In the two decades since China’s State Council officially classified the real-estate sector as a “pillar industry,” the sector has undergone rapid development, propelling GDP growth and inspiring in millions of Chinese the dream of owning their own home. But the sector is now plagued by problems, from high prices to massive debts, and threatens to undermine growth at a time when China can ill afford it.
Though there is no private land ownership in China, households are eager to own their own homes, both to improve their living conditions and to accumulate wealth. Chinese cannot easily purchase foreign assets, owing to capital controls, and Chinese stock exchanges have not been performing strongly. China does not tax residential real estate, capital gains, or inheritance — and promises major gains in value. As a result, property becomes the most attractive asset form to own.
China’s government has repeatedly attempted to rein in housing prices… [b]ut such measures have proved largely ineffective and sometimes even counterproductive.
From 2005 to 2021, the real price index for residential property in China increased by 28.5 percent, from 87.95 to 112.99. While the price index has fallen a few times over the years, it has always rebounded strongly, giving Chinese the impression that, when it comes to wealth accumulation, home ownership is practically a sure thing.
But as expectations of rising housing prices and speculation cause actual prices to increase at a far higher rate than growth in household disposable income — homes have become increasingly unaffordable for young Chinese people, let alone migrant workers, who do not enjoy the same rights as permanent city residents. In some first-tier cities, housing units cost more than 40 times the average income.
China’s government has repeatedly attempted to rein in housing prices, such as by restricting the number of real-estate purchases a single household can make and even imposing administrative controls on house prices. But such measures have proved largely ineffective and sometimes even counterproductive. While this is partly because buyers and sellers find ways to circumvent the restrictions, the fundamental reason is that the real-estate sector has effectively hijacked the Chinese economy.
The real-estate sector has a very long value chain, so whatever happens there has far-reaching effects, both upstream and downstream. Slower growth in housing prices leads to slower growth in real-estate investment. Since such investment and related activities account for a major share of Chinese GDP – more than 10 percent, on average, over the last decade – this drags down overall economic growth.
For years, whenever this happened, China’s government would respond by loosening or reversing whatever measures were impeding price growth, opening the way for a powerful recovery in both real-estate investment and property prices. After the 2014-15 crash, housing prices surged – and continued to increase for the next six years, in what amounted to the longest (mostly) uninterrupted price rise since 2003.
So, in 2021, China’s government again intervened, introducing three “red lines” for real-estate developers. If any developer had a liability-to-asset ratio of more than 70 percent, a net gearing ratio of more than 100 percent, or a cash-to-short-term-debt ratio of more than 100 percent, it would lose access to bank credit. Not surprisingly, the housing price index soon started to fall, followed by growth in real-estate investment.
What was surprising was the magnitude of the fall: in 2022, real-estate investment plummeted by 10 percent year on year. And even though the government soon loosened its restrictive policy significantly, the familiar rebound never materialized. On the contrary, in the first ten months of 2023, growth in real-estate investment fell by another 9.3 percent year on year, and the amount of unsold floor space increased by 18.3 percent.
Today, a growing number of real-estate developers are teetering on the brink of default, owing to the combination of high liability-to-asset ratios and a liquidity shortage. And some – most notably Evergrande, China’s second-largest developer – have already fallen over the edge. While the Chinese regulatory authorities insist that Evergrande’s default is a one-off event that will have little impact on the market, there is no denying the rising risks in the property sector. In the past, China always managed to muddle through, but this time may well be different.
To be sure, defaults among real-estate developers, even very large ones, are unlikely to cause a systemic financial crisis in China. At the end of the third quarter of this year, outstanding bank loans in China totaled CN¥234.5 trillion ($33 trillion), with mortgage loans accounting for just CN¥39 trillion (16.6 percent of the total), and credit to real-estate developers stood at ¥13 trillion (5.6 percent of the total). Given high standards for borrowers and large down-payment requirements, the quality of mortgage loans in China is high.
…China’s government can contain the financial risks by putting real-estate developers that are at risk of insolvency under greater government control…
The problem facing banks is not the prospect of large-scale borrower delinquency, but rather a growing desire among borrowers to repay their mortgage loans early. While Chinese banks’ non-performing-loan ratio is currently very low – below 2 percent – it could rise sharply if the government fails to address the deteriorating finances of developers (and their upstream and downstream firms).
Beyond the liquidation and restructuring of failed real-estate developers, China’s government can contain the financial risks by putting real-estate developers that are at risk of insolvency under greater government control, whether through conservatorship or temporary nationalization. It could also provide liquidity to solvent developers that need it and purchase the (financial or physical) assets of developers that are under pressure to offer “fire sales.”
With a relatively strong fiscal position and a central bank with space to adopt a more expansionary monetary policy, China should be able to facilitate solutions to the real-estate industry’s debt woes. One hopes the Chinese government will muddle through yet again.
Credit: Project Syndicate, 2023.
Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006.
