China is facing a real property collapse with up to 65 million surplus homes, plummeting demand, falling prices and big property developers drowning under a mountain of debt. In the past few decades, the property sector has been a key factor in the Chinese economic miracle but as the boom turns to bust, what will be the effect on the Chinese and the global economy? How bad is the bust in Chinese housing and how much further is there to go?
Background to Crisis
In 1998, China deregulated property sales; with a rudimentary and volatile stock market, people saw property as a much safer and more lucrative investment.
Prices reliably rose and with a growing population, housing was a very profitable business. Encouraged by the state, developers made huge profits and this encouraged a highly leveraged expansion. To maximise profits, developers sold houses before they had been built. With ever-rising prices, citizens were happy to keep buying – even if they didn’t intend to live in the house. And this housing investment helped to boost a roaring Chinese economy with property accounting for 30% of the economy.
But, then the whole market turned. Worried by the property speculation the Chinese government introduced reforms to block house purchases which were not for living but for investment – A worthy sentiment, but the whole property sector had become dependent on precisely that speculation the government now wanted to stop. Demand dried up. Apartments remained empty and prices started to fall.
Suddenly the highly leveraged property companies were struggling to meet their basic finance deals. The problem is that they sold houses before they were even built. To pay for houses under construction, they needed to sell the next tranche of houses. It was a Ponzi scheme by any other name. However, the great boom in demand was over.
With property companies running out of cash, building projects were stopped halfway through. According to S&P, an estimated 2 million homes remain unfinished. Citizens who had paid for a house were unable to move into what they had bought. In a county where protest is rare, angry buyers protested their catastrophic losses and started mortgage protests. Like wildfire, the ugly truth of the property bust spread – who wants to pre-buy a house when there is no guarantee it will ever be built? The economist reports just 60% of homes that were pre-sold between 2013 and 2020 have been delivered.
On top of that, China’s population has peaked and gone into reverse. With a declining population, it will take years to offload the unsold housing. Goldman Sachs predicts China’s annual urban housing demand peaked at 18 million units in 2017 and will fall to 11 million units this year and 9 million units by 2030.
The losses for big property developers mounted. Firstly, Evergrande announced losses and was unable to pay debt interest payments. Recently problems spread to another big property developers such as Country Garden. Nearly a third of all Chinese property loans are now counted as bad debt.
Wider Economic Problems
But, how will this property crash affect the economy? Will it be like a Japanese style asset deflation of the 1990s or can they survive? The problem is that the Chinese economy faces multiple threats at the same time. Export demand has remained relatively weak due to higher interest rates and a slowdown in the global economy. Secondly, the return of deflation raises the prospect of rising real debt and deflationary pressures which limit demand. Investment once the great driving force of the economy is going into reverse, with 23% fewer housing starts and a decline in private investment. Youth unemployment has risen so much, that the government have stopped producing the statistic, but it can’t hide the lack of prospects from a young generation who are remarkably pessimistic about job opportunities. It has led to a collapse in birth rates and marriage. Last year there were only 6.8 million marriages, the lowest since records began in 1986, and nearly half the 13.5 million of 2013. And despite the end of one-child family, birth rates have remained stubbornly low.
Strengths of Chinese Economy
The Chinese state still has great reserves with relatively low borrowing and a huge surplus of foreign assets. However, state intervention has been heavy-handed, such as the crackdown on tech firms who publicly criticised the government. The government seems more driven by political authoritarianism than economic concerns. The result is that entrepreneurs are less willing to take risks in case they face the wrath of the Chinese state. The loss of confidence was exacerbated by prolonged and very strict Covid shutdowns which the Chinese economy is still to fully recover from.
The big concern is how far the property bubble still has to burst. Prices are falling faster than official statistics suggest and bad loans will only rise as the market continues to decline. A remarkable 70% of Chinese household wealth is now tied up in real estate. Yet, at the same time, prices are much higher than incomes. In Beijing, prices are 34 times the average salary, one of the highest in the world. Unlike America and Europe, the government can intervene to stop prices falling. When a desperate seller cut prices by 50%, it was halted by officials.
Efforts to prop up the market
The government has belatedly sought to deregulate buying houses – reducing deposit requirements, removing limits on second homes and cutting existing mortgage rates, to help encourage demand. But, there is an element that this is too little too late. With prices falling and the bubble burst, the desirability of investing in a second home is much reduced. Perhaps more importantly, the Chinese state has started underwriting new home loans and providing liquidity into the market. There has been an estimated 200bn Yuan lending programme, however, this has not matched the scale of the problem, as it only accounts for 10% of what is needed to finish unbuilt properties.
Whilst the property sector is in crisis, we should not ignore the fact that other areas of the Chinese economy are still vibrant. Chinese manufacturers have seen a surge in production of electric vehicles. China is a leading producer of solar panels and renewable energies. Despite efforts to reduce reliance on China since the Ukraine War of 2022, western companies have found it very difficult. China’s place as the dominant manufacturing base can’t change overnight. Despite all the problems, China is still posting positive economic growth with the forecast for 2024 still relatively optimistic in the range of 5%. China has witnessed many prior warnings of economic collapse, which have not materialised. However, whilst China has some strong economic fundamentals, it would also be a mistake to underplay the damage from the property fallout. It was a classic boom and bust, the like of which China has not seen before. This property bubble is a new experience and so far the government is struggling to contain its fallout. The real concern is that there is still a long way to go. Hao Hong who was banned from Chinese social media for his pessimist warnings argues
“Fixing the property sector may be a multiyear or even a decade’s work in front of us”
To make an international comparison, in 2009, the over-supply of housing in Ireland and Spain saw house prices fall 50% . With up to 65 million surplus units, and a catastrophic fall in confidence, there is more for Chinese prices to fall. And as prices fall and loan defaults mount, it will cause a raft of economic problems both directly and indirectly.
The property crisis also throws into stark relief, long-term problems. A geopolitical suspicion of China, a rapidly falling birth rate and a political system that is damaging the free market entrepreneurial spirit that was so important in the past few decades.