China's property sector is no stranger to the booms and busts that characterize most capitalist economies. But in the two decades since the country commercialized the allocation of real estate, the flourishing industry has become a model of the investment-driven growth on which the Chinese economy so heavily relies. After ballooning in 2015-16, the property sector now accounts for at least a sixth of the country's gross domestic product and is the largest source of local government revenue and household assets.
For the most part the industry seems poised to continue growing in the years ahead as China urbanizes and restructures its economy. There is a chance, however, that the property bubble will stop expanding — if not burst outright. As consumer debt soared and credit dried up throughout the year, the real estate industry began to deflate, causing prices and purchases to sag in most major cities across the country. Over the next few years, Beijing will have few means of propping up the sector amid mounting debt, growing mortgages and increasing speculation. How well the Chinese government weathers the ups and downs of the all-important industry will determine the country's economic, financial and social stability down the road.
A Crutch in a Crisis
The life cycle of China's property market is the direct result of state policy and a reflection of the economy's health. In 1998, a series of housing reforms ushered in a golden era of real estate that corresponded with — and greatly contributed to — a surge in the acquisition of household assets and double-digit economic growth. At times, speculative bubbles forced state and local governments to take steps to tame the market. But by and large, rapid urbanization and industrialization spurred the real estate sector ever forward, boosting prices more than tenfold in many areas over the past two decades.
During the global financial crisis of 2008-09, the prosperous market became a panacea for China's economic ills. As cheap exports made up a diminishing share of the country's economy and household consumption stagnated, property served as the primary driver of growth and employment in China — and, by extension, a cornerstone of national stability. The government sought to ensure a steady flow of funds into the sector with a combination of preferential policies and a massive influx of credit.
At the time, most Chinese real estate investment originated with state-owned banks and was funneled through state-owned enterprises. This not only underscores the importance of such investment as a policy tool, but also shows Chinese leaders' liberal use of it to offset other weaknesses in the economy. Beyond providing key sources of revenue for cash-strapped local governments, property now serves as collateral and a financial vehicle for individuals, businesses and banks, adding to the growing pile of debt burdening China's economy. All told, real estate accounts for roughly 50 percent of new lending and about 40 percent of the country's outstanding debt, which currently totals about 250 percent of GDP and will keep climbing until at least 2022.
The sheer magnitude of China's property-related debt is only part of the problem, though. The real estate market is closely intertwined with the most indebted portions of the economy. Nearly all of the country's biggest corporate borrowers — including property developers, power utilities and energy, construction and mining firms — depend on the real estate and construction industries to make ends meet. The property market contributes a considerable share to China's $15.2 trillion in informal lending through wealth management and trust products that did not come under regulatory scrutiny until recently and were therefore quite volatile. Today the average debt-to-equity ratio of these highly leveraged companies, most of which are state-owned, has reached more than 90 percent. For some, it is as high as 250 percent.
To make matters worse, Chinese household debt has almost doubled from 30 percent of GDP in 2012 to about 60 percent in 2017. Compared with most economies in the West, such as those of the United States (79.5 percent) and Japan (62.5 percent), that figure is still low. The country's high deposit rates somewhat buffer those debts as well. Nevertheless, the overwhelming concentration of China's household debt in the real estate sector has made homeowners even more vulnerable to volatility in the market.
A House of Cards
Rising financial risk, coupled with diminishing returns on investment and high property prices in many cities, suggests that China's real estate boom may peak over the next two to four years. At the very least, Beijing can no longer afford to lend relentlessly to the industry to keep it afloat, as it has in the past. In fact, over the past year Chinese authorities have launched a sweeping campaign to deleverage the economy, contain debt and steady the real estate sector. As access to credit declines, so will investment into real estate and fixed assets. Meanwhile, Beijing has tightened regulations on the financial sector and informal lending while restricting land supply, development and property purchases in big cities.
To some extent, these efforts have mitigated the risk to the most susceptible parts of the economy. But barring a decision by the government to loosen its grip on credit, investment and home purchases, the Chinese real estate sector will likely continue to slow as property inventories and construction dwindle in 2018. Furthermore, the threat of a more drastic downturn could damage China's economically fragile and debt-laden regions, such as the northwestern rust belt and the central provinces. Real estate developers, which hold half of the Chinese corporate debt scheduled to mature in the next two years, may be hit hard as well. And through it all, Beijing's options for preventive action will become increasingly limited.
When One Door Closes
Should China prove successful in its attempt to encourage urbanization, rebalance its economy and accumulate wealth, the country will be able to sustain its robust real estate market over the next two years. But as the highly leveraged sector nears its next peak, its numerous flaws will start to outweigh its perks. Whether by squeezing urban consumption or by diverting resources from manufacturing and high-tech industries, these problems run contrary to Beijing's imperative to create a consumption-driven and high value-added economy in the long run.
Even so, the flagging property market may also give China a rare opportunity. In a keynote speech at the 19th Communist Party Congress in October, President Xi Jinping declared that the era of "housing speculation" may be gone. In the weeks that followed, the government jump-started the long-delayed legislative process to push through policies on a property tax and rental housing. The property tax, in particular, would offer Beijing a powerful tool for stabilizing the property industry by reducing local governments' reliance on one-time land sales and the transfer of resulting tax revenue from the central government. (These sales have fueled skyrocketing real estate prices and bubbles over the past decade.) Because of local governments' continued dependence on and collateral in the property market, however, China will take care to pursue any new property tax program with caution.