housing prices China

China’s Most Profitable Industry Becomes One of the Toughest

4 Comments / July 7, 2011

Chinese real estate is no longer the easiest legal risk-adjusted money-making business in the world. It’s been a swift reversal. For the better part of twenty years, there’s been no simpler way to amass a great fortune than developing property in China.

The business model was as simple as it was profitable: acquire a piece of property from friends in government at a fraction of its market value, mortgage the property heavily with obliging state-owned banks, sell out most of the units (either offices or apartments) within weeks of construction beginning, and then pocket returns of 500% or more before the building was even occupied.

Continuously rising property prices, often increasing by 10% or more per month,  provided incentive to hold onto some units for later sale. A final wrinkle was to demand a cash advance from the construction company when awarding the building contract, so limiting even more the amount of capital needed, and improving return-on-equity even more.

There was just about zero risk in deals like this. Then, the Chinese government began clamping down, starting gingerly about a year ago and then with added ferocity in recent months,  in an effort to restrain property prices and overall inflation. At this point, what was once the easiest business in China has become one of the hardest. Sweetheart land deals are far more rare, as the central government in Beijing is no longer turning a blind eye.

More importantly, banks have all but stopped lending to property developers. This has dried up liquidity in an industry that was for many years awash in it. The projects getting built now, for the most part, are those where little or no bank debt is required. That means heavy upfront equity investment, or taking money from loan sharks who charge interest rates of 25%-30% a year. This fundamentally alters the arithmetic of a real estate deal in China. The more equity and high-interest debt that goes in, the lower the returns and, it seems,  the more likely a project is to hit problems.

And problems have become the norm. Another government change, little reported but absolutely crucial to the change in fortunes of the real estate business in China, is that it’s no longer easy and cheap to get current residents off the land, so it can be sold at a high price to a developer. New rules make it very expensive and risky for any developer to undertake this process of relocation and demolition.

Any delay, and delays are rampant, can quickly drain away a developer’s cash. For example, if one old tenant refuses to take the relocation money and move out, it is no longer a simple thing in most instances to get the local government, or hired goons, to force them out. Until all old tenants are resettled, no construction can begin. This can push back by months or even years the date that developers can begin pre-sales. Meantime, you keep paying usurious interest rates to lenders who have taken the whole project, as well as many of other unrelated assets, as collateral.

A final nail: residential real estate prices are now rising far more slowly. This is the result of tighter mortgage rules, property taxes in some cities, as well as new regulations that limit the number of apartments people can buy. In Beijing, for example, you need to prove you have paid local Beijing taxes before being allowed to buy.

Of course, taking the easy money out of real estate is a prime policy objective of the Chinese government. That the government would be successful in this was never much in doubt. The speed and geographical scope of the impact, however, has caught a lot of people (including me) by surprise. Projects that six months ago looked like sure things are today struggling. The sudden evaporation of bank finance, in particular, is playing havoc. Banks in China are state-controlled. When they responded slowly, earlier this year, to government suggestions they slow the flow of funds to the real estate sector, the government took more active measures, including raising six times banks’ reserve requirements.

Rocketing property prices are a major contributor, directly and indirectly, to inflation, which is now, by official figures, at its highest level in China in over three years. So, the government’s actions had a broader purpose than altering the return formula for real estate investment in China. At the moment, though, that’s been the main impact, to make it far harder to do both residential and commercial real estate projects in China. When and by how much inflation will be curbed is unclear.

The bigger question is: has the game changed permanently in Chinese real estate, or will things revert as soon as inflation is down to where the government wants it to be. The rising real estate prices of the last 20 years have not only helped the country’s real estate barons. They have also been a main source of rising middle class wealth in China. That’s where the government policy becomes more an art than science: how to strip away real estate developers’ easy profits, while keeping the middle class feeling flush and contented. I’ll write about that in a following blog post.

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Toiling from Tang Dynasty to Today – Buying a House in Beijing

1 Comment / January 13, 2011

sancai16

How long would it take an ordinary Chinese peasant to save up and buy a nice apartment in Beijing? You’ll need to brush up on your dynastic history.

1,400 years ago, as the Tang Dynasty dawned in China, a peasant began farming a small plot of decent land 6mu (one acre) in size. Every year, in addition to providing for his family’s needs, he was able to earn a small profit by selling his surplus. His son followed him on the land, and maintained his father’s steady output and steady profit. Same with is children, and children’s children, through the Song, Yuan, Ming, Qing Dynasties into the Republican period and then the modern era marked by the founding of the People’s Republic in 1949, down to present day.

Some 280 generations later, there should now be just about enough in the family bank account for the family to pay cash for a new two-bedroom apartment in Beijing. This is assuming no withdrawals from the bank account during that time, and even more unlikely, no bad years due to floods, famine, locusts, rebellion.

I heard this calculation second hand, and so can’t check the figures. But, it certainly has a ring of truth about it. Property prices in Beijing particularly, but other large cities as well, have reached levels utterly disconnected from average earning levels, especially in rural China.  New apartments can now cost over USD$1 million. Prices continue to rise by over 5% a month, despite aggressive actions by government to curb the increases in residential property prices. According to the Wall Street Journal, “Housing prices in the U.S. peaked at 6.4 times average annual earnings this decade. In Beijing, the figure is 22 times.”

The collapse of this “housing price bubble” has been widely predicted for years now  — not since the Tang Dynasty, but it sometimes seems that way. The housing price crash was meant to be imminent two years ago, when prices were about 30% of current levels.

Still, they keep rising, most recently and most dramatically in second and third tier cities in China, places like Lanzhou, a provincial capital in arid Western China, where the cost of a 100 square meter apartment has doubled in price in the last year, to about $300,000.  Some apartment owners in Lanzhou earned as much profit  during 2010 from the sale of their property as a typical peasant in surrounding Gansu Province might make in a century.

My prediction is that housing prices may soon peak relative to incomes, but will keep moving upward. There are a few fundamental factors at work that raise the altitude of housing prices: rising affluence, China’s continuing urbanization and a dearth of alternative investment opportunities. Real estate, despite what can seem like dizzying price levels, is often seen to be a safer long-term bet than buying domestically-quoted shares.

Introducing property taxes, and allowing ordinary Chinese to buy assets outside China, would both alter the balance somewhat.  But, many a hard-working peasant is still going to need a thousand years of savings to join the propertied classes in Beijing.


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The Middle Kingdom’s Mighty Middle Class

Leave a Comment / November 18, 2010

Ming Jiajing from China First Capital blog post

China recently overtook Japan to become the world’s second-largest economy. China’s population, of course,  is ten times larger than Japan’s. So, per capita, China is still one-tenth as affluent as its Asian neighbor.

A far more important, if little noticed, economic trend is that China’s middle class is now far larger than Japan’s. Indeed, the Chinese middle class will soon surpass, if it hasn’t already,  America’s, and so become the largest middle class country in the world.

There is no standard definition of “middle class”. So, measuring the number of people falling within this category is an imprecise science. It generally refers to people whose household income allows them to enjoy all the comforts of life well-above pure subsistence: these include vacations, air-conditioned homes, the full assortment of labor-saving home appliances, personal transport, and sufficient savings to cope with shorter-term economic problems like unemployment or a health emergency.

In China, by my estimate, there are at least 250-300 million people who now fall into this category. This is an economic achievement of almost unimaginable scale. Thirty years ago, there was no “middle class” in China, and but for a tiny group of top or well-connected party officials, virtually no one in the country of 1.4 billion could be described as living above basic subsistence.

Today, China has more internet and mobile phone users than anywhere on the planet. It is the world’s largest market for new cars. Housing prices across the country, in most of the major cities, are at or above the average levels in the US.

These housing prices are a big reason for the swift rise in the middle class in China. With few exceptions, anyone who owns a home in a Chinese city can now be considered middle class. That’s because most urban housing now is worth at least $50,000-$70,000. In major cities like Shanghai, Beijing or Shenzhen, housing prices are now among the highest in the world, and so just about every property-owner is sitting on an asset worth well in excess of $100,000.

Most Chinese either own their homes outright, or have mortgages that represent less than 50% of the home’s current value. Even in more rural parts of China, there are tens of millions of home-owners who have equity of at least $20,000 in their home.

Unlike in the US, Chinese can’t easily tap into the wealth locked up in their homes by taking out second mortgages. But, the wealth effects are still very real in China. People know how much their home is worth, have confidence the price will likely continue to appreciate. So, spending habits can reflect this.

In fact, most Chinese have a better idea of the current value of their homes than anyone in the US or Europe. That’s because property is sold based on price per-square-meter, and everyone in China seems to know that current value of the square meters they own. The Chinese government has been trying for the last sixth months, with limited success, to moderate the fast rise in property prices across the country.  Most housing has appreciated by at least 15% this year.

Housing is the main bedrock of middle class status in China. But, salaries are also rising sharply across the board in the professional class (as well as those working in factories), putting more cash in people’s pockets. The stock market has also become a major additional source and store of wealth.

It’s a common characteristic of the middle class everywhere to feel a little dissatisfied, and a little anxious about one’s economic future and ability to remain among the more better-off. This is very noticeable in China as well. Many of China’s middle class don’t consider themselves that comfortable.

The pace of social and economic change is so swift, and prices for many middle-class staples like cars, foreign vacations and housing are so high,  that people don’t have a real sense of “having made it’.  They also fret about their retirement, about saving enough to put their kids through the best schools, about job security. In other words, they’re very much like the middle class in the US.

Middle class spending is the single most important source of economic activity in the US. This isn’t yet true of China, but each year, it will become more important. This reality should be at the top of the agenda for boardroom planning at companies in China and much of the rest of the world. China’s middle class will become a market not only larger in size, but in purchasing power, than America’s.

China’s very rich (it now has more billionaires than any other country except the US) and poor tend to be the focus on most of the reporting by the world’s financial press. They are generally blind to the most significant development of all, the emergence over the last ten years of an enormous middle class in China. Without a doubt, more Chinese join the middle class each year than in the US, Europe and Japan combined.

Remember, many of the most successful global businesses in the US over the last 50 years – Ford, McDonalds, Disney, Coca-Cola, P&G, Wal-Mart to name just a few – got that way by focusing originally on selling to America’s middle class. China’s middle class is fast becoming an even richer target.

Anyone selling services or products for the middle class ought to find a way to do so in China. Quickly.

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