By Wu Jiangang (China Daily)

China housing market has just gone through a year that had two
strong characteristics: either standing still or going back. Just
as prices remained largely static, the volume of trade fell
sharply. Developers are in difficult financial straits. To
understand the predicament the market now finds itself in and to
forecast the short-or long-term trend, one needs to look at the
supply and demand and at government policies.

First, housing prices are affected by demand. There are essentially
four groups of buyers: the middle class, public servants, foreign < br /> investors and private entrepreneurs. There are essentially two
strong economic sectors, infrastructure and manufacturing, and both
are mainly labor intensive. Workers in these industries, many
earning very low wages, cannot afford apartments and cannot settle
in cities. For years, the middle class has been the main source of
real demand in buying apartments to live in. But the number of
middle-class people cannot grow that much as long as China
service industry continues to be controlled by State-owned
companies.

There are not enough jobs to go around for new university
graduates. While the middle class is relatively small, those in it
are mainly concentrated on first-tier cities such as Beijing,
Shanghai, Guangzhou and Shenzhen. They have always been there to
help push prices to a level that might be regarded as reasonable,
but their influence on prices that are now well above their
purchasing capability is minimal.

The other three groups, mainly investors or speculators, who regard
apartments as capital assets and whose investment behavior is
driven mainly by their expectations on housing prices, have been
pivotal in pushing housing prices in some cities to ludicrous
levels.

While foreign investors may use free cash flow to buy some real
estate, they use most of the profits from their foreign direct
investments to expand production. While the concerns aired about
hot money from abroad are reasonable, people do not realize that
they may need to worry that foreign companies may turn their
profits and working capital into short-term investments by
speculating in capital goods in China.
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Private entrepreneurs, hobbled by low profits in manufacturing,
have for years turned to financial investments, especially real
estate.

There is a well-known riddle called” missing money “that goes like
this: Since the broad money supply (M2) growth rate is much bigger
than the total of the GDP growth rate and the growth rate in
consumer prices, where does the excessive money go? It can be
reasonably assumed that much of it turns into hidden income for
public servants. Since the investment opportunities in industry are
extremely limited, for many years buying apartments has been the
easiest way to keep money growing.

Many of these investors or speculators, who feel that it is either
costly to renovate these apartments or inconvenient to rent them
out, leave them empty. It is estimated that as hundreds of millions
of ordinary people fight for their dreams of owning their own home,
tens of millions of apartments or houses lie unused.

Second, housing prices are affected by supply . As housing prices
increase, real estate development becomes rampant. In the new
housing market, local governments – the land providers – are
rushing to sell land to developers, who rush to build houses .

Though under such high prices the housing market has little
connection with most people, supply cannot satisfy the feverish
speculation of the rich.

In the second-hand housing market, with the expectation of further
price rises, the fear of inflation and few other investment
opportunities, most homeowners are reluctant to sell their houses
and instead hold on to them.

Though local governments are unwilling to build more apartments to
rent to the public, as a political task they are obliged to provide
apartments.

Finally, the government holds sway over the housing market. The
government has an important role in the trend the market follows.
It is not only a rule maker but the most important market player,
because it is the only land provider and owns almost all the big
real estate companies. However, the local government and central
government do not see eye to eye.

Despite spectacular growth in the housing supply, for the majority
of Chinese, owning a small apartment has become increasingly out of
reach. The central government, seriously concerned about the
systemic risk and about social instability, has begun the arduous
task of pulling the price of housing back to a reasonable
level.

It has made many policies, such as tightening monetary supply,
increasing the size of down payments, increasing the cost of
mortgages and restricting the purchase of additional
apartments.

The central government will need to continue the efforts to pull
prices back to reasonable levels, and it has many highly effective
tools at its disposal, such as imposing high property taxes ,
continuing restrictions on additional apartments, providing more
apartment rentals, releasing more land, investigating public
servants property holdings, reducing the expectation of inflation,
and providing more opportunities by giving up its monopoly in many
industries.

Local governments continue to rely on land sales for revenue and
they together with real estate and property developers are a
powerful lobby. They do not want a sharp drop in prices.

However, there are some new trends. Many wealthy families are
considering investing or even migrating abroad, which will reduce
demand and increase supply. And the government, with the legitimacy
of its authority in mind, will need to ensure a soft landing for
house prices.

Two important groups driving high housing prices in China are
foreign investors and private entrepreneurs. It seems that they are
withdrawing from China.

As capital assets, the prices are mainly decided by the expectation
of future prices. Because housing prices have kept rising without
fail for many years, a self-fulfilling expectation has been
created. But after all these years of speculation in real estate,
2012 may prove to be a turning point. < br />

Since price expectations are at a turning point, a drop in prices
is highly likely. China is vast, and different levels of cities
will face different situations.

For first-tier cities, a drop of 30 percent this year may be a
little too big to contemplate – it would put at risk local
government revenues, government debts and bank loans. A more
plausible drop in housing prices would be in the order of 15-25
percent in first-tier cities, 5-15 percent in second-tier cities
and up to 10 percent in third-tier cities.

Considering changes in competitiveness, aging of the population,
urbanization and future inflation, it is possible housing prices in
first-tier cities will be halved in the long run. For the first
several years the drop will be big, and for the following years the
drop will be small.

The author is a lecturer at the Management School of Shanghai
University and a research fellow at the China Europe International
Business School Lujiazui International Finance Research Center. The
views do not necessarily reflect those of China Daily.

(China Daily 01/20/2012 page11)

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