We must understand the housing market in China to fully comprehend how wealth is stored by many people in China. To those looking in from the outside, the housing market in China appears a house of cards ready to collapse at any minute. It is also a market sector that has become so greatly oversized that it may now account for 25% or more of China's GDP. Because it has become so ingrained in China's economy, we find that the Chinese government has no choice but to shore it up, while at the same time trying not to encourage its growth.
Prices have soared in top tier markets
China has over 680 cities, but four are considered to "rule supreme" and are viewed as the best: Beijing, Shanghai, Shenzhen, and Guangzhou. As in many countries, the supply of housing falls well short of demand in the top cities, leaving many people increasingly stretched to buy there. The average price for a one-bedroom apartment in Shanghai is nudging towards $1 million. The job magnet metropolis of Shenzhen is no bargain either, at about $700,000 for a flat.
A clear sign something is wrong is evident in the findings of an analyst for economic research firm Rhodium Group that estimates around 90 million apartments across China are sitting vacant. This indicates a huge oversupply in some areas of the country and unaffordable homes in certain cities. For years, developers have put up large apartment blocks in isolated parts of China. This was done because the land is less expensive in these areas and under the concept "if you build it they will come," but often, they have not.
China's housing and iron ore
Yes, people bought these apartments - which still remain empty - as investments because housing prices in China have a history of rapid price appreciation. Earlier I referenced this market as a house of cards, maybe the term Ponzi scheme might be more appropriate. This is why recently some commentators have pondered whether the collapse of the world's most indebted company, Chinese property giant Evergrande (OTC:EGRNF), will doom China's economy and spill over across the globe. To be clear, Evergrande's meltdown is partly due to a cooling in demand for new projects in smaller cities.
China's government pulls the strings
To fully understand the importance of real estate we must look at the figures, China's property market is worth around $US60 trillion ($83 trillion). The property market represents about 25 percent of GDP and is where 62 percent of household wealth is being held and by its nature, it is deeply interwoven with shadow banking. Any drop in real estate values would have huge ramifications. Deeming many of those 90 million vacate apartments as uninhabitable and possibly worthless would be a very big deal. It would not only impact the wealth of millions of Chinese citizens and companies but also shake faith in the whole Chinese economy and financial sector.
The government of China has been concerned over rising house prices for years. Following the Central Economic Work Conference in December of 2016, it issued a statement saying, "Houses are built to be inhabited, not for speculation." Over the years low investment returns in the real economy and easy credit have triggered excessive growth in property prices in China and attracted too many financial resources to the real estate sector. Despite efforts by the government to cool this market and moderate property prices, market sentiment has remained robust, partly due to a lack of other good investment options.
Typical upscale housing development in China
As a contractor and being heavily invested in real estate, I was thinking about how "draw systems" work. This has to do with how a certain percentage of the cost of construction is shelled out as each stage of construction is completed. This is done partially to make sure projects are actually completed. Please note, much of the money spent on constructing a housing unit is spent in finishing - many people give this little thought.
Years ago, Home Depot (HD) was excited about entering and developing the massive market in China because apartments are sold by the developer at the "roughed-in" stage with no interior. You might know Home Depot cut and ran after a few years adding to the list of American companies that failed in China. Home Depot has blamed their bad experience on not understanding the Chinese culture. After reading this article, you may question both the quality and just how well many of the housing units in China have been finished. The fact is, many will never get "finished" or occupied.
In trying to understand the massive housing market that drives much of China's growth, it is important to realize that people in China buy apartment units that are only roughed-in. This means the buyer is essentially purchasing what we in America would call an "empty shell" or an unfinished apartment. In most cases, apartments are sold with internal walls and electrical outlets in place but everything else, including doors, flooring, and bathroom fixtures, will need to be built out by the owner after purchase. Understandably, this created a great deal of excitement for a company like Home Depot that sells the "rest of the package" in a way that can be a one-stop answer for any home buyer.
A close look at housing in China and the customs under which deals are completed will give Americans some real surprises. Getting information on this subject is not as easy. It takes a bit of digging and research to better understand the internal workings of China and how its real estate system functions. Unlike property and housing ownership in America and other western countries, all property in China is simply being leased for 70 years. Also, the various procedures and steps Americans take for granted when purchasing a property, such as due diligence, housing inspections, and secure escrow accounts, simply do not exist.
The lease is supposed to renew automatically upon expiration, this might unnerve many buyers that know the Chinese government's relatively new Ministry of Housing and Construction retains full "property prerogatives," meaning that leases can be nullified at any time if the government determines that it needs that property for any reason. In addition, the government is also entirely free to decide how much compensation should be offered for that property in the event the land your apartment happens to be located on is reclaimed by the state. Residents now have the right to sue the government if they feel they receive unfair compensation, but they rarely win in court.
The trends shown in this 2016 chart continue
It could be said cheap housing is something you won't find in China. While many of these units are poorly built, they are not cheap. China's housing market is among the most expensive in the world when compared to per capita income. To be honest, the numbers I found are all over the board. For example, the average price of housing in New York City is around $1,000 per square foot, with an average family income of $76,000 per year. By comparison, the average cost of housing in Shanghai for the year 2021 is around $1,200 a sq. ft. against an average family income of around $10,000. By American standards most apartments are small - no more than 30 percent of all new apartments can be larger than 90 square meters (970 square feet).
China gives savers few good options
China is a place where the rules affecting value can change with little notice. Until now, investors have ridden the housing train to Profitville. How long this can go on is questionable. Global Property Guide notes on the information they post that China has poor house price statistics. They go on to state, the National Bureau of Statistics of China (NBSC) has monthly house price time series starting January 2011 but only until August 2013.
On Quora back in 2015, Mike Lim, who worked in Shanghai, reported of colleges that earned around $700 a month selling apartments for around $5,000 a sq. foot and driving to work in a 3 series BMW and carrying LV bags and totting the latest iPhones. He stated, since the late 1990s to early 2000, there have been many forced relocations to free up inner-city locations for development. New apartments are then allocated to these households, and often, a mid-sized family (e.g., two grandparents, two parents, one kid) could get 3 new apartments. Couples have been known to divorce just to get another apartment! Now with these 3 apartments, they usually occupy one, rent out the second and sell the third.
Aside from the disagreement over the stability of China's housing market, it should be noted that foreigners may only purchase apartments to live in for personal use and not to rent out. Virtually no secondary market exists to sell into if you decide to relocate. When someone in China seeks to buy an apartment, few give much consideration to anything but new construction. Still, most bizarre is that for such a large market, legal protections and real estate standards are not yet well-established.
This article was written by
Bruce Wilds
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Bruce Wilds is an independent businessman and licensed general contractor that owns real estate in the Midwest, his holdings include apartments, retail space, and office complexes. He has invested in several businesses and traded both commodities and stocks for several decades. Wilds considers himself well anchored to reality and the economy as he maintains, designs, and leases buildings. His work has made him keenly aware of rapidly changing lifestyles and trends in new business formation. The not for profit blog he maintains incorporates many of the experiences and knowledge garnered from his hands-on business style, extensive travels, and studies of history, politics and economics.Bruce Wilds is also the author of the book "Advancing Time", the book focuses on how the ever quickening pace of change impacts today’s society and the massive challenges it creates. He feels that it is crucial we understand that we are living in a unique era the likes never before experienced by past generations. History viewed in the framework of mans time on earth forms the crux of this somewhat radical perspective. Journeys from the beginning of man to our current state helps us make sense of our fast changing chaotic world. Advancing Time illuminates the responsibilities society faces. Used as a tool Wilds wrote it with the hope it would help clarifies the choices before mankind, guiding and giving hope to those who want to have a positive impact.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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