Zhang argue, contributed to the “buyers’ strike” that lasted most of last year: Potential buyers expected that developers’ financing problems would persist, and held out for lower prices. But as financial pressures on developers have eased since October last year, downward pressure on prices has also been relieved, Morgan Stanley’s analysts argue. Expectations of further price cuts have waned, and the “buyers’ strike” has fizzled.


At the same time, looser monetary policy tends to push up asset prices. Tony Young, senior analyst at Greenwoods Asset Management, a Hong Kong-based investment firm, argues that the real estate market is largely being driven by relaxed monetary policy, which has set in play an inflationary cycle. Loan growth has been phenomenal in recent months: By the end of April, credit had already exceeded the government’s five trillion Yuan target for the year as a whole. Given the flood of liquidity hitting the economy, Young and other analysts think that economically literate denizens of first-tier cities such as Beijing will invest in real estate as a hedge against inflation.


Aside from those who are buying primarily for investment purposes, general consumers also appear better able to afford higher prices. Morgan Stanley estimates that while average prices per square meter for residential property remained broadly unaltered last year, urban incomes increased about 14%. This large increase in affordability contrasts to the period between 2003 and 2007, when affordability remained roughly stable.


As recent sales strengthen with the help of government policies, it nevertheless appears that in top-tier cities supply and demand are to be poorly matched. Presenting a study of China’s property markets in Shanghai recently, Alicia Garcia Herrero, chief emerging markets economist, and Li-Gang Liu, chief China economist at BBVA, a Spanish bank, argued that markets in Beijing, Shanghai and Shenzhen are overvalued by 16%, 18% and 20%, respectively, while some second-tier cities such as Chongqing and Tianjin, also exhibit exaggerated prices of 20% to 25% above what the fundamentals alone would support.


Near-term price adjustments, therefore, look unavoidable given the current economic downturn and oversupply in high-end residential housing, they say. While the landscape looks very different depending on province and city, first-tier cities, where much luxury housing is concentrated, could see drops of up to 20%, concludes the report, BBVA China Real Estate Watch, published in May.


Even so, the authors stress that this does not reflect the overall market. “At the national level, China’s growth in GDP per capita is twice as fast as that in property growth. Meanwhile, housing appears to be quite affordable based on the price-to-disposable income ratio, even by international standards.”


Government measures have played an important part in bringing property within the reach of more potential buyers, even in first-tier cities. Michael Klibaner, Jones Lang LaSalle’s head of research for Shanghai, showed in a recent report how government measures have improved affordability. For middle income earners in Shanghai, the monthly housing loan burden (which is made up by public housing fund borrowing and commercial mortgage borrowing) was lightened from 56% of disposable income in February 2008 to 42% a year later, he explained. Down payments fell from 4.5 years of disposable income in 2008 to 2.6 years. At the same time, house prices stagnated in the city last year while incomes rose, he wrote in the Jones Lang LaSalle publication On Point.


This suggests that, in addition to those who are coming into the market after staying away while confidence was weak, the recovery has also been fuelled by a pool of people who could not previously afford to buy (although prospects are less bright in the luxury end). The upshot, Klibaner told China Knowledge at Wharton, is a broader base of demand that will lead to a more sustainable recovery.


Risks Remain


Despite the increasingly positive signs for China’s real estate market overall, even optimists acknowledge some risks.


For one thing, analysts distrust inventory figures, making it difficult to get a clear picture. The amount of floor space completed in 2008 looked strangely low to some observers, fuelling suspicion that developers, under intense financial pressure last year, understated completion levels in order to avoid paying fees on inventory. This could imply that the sharp acceleration in floor space completed (which by April had reached 28%) is due to developers belatedly reporting completions, which in turn suggest that the current surge in reported completions is set to moderate.


Meantime, though in April land purchases showed their first expansion since June last year, new building starts, a better indicator of future activity, remain negative.


“The completion of projects has risen significantly, and is expected to remain very strong this year, thanks to the property construction boom in 2007 and early 2008,” writes UBS’s Wang Tao. “If completion continues to outpace sales of new constructed property, then the accumulation of inventory could put downward pressure on prices again. Moreover, we still see a serious mismatch between oversupply in the high end and significant demand in the middle market segment at the national level.”


This leads her to remain cautious about the ultimate sustainability of the current recovery, particularly in prices, but she believes that low end and mass market investment and construction will pick up in the second half of this year, even as weakness persists at the luxury end. “Fundamental demand from the upper middle income urban population is strong,” she writes. “We believe that there is no oversupply at the aggregate level, but one at the high end and in some cities.”


A further area of concern is the impact of the government’s affordable housing program, which has been earmarked 400 billion Yuan out of the 4 trillion Yuan stimulus plan. “There is a risk that the publicly funded housing program may creep into an overly ambitious public housing program,” observe Morgan Stanley’s Wang and Zhang. “It could end up becoming a heavy-handed intervention by the government into the property sector under the pretext of an aggressive implementation of the pro-growth fiscal stimulus plan. This would run the risk of damaging the otherwise market-based, sound, commercial housing sector by crowding out private investment, threatening the sustainability of the property sector as an engine of growth in the long run,” they warn.


Given the property sector’s importance as an engine of growth, though, Wang and Zhang believe concerns are ultimately unwarranted. Others point out that, although the scale of spending looks spectacular, the current affordable housing program is miniscule, so there is plenty of room for growth. <SPAN lang=EN-US style="FONT-SIZE: 10pt; FONT-FAMILY: Verda