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China Real Estate Unravels

May 16, 2012

As a prelude to a broader analysis of China’s GDP, and the accuracy of its official GDP figures, I want to start by examining the national real estate statistics for the first four months of 2012.  This discussion feeds into the broader GDP picture, but the property story that has been unfolding is important and interesting enough to be worth taking a close look at on its own.

Getting an accurate view of the property sector is complicated by the fact that neither the official price index, nor the Soufun price index, nor the average price/square meter that can be calculated from the investment numbers seem to track very well with each other or with point-of-sale impressions of steep developer discounts over the past eight months.  Developers and local governments also enjoy a great deal of discretion in deciding what to count as a “start” or a “completion.”  Monthly data releases are never revised, which often gives rise to huge corrections that are simply lumped into the end-year December data release, giving a distorted impression of how trends are unfolding (so, for instance, the 19% drop in property starts in December 2011 probably wasn’t as sudden as it appears, and more likely reflected an unreported decline spread over several preceding months).

All that being said, I’m seeing some rather striking patterns in the data that tell us two main things:

  1. The market is not poised to recover, but will continue to see greater downward pressure on prices; and
  2. Real estate investment is likely to flatten out or start falling, erasing several percentage points of GDP growth.

Last month, many observers took comfort from reports that overall real estate investment in Q1 rose 23.5% (in nominal terms) compared to the same period the previous year.  To be sure, this was a comedown from 2011, when property investment rose 27.9%, or 2010, when it rose 33.2%.  But it still seemed to reflect resilient growth: hardly a collapse in market, more like the kind of modest slowdown consistent with “soft landing.”

Very few people paused to ask where this investment growth was actually coming from.  After all, the market was clearly struggling.  Year-on-year sales in Q1, for all real estate, was down -14.6%.  The decline was even steeper, -17.5%, in residential property, which accounts for about 80% of the market.  Office sales were down -10.2%, while growth in “commercial” (i.e., retail) property sales, which saw a boom in 2011, decelerated to +10.5%.  Although many people were touting a month-on-month sales recovery in March, compared to the Chinese New Year period, March sales were still down -7.8% from the year before, for the sector as a whole, and -9.7% for residential properties (by comparison, sales in January-February were a disaster, falling -20.9% overall, compared to the first two months of 2011, -24.7% for residential).

Given this consistent fall-off in sales, it’s not surprising that new property starts began to stall.  I already mentioned that the 19% drop in new starts in December may have been a bit of a statistical aberration.  Starts (measured in floor space) in Jan-Feb were up 5.1%, although the gains came entirely from office and retail — housing starts were flat.  But overall starts fell by -4.2% in March, with housing starts down -9.8%, ensuring that overall starts for Q1 were flat (+0.3%) with residential starts down -5.2%.  Land sales for Q1 were also flat, with sales proceeds rising 2.5% but land area sold down -3.9%.  In March, they were negative (-3.6% sales revenue, -8.5% area sold).

So if sales were down, and starts were either flat or down, where was the 23.5% investment growth coming from?  Developers, burdened by 70% leverage ratios and loans threatening to come due, were rushing to complete whatever projects were already in their pipeline, in order to put those units onto the market and raise cash.  Completions (measured in floor space) were up 39.3% in Q1, compared to last year (residential completions were similarly up 40.0%).  But, of course, those completed units weren’t selling like last year, so unsold inventories expanded.  At the close of Q1, the total amount of floor space “for sale” was up 35.5%, compared to the same date last year, while the floor space of residential units “for sale” grew 47.4%.

(That’s just the floor space that developers admitted was for sale.  There are plenty of tricks they can use to hold units off the market, in order to massage the official data and avoid spooking buyers.  At the end of 2011, total floor space “under construction” was roughly 4.6 times the floor space sold that year.  Assuming it typically takes three years to build a unit, from start to finish, that suggests about a year and a half worth of excess inventory hidden somewhere in the pipeline.  The ratio for residential property was 4.0, which suggests that, while there may be about a year’s worth of unsold inventory in the housing market, the overhang in commercial real estate is even steeper.  Although in absolute terms, it’s the housing overhang that matters).

China’s developers are playing out a kind of prisoner’s dilemma:  rush to complete, in hopes of cashing out.  But while supply keeps going up, demand is going down.  In late March, a central bank (PBOC) survey reported that only 14.1% of Chinese consumers were looking to buy a house in Q2, the lowest level since 1999.  Only 17.7% expected home prices to rise in Q2, and 62.9% said they still consider prices to be too high.  So all those rushed completions only add to the glut already on the market, driving prices down further and giving buyers — investors and aspiring residents alike — all the more reason to hold off for a better deal. Perhaps this is why Qin Hong, deputy head of research for the Ministry of Housing and Urban-Rural Development (MOHURD), told the Oriental Morning Post in late March that she doesn’t expect housing prices to rebound significantly for the rest of the year.  A strong rebound is impossible, she said, due to the continued property tightening policy and high housing inventory (my italics).

The second implication of the dynamic I’ve just described is that the “resilient” growth in real estate investment that seemed to promise a “soft landing” is not very resilient at all.  It’s more like the last gasp of a market that’s running out of steam.  Once the surge in completions plays out, the declining number of new starts will become the pipeline, and growth in property investment will flatten or go negative.  Property investment accounts for roughly a quarter of gross Fixed Asset Investment (FAI), and net FAI accounts for over half of China’s GDP growth.  As I noted in January, in a back-of-the-envelope thought exercise, if property investment plateaus (growth falls to zero), it could shave as much as 2.6 percentage points off of real GDP growth.  If it fell 10% (in real, not nominal terms) it could bring GDP growth down to 5.3%.

At the time I first saw this dynamic in the data, when the Q1 numbers came out, I figured it would take several months to begin playing out.  But the April numbers suggest it is already happening.  In April, overall completions rose only 2.8% year-on-year (down from 39.3% in Q1), and housing completions flatlined at 0.8% (down from 40.0% in Q1).  As completions petered out, growth in real estate investment decelerated markedly, to just 9.2%, with residential investment growing just 4.0%.  Investment actually fell month-on-month, in absolute terms, by -10.7% overall and -9.5% in housing.  It only grew year-on-year at all because of a low base set last April.  If you plugged this year’s April versus last year’s May, you’d get a year-on-year drop of -9.1% for property investment overall, and -11.0% for housing.  (In this context, it’s worth noting that, according to the Beijing Municipal Bureau of Statistics, overall property investment growth in the capital already went negative in January-February, for the first time in three years, dropping -4.6%).

If there’s one bright side to the plateau in completions, it was that unsold inventories advanced less rapidly over the year before.  Floor space “for sale” did rise in April, in absolute terms, but not by much.  It’s important to remember, though, all the unsold inventory that remains held back and hidden in the pipeline, as noted before.

Meanwhile, the contraction in sales, new starts, and land sales deepened even further in April.  Although the decline in sales appeared to moderate slightly for the sector as a whole (-4.5%) and for housing (-2.9%), this was again largely due to a lower base effect from last April, when sales contracted month-on-month by nearly RMB 100 billion.  This year’s April sales also registered a significant month-on-month decline, by -17.2% for all property and -15.5% for housing.  The more striking news, perhaps, is that commercial property sales, which have been much more resilient until now, also plunged, with office sales falling -23.4% year-on-year and -34.4% compared to March, and retail property sales falling -9.5% year-on-year and -22.7% month-on-month.  April was the first month in which all three categories were in year-on-year decline.

New starts in April fell -14.6% year-on-year and -27.0% month-on-month, for property as a whole.  Housing starts fell -14.4% year-on-year and -23.4% month-on-month.  Office  and retail starts, which had remained quite strong through Q1, also plunged.  Office starts fell -21.0% year-on-year in April, and -45.1% compared to March.  Retail property starts fell -18.7% year-on-year, and -36.8% compared to March.  (The year-on-year April comparisons for office and retail rely on a reverse calculation to isolate April 2011 figures, which NBS did not provide in its earlier releases).  In short, the trendline in starts has dipped into negative double digits across all categories.

Land sales, meanwhile, fell off a cliff.  Land sale revenues in April (RMB 27 billion) were down -54.7% compared to April last year (RMB 60 billion), and -47.0% compared to March (RMB 51 billion).  Total area sold was down -52.5% compared to last April, and -43.4% compared to March (the year-on-year comparison here relies on a similar reverse calculation as before).

It should be no surprise, then, that foreign investors are pulling back from China’s property sector.  Foreign funding for property development was down -91.4% in March and -80.8% in April, compared to the same months last year.

I think most readers will agree, this is pretty powerful stuff.  At least one major sector of the Chinese economy (10-13% of GDP), which had been a leading growth driver, is undoubtedly in contraction.  More importantly, the dynamics behind these numbers suggest that the market has not bottomed out, but is still in the process of unraveling.  That is why I told CNN, in late April:

“No one has hit the panic button yet,” Chovanec said. “Everyone is holding out hope that at some point it turns around somehow. But I also think that’s a triumph of hope over reason.”

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62 Comments leave one →
  1. The Digit Man permalink
    May 16, 2012 2:09 pm

    No doubt the shadow banking system is imploding too, ouch. It accounts for ~50% of commercial lending, ouch. Capital flight is underway, and the Party thinks it can tinker at the edges, Phoo-ee ! “the bigger they are …” Soft landing is an oxymoron from way back. Buckle up China.

  2. Davis3 permalink
    May 16, 2012 3:09 pm

    All these empty complexes in China. True, most people agree there is a property bubble. What about the people who actually spent their family’s life savings buying apartments that will be falling apart a few years from now? I have lived in China for about China for about five years. The bubble, and quality of construction convinced me to not buy a home in China. Anyone who has lived in China knows how poorly buildings are constructed. Aside from the bubble what happens when the homes people invested two generations of savings into fall apart? Surprised as much as the China property bubble is talked about in mainstream media no one mentions this. Why Patrick?

    • prchovanec permalink*
      May 16, 2012 3:16 pm

      Because China’s market in property ownership (actually long-term leasing) is only 15 years old, and nobody’s had any experience of this, so they just don’t think about it.

    • Ulick McGee permalink
      May 17, 2012 5:16 pm

      It’s not just housing that is made badly. Almost everything is made as shoddily as possible in order to save cost. It is genetic. The Chinese Mind sees the life as a zero sum game whereby if you are winning it must mean that I am losing. In order to avoid losing, they get their retaliation in first. It takes big pressure to force them out of this mode of thinking but it can be done, as inter-familial relationships can be win-win. Nonetheless, if I don’t cut my price, you will steal all my business and on it goes in a sprint to the bottom until every product is as shoddy as possible but the Chinese end-user can just about bear it because the price is so low.

      When I read reports about the fall of America and the rise of China, I chuckle. Americans often make the mistake of thinking that the Chinese are like the Japanese. Put them under pressure and Chinese limitations will probably start to kick in and expose their massive flaws. They have had a nice run of it during the last 20 years but now we will see what they are made of.

      I wish them well but odds are that they will sabotage their own success during the next 10 years as they have often done during their history. They are very smart and hard working but ultimately, they can’t cooperate for the common good, unlike the Germans (including Scandos, English and Americans) and Japanese.

  3. andao permalink
    May 16, 2012 5:53 pm

    Professor, two questions:

    First, quality of data. You acknowledge that the unsold inventory numbers are probably being dressed up to avoid panic, but in reality, couldn’t all numbers be fudged? Each time a new substitute indicator comes up (electricity usage for GDP growth, for example), then there’s new incentive to fudge those numbers as well. How do you keep from going crazy when trying to verify accuracy of data?

    Second, I think the drop in land sales is most interesting. Have you heard of any plans for local govs to raise new revenue? It looks like local government budgets are going to be completely devastated this year without any new land sales and with the trillion USD or so of debt already on the books.

    I had heard a conspiracy theory that this was intentional in order to bring local governments back under strict central control, but it’s hard to believe there aren’t cheaper methods than this!

  4. Iyer permalink
    May 16, 2012 6:54 pm

    Professor, I wish we had someone like you analyzing the Indian property market ! We have an almost similar situation in India !

    • Prashanth permalink
      May 17, 2012 4:16 am

      I too want to know about the Indian scenario. Can the professor/anybody please elaborate on this?

    • sam permalink
      May 19, 2012 9:02 am

      In China, property is owned by the government. Chinese developers buy property from the government and construct these apartments and industrial real estate. So there is an incentive for the local governments to sell property. These property developments in China are funded by a shadow lending system. The banks in China give money to developers. In china houses are used as stores of value. It’s not rented out. People who own houses do so because there is nothing else to store value in.

      In the case of India, even if there is a bubble in prices and property the system is different. All large part of new construction is on private land. It could be private owned farmland converted to residential use. There is transfer of wealth to the land owner. There is also government owned land which is converted into real estate, but is isn’t as staggering as the Chinese case. Indian purchases of property and then subsequent non use are unheard of. Most Indian property which has been purchased is leased out to families who live in them and pay rent. If there are ghost properties in India with owners but no tenants it’s news.

      The Indian governmental revenue on property comes from a stamp duty on property transactions even if it’s an old property. Unused property is an economic waste. Slow down resulting in slower off take will slow down construction in India. The companies go bust. The prices go down. The construction will restart in a few years when all the inventory is taken out. In India, the developers can go bankrupt.They make market decisions which may or may not be profitable. The same market created property boom occurred in USA and Europe. Markets are self correcting. This happens globally.

      What the professor has pointed out in the Chinese case is the market correction is skewed by the continuous demands by the local government for property revenue through land sales. There is also a data skew. They have constructed so much property through this incentive that people will never live in these houses. There are entire ghost cities. Similar excesses of unoccupied houses in India is news. There are no ghost cities in India.

      So comparing China and India which have different markets and market conditions is specious. Economic activity goes through a boom and bust cycle. This does not mean there are structural issues. As long as it’s self correcting there isn’t a problem.

      • Lunar permalink
        May 20, 2012 2:22 pm

        In India , the interest rates are also liberalized that’s why you see such high interest rate on deposit. In china, the there is a cap on deposit rate, which means it is negative real interest for household and corporates on their cash. With no other alternative to invest in, this all goes in real estate. It used to go in stock market but Chinese household really got burnt during 2008 and real estate is the only option now.

  5. drstool permalink
    May 16, 2012 8:17 pm

    Reblogged this on The Wall Street Examiner.

  6. geoih permalink
    May 16, 2012 9:16 pm

    Malinvestment due to market intervention and manipulation. Looks like China is about to get a lesson in the heterogeneity of capital.

  7. l0nEr permalink
    May 16, 2012 10:52 pm

    Professor, may i know where the data from the table is obtained from? While sales seems to have been falling, it seems as though some of the larger China property developers (such as China Overseas Investments, Evergrande, Shimao, Vanke) have reported strong contracted sales in March and April. Most of them also commented that H2 tend to be the stronger sales season. However, the general price trend still remains down with price cuts across the board. I also read that prices in tier-1 cities are more resilient as compared to those in lower tier cities.

    Also, do you think that there might be a possibility that the official numbers are fudged to present a view that prices are falling and sales are dropping, so as to present a improving wealth gap. I always felt that the government just wants the headlines to reflect that their policies to cut prices are working (especially since the politician in charge wants to be in the next standing committee). After all, such headlines could turn real by inspiring buyers to wait off for better deals.

    • andao permalink
      May 18, 2012 3:35 pm

      I haven’t seen the property developer figures but that would be interesting to look at. You might argue that they are fudging their own numbers to keep prices from crashing though. If they say demand is strong, it gives them an excuse to sell properties at very high prices.

      As far as the official numbers go, I think there’s significantly more incentive to have a high GDP growth number than to have a low Gini number. I do think the gov’s efforts to cut housing prices and promote social housing are genuine, but I also think they are dangerously arrogant to think that they can control the fall of housing prices and suddenly stop the crash when they fall too low.

  8. May 17, 2012 12:20 am

    “China’s developers are playing out a kind of prisoner’s dilemma: rush to complete, in hopes of cashing out….”

    That’s exactly what happened here in the U.S. with homebuilders. They built into the glut, it seemed completely absurd.

    Check out Calculated Risk’s graphs to see the results:
    http://www.calculatedriskblog.com/2012/05/housing-starts-increase-to-717000-in.html

    I’ve often wondered about the maintenance issue of unused apartments as well. Here in the U.S., it’s understood that unoccupied housing deteriorates quickly. Things fail and go unnoticed. But even ignoring the problems of the individual apartments, they must be paying monthly fees for the common areas?

    And with land sales down, local governments might be forced to institute property taxes at the worst possible time.

  9. May 17, 2012 1:02 am

    In my Predictions for 2012 I suggested China’s GDP growth could fall below 7% this year on its way to an eventual hard landing (below 5%). If the trend above continues this prediction may very well come true.

    http://bubblesandbusts.blogspot.com/2012/05/patrick-chovanec-china-real-estate.html

  10. May 17, 2012 10:21 am

    Chovanec gets it right (better late than never). Contrast with CLSA’s Rothman who is late (with his choice of datapoints) but wrong – oh so very, very wrong – with his conclusions.

    http://www.businessinsider.com/clsa-16-western-misperceptions-of-china-debunked-2012-5#chinas-economy-is-driven-by-exports-1

    • prchovanec permalink*
      May 18, 2012 9:03 am

      Why am I late? This is just an update of what I’ve been saying for almost a year now.

      • The Digit Man permalink
        May 21, 2012 7:11 am

        Patrick, a classic case of self-interest on behalf of A Hupert. He is a competitor of yours pure and simple.

  11. steeltrader permalink
    May 18, 2012 5:54 am

    Bob in MA not sure if they will do the property taxes yet but I have recently noticed 2 new local government cash raising scams/schemes:

    Asking for additional VAT when it is not due.

    Fining companies for paying bribes. 4 iPads were given as gifts to suppliers – local tax office said they must be bribes and we will be fined upto 50.000 RMB. Wonder if we can quote this when the local tax people come looking for red envelopes next time

    • andao permalink
      May 18, 2012 3:37 pm

      That is hilarious. I’m sure when the squeeze comes it will be foreign firms that get hit first. Chinese firms aren’t engaged in bribery, nooo.

  12. May 18, 2012 4:29 pm

    China is about to undertake big financial reforms with the coming of the new regime. In the US and UK financial liberalisation of the 80s helped fuel a long financial boom that went bust in 2007.
    Does anyone think that something similar could happen in China? ie you get more and even bigger financial bubbles that create a growth illusion in China and make it appear as if the country is doing well only for it to end up in a big crash a few years later – or given the comments about real estate on this blog are we already at that stage? Any thoughts on that would be appreciated – thanks

  13. May 19, 2012 4:33 pm

    Reblogged this on Investing in US for Kiwis and commented:
    When markets are booming and you hear talk about it being different this time be afraid, very afraid. For years we have been hearing about the China frowth story and watched as the World’s most populous nation has recorded huge GDP growth numbers. With changes allowing Chinese to buy property this huge growth in the economy has translated into one of the biggest property booms in history. I don’t know how many times I hear that it is different in China. Just last night at a comfy pub in Auckland i was talking with a friend who married a Chinese woman and they regularly visit. He tells me that his Mother in Law owns an apartment in city I had never heard of in Northern China about 5 hours from Beijing. He said it is the most drab place full of apartments and his Mother in Laws apartment is now worth NZ$1 million He believes it will be worth $2 million before long. Well that is based on hope. Reality is somewhat different. In the article below you can read all about it. As cashflow porpery investors we look for markets that

  14. a_obama permalink
    May 22, 2012 1:23 am

    What a bunch of stupid dolts and nuts. If the Chinese government can impose regulations to waterdown property prices, it sure has the tools to pop them up. Appreciate the differences before making your last jump.

    • choo permalink
      May 23, 2012 3:50 pm

      every government can introduce anti speculative measures to cool prices. trying to prop up prices is another thing. The large number of completed and vacant apartments together with the many under construction paints a very bleak picture for the Chinese economy. What real value does all these construction creates. Also the fact that they are holding onto a long term lease may have escaped investors.

      • a_obama permalink
        May 29, 2012 1:19 am

        Every gov’t can turn away speculative tides? Not really. Had the US govn’t had the tools, it won’t take three rounds congressional debates to give what the market demanded after the holes of Leman Brothers’ speculations exposed. By the time the bill passed, damage was already done.

        You must be brain-washed by someone who knows nothing about China but never resist the urge to write about China because he is in search of badly-needed fame. Just keep one thing in mind. China still has a large rural population who want to move into urban areas. Besides, China has a huge number of unsafe, energy-wasted, outdated housing buildings that were built in the old era. China will need more, not less, houses than anyone can guess.

    • andao permalink
      May 23, 2012 4:06 pm

      Like choo said, I’m very curious as to how you think the gov can prop up housing prices.

      • a_obama permalink
        May 29, 2012 1:28 am

        What the Chinese gov’t needs is just keeping a blind eye to speculators and the property prices in China will sky-rocket on their own. Every single piece of asset labeled in RMB will appreciate once RMB becomes fully convertable. Have you seed the wage differences between China and other countries? Don’t you believe these differences will level off over time?

  15. Sinclair Lin permalink
    May 30, 2012 11:05 am

    what is your thought on the new stimulating plan?

  16. June 22, 2012 9:18 pm

    I guess the housing scenario in China is not really that good. They should have enough learning and strategies to be able to make the real estate business in China will be in good status.

  17. August 1, 2012 8:44 pm

    Thanks for Sharing!!

    Nice Blog

  18. August 13, 2012 8:31 pm

    Even with Chinas ever growing population it will still hit a wall with the economy. Many countries are outsourcing to China. With most countries, the real estate market has come to a hault and will take time to recover. I believe China will be back in right direction in due time.

  19. September 3, 2012 4:49 pm

    China is growing up rapidly I would expect the increase in property there is continuing. The only fear is from political risks

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