CKGSB’s Liu Jing explains how China’s housing bubble relates to buyer expectations and why now is not the time to buy
The real estate market in China is essentially no different from other markets, there are two kinds of buyers: one is looking for a place to live, the other is looking to invest or speculate. But in China, the housing market is driven much more by investment than in other markets. Housing is really one of the countryʼs major investment vehicles, as a result the market is much more speculative.
The government sees the speculation as the principal cause of the recent housing price increases, and subsequently responded with measures to curb speculative buying and hopefully keep prices down. The cooling measures are having an effect, but I donʼt think the current methods of the government are optimal. In order to prevent the bubble from getting bigger, we need to first understand whatʼs really driving the bubble. The current methods on the table are that of a surgeon trying to treat a patient using surgery by removing a ʻbubble tumorʼ from the economy. But the economy doesn’t really have a tumor. Rather it has a chronic disease due to some systemic imbalances, and the housing bubble is just one manifestation.
Chinaʼs housing bubble, as with real-estate bubbles in other markets, is driven primarily by expectations. The return on a housing investment has two components: income from renting the house to tenants and an appreciation in the price of the house. The rental yield is actually tiny, approximately 2%, but many people expect a major price appreciation from the time they purchase the house. So you can see that the expectation of the yield on investments is driven primarily by the expectation of future price increases.
So to control the bubble, you need to find a way to influence expectations. The current cooling measures may actually have a negative effect in terms of managing expectations. For example, if you try to limit the supply of housing, then people assume supply will continue to shrink, causing even greater price appreciation in the future, which translates into incentives to buy, thereby making the problem worse.
Taking all this into account, it would be quite stupid to buy a house now. In this kind of speculative market, the short-term is very volatile. You may see housing prices go up, perhaps even violently, but the long-term reality is that the bubble will burst. So people say ʻOkay I’ll catch the short-term wave and cash out when the prices start to go downʼ. But that never happens. When the bubble is bursting, everyone wants to get out and when that happens there will be no liquidity. No one will want to buy.
In terms of investing, the only sensible thing to do is long-term investing, which means you should expect long-term appreciation of housing prices. Rental appreciation should also continue for the next 10 years. Looking at the Chinese income distribution, income hasn’t expanded as quickly as the economy, so now we have a catch-up effect, and rental prices are directly correlated to income.
Now we’ve also reached a stage where government intervention is quite predictable. The government will likely be strict on the housing market for a long stretch of time. If the economy goes south, the government may use housing to boost the economy; if not then price control measures will continue. These measures of course donʼt alleviate the bubble. They only temporarily delay its bursting. Yet another reason not to buy right now.
Itʼs important to remember that when assessing housing price increases, buyers should expect a certain level of appreciation. The China housing market should be high to reflect the increase in incomes and growth of the economy. But how high is too high?
Housing price increases are driven by three things: growth in real GDP, inflation and migration. Over the last 10 years average annual growth of real GDP has been 10%, so an overall increase of 150%. Inflation has roughly been 5% per year, so over 10 years thatʼs another 50%. In terms of migration, city populations are 50% higher than they were 10 years ago. We donʼt need a fancy economic model; just adding these rates together gives us 250%, which is the kind of increase we should expect from the housing market if property prices grow with the economy. So much of the price increases are rational.
So how do you detect a fever versus rational appreciation? By my calculation, an annual appreciation of 3-5%, corresponding to inflation, is tolerable. If increases are way beyond that, than investors may find theyʼre in the middle of a spree that will be either reined in by the government, or lead to the bursting of the bubble.
The housing problem is systemic in the sense that itʼs really driven by the unequal distribution of income in China. Most of the wealth created by Chinaʼs economic rise is being invested by a small percentage of rich people, and the investment portfolios lean heavily toward housing. That pushes prices up in a major way, which severely limits the options for common folks.
Therefore the root of this problem is the imbalance of the economy. Itʼs not an isolated local problem that you can use surgery to move. We should be adjusting the economy in a systemic way, thatʼs the only way to bring the housing market back to equilibrium.
(This article is based on an interview with Prof Liu Jing by Suzanne Edwards)
Liu Jing is Professor of Accounting and Finance and Associate Dean at CKGSB. His research has been published in leading academic journals such as the Journal of Accounting Research, Accounting Review and the Review of Accounting Studies. His work has received the Outstanding Research Award from CKGSB, Eric E. Juline Research Award from the UCLA Anderson School and the Barclays Global Investors (BGI) Best Paper Award from the Review of Accounting Studies. A member of the editorial board for the Review of Accounting Studies, he is also a director at several Chinese companies and an advisor for a number of financial institutions.
(Photo Credit: Bert van Dijk’s Photostream)
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