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What’s Driving China’s Prolonged Real Estate Boom?

And could it go bust anytime soon?

China’s real estate boom may be the longest, least volatile bubble in financial history. No matter what the doomsayers predict, real estate values still keep rising. A couple of key trends are helping to keep this bubble afloat – but unfortunately, neither tells us much about when it might pop.

Drivers of China’s real estate boom

  1. Urbanisation

China’s manufacturing industry has expanded rapidly over the past few decades, spurring hundreds of millions of people to move from the countryside to the cities. The Guardian reported that more than 100 Chinese cities now have over 1 million people in them, compared to just 10 cities in the United States. That many Chinese people moving to and living in cities has buoyed China’s big housing boom.

Only 18% of the population lived in cities in 1978, when former leader Deng Xiaoping began his famous “Reform and Opening Up” policy. That figure reached 57% in 2017; current leader Xi Jinping hopes to reach 60% by 2020.

However, a lot of China’s housing isn’t being bought by new homeowners – young families from the countryside starting a new life in the city. Those migrant workers are often renting cheap apartments on the outskirts of the city. On the contrary, a lot of the new properties are being snapped up by China’s growing class of nouveau riche, looking for places to invest their newfound wealth.

  1. Lack of investment vehicles

Apart from properties, Chinese people have no other good places to invest their money. The Chinese bond market is weak. The Chinese stock market can best be described as a casino. The latest investment trend – opaquely run wealth management products – doesn’t seem to be a good solution. Furthermore, there are severe limits on how much Chinese people can invest overseas. Hence, the growing affluent class can only park a million dollars in real estate.

In order to cool this out-of-control housing boom, the China government has implemented various restrictions. For instance, some tier 1 cities like Shanghai added a requirement that second-time homebuyers must make a 70% down payment, instead of the typical 40%, to discourage people’s property fever.

Nevertheless, the clever Chinese found a loophole. Some couples chose to file for divorce legally in order to buy an investment property with a smaller down payment. The Chinese government has just closed that loophole, and also implemented other restrictions to cool off the investment market. Those include capping prices on certain new developments, and requiring buyers to use their real names instead of using shell companies to get around limits on second homes.

Could this boom go bust soon?

Most property booms often followed by devastating busts, like Japan in 1990 and the US in 2008. In the U.S., big cities have recovered, but many more rural areas haven’t.  In Japan, the average property price is still just half of its 1990 peak. Could this kind of crash happen in China?

Some economists said that China has overbuilt apparently, since “ghost cities” are everywhere, particularly in tier 2 & 3 city regions. The China government is trying to get rid of this unsold real estate by encouraging migrant workers to buy instead of rent. Unfortunately, prices for those properties remain too high for most people to afford – so outrageously high, in fact, that the average housing unit in China costs 160 times the average person’s annual income.

On one hand, the Chinese government wants to keep real estate prices rising, because that spurs construction, and construction means jobs and GDP growth. On the other hand, real estate prices are getting so high that they’re affecting the rest of the economy. The Wall Street Journal reported that one person in China bought a property whose monthly mortgage payment consumes roughly 75% of his monthly income. People with burdens like this one can’t spend money on other stuff. That’s a problem when the Chinese government wants to rely on domestic consumption to prop up its economy in the future.

The problem with real estate bubbles is that you can’t tell whether they are really bubbles until after they burst! We don’t the crystal ball to time the market, but we can always plan ahead for a potential disaster. In response to the expensive valuation, we think investors should sell their investment property in China though it is generally fine to keep one for self-occupancy.

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Disclosure: Hayes Chan, CFA, is The Motley Fool Hong Kong’s investment analyst. Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance.