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Why China’s property bubble may be inflating

Customers and realtors look at building models at an exhibition in Jiashan in East China.
AFP | AFP | Getty Images

The rapid rise in house prices in big Chinese cities may mean a real estate bubble is inflating to bursting point, UBS warned on Tuesday.

"A stronger property rally lasting into 2017 may increase the risk of another major round of downward adjustments thereafter. Investors should closely monitor property sales, new property starts and property investment for near-term upside risk, which may increase the medium-term downside risk," UBS Economist Tao Wang said in a report on Tuesday.

Chinese property sales growth reaccelerated in 2016, increasing by 25 percent year-on-year, year-to-date, according to Wang. Property starts grew 12 percent year-on-year in the same period, after two years of decline.

Property prices in some cities have risen by 30-40 percent or even 50 percent year-to-date, Wang said. While the rally is spreading, many smaller cities are still struggling with oversupply.

"The property recovery has helped to stabilize domestic demand and the overall economy, but the recent +30 percent y/y ytd (year-on-year, year-to-date ) price rally across a number of big cities has heightened policymaker concerns that another property bubble is being reflated, especially with leverage rising so sharply," Wang said.

Four of the five cities with the fastest-rising global housing markets in the year to March were in China, according to real estate agency Knight Frank. These were Shenzhen, Shanghai, Nanjing and Beijing, where house prices rallied bybetween 62.5 percent and 17.6 percent in the period.

China's property recovery follows two years of policy relaxations, starting with the easing of home purchase restrictions in 2014.

Investors should watch for the government's response if the rally shows signs of bubbling, Wang said.

"The spreading of surging price momentum to more cities alongside an alarming rise in leverage could trigger more aggressive policy tightening, cooling the property rally," Wang said.

How the property market fares will be tied to China's overall economic performance. The International Monetary Fund sees Chinese economic growth continuing to slow, but remaining high compared to global norms. Gross domestic product (GDP) expansion is forecast by the institution at 6.6 percent this year and 6.2 percent in 2017.

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Construction of apartment buildings in Wuhan, China last month.
Zhang Peng | LightRocket | Getty Images