Evaluating Conditions in Major Chinese Housing Markets

Abstract

A year after the adoption of the 4 trillion yuan (US $586 billion) economic stimulus package, Chinas GDP grew 10.7% year on year in the last quarter of 2009, accelerating from 6.2%, 7.9% and 9.1% in the first, second and third quarters, respectively. Riding the strong economic growth, the rolling bull market prospects continue in China\'s housing sectors. China\'s land auctions continue to set new price records, with new price peaks reached multiple times in recent months. Housing prices in China\'s major cities grew at the fastest pace in recent months, with prices rising at a double digit rate in the latest data available for February of 2010. Prompted by fears of a bubble in the housing market, at the end of last year, the government announced a series of measures to dampen the overheated housing market. Among the new rules was a harsher property sales tax to curb speculation in the housing market. Thus, the Chinese government and many international investors appear worried that house prices might have reached unsustainable levels. Whether the fallout from any such mispricing would be similar to what happened in the U.S. is another important question for policy makers in particular. This study examines a wide array of data to document what has happened to prices across the many markets in China and to gauge whether they are sustainable. Data limitations are the key problem for any such study of the Chinese housing market. Times series lengths are no more than a decade for virtually any market because of recent changes that allowed for competitive bidding and pricing of property in China. To help deal with this limitation, we study the issue from a variety of perspectives. Two are traditional affordability metrics used in housing studies around the world: share of income devoted to housing and price-to-rent ratios. Income shares spent on housing are very high in China, but that alone does not necessarily indicate the presence of a bubble or general overpaying for property. As we discuss in the paper, there are various cultural and social reasons why it is not considered abnormal for Chinese households to dedicate much more than 30% of their income to housing. More interesting are the recent sharp rises in price-to-rent ratios in Chinas major markets. In the top seven markets nationally, the price-to-rent ratio increased from about 30 to 50 just within the past two years. As we argue in the paper, the key features in the sharp rise in the ratio, not the level of the ratio itself. Beyond these traditional affordability metrics, we also examine how Chinese house prices compare to fundamental production costs (which includes physical construction costs, land costs, and a normal profit for the developer). In the U.S. context, Glaeser, Gyourko and Saiz (2008) have shown that this supply side approach is a good predictor of mispricing in the bubble markets of the U.S. sunbelt region. Many Chinese markets are not in elastic supply, so this approach is not so readily transferable to them, but the analysis does suggest that prices are well above fundamental production costs in a number of markets. If the Chinese government does not restrict the supply of land in these markets, the implication is that prices should fall. We also conduct a detailed micro-level analysis of over 300 recent land auctions in Beijing. We are able to identify the location of each land sale, and then compare it to prices of fully finished housing units. While that analysis remains to be done, some market observers claim that recent land prices in particular have been above the trading value of completed units. If so, that would be a signal of mispricing. While that part of our analysis remains to be done, we will be able to document whether these claims are true, using hard data and spatial mapping technology.