China has been struggling for some time with an enormous, self-inflicted bubble in its housing market. After years of excesses, housing market euphoria reached a turning point in 2020, when the government imposed strict supply-side regulations known as the three red lines and the COVID-19 pandemic struck. Since then the bubble has started to deflate, placing a drag on economic growth. In order to track these imbalances over time, Fathom Consulting has built a rich dataset and a suite of proprietary indicators to gauge the underlying health of the Chinese real estate sector.
The updated dataset showcases the unaffordability of homes in China. In 2000, a Chinese household needed just over 6 years’ worth of annual disposable income to buy a home, but this ratio now stands at around 8.5 years. It had reached almost 9 years in 2020, coinciding with the peak of the housing market bubble, but moderated thereafter. However, unaffordability has risen again in 2023: household income has improved, but not enough to offset the increase in house prices. It is notable that China house price series suffer from great variability, as shown in the second chart below.
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To reduce the risk of the whole house of cards coming tumbling down, over the past couple of years authorities have implemented a series of measures aimed at reviving housing demand, such as lowering mortgage rates and easing downpayment requirements for buyers. However, housing demand remains subdued. Households have been hit by a negative wealth effect from the fall in house prices (more than 90% of Chinese adults own a home, compared to 50% in the UK) and scepticism is growing about the ability of real estate developers to deliver on projects in light of recent defaults.
On the surface, it could seem like the Chinese housing market is in equilibrium, as the number of complete and vacant homes roughly equals demand (this happens if the indicator equals 1). However, this is achieved by the direct intervention of the authorities, who declare new homes ‘complete’ or ‘vacant’ in line with demand through the extension of construction times. Indeed, once we also take into consideration ‘incomplete’ homes, developers would need around six years to sell the stock of housing.
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In reality, China suffers from a massive oversupply of homes: enough to accommodate 200 million people according to Fathom analysis, which is roughly equivalent to the population of Brazil. However, property developers and policymakers are preventing these houses from reaching the market by intentionally delaying completion: if they did, house prices would collapse, resulting in significant losses for the developers. According to Fathom, real estate developers needed around four years to finish the construction of a residential property in 2012, a figure that rose to nearly ten years in 2022. This imbalance has however improved slightly in 2023, as the number of new housing starts ebbed and more were completed. The latter may reflect property developers pulling forward the completion of some projects, hoping to quell growing skepticism from buyers that has caused downpayments on unbuilt homes to dry up.
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Reflecting the perceived instability in China’s housing market, foreign investors are currently charging prohibitively high interest rates to Chinese real estate companies, implying that Chinese real estate firms have more or less been shut out of overseas borrowing. That leaves the local banking system, and implicitly the government itself (as most important Chinese banks are state-owned) as the ultimate lender of last resort in case some systemically important developers face serious financial troubles. For now, that implicit guarantee is assumed to exist by market participants; but a misstep by policymakers could make the whole house of cards collapse, and this would send the Chinese economy into an outright recession, according to the housing market slump scenario in Fathom’s Global Outlook, Winter 2023.
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The views expressed in this article are the views of the author, not necessarily those of LSEG.
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