China’s property market has been a hot topic in public debate recently, from grassroots discussions to online chat forums. Even government-backed media, including Xinhua News Agency and the China Central People’s Broadcasting Station, have not been shy about sharply criticizing corrupt property market practices and local governments’ over-reliance on land auction revenue.
The sizzling market has pushed regulators at the Ministry of Land and Resources (MLR) into the spotlight over the past few weeks as it crafts new reforms aimed at addressing the situation. The MLR issued a new rule on March 8th to increase the supply and strengthen the management of land used for real estate sales, and says it also wants to increase the threshold for developers to acquire land while making the expansion of low-end supply mandatory.
Then on March 29th came the discussion on implementation of Regulation 39, which had been issued back in 2007 to contain soaring property markets by tightening the monitoring of land auctions called on by MLR. Meanwhile, the Bureau of Land and Resources in Beijing and Shanghai, the country's two biggest cities, are considering a review of the land auction system to include selection criteria other than price.
Auction bidders – mostly rich, state-owned enterprises (SOEs) with access to cheap financing that are considered the driving force behind rising land prices — are trying to absolve themselves of any responsibility for the growing concern about a real estate bubble. Yet on March 18th, the Assets Supervision and Administration Commission of the State Council, the top watchdog of the country’s big central SOEs, announced the surprise news that 78 SOEs needed to step out of the market because their main business focus weren't in property, leaving only 16 real estate SOEs.
China Knowledge at Wharton recently spoke with Wang Kai, a legal scholar visiting the Penn Law School, about her views on the repercussions of this flurry of activity , and whether it's enough to prevent China's property bubble from popping.
The following are edited extracts of the interview.
China Knowledge at Wharton: How did you get involved in your academic focus on property?
Wang Kai: I obtained a juris doctor degree from the University of Hawaii. After graduating in 1999, I took a job with the largest local law firm at the time Carlsmith Ball, and was made partner, with a focus on real property and commercial land use law. I also have an LL.M. degree from Harvard Law School.
Hawaii is a naturally beautiful place and is a famous tourist destination. Because of this, the state has numerous shopping malls and golf courses, which have led to probably the most advanced commercial property law system governing zoning and land use.
I left the law firm and returned to China in 2008 to join an international law firm, lured by the country’s amazing development.
China Knowledge at Wharton: Some experts say China's property market is full of contradictions today. On the one hand, China’s economic recovery is weak enough that it is depending on the housing market. On the other, housing prices continue to soar while the risk of an asset bubble grows, which leaves the Chinese government in an awkward dilemma. Would you agree with this argument?
Wang: I would have to say yes and no. I agree with the contradictions. It’s absolutely true that China’s property market is one pillar of the national economy, and there is definitely a property bubble. But I disagree with [some points], which I’ll come back to in a minute.
The Chinese housing market is a major contributor to the nation’s economy. Data show that the average annual growth rate for the entire industry has been roughly 37.8% since the 1990s. Property contributes to a major portion of overall fixed-asset investment as well, at around 20%. From 2007 to 2008, investments in property development increased over 20%.
The growth rate of China’s GDP in 2009 was 8.7%, with over 2% of that directly attributed to the property market. There are over 60 industries related to property, from the upstream sectors including steel, concrete and chemicals to downstream sectors, such as interior decorating and household appliances.
There is a term called "impact factor" in China, which illustrates the impact of the property market on others sectors. The estimated number is 1.7, which means that if you spend RMB 100 on commercial housing, you’ll spend about RMB 170 on related products. From this point of view, the Chinese government is wise enough to know that if you are going to stimulate the economy as it did during the financial crisis, you can start with the housing market.
China Knowledge at Wharton: What is the definition of a bubble? And is there one now in China?
Wang: I definitely think there is a bubble, but a more important question is whether it will pop. There are many standards by which these bubbles are defined. The United Nations uses the proportion of incomes to property prices to measure housing bubbles. Normally, for housing, a bubble appears when prices are triple that of the average annual income. In terms of commercial real estate, there is a bubble if retail income and property prices reach a certain imbalance.
The Chinese government invested over US$580 billion to resuscitate the economy after the financial crash of 2008. [Such a large rescue package sent asset prices through the roof,] while a looser monetary policy has smoothed the way for bank loans. Some local governments took out huge loans, which they never considered repaying. Today, housing prices have skyrocketed, and many are forecasting a similar fate for China as that of Japan when its bubble burst [in 1989 and house prices fell as much as 80%].
But I doubt this bubble will pop. First, China’s mass migration to urban centers since 1978 has been unprecedented, and these migrants need housing. Second, owning land is incredibly important to most Chinese. Third, many parents use all their savings to buy a house for young newlywed children. Fourth, many Chinese families save huge amounts [with the sole aim of] buying property. So there is a capacity and strong demand for getting a house.
On top of that, there are only two channels for individual investment in China: Real estate and stocks. If the stock market is too unpredictable and the housing market is continuing to grow, lots of people put their cash in housing.
Property is a strong pillar of China’s economy, and there is indeed an asset bubble. I am not sure the bubble will burst. It will depend on the strength and effectiveness of government regulation.
China Knowledge at Wharton: In what way don't you agree with other experts about the bubble?
Wang: I don’t agree with the belief that the Chinese government is in an awkward dilemma. We need to look back at history. Deng Xiaoping started the country’s reform by testing new policies and the Chinese government is good at experimenting with policies to make things change.
In the housing market, it’s not just one set of buyers and sellers. For buyers, there are three levels. First, first-time homebuyers are looking for a place to live. This basic demand is viewed as being very important for a stable society. Second, some will upgrade their property when they earn more money. This is called improved demand. Third, foreign capital or high-income people will invest in housing. The government has been launching different measures for different buyers. They encourage the first kind, protect the second and control the third. My view is that the policies are reasonable at the moment and I am pretty confident about China’s regulatory wisdom.
China Knowledge at Wharton: As a lawyer who represents foreign investors entering the Chinese housing market, are there any areas in which they should do more homework?
Wang: Normally, foreign investors spend a lot of money on lawyers or consultants to pave their way into China, but still, even for me — a native Chinese person, who studied and practiced law in the U.S. for nearly two decades, the main challenge has been culture shock.
Take transparency. The Chinese housing market is not too transparent. Recently, property consulting firm Jones Lang LaSalle published a market transparency survey, which ranked China 49th out of 82 markets. So what are the major weaknesses in China? The first thing is the absence of data. In a real estate transaction, the price is the most important thing. But there is not much accounting information. Even if it is available from, say, official sources like the statistics authorities, there's a question mark as to whether it is reliable.
Second is the inconsistent legal system. I graduated from a law school in China [Yantai University] in 1993 and there have been many new laws issued since. I believe China made many promises before entering the World Trade Organization to improve the investment environment, however, there are many issues that remain unresolved. Our discussion can focus on two angles, time and geography.
In terms of time, different authorities across different levels have issued different rules, opinions and notices regarding property investment and on foreign investment since the 1970s. In terms of geography, legal systems are inconsistent from one region to the next.
Also, buyers and sellers are different in China than in the U.S., which is related to the Chinese bidding system, which is run by the public rather than the private sector. There is now a composite index in China assessing buyers, including their trading record, financial viability and management experience.
China Knowledge at Wharton: Are there any challenges in terms of due diligence?
Wang: China doesn’t allow foreign law firms to practice law in China. For example, they are not allowed to issue things like opinion letters [to approve an investment legally]. So foreign firms need to collaborate with local law firms on due diligence, which means as a client, you need to hire two teams, and pay double the bills.
Even checking a title certificate in China can be a challenge. Although a law issued in 2007 is said to have established a consistent system, things haven’t changed much. In one case I handled, I eventually found the seller had no legal right to the first floor of the building, which made the deal fall through.
China Knowledge at Wharton: Where do you think the housing market will go this year?
Wang: I don’t think the property market will experience drastic changes this year.
Investment will keep growing this year. The reasons are multiple. First, the loose monetary policy will continue, although the reserve ratio for banks has been increased a little recently. Second, in the past two years, developers have been building houses and the projects are still on-going. Third, a big part of China’s stimulus package is focused on infrastructure, including railways, subways and housing for low-income households, which will keep fuelling investment.
Statistics show Shanghai’s housing transactions fell 57% between January and February. The Chinese New Year holiday week in February might have been one of the reasons, but another reason was that developers preferred to hold back their investments in the hope of better opportunities later.
Current data show that housing prices are still increasing. Housing prices in Shanghai and Beijing have hit new highs. The price of new property sales rose 13% over the same period last year and prices for existing housing rose about 10%. Obviously, prices will keep rising.
China Knowledge at Wharton: There is a lot of talk about a new property tax to curb the market. What’s your view on that?
Wang: At the end of last year, when the market was already over-heating, China reinstated its property sales tax, after keeping it on hold for the past years. This means the government will collect a tax if you sell a property within five years of purchasing it. Some places are testing levying property taxes. In the meantime, China has issued a lot of new polices in land auction reform. The key for China’s regulatory strategy in 2010 is to stabilize the property market.
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