World Economy

Chinese property boom props up Xi’s hopes for the economy

Tom Hancock & Gabriel Wildau
Luxury apartment blocks at the seaside city of Sanya, in China's southern Hainan province.
Wang Zhao | AFP | Getty Images

Ocean Flower Island is a vision of luxury, Chinese-style. A man-made archipelago off the coast of the tropical island of Hainan in the South China Sea, it will boast thousands of apartments, 28 museums and 58 hotels including one which is "7-star level" and another shaped like a European castle.

Gold-painted Mercedes golf carts whisk potential customers to the sales centre for the project, where Chinese developer Evergrande Real Estate is leading construction. Inside the centre, Mr Yu, a 56-year-old owner of a building company who asked not to use his full name, wears a shirt emblazoned with the words "Beverly Hills Polo" and sips green tea. He is keen to buy a 108 sq m apartment on one of the islands, adding to his eight properties elsewhere. "The house will definitely increase in value," he says.

As China's Communist party elite gather in Beijing this week to select its top leaders, President Xi Jinping has benefited from the strong recent performance of the economy, which is poised for its first year-on-year acceleration in growth since 2010. On Thursday China reported that gross domestic product grew 6.8 per cent in the third quarter, ahead of Beijing's full-year target.

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That rebound owes much to the confidence of homebuyers like Mr Yu and to projects like Ocean Flower Island. Housing prices and construction starts rebounded from a slump in 2014-15, boosting overall business investment and driving demand for output from China's huge manufacturing sector.

The property sector has been given a helping hand. Urged on by Beijing, 38 per cent of all bank loans issued in the 12 months to August were home mortgages, according to official data, and local governments purchased 18 per cent of all residential floor space sold last year as part of a drive to provide affordable housing, according to estimates by E-House China Research Institute.

The result has been another heady boom in construction. Rome was not built in a day, but based on residential floor area completed last year, China built the equivalent of a new Rome about every six weeks.

With the surge in housing investment has come a round of questions about a potential bubble in the market and the implications for the long-term health of China's economy.

Some economists and investors warn that short-term growth from the latest housing boom has come at a cost: inflating a property bubble whose eventual bursting will inflict great pain. A senior Chinese legislator recently warned in unusually blunt terms that the economy has been "kidnapped" by property.

"The government keeps this market going. Last year, they needed to jump-start property so the economy would be in good shape for the party congress," says Andy Xie, an independent economist and asset manager who has warned about a property bubble. "In the short term it works, but only if people believe the government will protect them."

But others insist that fears of a bubble are overstated. On this view, economic fundamentals justify substantial investment in housing, especially in inland cities where development still lags far behind wealthy coastal areas. These more sanguine observers also note that outrageous price levels for Chinese apartments are mainly restricted to the megacities like Beijing and Shanghai.

Despite its importance, China's real estate market has proved to be tricky for foreign investors and experts to grasp. Dire prophecies of a Chinese housing bubble have been a staple of economic punditry for at least a decade. In 2010, billionaire short-seller James Chanos called China's property market "Dubai times 1,000". But apart from a few cities, the market has experienced only mild corrections.

The stakes in this debate are high. Chinese residential property is arguably the world's most important asset market. The sector drives global commodity prices, making the difference between growth and stagnation for resource exporters like Australia and Brazil.

For China's domestic economy, the world's largest at purchasing-power parity, property investment directly contributed 10 per cent to GDP in 2016. When manufacturing sectors like steel, cement and glass and retail sectors like furniture and home appliances are included, the share is at least 20 per cent. The health of China's banking system, now the world's largest by assets, is also deeply tied to the fate of the property sector.

Developments such as Ocean Flower Island are used on both sides of the debate. To some, it typifies the excesses of the market, which they say feeds on speculative demand in an already oversupplied sector. Evergrande is one of China's most indebted developers.

However, the company has so far defied the sceptics. Short-sellers betting against Evergrande's stock in Hong Kong this year were trounced, as the group's share price has risen sixfold this year. Evergrande chairman Xu Jiayin this year become China's wealthiest man, according to the Hurun rich list.

"It's never wrong to express worry over China's housing market," says Larry Hu, China economist for Macquarie Securities in Hong Kong. "But it's interesting to consider why the housing sector has become the Bermuda Triangle for economic forecasters. So many smart people have made wrong predictions about it."

The leading claim of the housing bears is that after a 15-year construction boom, China has built most of the housing it needs to meet fundamental demand. On this view, investors speculating on price gains, not families seeking shelter, now drive the market.

People buy property not because they like the property, but because the price is rising," says Ning Zhu, professor at the Shanghai Advanced Institute of Finance and author of China's Guaranteed Bubble. "It's this panic that if they don't buy now they will never be able to afford it."

Central to this narrative is the notion of "ghost cities" — huge blocks of empty apartments where expected demand never materialised.

The most extreme example is Ordos in Inner Mongolia, where hundreds of high-rise buildings lay vacant for years but are now slowly filling out. In the mid-2000s, rising coal prices fuelled a building boom, but when growth slowed and coal prices slumped, the city experienced a crisis. In commercial real estate, Tianjin's Yujuiapu skyscraper district, billed as the "Wall Street of North China", remains largely empty.

In Mr Xi's speech at the opening of the congress on Wednesday, he repeated his mantra that "houses are for living in, not for speculation".

Yet even in major cities, evidence suggests that there are a substantial number of empty flats held for investment purposes. A survey by FT Confidential Research, an independent research service owned by the Financial Times, found that 32 per cent of families own at least one home that is vacant.

An estimated 50m homes, or 22 per cent of the total urban housing stock, were vacant in 2013, according to the most recent data from the China Household Finance Survey led by Li Gan, economics professor at Texas A&M University.

"When you look at the relationship between demand for housing and demand for fridges and other items, it really broke down in the last couple of years. So I would say that it is investment demand," says Diana Choyleva, chief economist at Enodo Economics, a London-based independent research company focused on China.

Prominent business leaders and financiers have also expressed concerns about a bubble. Levin Zhu, son of former premier Zhu Rongji and former chief executive of investment bank China International Capital Corp, believes that all new residential construction is essentially oversupply.

"According to the statistics bureau, if you add each year's numbers together, China's current total housing capacity can supply 1bn people at an average rate of 30 sq m per person. Counting even people living in small towns, China has only 700m urban dwellers. That means there is a 300m over-capacity," he told a forum in June.

Further underpinning the bearish outlook is the belief that fundamental demand for new housing is drying up.

The extraordinary transformation of China's economy over the past 40 years was driven by the migration of farmers into cities. That urbanisation process is now slowing, however, as relatively few young people remain in rural China.

The number of migrant workers living outside their home province rose by 12m in the five years through to June this year, compared with an increase of 26m in the five years ending June 2012, according to official data.

Says Mr Xie: "If you go into villages, there are no young and middle-aged people any more. Where is this next wave of urbanisation supposed to come from?"

To longtime observers of China's economy, the current hand-wringing over the property market feels familiar.

After two years of falling prices and sluggish sales, analysts were warning in early 2016 that some smaller cities had enough unsold inventory to last for years.

Yet by August this year, inventories in the 80 cities tracked by E-House China Research Institute stood at their lowest level in almost five years.

"A year ago, my view was that many smaller cities just had to absorb sunk costs. A year later it's a totally different story," says Shuang Ding, head of greater China economic research at Standard Chartered in Hong Kong.

Looking ahead, Mr Ding believes that fundamental demand can support the construction of about 6bn sq m of housing through to 2021, implying growth of about 5 per cent a year in residential property. That would be far below the boom years of the mid-2000s, when overall property investment grew 25 per cent a year on average, but it would still set a floor under growth that will put Mr Xi and the new politburo at ease.

Perceptions of unreasonably high housing prices appear to be disproportionately influenced by trends in first-tier cities — Beijing, Shanghai and Shenzhen. All three rank among the world's most expensive in terms of price-to-income ratio.

Of the 70 cities in the official price survey, however, 12 have seen outright price falls in the three years through to August this year. In a further 29 cities, prices rose by less than 10 per cent in the same period. Meanwhile, median per capital disposable income has grown 28 per cent in roughly the same period.

Despite major concerns about Chinese corporate debt, household borrowing remains low by international standards at 37 per cent of GDP, compared with 79 per cent in the US and 59 per cent in the euro area, according to the Bank for International Settlements. And Chinese homebuyers use less debt and more equity than counterparts in the US. The average downpayment on Chinese home mortgages extended in 2016 was 40 per cent.

Despite their differences, both sides in the debate mostly agree that an outright crash of the housing market is unlikely. Chinese savers have few options for investing their money. The stock market is volatile, returns on bank deposits are meagre and foreign exchange controls largely prevent households from buying foreign assets. Housing is the least bad option for many investors.

The combination of capital controls with years of monetary stimulus virtually ensures that "trapped cash" will slosh through different asset classes, creating bubble-like conditions that the government either encourages or struggles to contain.

Still, given the pain that would result from an abrupt policy shift, analysts widely expect that Beijing will continue the current approach, tightening controls when the market gets too hot, while priming it with cash when it slows too sharply.

"The government is really losing its credibility," says Mr Ning. "At this point everyone realises they don't really intend to crack down on the housing market."

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