Waiting for Chinese Real Estate to Land
When discussing the outlook for BHP Billiton, CEO Marius Kloppers pays particular attention to the Chinese economy and its impact on his business.
“What happens in China is very important,” said Kloppers during the investors’ analysis and briefing of the 2010 preliminary financial results.
The massive infrastructure and housing development in China has supported high commodity prices. But when reports about a housing bubble start appearing in Time, The Economist, Business Week, Bloomberg, New York Times and other publications, there is reason to be concerned.
Wiring homes and laying pipes require a lot of copper. Fifty-one percent of worldwide copper demand is used for housing and infrastructure. Frank Holmes, chief executive and chief investment officer at U.S. Global Investors, regularly discusses China and its impact on mining and commodities.
“China already has over 100 cities of 1 million people and is expected to have over 200 of them by 2025,” he writes.
“This urban migration has overwhelmed existing infrastructure such as roads, sewers and electrical grids. The build-out of this critical infrastructure will require vast amounts of copper and steel and will increase demand for all commodities.”
China already has the world’s biggest property investment market, according to a study by Cushman and Wakefield. In 2009, the U.S. real estate market slumped 64 percent to $38 billion while China’s market doubled to $156.2 billion.
There are several factors driving the housing boom in China:
No Property Tax — Investing in property in North America comes with a hefty tax bill every year, which can amount to three percent of a typical homeowner’s annual income. Patrick Chovanec, an associate professor at Tsinghua University’s School of Economics and Management in Beijing, wrote in his blog that there is no holding cost in China and “Chinese owners are unconstrained by the need to make the property ‘pay’ in cash or in kind. For them, an empty condo is a store of value, much like gold, another asset that performs no practical function besides retaining its worth”;
Lack of Alternative Investment
Opportunities — Overseas investing is curtailed. The stock market is not held in high esteem due to recent manias. The desire to buy bonds or put cash into banks is hampered by low yields, whereas real estate is viewed as a protection against inflation;
Cultural Reasons — Owning a home is a sign of prosperity. The Business Insider and Shanghai Daily argue that home ownership is an important step towards starting a family;
The Stimulus — During the financial crisis of 2007 to 2008, the Chinese government launched the largest stimulus of any country relative to the size of its economy. Bank lending was increased through lower reserve requirements and local governments primarily invested in infrastructure and housing;
Revenue Source — Local governments rely on land development as a major source of income since there is no property tax. Land sales can account for 30 percent of a city’s budget;
Animal Spirits — Since the real estate market was liberalized in China, it has been a good investment. Property investors, says Chenovac, are products of their own personal experience, and people’s experience is that property prices go up and up.
So there may be a housing boom, but is it a bubble? There is anecdotal evidence. Uber- logger and columnist at The Washington Post, Ezra Klein, toured China in the spring of 2010 and writes about “the coastal cities [that] are thick with empty office buildings and uninhabited luxury condos.
Time magazine observes that,“In Beijing, vast swaths of commercial space sit vacant — including floors of retail space right next to the iconic Water Cube, the swimming venue for the 2008 Olympics.”
Chovanec writes about buying a condominium with his wife and actually being one of the few to decide to live in it: “Originally we tried to rent the place, but we couldn’t find takers at any price that could remotely cover the mortgage, despite a prime location. When we decided to move in instead, we discovered that while the building was sold out long ago, hardly anyone actually lives there. [It is the] same with another 800-unit project down the street: every unit went for top dollar well before completion, but now the lights are off and nobody’s home.”
Michael Ding, analyst at U.S. Global Investors, sees many factors that would counter a bubble in China:
• Housing prices have risen, but GDP has risen much faster. More wealth is being created. Any housing oversupply will eventually find a demand;
• “China’s prices have risen from a much lower base than in the developed countries (among them, Britain, Ireland and Spain) in which bubbles were created,” he writes;
• The debt levels of households compared to other countries that hit a bubble is much lower. The down payment needed to buy a house is also much higher, averaging around 20 percent. Second home buyers have to plunk down 40 percent, a move intended to dampen speculation.
Pushing back, Chovanec ruefully notes that every bubble is driven by a grain of truth. The housing bubble in Hong Kong in the late ‘80s was driven by the fact that Japan had so little land. And in 2000, the tech bubble was driven by the fact that technology and the Internet was going to change business.
The story behind the rising real estate prices in China is that there are so many people that need housing, people are moving to the city and the incomes of so many people are rising.
All this is true, says Chovanec, “But it doesn’t justify any price.”
Chovanec notes that there are many government programs in place that are tempering the residential property boom, but the commercial market, where state owned banks lend to state-owned businesses, has all the signs of a classic leveraged bubble. Most business loans use real estate assets as collateral, writes Chenovac.
“If that collateral were suddenly cut in half, China could face a banking meltdown that makes the West’s financial crisis look like a walk in the park,” he says.
BHP, talking about the Chinese economy overall, sees volatility ahead but feels that China will muddle through.
“Our view is that for the remainder of the calendar year we will likely see slowing growth on the back of removal of stimulus and tighter monetary policy,” says Kloppers. “However, our anticipation is for a soft as opposed to hard landing, and second half GDP growth this calendar year could be closer to eight per cent. Despite slowing near term investment growth in China we expect a continued focus on a broad range of infrastructure projects to promote inter connection across the country.”
Other analysts see real danger.
Andy Xie, an independent economist and a former analyst for Morgan Stanley, believes that the real estate market has peaked and a five-year bear market has begun. He says prices in large cities will decline by 50 percent, and land values will decline even more.
Bill Bishop, who runs the blog Sinocism, takes Andy Xie to task for predicting a bubble. He says that Xie forgets that China is not a free market economy. Rather, the market is controlled by the government, and the government’s number one goal is social stability and the survival of the Communist Party. A housing bubble would be a threat to both.
“The bearish foreign fund managers, pundits and analysts may be making a classic mistake [by] viewing China through their financial models,” Bishop writes.
“China may very well have bubbles in many sectors, but bubbles can last for a very long period, especially when you have an authoritarian government, a non-market economy and a ruling party that took as one of its lessons after the collapse of the Soviet Union the need to deliver fast economic growth at all costs. Maybe that growth is inefficient, maybe it is wasteful, but that does not mean it has to end any time soon.”
Bishop paraphrases Soros on bubbles: [Whether a bubble is a true bubble depends on whether] the landing is hard or soft. If the landing is hard, it is a bubble. And you will only know after the fact.
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