With China posting a first-quarter GDP growth of 11.9%, some question whether parts of the economy, such as the real estate sector, are on the verge of overheating. In fact, the selling price of residential property in some of the largest and most established cities, or so-called Tier 1 cities, has risen significantly in the past five years and in some areas faster than growth in middle-class income.
However, I do not believe there is a residential housing bubble in China.
Urbanization is creating sustainable demand for residential housing
There is a strong trend of urbanization under way that is encouraged by the government. For example, more than 400,000 people are moving into Beijing and another 400,000 into Shanghai each year. The government is targeting raising the current urbanization rate from 45% to more than 70% in about two decades, which means another 300 to 400 million people moving to Chinese cities. [Jones, Lang, LaSalle]
However, the Tier 1 cities, which include Beijing and Shanghai along with Guangzhou and Shenzhen, only represent about 8% of total residential real estate transactions in the country. There are now more than 150 cities around the country with a population of more than one million people each — Chinese residential real estate is more than just about Tier 1 cities.
This strong urbanization opportunity in China implies robust long-term structural demand for residential property in Tier 1, 2, and 3 cities, and indicates that any temporary excess supply in any given year will be absorbed quickly.
There is little leverage in the system
To have a proper bubble, you need excess leverage in the system, which does not currently exist in China.
Among the big banks in China, mortgages represent only a modest amount of total assets. Banks are simply not indulging in providing credit to the real estate sector.
Moreover, a first-time homebuyer faces a minimum down payment requirement of 20%. For a second home, the buyer is required to put down a minimum of 50%, recently raised from 40%. Additionally, the phenomenon of home equity lines of credit does not exist in China. More surprisingly still, about 25% of all the houses are purchased with 100% cash, including 50% of homes purchased by middle class buyers. [CLSA]
The average loan to value for all home loans issued since 1997 is a rather modest 30%; property prices would have to decline significantly before Chinese borrowers owe more on their homes than their homes are worth. The Chinese are very debt-averse, and the average life of a mortgage is only eight years.
In short, the rising prices in Chinese residential real estate are not credit-fueled, and any near-term correction of real estate prices would most likely not create financial strains on homebuyers or the banking system.
There is no destabilizing glut of inventory
Unlike the United States, where the recent excess inventory continues to weigh down home prices, China faces an inadequate supply of housing and significant pent-up demand for residential real estate.
The country has had 40 years of undersupply. From 1950 to 1989, all of the housing that was built was poorly constructed or inadequate, based on modern needs. China has only been building modern housing since 1990. Since then, the total supply built is only sufficient for about 20% to 25% of the population. There is plenty of room to grow.
Also, it takes about three plus years to acquire land, secure permits, and construct in major urban areas, which results in significant supply lags.