China’s property market crackdown: how concerned should investors be?

The recent regulatory changes in China’s property sector – characterised by “red lines” and a forthcoming property tax – suggest that the nature of the market crackdown this time is different from past episodes. However, an abrupt change of expectation for such a large part of the economy and financial system is risky. Beijing, therefore, has a delicate task on its hands and needs to proceed cautiously. While deleveraging certainly remains a high priority, with property still a significant contributor to the economy, a large unintended amount of distress and impairment could be damaging to the recovery of any sector as well as long-term economic growth prospects. As the sector undergoes profound structural changes, investors are rightly concerned about the long-term outlook of the market in light of slowing population growth, already high home ownership and frothy housing prices in some cities. To assess the validity of these concerns, one needs to examine the two types of demand for property in China: one is for shelter – the so-called fundamental demand, the other – financial demand – is for investment. On the former, demand – measured by unit of property – peaked around 2018 and is expected to decline in the future because of deteriorating demographics. This does not necessarily mean that property transaction values will decline, given that new flats will be larger, of better quality and packed with modern facilities. However, it is true that diminishing fundamental demand does not bode well for the housing market, all else being equal. On the investment side, China is somewhat unique. Around 70 per cent of Chinese household wealth is tied to property, compared to about 30 per cent in the US. The lack of investment channels domestically and the closed capital account have made the real estate market the dominant recipient of the wall of money created by the central bank. In the US, one may argue that the Federal Reserve’s money printing has created a big financial bubble shared by multiple markets – equity, bond and real estate. In China, all those are wrapped in one – property. Hence, China stands as an outlier globally on all the standard metrics of housing affordability, such as price-to-income ratio, rental yields and mortgage serviceability. But, from another perspective, if one strictly looks at property as an investment, the price-to-income ratio becomes irrelevant. Rental yields between 1.3 per cent and 2 per cent in top-tier cities are low internationally, but the level of valuation this isn’t any worse than many stocks, even those that do pay a dividend, and much better than the US$11 trillion worth of global bonds trading at negative yields. The point is that, as a form of investment, property’s valuation should be aligned to the state of the monetary world we are in. If bitcoins that generate nothing can trade at US$65,000 a piece, an asset – selling at a price-to-earnings ratio of 50 times – may not seem outrageously overvalued to some. With tough economic choices ahead, can China still have its cake and eat it? One added functionality of housing is its role as a collateral asset. It is common globally for property and land to be used as safety pledges against bank borrowing. But this role is amplified in China where banks dominate the financial system. For small and medium-sized firms that need to access credit, it makes sense for business owners to park savings in property rather than a portfolio of equities or bonds, which cannot be collateralised. Hence, one needs to assign an extra value premium to property for its role in credit facilitation. Looking ahead, judging purely from fundamental demand and affordability matrices, it’s hard to have a rosy view of the housing market. China will still need to build a lot of houses to accommodate the ongoing urbanisation and upgrading of housing, but the natural speed of building will fall, and may even turn negative in some years. The bigger question is on the financial side. Property has become an investment of choice because of very supportive policies that brought everyone into the carnival: the central government uses it to manage the economy, local governments use it to gather resources via land sales, rich households use it as an effective saving vehicle, and banks and developers use it to expand balance sheets. All have benefited from the housing boom, except the poor and underprivileged who are getting increasingly priced out of the market. But as China moves towards common prosperity, the carnival might be gradually approaching an end. How much will China’s struggling local governments benefit from property tax? One potential material outcome of the crackdown on the property sector is that a growing amount of wealth might be redirected towards other asset classes – such as equities or fixed income – and may also result in an increasing institutionalisation of the savings market in China. To succeed in this endeavour and break faith in the belief that housing prices will never fall, it is necessary to reallocate resources away from the sector. A two-steps-forward-and-one-step-back approach – as seen in past major reforms – is likely to be repeated here. And one may argue the recent policy changes to ring-fence the troubled players are consistent with the authorities taking half a step back to manage risks. Aidan Yao is senior emerging Asia economist at AXA Investment Managers