It begins as it always does. With
someone getting a little extra money.
So they think, what do they do with it?
Well in China, they could put it in the
bank, but interest rates are lower than inflation.
They could put it in the stock market,
but the only people who make money there are insider traders.
Sending it overseas to invest is
difficult to say the least, due to China’s control of the capital
account.
Well, it would be nice to upgrade to a
better apartment they say, so they decide to buy a new house to live
in.
Marvellous! So they buy a house, and
their similarly rich friends also buy houses. Suddenly house prices
are rising and the market is looking good.
And China's rapidly growing economy
means people are making more money! But what should they do with
that?
How about investing in property? Don’t
worry about renting it out, rents are low, and renters will just
spoil the place. Buy property and hold onto it purely for price
gain.
Well prices are still rising, and
there’s a great apartment deal across town. Luxury apartments
(expensive, but high returns expected), 20 minutes from town, right
next to the subway station. It looks a steal. They buy in.
It is a steal. Prices keep rising and
they quickly amass a fortune.
Up and coming families then get jealous
of others' wealth. The luxury apartments 20 minutes from town are
very expensive now, but there’s some nice ones 40 minutes from
town, a 20 minute bus ride to the subway.
So they pool their money together, take
out a loan for the other 50% of the property value and buy in.
And they make money too! The loan is
quickly paid off, and the family is rejoicing in riches.
People are making more and more money.
And there are still no good investment options other than property.
So they keep pouring more money into
luxury apartments. They take out a 50% loan and buy a luxury
apartment where? Oh who cares where! They all make money. Some
even buy properties in the middle of the desert... (http://molldrew.blogspot.com.au/2011/07/lost-city-of-ordos.html)
Ordos, housing for 1.5 million people, Population: not that many
And so, China builds a property bubble
where the richest buy luxury apartments built purely for capital
gain.
So the bubble continues on and on. But
what happens if the dream ends? What happens if people start getting
scared that luxury property prices are going to fall?
Well that's where we are now. The
central government saw the bubble emerging and instigated a slowdown.
This pricked the confidence of the housing market. And the impacts
are noticeable, with the Real Estate Climate Index in China now at a
lower level than during the Global Financial Crisis.
But is this a bad thing? Well
strangely enough, probably not.
For starters, this housing downturn is
unlikely to trigger a financial collapse like the US one did. Most
housing loans are only for 50% of the house value, so house prices
would need to drop at least 50% for most buyers to be tempted to
default on the loan. This would only occur in the worst type cases.
Some developers will likely go bankrupt
and owe banks money. But, with China's big 5 banks making combined
profits of around US$100 billion over the past year, they can afford
to lose out on some loans.
The advantage of the downturn is that
it helps people think logically. A downturn reminds investors that
they can lose money on housing. This will make people think less
about luxury apartments and more about what to invest in to make a
solid return in the future.
So, do good housing projects still
exist?
Yes. The interesting thing about this
housing bubble is that there is still strong demand for Chinese
housing, as this recent paper by the Reserve Bank of Australia
ascertains.
(http://www.rba.gov.au/publications/rdp/2012/pdf/rdp2012-04.pdf) However, demand is coming from middle-income families who want a
house to live in. These people can't afford the already-built luxury
apartments, but are interested in smaller, cheaper apartments with
reasonable access to utilities.
Previously
developers shunned middle-income housing because it didn't make the
same profits as the luxury apartment bubble. However, with profits
in luxury apartments disappearing, their best source of revenue will
become medium-cost housing.
So strangely, by
aligning what developers build with where the owner-occupier demand
is, this housing slowdown could be the best thing that could have
happened in China.
Disclaimer: This blog reflects my
personal views and does not reflect those of any organisation I am
associated with.
