China Special (5-1): I disagree with the details of Pivot’s view

on Real Estate, but…

Pivot Capital is quite negative about China’s real estate and it backs up its view with

1. Urbanization rate is (significantly) higher than believed

2. There are no physical shortage of residential real estate
3. Home ownership level in China is high (86% in 2005 vs. 69% in US in 2005)
4. Price to income ratio (“PIR”) have reached 15-20x in major cities and c.10x in regional
cities. (v.s. 9x in London and 12x in L.A. at the peak)

I disagree with these details. In my opinion,

1. Urbanization rate is a red herring. It seems there is no clear definition of “urban” and
while the % of population moving into cities is one driver of the construction demand,
pace of income increase is probably a bigger growth driver. (There is also an argument
that China’s urbanization rate is lower than reported. See “Myths and realities of
urbanization” by UBS published May 2, 2008)
2. Floor space per household should be considered in light with population density. Pivot
writes “In terms of floor space per household levels, China has overtaken South Korea
already in 2003,” but Korea’s population density is about 9x higher than China.
1. Home ownership in China is high because of China’s housing policy history. Previously,
all housing was owned either by government and Danwei(单位), but in the housing
reform that started in 1978 (and accelerated in 1994), government and Danwei sold
housing to dwelling households at subsidized prices. If you have visited those housing
units people bought from Danwei/Gov, you know how small and old these housings
are. Yet, they are still the majority of the housing in China. According to UBS (“All about
China’s property sector downturn,” Sep 2008) Privately developed housing still accounts
for only about 35% of total urban living space. The point is that while most of Chinese
live in their own home, most of these people dream to move to newly developed
housing.
1. Also, if anything, I believe home ownership in China is going down not up. What
is happening is that often as the cities or areas gets redeveloped, the people who
were originally living there in their own house/flat that they bought from
gov/Danwei move out. They get compensation for their housing, but once they
move out they cannot afford to buy a new housing with the compensation
money. This is because
1. Compensation is not at market price (I don’t think this is practice but I
know cases exist)
2. Even when compensation is fare at market price, they get compensated
for 400sqf flat that they owned but the newly developed flats are 800sqf
or bigger.
3. In theory they can pay down payment with compensation money and get
mortgage to pay the rest, but for some reason (no income proof,
insufficient income or personal rejection of indebtedness) they
cannot/do not purchase new home in this way.
4. As a result, the old self-occupying landlords are now renters.
2. PIR seems high, but focusing too much on PIR is wrong because there are two ways to
normalize PIR: one by decline of housing prices and the other by increase of income. In
fast growing countries like China, income growth can outpace property price
growth. Korea is a good example. What you can see is that PIR was once at seemingly
unsustainable level, but PIR came down to reasonable level without crash-like price
adjustment. In addition to this, you have to consider that 1) this PIR understates the
real PIR as I compare “national” housing price to “urban” “wage earners’” household
income, both of which tend to higher than national average household income 2) for
Seoul, PIR must be higher than national average and I wouldn’t be surprised if it was 20-
30x in late 1980’s. Yet, Seoul apartment price, which is the most volatile, did not
crash. (Note: The graph starts at 1986, simply because that is the earliest year I can find
data on.)
China Special (5-2): Clear over-supply of real estate exists in
China?
I wrote about China’s possible property bubble in the past (1, 2) and there are many anecdotes
of property bubble on the web (Guiyang, Beijing Commercial, Ordos, Ghuangzhou). The below
graphs from Colliers show high vacancy rate in offices (c.18% in Beijing, c.13% in Shanghai) and
residential (c.29% in Beijing and c.25% in Shanghai) properties.

Colliers’ information exaggerates the overall situation, because they portray Shanghai/Beijing
Grade A/Luxury property (my experience tells me 1) big cities and 2) higher-end developments tend to have bigger over capacity), but
I think the trend is shared across the country. There are two particularly interesting things the
above graphs reveal:

 Due to fast growth of new supply, 30% over capacity presents more dire problem than
that 5 years ago: Leek at Beijing Luxury Residential graph. It shows that overall supply
in 3Q09 is more than 2.5x that of 3Q2004, but the vacancy rate has been more or less
stable. Yet, if you look at the actual vacant floor space, then you can see that today’s
vacancy is almost equivalent to 2004’s occupancy in floor space terms.
 The graph of Shanghai high-end residential market shows that vacancy has trended up
continuously.

However, despite such over capacity, real estate prices did not correct in significant
manner. Even the much talked price correction of Shenzhen and Guangzhou of late 2007 to
2008 doesn’t seem disastrous when looked at annual term.
So, what is going on? How is this possible? It basically means that increasingly more people
people cannot afford to live in the newly developed properties but some people has enough
money to buy increasingly more new property. This is clearly not what a sustainable or healthy
property market look like. It is the more interesting when you look at the monthly rent trend
graphs from Colliers International. What you can find is that monthly rent per square feet has
been stagnant or declining in China (except for Shanghai Grade A Offices). However, income
has been growing close to double digits (at least until 2008), so why didn’t/doesn’t vacancy rate
decline? One factor could be because average size of new housing has been increasing faster
than people’s income. (I do not have any hard data so I cannot say for sure, but from my
observation I know there is trend of building bigger flats.) Another factor could be that
increasingly new homes are built far outside of cities and people do not want to relocate that
far. However, the dominant factor is that supply at current level over-whelms the demand. Or,
more precisely, there is enough “ownership” demand from the few but not enough
“residency” demand from the majority. But then maybe calling the buyers “the few” is
probably wrong given how much new supply has been there.
No wonder when my friends, not only those very rich but only upper middle class friends, did
not bother to rent out their apartment when they moved to another city or country. The
answer I got was always “how much am I going to get? and all that hassle? it isn’t worth it.” I
will try to find out more about who the buyers are in today’s market in China Special (5-3):
Chinese property market is wrong-supplied rather than over-supplied.

<Update December 4, 2009>

I do not fully believe the rents trend in the above graph. I know from my experience that quite
high-end development have seen rental increases. The real rent (as opposed to nominal rent)
the graphs imply is simply against my experience. However, it is very true that rent did not
increase at the same pace as sales price.

China Special (5-3): Chinese property market is wrong-

supplied rather than over-supplied.
<Question Number 1> What would you say about a property market that after 8 years of boom,
2 years of supply is left vacant? You would probably say it is unsustainable and that it is hard to
believe the market even boomed for 8 years with such a high vacancy rate.

<Question Number 2> What do you think of a property market with about 7% of vacancy
rate? You would probably say it is quite healthy level. (see US vacancy rate at the bottom of the post)

<Question Number 3> What would you say if I tell you the country in Question 1 and Question 2
is actually the same country? Improbable, huh?

But this is what China can be in 2013. Let me tell you how I came to this estimate. In fact, this
is little more than guess rather than estimate, as there is no reliable statistics on vacancy rates
to work with. Anyhow, here it goes:

1. Vacancy rate for commodity housing built within the recent 3-4 years: 20-30%. Reports
(here and here) and my observation tells me some high-end developments in the
outside of city centers have very high (I’ve seen buildings/complexes about 70-80%
empty 1 year after hand over) vacancy rate. But vacancy rate is lower for mid/low end
housing (though they are small % of development) and also lower for more city-center
based housing (very few in cities like Beijing but a lot in cities like Wuhan). Also, in cities
like Lanzhou or Urumqi, the newly built housing seemed to be quite well occupied. So,
while buildings with very high vacancy rate catches my eyes, it is probably more correct
to say 20-30% of total newly built commodity housings is left empty.
2. Vacancy rate for all commodity housing: 10-15%. Given that commodity housing
started in large scale only from 1998, housings built in the 3-4 years should be roughly
30-40% of total commodity housing that exists today. If we assume 5% vacancy rate for
older commodity housing, that gives us 9.5-15% vacancy rate. This seem roughly
correct when checking against 25-30% vacancy rate of Beijing luxury and Shanghai high-
end shown in these graphs.
3. Overall vacancy rate including welfare housing: 3-5%. 40-45% of total living space in
urban area is commodity housing. (UBS wrote in “All about China’s property sector downturn” (Sep ‘08) that 35% of
urban living space is commodity housing.) About 55% of Chinese live in rural area, so let’s assume 45%
of total housing is in rural area. Let’s also assume commodity housing is 20% of rural
living space. Combining all this factors and 10-15% commodity housing vacancy rate
gives 3-5% nation-wide vacancy rate.

From here, you assume an unrealistic assumption that new development will continue at
current pace, but 25% of all new development in the coming 4 years will be left vacant as they
are today (from #1 above). This increases gross vacancy rate by 2.5-3.5%. Adding midpoint of
this to the mid point estimate of 4% (from #3 above) you get c.7.5% gross vacancy rate. (See the
bottom of the post for calculation method.)

Why does this seemingly inconsistent two pictures co-exist? It is mainly because 1) commodity
housing is minority of total housing in China 2) development is concentrated in commodity
housing 3) current purchasing is made by small group of people 4) home ownership level is
currently high at 85% 5) the type of homes supplied do not match the type demand demands.

Now, let’s think about who buys home in China today. In any cities in the world, the buyers can
be categorized into:

ol.withalpha { list-style-type: upper-alpha }

1. Those who are marrying. Buys their first home. Likely take mortgage and for self use.
2. People who move to a new city. If middle class likely to sell the original home to fund
the purchase in the new city which is presumably bigger city and is likely to be for self
use.
3. People who upgrade their housing. Likely taking mortgage for self use.
4. Middle class who have extra money to invest. Owns 2, likely to take mortgage and try
to get utility from the 2nd home either by renting out or by letting their kid live there.
5. Investment companies whose business model is renting housing. Bank loan involved
and tries to let.
6. Professional speculators who own lots units through legal/illegal/gray
methods. Usually flip relatively fast, and do not bother to let out.
7. Very wealthy people who own many units. Probably do not need mortgage loans to
purchase, and don’t care much about letting out.

It is really the mixture that matters. If most of the buyers fall into A, B and C category, then the
market is unlikely to be bubble, but if D-G make up the majority of the purchase, then it is
hardly a healthy market. There is an estimate that the newly wed can take up as much as 450M
sqm of residential property every year. Given that China’s commodity housing sold is about
600m sqm per year (’700M in ‘07, 500M sqm in ‘08 and likely 700M in ‘09), this means the demand from newly wed
is about 75% of the annual supply. However, this is about potential demand not considering
affordability. When you see this kind of subway stunt or two-generation mortgage (granted it seems
to have been introduced in 2006), you doubt that this potential demand of 450M sqm is finding it easy to
buy purchase a home they want.

In my opinion, whether parents can afford to buy new housing for their newly wed son is a
good indicator of affordability at least in Korea and China where parents try their best to
provide housing to their kids (and a family who do not own their own home is not considered
middle class.) When Korea had GDP per capita of US$3,500 (1987-1988), many middle class
parents could buy new housing for their sons who were getting married. And Korea didn’t have
mortgage loan at the time so flats were bought 100% cash. China has per capita GDP of
US$3,500 today and China has mortgage loan product, but most middle class parents already
struggle to pay the down payment for their previous single son. So, while there is potential
450M sqm p.a. of demand from newly wed, the actual purchasing power of this group is in
doubt.
On the other hand, it seems Category F is a bigger portion of the buyers than in other
markets. I certainly hear a lot about them on TV, from friends, and from agents. If you read
Chinese, 房虫，这才是真正的房虫！will give you good color on how speculators operate in
China. The article also discloses the similarity between Chinese property market and Dubai’s. I
learned this through sort-of first hand experience. There the way it worked in Dubai was the
developer built a high rise residential building, then pre-sold it unofficially to speculators from
around the world at about 30% discount to the supposed market price. This is a whole-sale
market and the buyer can buy by floor not by unit. Then, the developer launches the project to
the market, but by this time most of the units are already sold (to speculators), thus the
innocent buyers, either local or foreign, have to compete for the limited supply. As a result, the
transaction price goes up and it generates the impression that these properties are selling like
hotcakes. Similar things are happening in China. This does not mean that China will follow
Dubai’s steps. China has 1,000x more local population than Dubai, little foreign
capital/borrowing is involved in property boom and real estate is also smaller part of economy
than in Dubai.

Conclusion:

When I started writing this post, I thought there is a chance I will find that I was overly drawn to
the blatantly empty projects like that of Ordos, and, in reality, overall balance of Chinese
property market is quite healthy. I found what I wanted: 3-5% overall vacancy rate. However,
as I explained above, this data give me little comfort. The more I look, the more undeniable it
becomes that the apartment prices are unaffordable, and current sales patter is not
sustainable.

Yet, when it comes to those predictions of property market crash followed by big economic
debacle, I am a bit reluctant to give a quick consent. To me, the core problem of Chinese
property market seems to be wrong-supply rather than over-supply. China has healthy
demand for housing coming from population migration (different from urbanization), new
family creation (wedding), and housing upgrade need. These real demand buyers are
supported by their larger family (parents, in-laws and sometimes children) for housing
purchase. The reason there is a c.25% vacancy rate for recently developed housing is because
they are big and targeted for luxury market. (In Korea, outskirt of city center were where
affordable housings usually got built providing housing for middle class and bringing expansion
of the boundary of cities. Too often in China, luxury 别墅’s are built in these areas.) The line
between over-supply and wrong supply is thin, but given the situation, I think China can have
good support when property prices correct.

Also, such correction of price is more likely to affect developers across the board and maybe
banks (I don’t know how much banks are exposed so can’t say for sure), but general population should remain in
reasonable condition. Where as many Americans actively cheated mortgage papers and
actively took equity out of housing thus increasing debt portion of balance sheet, still some 25%
of Chinese home buyers buy with 100% cash and when they take mortgage they do their best
to pay it down as quickly as possible. In other words, the general sentiment toward debt was
very favorable in the U.S. but in China people are quite debt-averse. And the portion of debt
loving speculating Chinese are relatively small portion of the total home buyers pool.

I will look more into how important property market is to China and how likely a bust is in the
China Special (5-4)

Reference: US vacancy trend

Reference: % of Chinese home buyers who take mortgage to finance purchase

China Special (5-4): Comparison of Korean and Chinese

property market
There are many similarities between the path Korea took and the path China has been
taking. Here is a property version.

Similarities  “Property prices do not go down” mindset

 People want to own housing (Probably because pension fund do not exist
or small that paying rental when you retire is almost impossible.)
  Property price to income ratio is high
 Parents help children’s purchase of home. Sometimes even siblings chip
in.
 People never say homes are affordable. (Such complaints don’t mean too
much.)
 Owning home is considered as a way to accumulate wealth rather than
living expense. It is often said the best way to save is to buy a home and
pay back the loan.
 Few foreigners can invest in local property market (Until 1998 foreigners’
ownership of even commercial property was banned in Korea. China
more or less blocked it in 2006/7.)
 Capital control (Korea until late recently) and few overseas investment
option for locals
 Absence of personal bankruptcy law. (In Korea until 2003/4)
 Child education is a big factor in selecting residence
 Hiring thugs to remove poor residents for property development is a
common practice.

Differences  Korean investors always rented out homes whereas Chinese investors
seem relatively happy to hold them empty. This could be because
o Korea has had property holding tax while China has only
transaction tax
o In Korea flats come in ready-to-move-in shape, but in China it
comes in a bare concrete. I.e. significant cash outlay is needed to
rent out flats in China.
o Korean did not mind purchasing used property or property with
tenancy or but Chinese prefer new and empty units
 Chinese market is more geared toward high-end
o In Korea, most of supply were 70-100sqm during the years of
economic development, but in China most of the new units seem
to be 140sqm+ in size. While overall population density is about 9x higher in Korea, I think
the population density in major Chinese cities is (or will soon be) as high as Korea, and thus the big size
units do not make much sense.
o In Korea, smaller and cheaper houses were built in locations far
away the city centers for the emerging middle class but in China
humongous and luxurious villas are built in such locations
 Affordability at similar income level is higher for Chinese than Korean
o During development, Korea didn’t have mortgage loan (only in the
late 1990’s but with many limitations), but China has mortgage
loan. (In Korea people usually bought with cash. There were some loan available from company where
they are working or from the developer.)
o Multiple children in Korea vs. one child in China
 Commercial property in apartment complex were highly sought-after
investment in Korea and were soon filled with businesses catering to
 residents but in China they are mostly empty even 5-6 years after very
high occupancy of the flats. I was very surprised even those at 北京天通
苑 were deserted.
 China has monthly-rental but in Korea monthly-rental is only for very low-
end housing or for very expensive expat housing. It is mostly ownership
or “Jeonse” in Korea.
 In China, state owned enterprises and government ministries are involved
in real estate development and/or speculation (source) whereas in Korea
it was private sector’s play.
 Equilibrium price for Chinese property is higher at the same income level.
o Korea had 45M people migrating to Seoul but China got 1.3B
people migrating to Beijing, Shanghai, Guangzhou, Shenzhen,
Chongqing.
o Expats have more reasons to live in China than Korea
 Rich-poor gap is significantly bigger in China and poor people as % of
population is also a lot bigger. It was rare to see very poor area next to
very rich area in Korea, but it is a common scene in China.

China Special (5-5): Why is Chinese property market more

volatile than Korean market?

The above graph shows the historical price trend of Korean residential property market. What
you can see is that while price became increasingly more volatile in the recent 10 years, price
increased steadily from 1970 to 2000 except for 1997/8 Asian economic crisis period. (The reason I
am excluding 1991/2 is because despite what the graph says when I speak to people who have speculated/invested in the property market since 1970’s,
they say prices did not drop in early 1990’s. I guess the reason they say differently from the graph is probably because there was not much transaction at
the time. The fact that it was difficult to own more than one home in Korea must have played a role in the low transaction volume at the time. I will
 However, Chinese property prices have already corrected significantly a few
write more about it below.)
times. Shenzhen property prices dropped by 14% between 1995 and 2001 while income almost
doubled (here) and Shanghai’s prices dropped by 27% between 1995 and 1999
(here). Shanghai’s property price dropped gain in 2005 and prices in the Southern cities
dropped in 2007 even before the global financial crisis. (here) China’s past 20 years have much
similarity with Korea of 1970-2000: middle class was growing,wages were increasing, and more
population migrated to larger cities. So, why does Chinese property market behave so
differently from Korean one? Below are potential explanations, I found:

1. Not only the tax rate is higher in Korea but Korean tax system is designed to keep
people from buying and holding multiple properties

When you Korea China

buy About 5.6% of purchase price (previously based on Roughly 2% of purchase
registered price which is significantly lower than actual transaction
price (based on registered price which is
price, but since 2002/3/4 it became transaction price) (source) significantly lower than actual transaction price)
(source)
hold -Property holding tax: 0.1-0.4% Nil
-Comprehensive property tax: Looks at all
property holdings including land,
residential and commercial properties. 1-
3% of the holding above threshold
amount. (Since 2003/4)
sell - 6-33%; profit threshold for 33% rate is - 6% of sales price (based on registered
price which is significantly lower than actual
KRW88M (~US$80K), which is easy to
transaction price) waived if held over 5
meat. Discounts available depending on
the holding period. However, if sold within yrs. (source)

1 year tax rate is 50% and if sold between - 20% of profit after deducting
1-2 years then tax rate is 40%. decoration cost and mortgage
- If the selling household own more than 1 expenses. (Since 2006)
home, then 50% of profit regardless of the
holding period.

2. Leverage is more widely used in China

1. Mortgage loan was almost non existent in Korea until late 1990’s. Even today,
the maximum amount mortgage loan provides is 500M Won (US$420K; not
enough for 100sqm apartment in the hot Kangnam area) and completely
unavailable for someone who wants to buy 3rd home. I am not sure about now,
but in summer 2006, when my friend was buying a flat in China we both agreed
that mortgage loan system is a lot more advanced (meaning more easily
available to home buyers) in China than in Korea.
 2. Before year 2000, Koreans mostly bought with cash. Sometimes they got some
loan from company, if they are working for a big company, and often if you buy a
new home from the developer, the developer would arrange some loan.
3. There are more foreigners involved in Chinese market
1. Prior to summer 2006, foreigners could buy Chinese property freely. China has
tightened the rule since then and from 2007 only those foreigners who have
lived in China over 1 year can purchase 1 property. However,
1. Taiwan, Macau and Hong Kong citizens can purchase one home per
person without living in China.
2. For Taiwan, Macau and Hong Kong citizens the 1 home per person rule
was not applied seriously that I know a few people who own 4-5 flats.
3. Since early 2009, foreigners who have residential permit in China are
allowed to hold more than 1 property. (It was one of the measures to
support property market.)
4. Foreign companies especially Hong Kong, Singapore, and Taiwan
developers are still active in China. (despite many rule changes to make
things difficult for foreigners. source)
2. On the other hand, it was almost impossible for foreigners, including Korean
descendents who hold overseas passport, to purchase property in Korea under
their own name until 1998. Also, I do not think it was possible for foreign
developer or property management companies to have business in Korea.
4. Property market is not mature in China with only 20 years of history
1. Homes were never free in China, but they were provided for free only 25 years
ago.
2. Homes and lands were always private in Korea, but in China modern property
market started only between 1988-1990, so it has only 20 years of history. So, in
this sense, the quick boom and correction of the 1990’s maybe shouldn’t be
interpreted too seriously. 20 years of the market with very fast economic
growth and foreign money inflow probably did not give the government enough
time to prepare all the systems that needed to make sound market environment.
China Special (5-6): Final thoughts on Chinese property market
 Homes are still affordable but affordability is really up to the neck
o Middle class parents living in tier-1 cities (own home, can travel once or twice a year, got
income of RMB 6-8,000 from pension and other sources, and have a child who went to college
and got white collar job) can give RMB 300,000 to their son to help him buying
home. Given that now the bride’s parents are also chipping in, the young couple
is likely to have RMB 450-600,000 for home purchase. Assuming 30% down
 payment, they will be able to buy a RMB 1.4-1.6 million home.. At RMB
20,000/sqm, you can buy a brand new non-fancy 7-80sqm flat at about 30-40
minutes commute to city center. This is not bad.
o However this not-too-bad arrangement comes with a few troubles.
 The new couple now has RMB 1M of debt. As a first time buyer, their
mortgage rate will be about 4.2% as of now. This means monthly interest
payment on RMB1M loan will be c.RMB3,500. If you do not speak English
and have been working for 3-5 years with bachelor degree from an
average college in white collar job, your monthly salary is about RMB
5,000 in tier 1 cities. So the couple will spend 35% of their income in
interest payment. Including principle payment, they are likely to be
spending 50% of their income in housing. (Of course as their tenure
grows, their salary will be raised and the burden will be smaller.)
 70-80sqm is not the most widely supplied unit. It seems most newly built
are at least 100sqm in size.
 Most Chinese are below middle class even when we adjust the middle
class threshold for smaller cities.
 Parents, who are only 55-60 years old and who do not have big pension,
now have little savings and soon the couple will have to support 4 retired
people for 20-30 years or longer.
o The market might be able to take a little more price appreciation. Newly wed
couples can buy a bit more outside or buy older second hand flats. And the fact
that the old ladies gladly tell me they can pay RMB 300,000 for their sons
probably mean they can actually pay a bit more.
 There are clear signs of residential property bubble especially in the high-end market
o Pangu(盘古) Plaza in Beijing is next to Water Cube (水立方) but really in the
middle of nowhere. It has homes with 600-700sqm of size. Phase 1 was sold at
about RMB50,000/sqm before the Olympics and Phase 2, which started selling in
Aug 2009, are selling at RMB70,000/sqm. So far about 100 units are sold (100%
of Phase 1 and 50% of Phase 2), but the apartments are very dark at night.
o Sheshan(佘山) is a villa area about 1 hour’s drive from Shanghai’s city center
after passing a lot of farm land. There are hundreds of villas mostly around
500sqm. They are now selling for RMB50-60,000/sqm and all launched projects
are sold out. However, residency rate of most of these villas are not even 30%.
o In Beijing, new apartments that started moving in 2008 are still 50%
empty. Check out 范海国际 or the new phase of 观湖国际. The more luxury
development it is, the higher the vacancy rate.
o In Shanghai, vacancy rate seemed lower than in Beijing for new downtown
apartments, but there were many strange projects far outside of city that costs
20,000+/sqm that are just empty. Go to 芦恒路站 area.
o In Tianjin, especially around Gulou(鼓楼) are luxury villas and apartments all new
and empty. The apartments are now RMB20,000/sq
o And see my summer China trip note
 When bubble busts, it could be very nasty
o Property is inter-wound with other parts of economy.
o Over-capacity in cement, steel, aluminum, etc are currently not shown because
they are utilized by the real estate boom.
o I do not believe Chinese buyers use little leverage. Middle class buyers need
mortgage to buy homes and I believe a lot of cash-purchasers are actually
redirecting industrial loans to property. Also, many bank loans have property as
collateral but the value of these properties is often linked to residential property
nearby. Overall much of banks loan should be linked to property price. And
there are loans directly lent to construction companies.
o Real estate related income is 30-50% of local government’s fiscal income. Major
items of the income are business tax, income tax, and agricultural land
occupation tax from developers and property agents. Also, land sales make up
about 60% of local government’s off-budgetary income and it reaches as high as
90% in certain cities. (Source and Source)
 However, what Government wants is probably slow appreciation not correction
o Export has recovered back to normal level providing government some ground
for tightening, but given how inter-wound property is with other parts of the
economy, government would not tighten severely risking collapse. Also, as more
middle class purchase new apartments, collapse of property prices can cause
social unrest as well as fast increase of property price.

o
 There are also few other reasons for the bubble to collapse immediately
o Government and banks will not tighten aggressively until they have to, and they
don’t have to at the moment. Inflation is rising it is not too worryingly high, and
NPL ratio and capital adequacy are quite healthy
o It makes sense to buy property when real interest rate is negative, and it seems
real interest rate is has been negative chronically and systematically.
o Property as store of value makes sense in China in the long term. Simply put,
Shanghai will be New York with 8x bigger demand (4x population x2 as only one
side is coastal). What will be the equivalent price in 40 years? (Well, Chinese properties are
on 60 years lease, so only 20 years left by then.) Or in 20 years?
 As an investor, not much money in betting on property price drop today
 o I remember reading that when John Paulson shorted sub-prime, he figured that
home prices do not have to drop to cause trouble. Stable home price was
sufficient for his bet. That is not the case in China today.
o The most likely case today in China with property price drop is developers
getting into trouble. However, as long as banks got room to lend, I think it is
unlikely for a big developer to go bust. Also, those that were most aggressive in
2009 and thus most vulnerable are state owned ones. I.e. more government
support is likely.
 NPL will be a problem but probably around 2012
o Fast loan growth always causes trouble. It takes 2-3 years for consumer and SME
loans and a bit longer for large corporate loans (as they pose bigger stakes for
banks and governments). The big loan bonanza in 2009 was mostly to big state
owned enterprises, so it will be around 2012 for the loan troubles to show.
o Securitization can delay the time of reckoning, but China at least so far do not
securitize loans, as far as I know.
o Chinese government will rescue the banks as they did in early 2000, but by
definition rescue cannot come before the disaster.
 Office and commercial property more likely to be the trigger than residential
o Maybe buyers are buying residential property as store of value, but commercial
and office property developers are doing it for yield, yet these are the markets
where oversupply is more obvious and severe.:
 Beijing and Shanghai financial districts are quite empty. Beijing 东三环
CBD is not too different. Guangzhou financial districts are full of empty
buildings. It is not difficult to spot empty office buildings in Chongqing,
Wuhan, and Tianjin either. The newer and the higher end the buildings
are the higher the vacancy. The companies supporting China’s vibrant
economy needs good office space not Grade AA offices. Yet, next to
fancy empty buildings there are more constructions under
going. Whenever I see these scenes, I wonder how it is all
possible. These developers must be sitting on fat valuation profit, but
that is not cash and they need cash to pay employees and start next
projects. Apparently, these developers are finding cash somewhere, but
where?
 The foot traffic in shops at The Place, 前门大街, Intime Lotte, Plaza 66,
Maison Mode is very low. (During Christmas time, Louis Vuitton and Channel at Plaza 66 were so full
that customers lined up outside, but other shops were very empty.) The shops spent cash opening
a new store and they need cash, don’t they? Granted the luxury malls
have higher margin and do not need to sell as much to make same profit,
but they have to sell. And there are too many luxury empty malls. How
long will it take for the shops to stop wasting money and what will
happen to developers then?
o Another reason why I think residential is unlikely trigger is because there isn’t
wide spread blind chasing in residential market. During tech bubble, everybody
had tech shares. It was cheap and everybody had it. During US housing bubble,
 it was easy for even low income people to get mortgage loan with fake
document. However, getting bank mortgage is not easy for low income people
in China and majority of Chinese are low income earners. The participants of
the Chinese housing bubble are rich people, developers, local governments and
state banks. Most of population is actually excluded from it especially when you
count out those who only own one home for self use. Among the participants,
developers are probably the weakest.
 <Update Jan 11, 2010> Also, for residential markets, smaller cities are more likely to
be the trigger than Shanghai, and Beijing.
o Absurdity of Ordos size exists in smaller cities not in the mega cities. The entire
city was being dug in Wuhan while there were so many empty flats, and Tianjin
(though not a small city) surprised me with empty city center flats.
o The thing about smaller city is that it is an easier for a small number of wealthy
people to control the market. When I was in Wuhan, the locals were very bitter
about how Zhejiang people especially Wenzhou people came and tripled the
property price. In cities like Shanghai, Beijing, Guangzhou and Chongqing, there
are a lot of affluent migrants but I do not like wealthy people to want to buy a
flat in Wuhan to live in it. As a result, the high price of Wuhan has less support
than the high price of Shanghai, and thus easier to pop. And when it pops and
hurts the speculators, it impacts their speculative holdings in other cities
including very large cities.
o Shenzhen is a mega city, but it is an exception. Too much Hong Kong money is at
play in Shenzhen and the city is more volatile as a result.