China’s property market is at risk of an overcorrection, not oversupply -- views from Weijian Shan

China’s property sector woes not spreading into a financial crisis; A policy-induced housing crisis partly due to restrictions

Good evening. Today's post features Weijian Shan's latest opinion column on China's real estate sector, published in the South China Morning Post on Wednesday, April 3.

In recent months, both during my travels in the United States and in conversations with Chinese economists in China, I've noticed a consensus that tackling the real estate challenge is crucial for forecasting the future direction of China's economy. With this context, I find Mr. Shan's insights on the issue particularly enlightening and valuable. Therefore, I've obtained permission from Mr. Shan to share his article with you.

Weijian Shan is the Executive Chairman of PAG, a leading private equity firm, and is recognized as one of the most influential figures in the Asian private equity space. His articles, addressing concerns about China's development in "Is China's economy doomed?" and analyzing China's growth potential in "Will China continue to grow? -- views from Weijian Shan," have garnered significant attention among GRR's readers. He is also the author of Out of the Gobi, Money Games and Money Machine. I've been reading Out of the Gobi recently, and I've found it to be an exceptional book. I strongly recommend it.

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China’s property market is at risk of an overcorrection, not oversupply

Weijian Shan

A Chinese former official made headlines last September by saying that China had so many vacant homes that even its 1.4 billion population cannot hope to fill them all. Estimates suggested there were enough vacant properties to house as many as 3 billion people.

If true, China’s housing market is doomed. But, to paraphrase Mark Twain, reports of the market’s demise are an exaggeration.

According to the national statistics bureau, China has built 14.4 billion square meters (155 billion square feet) of saleable homes – excluding self-built homes such as in rural areas – over the past 30 years. In 2020, the per capita urban living space was 38.6 square meters, meaning that in three decades, China had built enough housing for 370 million people, just 40 percent of its urban population of 920 million. How many empty homes can there be?

There are two signs of significant oversupply in residential markets, according to economist Gao Shanwen, who based his work on data from economies including Japan and the United States.

The first is a prolonged contraction in transactions for resale homes. But in China last year, according to Beike Research Institute, resale home transactions surged, rising by 44 percent in terms of floor space sold and by 30 percent in transaction value.

The second is when investments in residential property development represent more than 7 percent of a country’s gross domestic product. In China, this ratio hit about 12 percent in 2013 but has fallen since, and is expected to be around 5.5 percent this year.

Therefore, Gao concludes, while there is a significant overcorrection in China’s residential property development sector, there is no oversupply in the housing market. The market correction has been so severe it has tipped over into an overcorrection.

China’s housing crisis isn’t over.

Even though overall home sales rose last year, by 6.3 percent in floor space and 5.8 percent in value, sales of new homes slumped by 8.2 percent in floor space and 6 percent in value. This is because developers are prohibited from selling new homes below certain prices, presumably to protect property values. Consequently, developers may not be able to offer new homes at market-clearing prices.

As of the end of last year, China’s home price index has slid 9 percent from its 2021 peak, creating a “negative wealth” effect that is dampening consumption and slowing down the economy’s transition from being investment-led to consumption-driven.

Meanwhile, many Chinese property developers are mired in financial difficulty or insolvency. Bankruptcies of property companies almost quintupled from 123 in 2022 to 590 last year. Defaults or the restructurings of offshore bonds issued by Chinese developers are more the rule than the exception.

Will China’s housing sector woes lead to a financial crisis like in the US and Europe in 2008? The answer is no, for three reasons.

First, the average loan-to-value ratio of home mortgages in China’s major cities is about 50 percent, which means that housing prices will have to fall by more than half to put mortgages at risk. That is not even remotely likely, and the ratio of non-performing housing loans among Chinese banks remains below 1 percent, according to ratings agency S&P.

Second, home loans are unlimited personal liabilities in China, so homeowners cannot simply walk away from them as one can in the US. So defaults are rare.

Third, banks’ exposure to developers represents less than 5 percent of their loan book, all of which is collateralized. Chinese banks are well-capitalized, with an average capital adequacy ratio of more than 15 percent, and an average non-performing loan ratio of about 1.6 percent.

Yes, non-performing loans have been rising in recent years. But banks are selling or writing them off quickly because the regulatory requirement for reserves to cover non-performing loans is more than 100 percent, making such debt not worth holding on to.

Indeed, China’s banking system faces a unique problem of having too much cash. Household deposits increased by 18 trillion yuan (US$2.5 trillion) in 2022 and a further 17 trillion yuan last year as consumers continue to hold back.

But the housing crisis continues to retard China’s economic recovery. The property sector’s contribution to gross domestic growth was a negative 4 percent in 2022. The good news is that this recovered to a negative 1.3 percent last year and is expected to further improve to a negative 0.9 percent this year, according to UBS.

Sources: CEIC, UBS

The prevailing view of China’s property market is that the housing crisis was inevitable, driven by the bursting of a property bubble and the immutable laws of supply and demand. In fact, it was largely policy-induced, as the government took measures to cool down the overheated sector by limiting purchases and controlling prices, mortgages and credit to developers.

The tightening in recent years has become so draconian as to choke the air out of the property market. Many of these cooling policies continue to suppress demand. For example, the Chinese can buy properties around the world but not in some major Chinese cities unless they are residents buying their primary home. Where else do policymakers handle a housing crisis by limiting home purchases?

The latent demand for housing is substantial. The Chinese have always considered residential properties the most preferred asset class to invest in. Whereas in the US, residential properties represent only about 25 percent of household wealth, this ratio is about 59 percent in China.

China is on track to increase its urbanization rate from around 65 percent now to 73 percent by 2035, which will add more than 100 million people to the urban population – all of whom require housing.

To avoid prolonged pain, it is advisable to remove all remaining restrictions on housing prices and demand, allowing the market to adjust itself and find its footing. Hong Kong set a good example by doing so in February, which immediately sparked a surge in property transactions. It is only by stabilizing the property market that public confidence can be restored, private consumption can resume and economic growth can reaccelerate.

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