There have been many metaphors thrown up over the years on the state of China’s real estate market. From warnings of a bubble about to burst to predictions of ghost cities haunting its future, the alarm bells have been ringing loudly.
Many observers have drawn parallels with the U.S. subprime crisis. Yet within China, despite the government’s curbs on speculation, demand continues to push prices upwards in the major cities of Beijing, Shanghai, Shenzhen and Guangzhou.
Indeed, over the course of 2017, the upward pressure on prices started to extend to China’s provincial capitals, resulting in local governments stepping in with radical policies to cool the market.
How does one reconcile the macroeconomic narrative of over-supply with the equally powerful reality of rising prices and unfulfilled demand?
Driven by Local Economic Performance
Unless your interest is purely academic, it never makes sense for individual investors or households to interpret local buying opportunities through the lens of aggregate national economic data and trends. The residential housing market is almost always driven by the local economy.
Even at the height of the U.S. subprime crisis, cities with a strong economic base like Seattle and San Francisco remained resilient, led recovery and went on to hit new price levels within a few years. This is because the economy and employment levels in these cities are powered by companies with a global presence that cushioned the national economic shock.
Likewise, the investors and homeowners that made money were the ones who had done their homework on quality locations and bought into cities growing faster than the national average.
Fundamentals Powering Demand
In China, the forces driving residential property demand have not changed in the past 20 years despite a series of government interventions. Against a tide of urbanization, rising middle-class income and the anomaly of a one-child policy, the trajectory of the housing market in key cities such as Shenzhen, Shanghai and Beijing is a predictable consequence.
High economic growth across diverse sectors created employment opportunities attracting talent from across the country. The fundamentals of rising population, income and employment sustained over two decades created real demand that powered housing prices to grow more than 600% in these cities.
While this caused loud protests from young people over the affordability of housing and resulted in the government imposing cooling measures, these fundamentals continue to exert upward pressure on prices.
In Beijing for example, from 2000 to 2016, the city’s population doubled to 21 million with a corresponding GDP expansion of 800%. The resulting increase in average income by more than seven times inevitably led to a near corresponding increase in residential property prices.
The astronomical rise in prices is simply the result of rising population with rising income chasing limited supply in choice locations close to employment opportunities.
Another factor driving demand and prices is the large floating population of commuting professionals and businessmen from neighboring provinces and buyers among the expatriate and overseas Chinese community.
With China’s growth Beijing, Shanghai and Shenzhen become global cities with a growing international community. As a result of this pressure, eligibility restrictions on foreign buyers were first introduced in 2012 and the policy was later adopted nationally.
Due to such regulations, the current price level can be deemed artificially restrained by multiple cooling measures that distort actual market demand.
Actual Affordability & Real Market Size
In China there are also unique socio-cultural forces at work. Forty years of the one-child policy, for example, has created a situation where parents are desperate to provide the best for their only child.
One pre-requisite for a young man to find a bride is to secure the approval of his future in-laws. Not surprisingly home ownership becomes a required qualification of a future son-in-law. This translates to parents setting aside significant funds to help secure a home for their son while the in-laws provide “gifts” in the form of appliances and furniture. Many parents also hope to move in with their children to care for the grandchildren while the young couple focus on furthering their careers.
Hence the seemingly out of reach price level was further supported and shared by additional financial provisions from both parents aiming to usher into the world a precious grandchild to continue the family name.
Is it really overpriced?
Another intuitive perspective to assess real estate price levels in China’s leading cities is to compare them with similar economic centers around the world. A quick glance at global statistics reveals that on average per square meter, London is 2.5 times the price of Beijing and Singapore is three times the price of Shanghai. At current levels, avera