01/09/2012 // New York, New York, USA // Igor Purlantov // Daniel Mathers
Recent growth in the Chinese real estate market has been nothing short of extraordinary according to Igor Purlantov. From 2009 to 2010 the average home price in Shanghai and Beijing grew 68% and 66% respectfully. By way of comparison, the average home price in the United States grew a total of 50% from January 2000 to April 2007. A prominent driver of this growth has been the large amount of inexpensive debt made available to real estate developers as a result of generous government policy according to Mr. Purlantov. This easy money has pushed developers to construct buildings with little consideration of demand leading to an inevitable oversupply. There are an estimated 65 million vacant homes throughout China with half of them being empty apartments in cities such as Beijing and Shanghai mostly held by speculators and investors. To put this number in perspective, it is the equivalent of half of the entire number of housing units in the United States of America says Mr. Purlantov.
Despite this enormous oversupply, real estate development continues to steam forward with the first six months of 2011 seeing year on year growth of 35.2%. This continued push in new construction despite oversupply has continued to drive up prices as speculators look to cash in on the real estate boom says Mr. Purlantov. In the Pudong area of Shanghai, which now claims the most expensive real estate in China, prices have reached $2,209 per square foot. The average new home price in Shanghai is $620,000 making it more expensive than markets such as Los Angeles, Miami, Chicago and Honolulu. Prices in Shanghai stand at 8.3 times the average Chinese household income and roughly 29 times that of an average farmer’s income. On the other side of the spectrum, the average home price in Guiyang (located in Guizhou, the poorest province in China) is already on par with Phoenix. Although both cities are roughly the same size, the per capita GDP of Phoenix is more than ten times that of Guiyang. This extraordinary growth in prices has already made home ownership impossible for 60% of the urban population which could grow to as high as 85% says Mr. Purlantov.
This growth in real estate prices despite an oversupply should sound familiar. The United States went through a very similar, if not identical, real estate boom that was driven in large part by easy money and enormous amounts of debt. In 2006, despite analyst claims that the housing market was just getting warmed up, the U.S. housing bubble was already on course to implode as it did in 2008. According to Mr. Purlantov the housing market in China has already started showing symptoms of the type of bubble that is inevitable when you combine easy credit and speculative lending encouraged by government policy. The Chinese government is already looking to tame surging homes prices and inflation through property tax legislation and interest rate hikes. There is also a push for increased down payment requirements and suspension of mortgage loans for third home purchases in an effort to slow the real estate euphoria. These attempts to stop a runaway train may unfortunately be too little, too late says Mr. Purlantov. The first six months of 2011 already saw year on year total housing sales drop by 26.7% and 18.9% in cities such as Shanghai and Beijing and more recently month on month declines have reached 21%.
Across the Chinese economy, the impact of declining sales and prices could see GDP growth decline by 30% given how much real estate has contributed to the current high nominal GDP. In 2010 alone, 14% of nominal GDP growth came from property sales, boosted in large part by rising land prices. Overall land prices have increased tenfold since 2002 with a thirtyfold increase in coastal cities and hundredfold increase in the most speculative areas. According to Mr. Purlantov the dramatic decline in real estate sales and prices will be profound for the Chinese economy given how dependent local governments are on revenues generated from development fees and taxes. Initial victims of such a bubble will be investors who overpaid on luxury condos and suffer large losses followed by the developers who relied on cheap credit. Many of these developers could go bankrupt and renege on their loans, leaving the Chinese tax payer with the burden as many of these loans are held by government owned banks.
When you add widespread irregularities to this already lethal mix of a real estate bubble, local governments heavily dependent on new development for their revenues and a government-run banking sector, you have the potential for a perfect storm according to Mr. Purlantov. This perfect storm could very well lead to a real estate bubble that will make the U.S. great recession seem like a walk in the park. Let’s hope that the Chinese housing market in 2013 behaves more like a tiger then a snake when investors and speculators get bit as a result of a real estate growth bubble that has peaked.
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