Will China’s housing bust turn foreign buyers into desperate sellers?
A housing bubble bust in China may prompt Chinese investors to dump their California investment properties to generate cash to pay debts to Chinese banks.
Chinese citizens invest in housing because it’s one of the few investment opportunities available to them. Until recently, there were no property taxes in China, so it cost very little to own property, so many Chinese invested in real estate as a store of wealth. Once valuations became detached from any fundamental value based on cashflow, the Chinese housing market became a Ponzi scheme similar to the US housing market during our bubble — except that the Chinese bubble is much, much larger. Is it ready to burst?
By Gwynn Guilford @sinoceros March 19, 2014
Investment drives China’s economy. And housing fuels a large share of that investment, contributing 33% of fixed-asset investment, says Zhang Zhiwei, an economist at Nomura—and, consequently, 16% of GDP. The decade-long housing boom that’s kept China’s GDP aloft has so far defied the bubble warnings, which began as far back as 2007.
But the building binge is finally catching up with China. Not just because sales are faltering (paywall). After building around 13.4% more floorspace each year, China finally has too much housing, argues Zhang in a note this week. The quirks of China’s economic model mean that a housing crash will be more devastating for the economy than many realize. …
But housing supply is tricky to make sense of when, thanks to China’s closed capital account, apartments are traded like stocks. Despite reports of housing gluts in smaller cities, many take heart in the fact that sales in first-tier cities—Beijing, Shanghai, Guangzhou and Shenzhen—remain robust, thanks to higher incomes among residents, and because people from other cities buy property in the big metropolises as investments. …
“This is comparable to when the US property bubble burst, since property prices did not collapse in New York, but instead in places like Orlando and Las Vegas,” Zhang says. “In China, the true risks of a sharp correction in the property market fall in third- and fourth-tier cities, which are not on investors’ radar screens.”
If China’s housing market crashes, the ripple effect could be even more cataclysmic for its economy than the recent housing market collapses in the US and Europe were for their economies. A fifth of outstanding loans and a quarter of new loans are to property developers, says Nomura; untold billions more have been lent out off bank balance sheets. As falling prices crimp margins, small developers—like the one in the news this week—will start defaulting.
But the fallout will be bigger still, says Patrick Chovanec of Silvercrest Asset Management. ”Not only is property important because it’s a key component of that investment boom, but it’s essentially the asset that underwrites all credit in the Chinese economy, whether it’s local government loans, whether it’s business loans,” Chovanec says, explaining that lenders require “hard” assets as collateral because financial accounts can easily be doctored.
This creates a circular system. ”All these loans are being made on the basis of property as collateral, which then goes into property and bids up the price of property,” he explains. “And then the property price—the price of the collateral—goes up, and you can get more loans. That’s a very dangerous cycle.”
That’s a Ponzi scheme. I wrote about this issue in depth in the post Would rental parity analysis in appraisals prevent another housing bubble? The problem is one of valuation: when the benchmark for valuation is only comparable sales, which it is in China and in our own residential real estate market, then each sale represents a higher comparable value justifying an even larger loan. There is no tether to real, underlying value as determined by cashflow. That makes for a dangerously unstable market because loan payments are not backed by rent. If a few borrowers become insolvent, the entire system crashes.
The housing bubble in China may finally burst. If it does, the fallout will be epic, and it may have global repercussions. Our own real estate market has enjoyed some influx of Chinese investment; I know because I live in a rental owned by a Chinese investor. I recently asked, Are the Chinese buying California homes in large numbers? The answer is: not really. In August of 2013, the OC Register published Foreign investors buying homes in O.C, and they reported that foreign buyers represent between 5% and 7% of the housing market.
But what happens if that 5% to 7% become sellers instead of buyers? What if the pretenders who borrowed their way to prosperity (yes, some Chinese did this too), what if they need the money to make debt-service payments?
One of the primary drivers of the real estate bubble in the past several years, particularly in the ultra-luxury segment, were megawealthy Chinese buyers, seeking to park their cash into the safety of offshore real estate where it was deemed inaccessible to mainland regulators and overseers …
But more so than mere analyses which speculate on the true state of the Chinese record credit-fueled economy, such as the one we posted earlier today in which Morgan Stanley noted that China’s “Minsky Moment” has finally arrived, we now can judge them by their actions.
And sure enough, it didn’t take long before the debris from China’s sharp, sudden attempt to “realign” its runaway credit bubble, including the first ever corporate bond default earlier this month, floated right back to the surface.
Cash-strapped Chinese are scrambling to sell their luxury homes in Hong Kong, and some are knocking up to a fifth off the price for a quick sale, as a liquidity crunch looms on the mainland.
Wealthy Chinese were blamed for pushing up property prices in the former British territory, where they accounted for 43 percent of new luxury home sales in the third quarter of 2012, before a tax hike on foreign buyers was announced.
The rush to sell coincides with a forecast 10 percent drop in property prices this year as the tax increase and rising borrowing costs cool demand. At the same time, credit conditions in China have tightened. Earlier this week, the looming bankruptcy of a Chinese property developer owing 3.5 billion yuan ($565.25 million) heightened concerns that financial risk was spreading.
“Some of the mainland sellers have liquidity issues – say, their companies in China have some difficulties – so they sold the houses to get cash,” said Norton Ng, account manager at a Centaline Property real estate office close to the China border, where luxury houses costing up to HK$30 million ($3.9 million) have been popular with mainland buyers.
Alas, as the recent events in China, chronicled in minute detail here have revealed, the “liquidity issues” of the mainland sellers are about to go from bad to much worse.
Those who don’t have issues with debt will likely be very happy they parked their money in California real estate, and they will hold their properties; however, the ones who ran personal Ponzi schemes will implode, sell their properties to meet their financial obligations, and potentially disrupt our real estate market in the process. If a significant portion of our demand suddenly becomes must-sell supply, that will not be a boost to home prices.