China's housing market – irrational exuberance?
REAL estate has been a key driver of China's rapid growth in the past decade. Residential real estate investment grew rapidly as a share of GDP over the past decade, and it currently stands at a high level relative to other economies. Real estate has strong links to other sectors of the economy as well – together with construction, it makes up roughly 15 per cent of total output.
China's property market is also unique in its unusually abbreviated cycles, having undergone almost four full cycles over the past decade. In other economies, we would expect to see one, or even half a cycle, in this time period. Housing price growth has continued to accelerate despite the peak in residential construction growth. This upturn is particularly pronounced in the tier one cities – Beijing, Shanghai, Guangzhou and Shenzhen – leading some to call a housing bubble.
Spotting bubbles is notoriously difficult with the Chinese property market no exception. Admittedly, the term ‘bubble' is often misused. By its purest definition, a bubble is a phenomenon whereby excessive expectations of future price increases lead asset prices to become elevated well above their fundamental values. Just because housing prices are rising rapidly, it doesn't mean that a bubble exists – the price increases must be significantly out of step with the fundamental values.
The very high growth rates of Chinese house prices need to be viewed in context. China's house price boom was accompanied by equally spectacular growth in households' disposable income. This joint presence of enormous house price appreciation and income growth contrasts the past housing bubbles in developed economies such as the US and Japan. Even during the Japanese housing bubble of the late 1980s, Japan was already growing at a more modest rate than that still enjoyed by China.
Besides that, financial repression might also mean that Chinese housing valuations are, for the moment, structurally higher relative to developed economies. Chinese households have high savings rates, but few avenues to invest their cash due to capital controls. Faced with this constrained investment set, it has been common for households to treat housing as an alternative investment vehicle, which also helps explain their willingness to pay relatively dearly for it.
Finally, there is apparently evidence that high and rising prices are partly caused by local government intervention. Some economists have claimed that Chinese housing isn't suffering from a bubble, but a severe fundamental imbalance between land supply and demand. Smaller cities have plenty of land for building but shrinking populations. Big cities, where people actually want to live and work, are sitting on large land banks but releasing only small plots. The obvious result has been soaring home prices.
Ultimately, much remains unknown regarding the Chinese housing market – there is simply too little data and historical precedent to take a conclusive stand on whether the sector is experiencing a bubble. While a house price crash would likely lead to a growth slowdown, the chances of it turning into a full-scale US-style subprime crisis seems unlikely to us.
Despite the housing market being a classic ‘known unknown', basing investment decisions on timing it is difficult to say the least – investors have been shorting the Chinese housing market for years, with little to show for it. Ultimately, we still recommend investing based on what we know – that growth is the norm, and diversification remains the best hedge against any potential Chinese housing bust.
:: Jonathan Dobbin is head of wealth and investment management NI at Barclays. He can be contacted on 028 9088 2925 or email firstname.lastname@example.org