Why China’s Housing Problem is Bigger than Most People Think

You won’t hear much about China’s housing market in the mainstream press these days. In a country rocked by daily stock market fluctuations, you can understand why. Chinese stocks soak up most of international attention.

Maybe economists assume there’s no story to tell with China’s property market. They look at surging prices in Beijing, and assume the market’s doing fine. But they’re ignoring China’s real estate market at their own peril. It’s the property market that could be the real scoop in explaining China’s fumbling economy.

Forget the stock markets. The carnage in Chinese stock markets is the effect of what’s happening with the economy. It’s not the cause of it, and that’s an important distinction. China’s stock market can never derail the economy. But it’s economy can, and does, influence the direction its markets go in.

Why is that? Well because financial assets, like stocks, have little bearing on household wealth. Certainly not to the extent that the property market does. Even trillions of dollars in stock market losses won’t affect households that much. And whereas that’s true of stocks, it most certainly doesn’t apply to housing.

So why aren’t economists paying more attention to China’s housing market?

Well, it could be that they assume Beijing and Shanghai represent the entire nation. Sure, these few big, important cities continue to see growth in house prices. And, on some level, there’s positivity to take from that.

Yet the rest of China is mired with markets that have either weak, non-existent, or falling prices. It would be like saying the global economy is doing well because the 1% have never had it any better. You’ll agree that’s no way to judge the health of a national property market.

We Aussies know this better than most. If China’s situation sounds familiar, that’s because it is. We’re facing the same problems here at home. We, too, have a couple of standout cities in Sydney and Melbourne. Both have grown at breakneck speeds in recent years. Meanwhile, the rest of nation is barely growing, if not declining.

The only difference is that, in China, the stakes are ratcheted up to a much higher level.

How property prices influence wealth

You shouldn’t underestimate the extent China’s housing market threatens its economy.

Take household wealth as an example of this. Over 15% of China’s gross domestic product is tied up in housing. If it doesn’t sound like much, rest assured that it is. To put this figure in perspective, consider that only 5% of US household wealth was tied up in property in 2008. In other words, the US mortgage crisis barely affected household wealth.

Yet with China, the problem isn’t that its housing market could spark a banking crisis. As economist Charles Hugh Smith notes, the real worry is how such a decline affects household wealth.

If house prices fell, what would it do to China’s wealth effect? Would it reverse it? Almost certainly. The wealth effect, for those that don’t know, is a theory that relates to spending habits. It argues that, as house prices increase, household spending goes up too. There isn’t much concrete evidence to support this theory. But logic suggests there’s something to it. If house prices are going up, homeowners feel richer, and are likely to spend more as a result.

Should China’s wealth effect reverse on a housing slump, it could weaken spending too. And for an economy still shifting to consumerism, that’s an outcome they’ll want to avoid.

China’s housing affordability: worse than Australia

An even bigger issue facing its market is the lack of housing affordability. Australia has the same problem.

In Beijing, a typical flat could cost 22 times the average household income. A sustainable ratio is around three to four multiplies higher than household income.

Does any of this sound familiar? Both Sydney and Melbourne have ratios that are 30% higher than the national market on a 10 year average. Across the nation, house price to income ratios sit at around 5.5. But if we separate Sydney from the rest of the nation, that ratio would be much higher.

The exact thing is taking place in China. At 22 times the average household income, few people can afford to buy homes in Beijing.

Like China, we also make the mistake of using high growth cities as a barometer for the national market. While Beijing’s market might be on the up, prices have fallen by a quarter in other cities around China.

Unlike Australia, that’s a much bigger deal in China. Why? Because Beijing and Shanghai account for a tiny percentage of China’s population. Sydney and Melbourne are home to 30% of Australia’s population. Whereas Beijing and Shanghai account for just 4% of China’s 1.2 billion strong nation.

So when analysts look at China’s housing market, they place too much stock in these few big cities. Problem is these cities may as well be different nations. They share few parallels with the rest of the nation.

China has a huge swathe of people feeling no wealth effect from rising prices. They’re seeing the opposite as house prices decline. Unfortunately, that suggests there are hundreds of millions of Chinese that will be spending ever less in the future.

China’s housing oversupply will test the market’s limits

One area where China completely trumps Australia is where it comes to housing oversupply. We think a glut of apartments slated for construction in Melbourne will be a problem. But China’s unit oversupply is on another level.

By some estimates, there are 65 million empty investment flats in China. In a country where most people earn in the region of $10,000 a year, these flats will be out of reach for many.

What’s more, the Chinese prefer newer homes. They’re not as keen on existing, already built homes. Which means there’s not only a glut of expensive apartments, but most are simply unwanted.

So where are the buyers for these properties going to come from? Nowhere, you’d think, especially given China’s ageing population.

China doesn’t have a demographic dividend anymore. Every generation is sizeably smaller than the one before it. That’s what 30 years of the one-child policy will do to a nation. It’s completely flipped their population pyramid upside down. Considering it’s 30 year olds who buy homes, you wonder where China will find those people.

It’s not that there aren’t any young people in China. But, relative to the size of supply in the housing market, there aren’t enough of them to meet demand. That’s a huge problem China’s property market doesn’t have an answer for.

I’ll give Charles Smith the final word on this:

China’s stated intent is to move from a fixed-investment/export dependent economy to a consumer economy. But if we consider what happens when housing slows or even grinds to a halt, we realise the impact on incomes, wealth and consumption will be extraordinarily negative, not just for China but for every nation that sells China vehicles and other consumer goods.

Or, as is the case of Australia, selling commodities to China.

Ultimately, if house prices in China continue to decline, there’s a strong likelihood consumer spending will tank. That, more than anything, threatens to turn China’s current slowdown into a full blown crash.

Mat Spasic,

Junior Analyst, Markets and Money

PS: Uncertainty over China’s economy is at the forefront of what’s playing out across global markets today. As house prices decline, so too will China’s purchasing power. That could hasten a crisis that spreads around the world.

According to Markets and Money’s Vern Gowdie, we’re already standing on the edge of this next financial crisis.

Vern is the award-winning Founder of the Gowdie Letter and Gowdie Family Wealth advisory services. As one of Australia’s Top 50 financial planners, Vern believes there’s nothing we can do to stop what’s coming.

It won’t be only stock markets that crash when the crisis hits. There’s another multibillion dollar market that’s poised to collapse when the credit bubble pops. Australia’s gone through two such credit bubbles in its history. The third, and latest, has been building for the last 65 years. When it pops, it won’t be pretty.

The fallout of this impending crash could do serious harm to your wealth. Yet, with some preparation, you can safeguard your wealth from the worst effects of the crisis. Vern will show you how to do this, and more, in his brand new report, ‘Global Financial Crisis 2016: 3 Crisis Scenarios, and How They’ll Impact Australia’. To get your free copy today, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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