China's Housing Bomb

keeps burning, though the fuse is getting shorter.



In an recent article (Year of the Hot Rabbit) I related the news that property purchase restrictions have been introduced in more than 40 of China’s major cities, in an effort to deflate their massive property bubbles.

In Beijing, for example, a property purchaser must prove residency status to purchase in that city, and is restricted to owning one primary residence and one additional property. The days where a non-resident investor could buy 20 or 30 properties is - at least according to the rules - over. For the moment, these rules seem to be working. In fact, they are working too well, and could potentially obliterate the bubble rather than deflate it slowly.

According to China Real Estate Index System (CREIS) statistics, home prices sank in most of China’s largest cities in March. For instance, prices in Shanghai dropped 7.6% in that month alone: an annualized rate of 91.2%! Most of this titanic drop occurred in the final week of March, where prices sank 5% (260% annualized). These large nationwide drops occurred despite very high volumes in “home trading” (their words, not mine).

Following the lead of real estate spokespersons throughout history, Zhu Zhongyi, Vice Secretary-General of the China Real Estate Association, said he predicts a “modest decline” in prices, adding that a large decline in real estate prices is “not quite possible.” He said this quite seriously, as if saying it seriously makes it true.

Nonetheless, not everyone has given up hope on one of the greatest booms in real estate history. Lin Lei, in charge of marketing for 21 Century Real Estate (not to be confused with Century 21, despite the libelously similar name), said that the market would drop only “if restriction policies were carried out strictly.” In other words, he hopes that if real estate prices continue to drop, government officials will simply ignore the new rules. Red "gift" envelopes are likely to fly off store shelves.

And the bubble continues...

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“Having a third party sign a mortgage loan contract on behalf of another person is a serious offense, and banks and financial institutions have to examine their own operations and investigate to find out who is responsible for such offenses.”

The China Banking Regulatory Commission, March 2011
(Showing that already, Chinese citizens are trying to get around new regulations that home buyers in a city must be residents of that city).
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For further information, see:
China's housing prices expected to drop, but not sharply, in second quarter

Year of the Hot Rabbit

Chinese real estate - hot as ever. But when will it fall?

Last week, the Chinese government implemented yet another measure to reign in the uncontrollable speculation that is gripping the Chinese real estate market.

Already implemented this year were new property sales taxes in Shanghai, and nationwide minimum down payments (for second properties) of 50-60%. This is on top of the Central Bank's three interest rates hikes since October. Now, as of this week, there are new rules for ownership in cities all over the country. In Beijing, for example, only residents are allowed to buy real estate (as proven by 5 years of tax returns and a residence card), and are limited to only one investment property.

It seems that due to strong new beliefs in capitalism, mixed with ancient beliefs about luck and prosperity, no one is getting the hint. Home prices are expected to increase another 6.4% for this year, despite public complaints about soaring costs.

It is impossible to say for how much longer this nonsense will continue. But one thing is certain - the longer it lasts, the more devastating the fall will be. My crystal ball, though hazy, sees the potential for riots.

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"Speculation is only a word covering the making of money out of the manipulation of prices, instead of supplying goods and services."

Henry Ford

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Chinese Real Estate - Trip Report

Back from China…

First off, my impressions of the housing market in China - one of my primary reasons for visiting Shanghai.

Virtually everyone I spoke with admitted that the Chinese housing market is “expensive.” Yet, when asked if prices would drop, almost everyone answered with a blunt, “No.” When I inquired further (ex. “Why not?”) I received any one of a number of points exhibiting national or local pride. For example, that Shanghai is “a great place to live. Everyone wants to live here.” Or, that “the Chinese people have an entrepreneurial spirit, and so prices will keep going up.” And of course the real estate bubble classic: “There is a limited amount of space.”

Then I asked the follow-up question: “Are you planning on buying a home?” Only two out of dozens said “Yes.” A few said they already own one. Many added that they would buy “if they had enough money.” Therein lies the problem.

An inexpensive one-bedroom condo in Shanghai costs around $140,000 USD. An inexpensive two-bedroom condo costs around $205,000 USD. At the surface, this does not seem overly expensive; that is, not until one remembers the reality of Chinese prices.

For reference, I had a three-course meal and two beer at a local restaurant for $6 USD. A 30-minute subway ride costs 22 cents. Despite recent prosperity, the average salary in China is 1/7th that of the United States.

So, that one-bedroom condo is equivalent to $980,000 USD, while the two-bedroom is equivalent to $1.44 million. The average Chinese citizen has no hope of buying even a basic home (unless several generations come together to make a purchase), while wealthy Chinese continue to buy multiple homes on speculation. This cannot last.

When I first started writing about the Chinese housing bubble in January, the media was speaking about it as an “if.” Since then, reality has started to set in. The Chinese government is – to their credit – well aware of the situation, and continues to take steps to lessen the coming catastrophe.

Beginning Aug. 31st 2010, insurance companies will no longer be allowed to hold more than 10% of their assets in property development. The government is also instructing banks to tighten (again) the lending requirements for 3rd+ homebuyers in Beijing, Shanghai and Hangzhou. I would list all the bubble-busting measures the government has implemented previously, but it would be a long list.

As the Chinese and related Asian markets unravel, worldwide construction-related commodity prices (iron, coal, copper etc) should decline. In addition, one should obviously avoid Asian banks, development companies, and in fact any company with non-essential products or services that relies on China for a substantial part of its business.

Despite government measures and media warnings, the Chinese housing bubble remains steadfast: greed, pride, and cognitive dissonance are hard to break. But, as soon as the cracks appear, reality will set in with a vengeance. This bubble is BIG.
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See also: Sell the Chinese Market SHORT!
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"China's economy, in general, is in line with the government's macro-economic regulation and control."

Chinese Premier Wen Jiabao, July 18th 2010
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Chinese Real Estate - the Time Bomb keeps ticking

Back in April, I recommended selling the Chinese market short, a move which many thought "suicidal." Chinese industrial numbers at the time looked fantastic - and still do. Nonetheless, the Shanghai Composite Index tanked exactly as I suspected, going from 3130 to 2365, a 32% loss (providing a 32% gain for short-sellers) in only two and a half months.

The market has since recovered slightly (to 2560), and the world economic picture looks somewhat brighter. So the question is, should you finish taking profits or keep the short sale going?

Despite drastic government measures, the euphoric mood of the Chinese market appears to have barely subsided. Prices remain stratospheric. Speculation remains rampant. Gleaming condos continue to rise.

A Xinhua news agency article from July 24th (Realty trouble in the offing), recognized that the housing bubble is still out of control, bluntly noting that "skyrocketing housing prices are the outcome of artificial speculation." In addition to calling the market "bloated," it adds that price rises could result in "social conflicts and lead to social unrests."

No, the Chinese meltdown is not over. But, the market fall may take a short hiatus (ie. make a slight recovery) as the world situation temporarily improves. Hopefully not for long, however, since the longer the Chinese euphoria lasts, the more devastating the final fall will be. Be ready to sell short again when the market plateaus.
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This will likely be the last article for the next two weeks, as I am off to Shanghai to find out about the market firsthand.

Thank you for reading The Frost Report.
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Additional reading: Sell the Chinese Market Short
Big realty program to solve house woes
Foreign investors eye China's realty market