The housing bubble dilemma

It has produced a series of undesirable economic, social and even political consequences

DURING the last decade, China's housing bubble has been a serious concern. The average house price in big cities like Shanghai and Beijing is now over 25,000 yuan (S$5,100) per square metre (by comparison, the resale price of HDB flats is around 15,000 yuan per square metre). Ten years ago, it was only around 5,000 yuan.

In what was an unexpected but nationwide trend, there was a quick recovery of the housing market in China after the world economic crisis in 2008. The crisis had only caused China's housing market to stagnate for half a year. In the previous 10 years, China had barely experienced any downturn in its housing market.

How was it that the housing bubble in China could last for so long? A simple explanation is market disequilibrium caused by the quick expansion of demand but limited land supply. The main factors behind the high housing demand in urban China are clear. They include rapid urbanisation over the past decade which resulted in about 200 million people moving from the rural areas to the cities; fast economic growth, which has given rise to a growing class of suddenly-rich households with strong purchasing power; and the idle capital which entered the property market - both as a store of value and for speculation due to the scarcity of other investment opportunities.

The restricted land supply, on the other hand, is simply due to the government's land supply control and China's land laws.

In view of the housing bubble, the central government has tried repeatedly to use policies to curb housing price increases. It has restricted land use for low density buildings and independent house construction. It has also restricted housing loans, as well as foreign home purchases. Unfortunately, all these policies have failed. Increasing land supply seems to be the last measure in the government's attempts to moderate the market pressure.

But supplying more land for urban development affects China's other long term national objective - protection of arable land for food security. China now faces a dilemma of whether to loosen the restrictions on land supply and forego food security or live with the housing bubble but maintain food security. Both are unappealing options.

Alongside the sizzling housing market, a series of undesirable economic, social and even political consequences are becoming evident. The society is bewildered and angered by frequent instances of corruption, huge profits of property developers, and the violence sometimes associated with land acquisition, among other issues.

The immediate economic impact of the housing bubble is the deterioration of housing affordability for low-income citizens. Official figures in China reveal that the average housing price in big cities is around eight times the average annual household income, which is much higher than the international standard of five times. In the top few big cities, the actual situation is even worse than the average. The big gap between high housing prices and low purchasing power of the majority of people has resulted in a very strange phenomenon in China, in which the vacancy rate of new housing has remained at a very high level of around 20 per cent.

In September 2008, I visited a suburb in Tianjin City, the Baodi District, where one of the largest property projects in China, comprising 8,000 independent houses, is located. Most of the completed houses were vacant. They were either purchased but not occupied, or not sold. Such developments reflect a huge waste of resources.

Why do housing prices not go down with such high vacancy rates? Part of the answer lies in the abnormally high profits of land developers in China due to their monopoly power over the limited land supply. Developers have become an obvious target among people who allege that China's wealth distribution mechanism is unfair.

How high are developers' profits? When I visited Nanjing city in January 2009 and asked one of my former students who was a CEO of a land development firm about the profit margin, his response was that even if prices were to fall by 50 per cent, his company's profit could still be maintained. This may not be true of all developers, but it does support the common belief.

Given high demand and limited land supply, the profits of developers are simply determined by the land cost. The land supply in China is, however, controlled by the government. Local governments are the only authorised direct land suppliers for urban development.

In the early years, many developers got land at low cost from local governments. Indeed, most of the biggest corruption scandals in China were related to local government land supplies. Only in recent years has strict open-bidding systems resulted in higher land prices for developers. However, even with the high land cost, developers can still partially enjoy monopoly power as housing demand expands faster.

Also, while urban municipal governments in China have the right to acquire land from villagers for urban development with central government approval, rural farmers do not have the right to sell their land, even when they are the owners. This is partly why land acquisition disputes have become one of the most high-profile social issues in China.

As a result of paying low compensation to farmers for land and charging high prices to developers, local governments have been able to use land as a significant source of capital. It is said that land profits could account for as much as two thirds of many local governments' revenue. Local governments have also relied on the housing construction as a rapid means to spur the development of other industries, especially after the crisis.

In dealing with all the complaints related to China's long-drawn housing bubble, the Chinese government must balance food security considerations, implications of the distorted housing market with economic growth imperatives. Trade-offs must be made, but change can only happen at a gradual pace. Some moderation of housing market pressure can be expected via increased land supply, the removal of incentives for speculation and provision of subsidised housing for low-income citizens. But achieving this goal could take five to ten years.

The writer is Associate Professor at the Department of Economics, Nanyang Technological University

Source: Business Times, 12 Jul 2010