Nearly two years after Beijing enacted policies to curb the housing bubble expanded by the massive 2008-2009 stimulus, the approach has yielded some modest results: Property price increases have slowed in major cities, and some reductions have even been reported in a number of first- and second-tier cities (spreading to lower tier cities as well). The property transactions and land sales in many areas have stagnated, and the land prices offered by local governments also fell considerably, with an increasing number of auctions.
However, Beijing has also seen less desirable consequences from these real estate- and credit-tightening policies. Land sales, a major source of local government revenue, have decreased — some estimated at 30 percent year on year — creating budgetary problems. Price declines have also generated some stability concerns, as real estate has been an important investment channel for personal assets in China, leading to sporadic protests involving investors and middle-class Chinese against real estate developers in cities where price drops have been recorded. And declining prices have raised worries about undermining the value of real estate used as investment or collateral for loans from individuals and state-owned or private enterprises.
For years, Beijing has known that the fundamental tension in its real estate policy must be addressed. China knows it needs to stabilize housing prices because the rapid collapse of the housing bubble could pose a systemic risk to its economy — especially given how connected real estate has become with other important sectors like banking and construction. But the central government is unable to use more forceful measures to put the problem in check for fear of hampering growth, which has been fueled in part by the housing bubble. This is particularly challenging as the country's growth is entering a downward trend, with the export sector no longer providing sufficient drivers to sustain the economy.
Resolving its real estate dilemma would require China to take on some of the most difficult, long-standing issues in the country. These include the divide between the wealthier urban population and the much larger poor, rural population, as well as the conflict between central and local authority and the need for banking sector restructuring. Whichever path Beijing chooses, it risks a backlash from whoever loses out.
Real Estate's Role
The 2008-2009 stimulus did not create the housing bubble, but it greatly expanded it. Since the 1998 housing reforms that allowed privatization of residential property, strong demand in urban areas and an accelerated urbanization process have kept prices steadily increasing. Large investment and speculative money in the real estate sector also flowed into the market, causing soaring prices in many cities, far beyond public affordability. By 2009, the total expenditure on housing reached 12-15 times the Chinese average annual middle-class income in major cities (roughly those with a monthly income below 10,000 yuan, or about $1,600). In first- and second-tier cities such as Beijing, Shanghai and Hangzhou, the ratio was 20-30 times higher, which is significantly higher than the World Bank's suggested affordability ratio of 5:1 and the United Nations' ratio of 3:1. The real estate sector has grown to account for 10 percent of China's gross domestic product (GDP), but together with the economic activity it generates in associated industries such as construction and finance, it totals closer to 20 percent of the country's GDP. Real estate-related construction, services and industries provide extensive job opportunities, particularly for migrant workers, sustaining China's employment.
Real estate has become an attractive sector for investing personal assets due to the limited options for personal investment — many Chinese are reluctant to participate in the volatile stock market, and other viable options such as interest from savings accounts have low returns. Soaring prices over the past decade established an expectation that there is little chance of losing money on tangible assets such as real estate. These expectations have been shaken by Beijing's relatively cautious moves to contain the housing bubble.
The country's banking sector has also come to depend on real estate. Aside from large purchases and bank loan investments, real estate is increasingly associated with the banking system through financing tools. Unlike the Western system, China's banking system is largely based on collateral loans. According to estimates, 70 percent of bank lending and 90 percent of individual lending are through collateral loans, as opposed to loans on credit alone, with real estate and property being the primary collateral offered for loans. With Beijing limiting access to credit for small- and medium-size industries as part of its monetary tightening policy, property has increasingly been used as collateral through both formal and informal lending channels.
The threat from falling real estate prices affects not only individuals holding mortgages at rates higher than they can afford, but also entities that have borrowed money using property that has now dropped in value as collateral, thereby threatening the financial health of China's banking system.
These transactions often consist of individuals and enterprises seeking loans from state banks, small credit firms or individuals (such as loan sharks) through a lease of a property or a piece of land, though the parties offering the loan often use the real estate-based collateral to take out their own loans. Official estimates from the Chinese central bank put outstanding real estate-related loans at about 10.46 trillion yuan — about 1.5 times the total official lending in 2010. The real number of housing market loans could be far more than reported. And given how many parties can be involved (and thus vulnerable) in each loan taken out with real estate as collateral, this can quickly become a systemic risk if prices fall suddenly and significantly.
Local vs. Central Authority
Real estate is also at the center of a government financing problem. Since the 1994 tax reforms, Beijing has taken a larger share of fiscal revenue, increasing from 22 percent in 1994 to a current rate of around 60 percent, leading local governments to seek out other funding sources. One problem has been land sales, which currently account for around 40-60 percent of local revenue. With strong incentive to promote land sales for increasing revenue, local governments have a fundamental interest to drive up real estate prices and collaborate with developers to maintain high prices.
As a result of policies intended to contain the housing bubble, however, the total volume of land sales in China's 130 cities has decreased by 30 percent. In major first- and second-tier cities, falling property transactions also resulted in a 10-30 percent decline in land prices offered by the local government. Falling real estate prices will limit local governments' ability to obtain the resources they need to sustain public expenditures. These financial constraints are one reason local governments have proved resistant to the central government's aim to construct more affordable housing, its key strategy for dealing with the negative consequences from the curbing of real estate prices.
Social Stability and Beijing's Solution
Housing is critical to the country's social stability, which is the ruling Communist Party's paramount concern. This cuts two ways. Investors and purchasers who bought at peak prices oppose efforts to rein in the housing bubble because they threaten investments. Meanwhile, China's massive rural, low- and middle-income classes would benefit from efforts to make housing more affordable via stabilized, lower prices, but even with lower prices, they still may not be able to afford property.
Beijing sees the construction of new affordable housing as the solution. In March, it initiated a plan to construct 10 million new affordable housing units by the end of the year and as many as 36 million by 2016. From Beijing's point of view, a massive wave of residential construction and all that it would entail in terms of employment and manufacturing would help offset the economic slowdown and the tightening real estate market. Meanwhile, a greater supply of affordable housing would help meet the increasing demand in urban areas, thereby stabilizing housing prices. This dovetails with the accelerating urbanization plan, which could also boost domestic consumption and reduce the wage gap, with more rural workers entering the coastal economy.
However, this has been consistently hampered by the lack of local incentive to build affordable houses, due in part to weakened local financial health and decreased commercial gain stemming from efforts to deflate the housing bubble. Even after Beijing's call to accelerate construction, of the 10 million houses that Beijing announced as completed, about a third are reportedly unfinished, not to mention the numbers that are from previous allocated houses faked by local governments. Some of the new buildings have also been reportedly given to unintended recipients (some to people who already have houses, or even mid- to high-income people with political connections).
Local governments could scale up their participation in constructing affordable housing, but in exchange they would probably demand Beijing weaken its tightening measures and refrain from pursuing additional ones. This would allow the very problem Beijing was hoping to contain — unsustainable housing prices — to expand again, making a push for affordable housing to offset the consequences of real estate tightening an unrealistic one.
The central government has tolerated or even encouraged the real estate asset bubble as a way to fuel growth for years, but with declining global consumption eating into already low profit margins for Chinese exporters, Beijing is being forced to address the issue. While it wants to squeeze the huge bubble to make the market more sustainable, squeezing too hard could lead investors to abandon the real estate sector, causing a sell-off that would damage local governments, middle-class personal investments and corporate savings channeled into property-related activities. Beijing can neither endure the risks associated with an out-of-control housing bubble, nor face the remedies needed to cure it, but it must soon make a decision on which interests to protect.