China's Renewed Real Estate Boom
Over the next 6 to 12 months it will be costly to be a China bear. The reason: Real estate. China’s renewed real estate boom is being underestimated by many analysts and pundits. After China's disappointing economic data in April, the latest narrative has centered around a loss of economic momentum as Beijing reflation efforts wane. But, dig deeper into the details, and there are some eye-popping numbers in China’s real estate market. April numbers included:
- A 25% annual jump in new housing starts.
- A 64% increase in the value of home sales.
- An near 80% increase in mortgage issuance.
- The construction PMI was 59.
- Residential investment rose 11%.
- Land sold to developers grew at 8%.
- Commodity imports have been fairly robust so far this year (see my trade data for more details).
Real estate is a big deal in China
Property is the largest source of household wealth and home prices have a sizeable wealth effect. Land sales pay a lot of local government bills, and sales are up. Construction is a massive industry and employs millions. Real estate overall, potentially 25% of China's economic output directly and indirectly, dragged growth lower in 2014 and 2015. But, 2016 will see a reversal.
The boost will come from a temporary reprieve for doomed old economy industries, like WW2’s battle of the bulge for large industries like materials, steelmaking, and construction. As growth slows and restructuring unfolds, China’s economy has become highly uneven. In fact, China’s economy is like four different economies in one: The tech and innovation sector riding high, the underdeveloped service sector proving resilient, light industry slowing in the face of weak global demand, and heavy industries sinking fast under the weight of debt and overcapacity. The renewed housing boom will prove to be a temporary boost to the last sector on that list, and provide a window of stable and possibly improving economic prospects in the short-term. In that scenario, it will be costly to be a China bear for some months to come.
How long can this new real estate boom continue?
The recent boom has been primarily driven by a few key factors:
- Supportive housing policies out of Beijing (including easier mortgage financing and lower interest rates).
- Investment money diverted from the hot stock market.
- A reduction in inventories over the last year or two.
- China’s frequent bubble-creating massive savings.
All of those factors, except for the last one, will eventually reverse sometime in the future. Savings deposits are around 200% of GDP and trapped in the country due to capital controls. That immense liquidity will continue to inflate asset market bubbles of all kinds, including housing, within China for a long time, as we have recently witnessed in China's commodity futures markets.
Household Debt as a Percent of GDP
The most important of those factors seems to be a boost in mortgage financing. Mortgage lending accounts for 26% of all 2016 real estate investment, up from 18% at this time last year. In 2016, mortgage borrowing has risen 54% from last year after Beijing reduced required down payments from 25% to 20% for first-time homebuyers, and from 40% to 30% for second homes. The PBOC has also driven down interest rates over the last year and a half.
The mortgage market is still underdeveloped in China. All household debt combined accounts for only 38% of GDP, low relative to global peers (see chart). In the US, mortgage borrowing alone accounts for 77% of GDP, as high as 98% in 2009. China’s households up to now have been pretty debt averse. The country’s much-publicized debt burden lies on the shoulders of corporations and state enterprises, roughly 125% of GDP. A mortgage boosted housing market could have a long way to run.
The real wild card is existing inventories
The biggest conundrum in China’s recent real estate boom is, how can a country with millions of unused properties be going through a double-digit increase in construction starts and skyrocketing prices? My guess: According to the IMF, China’s housing glut is primarily a lower-tier city problem. Inventories in the wealthier cities along the coast with larger GDP contributions are relatively tight given China’s urbanization rate. The recent price rises have come from the top tier cities with fewer inventories (see map). Those sizeable price moves have set off a new boom that is starting to spread beyond the top-tier regions. There is also plenty of uncertainty around just how big China’s housing glut actually is, and how fast real demand is growing.
There is no shortage of data and information on construction and house prices in China, from both official and private sources. But, information on inventories and vacancy rates is virtually nonexistent. That, unfortunately, leaves plenty of room for speculation. Vacancy rate estimates vary, but the most often quoted rate is 22% (about 50 million units), a number used by the Wall Street Journal, the St Louis Fed, and the China Daily. That compares with 3% in the US at the peak of the housing bubble in 2006, and Japan’s current rate of 13.5%. China appears to have a large housing glut, but there are three big differences between China and global peers.
First, urbanization is likely to move over a hundred million people into urban cities over the next five years, and they will all need housing. Second, wealthy Chinese view property as an investment and many of those unused properties will remain empty for a long time on purpose. And lastly, speaking as someone who lived in a Chinese apartment years ago, China’s housing stock needs updating. China’s last census revealed that 28% of Chinese homes did not have showers, and 16% did not even have toilets. With disposable incomes rising over 7% a year, there is a constant demand for upgrading in the housing market.
My point is, China’s housing surplus is unknown, but also unknown is the extent of future housing demand. China's housing market has significant oversupply, but due to uncertainty about the actual housing stock and potential for massive future demand, we should view that oversupply as a ceiling on any renewed housing booms, and not a catalyst for an impending US subprime-like crisis. So, the current double-digit pace of construction and sales are unsustainable in the long-term, but there is already enough in the pipeline to boost growth for some months to come.
The future of China’s economy will continue to be an uneven slowdown, whereby old economy industries that once drove the “miracle economy” forward drag down future prospects. But, for a short time, those industries – materials, machinery, energy, steelmaking, mining, and others – will get a reprieve from the latest real estate boom underway. That will provide a window of stability and decent growth prospects for the broad economy. Given the investment and construction in the pipeline already, the boost should last for at least the rest of 2016. But, uncertainty over China’s existing housing stock make predictions beyond that time horizon very challenging.