Wharton real estate professor Joseph Gyourko collaborated with colleagues at the National University of Singapore (NUS) and Tsinghua University in China on a project to create indices of Chinese housing land prices. (He discussed the project in a previous Knowledge at Wharton article, Why High Land Prices in China Are Not a Bubble.) Today, the indices demonstrate a decline, with some indicators showing the market has gone back to where it was five years ago, says Gyourko in this interview with Knowledge at Wharton.
An edited transcript of the conversation follows.
Knowledge at Wharton: It was a while ago that we did the first piece about the China Land Index that you have developed with some of your colleagues. Can you give us the latest update from the Wharton/Tsinghua/NUS Chinese Residential Land Price Index?
Gyourko: The latest data are from the third quarter of 2014. So they’re hot off the presses, and there are two interesting things about the data. No. 1 is we saw a 6.5% decline in real land prices across the 35 cities in our index. That’s the first significant decline in some time. It takes the price index level back [to] about five quarters ago. The second thing, which I think is potentially more interesting and maybe foreboding for what might happen in China, is the decline in the quantity of land sales from local governments to private developers who want to build residential complexes. That number is down 44%. That takes us back to levels of transactions volume we saw five years ago, not five quarters ago. So there is a very large in drop in transactions volume and a more modest, but real, decline in prices.
“Think about how many housing units you need if you’re going to have 10% growth in your economy versus 7.5%.”
Knowledge at Wharton: What factors do you think are driving these changes in China’s land prices?
Gyourko: No. 1 is that growth is slowing. China’s not in a recession; I don’t believe they’re going to go negative. But they’ve dropped from 10% annual price growth to 7.5%. Many people are wondering: “Are they going to go even lower?” Think about how many housing units you need if you’re going to have 10% growth in your economy versus 7.5%. In the U.S., we would love to have 7.5% growth. But in China, it is 25% below the 10% they were having. So I think what’s happening is that developers were building land for 10% growth. They got 7.5%, and you no longer need as much land. I think that’s by far the most important factor. Another factor that’s out there — we’ll know more about this at the end of the year when we report our city level indexes — is that different cities look to be doing very differently. Inside China, there’s awareness that shipbuilding and steel have excess capacity. So markets with a lot of shipbuilding and steel production activity are going to decline more than others.
Knowledge at Wharton: What do you expect going forward, say in the next few quarters?
Gyourko: I wish I knew. That’s why we’re doing the index, so I’ll know. I suspect we’re going to see variation at the city level — that’s No. 1. I think we’ll find that some cities are doing just fine, and other markets are not. We have 35 [cities] in our index, so we should be able to see a lot of variation across markets and across the country. We don’t just track Beijing, Shanghai and Guangzhou on the coast.
I think the second thing to look for is change in policy. If you look at our index, it is clear in our data that Chinese government policy can move the housing market. There was a similar decline in transactions volume in 2008, during the financial crisis, and it was rapidly turned around by the Chinese government stimulus policy. We saw a very large decline in transactions volume recently. The question is: Are we going to see a change in policy? I don’t know. But it has happened in the past. I kind of doubt it, but I don’t know. I think we need to look at what the Chinese government is going to do going forward.
“If you look at our index, it is clear in our data that Chinese government policy can move the housing market.”
Knowledge at Wharton: Based on what the data show, what do you think are some of the implications for investors and real estate developers?
Gyourko: Real estate developers inside China are clearly becoming more cautious. That’s why you’re seeing the drop in transactions volume. In the U.S. and in most other countries I’ve studied, drops in transactions volume lead to drops in prices. So I suspect they’re looking at those same studies and saying: “We’re worried about price drops.” And they’re worried about shoring up their capital structures to make sure they’re safe if there is a further downturn. I think that’s what people are trying to figure out: Is the quantity drop a predictor of price drops the way it has been in other countries?