China Housing Booms on Land Shortage…

‘The property sector contributes about 15% of GDP directly, but up to twice that on a broad multiplier basis on HKMA estimates, while real estate accounts for about 70% of household assets. On a cyclical basis, the housing market has been improving since mid-Q1, despite the misguided Spanish/Irish property crash parallels drawn by some observers (ignoring the huge equity cushion, the lack of securitization or a secondary market to propagate panic selling etc.). Ongoing easing measures and liquidity displacement from equity markets will boost property in the leading Chinese cities further this summer. Ultimately, the government desperately needs the fixed investment cycle in real estate to stabilize…’ Macro Weekly, May 22nd 2015

‘Mainland developer destocking continues to tighten the market as sector lending picks up. Indeed, the chart showing cumulative real estate floor space started versus sold is a critical one right now – it shows the huge inventory build-up in recent years has peaked, ex the Tier-3 cities – it’s hard to see destocking going much further. Your view on global cyclicals/materials as well as Chinese momentum hinges on whether you believe that property investment is set to stage a rebound.’  Macro Weekly, Jan 11th 2016

It was clear by mid-2015 that a cyclical rebound in China’s property market was looming, driven by healthy fundamental demand as inventory levels peaked, yet this critical macro inflection point was bizarrely overlooked by most commentators. We’ve gone from a China ‘running out of FX reserves’ consensus narrative in January to a ‘running out of apartments’ one now i.e. the feared deflationary impulse has become an inflationary one for the global economy, even before housing investment catches up with the inventory cycle.

Indeed the surprise has been the relatively weak new build response, but the suggested Q1 overweight bet in domestic deep cyclicals exposed to the construction cycle as well as global materials/mining has outperformed substantially this year. The largest Chinese cities have joined many in the West from San Francisco to Dublin and London where soaring prices have failed to generate significant developer new supply, partly because of zoned land and funding shortages.

This latest property boom is therefore very different to the 2009-2013 one, when developers and local SOEs rather than households were the driving force and leveraging aggressively. Given the fevered price surge, which is reaching even third tier cities, it’s remarkable that new starts fell over 19% y/y in September. Rapidly shrinking inventories offer fundamental support, although the recent spectacular pace of official price growth (exceeding 30-40% y/y across several of the 15 largest cities) is clearly unsustainable.

The backdrop remains broadly positive – rapid urbanization (from an official but likely understated 56% in 2015) is spurring first-time housing demand; demand for housing upgrades will increase alongside rising incomes as about 40% of urban households are living in low-quality housing built before 2000 while there are more than 230m people aged 20-29 who will be first time buyers over the next decade. The affordability ratio nationwide was at the lowest end of the historical range at just over 7x income as of the end of 2015, making property relatively attractive as interest rates fell and A-shares imploded. The ratio of house prices to household disposable income in Tier-1 cities was just under 15x at the end of 2015 and has now risen to about 20x, approaching HK levels and well above London/NY.

However, these conventional metrics are distorted by the huge amount of space hoarded as ‘concrete deposit boxes’ by the top 1% of households (who own about 25% of vacant space) and substantial undeclared ‘grey income’ for the elite. An alternative ‘reality check’ is to look at housing wealth versus national income; aggregate Spanish residential property peaked at about 460% of GDP in 2007; Australia (and NZ), considered the frothiest global real estate markets alongside Canada (and a surge in Chinese buying has been a major factor in all three) are now worth over 350% of GDP.

The US peaked at just under 200% and is now 140%. China’s property market is worth 350-400% of GDP at current price levels. Land remains the key form of collateral within corporate balance sheets and the wider financial system, as with Japan in the 1980s and national average prices are up 5x since 2004 on the independent Wharton/NSU/ Tsinghua index, and 11x in Beijing. It’s important to note that Spain, the US and Ireland all saw a dramatic supply response to rising prices which alongside the collapse in credit availability helped crash the market 40-50% peak to trough post 2008. China doesn’t face the same series of shocks but real estate is now clearly overheated and calming the market is becoming a policy priority for Beijing.

The bottleneck is what has been historically been a rapid new build response in China capping price surges is land. In the first nine months of 2016, residential land supply in 100 medium and large cities dropped by 10% y/y, even as apartment sales soared. In Shanghai and Beijing, land supply through September dropped by 33% and 80% respectively y/y. The recent trend of developers bidding aggressively for premium land is directly due to low levels of zoned land for sale (itself partly a function of the ongoing anti-corruption drive, which has created local government paralysis in what has been a very lucrative activity for city level bureaucrats).

Significantly, the Shanghai government has just tightened regulation on the financing of land purchases – developers are not allowed to buy land using financing from banks, trusts etc. but from internal funds. Developers violating the new regulations would lose the deposit they make before auctions and will be banned from purchasing land in Shanghai for three years but this looks more a supply than demand side issue.  The only sustainable solution is significantly more land and new floor space supply over the next year, further boosting producer prices and cyclical growth momentum, even as housing prices peak.