Why is it happens? (insider reasons)

This blog will focus on the insider reasons of housing bubbles in China. In simple, what happens in the real estate market to drive the housing bubble problem? Personally, I believe there are because of two main reasons.

1 The virtualization of the real estate market is directly driving the bubble in housing market.

Firstly, this is because of the undeveloped of the Chinese capital market which has made the financial structure unreasonable. Specifically, there are three main funding sources for Chinese real estate companies, which are loans (21.28%), company self-funding (29.85%), and other funding (45.52%). Overall, the main funding seems come from other funding (Data and following data are come from Chinese real estate funding sources Analysis Report which is researched by China Banking Regulatory Commission). However, the other funding in real estate in China is mainly from personal housing mortgage loans (70% to 80%). Therefore, actually over 50% funding is directly or indirectly from commercial banks. Other data may shows more clear view, the real estate development loan balances increased 11 times from 1998 (202.9 billion) to 2009 (2,527.8 billion). The personal housing loans balances rose more than 100 times (from 42.6 billion to 4,760 billion). Furthermore, this is also because of investment function of real estate has been highlighted in those years. The research from sina shows that almost 36.2% people are buy houses for investment which is close with the percentage of people who buy houses for living (44.3%). (Results from Shanghai Securities News)

2 the rigid demand of real estate is the strong support of housing price.

This idea is main support by the urbanization proportion which I have showed in the previous blog (Yesterday oncemore?). Moreover, the increase of per capita GDP also makes people to improve the residential conditions. The per capita GDP increased from 343.4 RMB to 22,698 RMB from 1978 to 2008, which will obviously raise the demand of houses (Peihui Wang, 2011 2vol Economic Theory and Business Management).

Why is it happens? (Outside reasons)

The outside reasons (the reasons outside the real estate industry, such as the economic environments, financial policies, and so on) of the Chinese housing bubbles can be separated in to two main areas which is the effects of liquid expansion and funding mismatch in fictitious economy markets.

Firstly, housing bubbles in China have roots in liquid expansion. The liquid expansion in China is caused by the Chinese foreign exchange holdings. Because of Chinese government implement compulsory sale and purchase foreign exchange policy. Therefore, the changes in foreign exchange reserves will directly leads to the change in monetary base of central bank, and then affect the supply of currency in China. From 1999 to 2009, the Chinese foreign exchange holdings have increased 12.5 times and foreign exchange reserves have increased 15.5 times. In the end of 2006, the scale of foreign exchange holdings is greater than the amount of monetary base, the percentage in M1 and M2 (Money supply) is 66.9% and 24.4% (data come from National Bureau of Statistics of China). In the end of 2009, the scale foreign exchange holding is 1.2 times of the amount of monetary base, the percentage in M1 and M2 is 79.1% and 28.7%. Just as I have introduced, the increase of foreign exchange holdings directly increased the amount of monetary base. And then, through the amplification effect of the money multiplier, it increased the currency supply, and finally leads to liquid expansion.

Secondly, the funding mismatch in fictitious economy markets is the other important reason. In general, bond market, security market and real estate market is the main market to absorb liquid. However, in China, the scale of Chinese bond market is still small, does not have enough ability to absorb liquid. The share market in China was the main market to absorb liquid. However, the bubble burst of security market in 2007 fuelled heavy flows out of equities and into real estate market. This let the over liquidity in real estate market and finally support the real estate bubble.

Yesterday once more?

As we all know that the Japanese housing bubbles led to a serious financial crisis in the Japan in last centre. It not only weaken the financial position of Japan (was the second highest GDP country in the world), but also led to GDP growth of Japan stay in 0% for more than 10 years (more information please read Historyof Japan's housing bubble). Many experts point out this the Chinese housing bubble problem is highly similar as the previous one in Japan. And they also worry about that China will get into the same trouble as Japan. So will history repeat itself?

Firstly, we can clearly see that the outside economic environment of both this period China and last centre of Japan is very similar. As both countries all have the loose monetary policy and prudent fiscal policy. Those two countries all have high savings followed with low rate pf consumption. Furthermore, the economic performances (as severe real estate bubble, the economy is too rely on exportation, upward pressure of currency, and so on) in china, are almost the same as the situation in Japan in 1980s when the bubble was not burst.

However, I still believe China won't repeat the same trend as Japan. This is because the financial system in China is obviously different as it in USA, Japan or even Hong Kong. Under Chinese financial system, the central bank has more controlling force to control the real estate loan, which is helpful to against the moral hazard and domino effects. Moreover, the Chinese government has effective measures to guide and regulate both banks and real estate agencies and this will significantly help Chinese real estate market back to the healthy development track. Finally, the market breadth and population structure of both countries are different. The urbanization level of Japan in 1985 is 76.7%, and it in China just around 45% in 2008 (data is from National Bureau of Statistics of China). This is means Chinese real estate industry still has large development space and growth potential which will give the real estate industry a strong support.

Vacant residential swimming in the real estate bubble.

In the middle of 2008, the State Grid Corporation of China (SGCC) observes that there are 65.4 million houses in 661 cities of China have no electricity consumption records for six consecutive months. In other words, there are 65.4 million vacant residential units which available for one hundred million people to live. And based on that, the housing vacancy rate of China has been calculated out as around 25% which is more than 2 times of the national reasonable housing vacancy range (generally is 5% - 10%). Because of that, many scholars and reporters are paid attention on the housing vacancy problem in China and found out the even more serious truth. March of 2010, Jiyang Liang (CPPCC National Committee member) point out this at least 40% land out of real estate development land is still cornered by land agents, and the housing vacancy rates of some large cities in China are reached 50%.  The video below is documentary by SBS Dateline (Australian TV) which is talks about the vacancy problem in China.

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However, in the meantime, the observation is seriously against and boycotted by real estate developers. Zhiqiang Ren (the board chairman of Hua Yuan Group which is a famous real estate agency in China) argues that the housing vacancy rate in China is only 4% which indicates that there are no bubbles in Chinese realty business.

25% or 4%, which is right? To be honest, I don't know the 25% is right or not. Through calculate price-to-rents ratio and price-income ratio, I can absolutely make sure that 4% is totally wrong. In general, the price-to-rents ratio should around 1/200 and couldn't lower than 1/250, which means that we can withdraw our investment funds with 200-250 monthly rents. In other words, this kind of investment is valuable, if not, then the investment is loss or in long-term depreciation which is no investment value. However, it in Shenzhen is lower than 1/500 and in Shanghai and Beijing is around 1/480. Therefore, the real estate in China actually has no investment values. The price-income ratio is another important tool to evaluate the bubbles in real estate. This ratio in Beijing is 1/20 and in some cities is around 1/40 which are obviously higher than the national reasonable range (1/3-1/6). Based on the comparison of two ratios above, the result is clearly showed out the 25% housing vacancy rate should be a reasonable estimate and there are serious bubbles in Chinese real estate.