In 2007 average home prices in the United States slipped from $221,900 to $219,000 which was then shortly followed by a massive 21% drop over the next two years. Chinese real estate, on the other hand, maintained its value through the Great Recession as property values tripled between 2004 and 2009. Fast forward another two years, and major cracks are beginning to surface within the Chinese real estate market as speculation about the collapse of the bubble has started to emerge. (To learn more about housing bubbles, check out Why Housing Market Bubbles Pop.)

TUTORIAL: Exploring Real Estate Investments


Standard & Poor's recently cut its outlook on Chinese developers from "stable" to "negative" in anticipation of a "sharp correction" for real estate prices. Analysts are forecasting that home prices will fall by 10% within the next year.

Oversupply
The primary concern for the sustainability of current prices is based on the oversupply of residential and commercial real estate in the country. In order to maintain GDP growth, the Chinese government has continued to overinvest in large infrastructure projects focused on real estate development.

At an average wage of $7,400 people are neither able to purchase the basic $100,000 apartments units nor invest into small businesses around the new developments. In cities like Hainan, residential apartment occupancy rates stand at only 30% while more industrialized cities such as Shanghai and Beijing also have substantial vacancy rates of approximately 50% and 35% respectively. Prior to deflation of the American real estate bubble, Michigan had the nation's highest rental vacancy rate of 18.4%.

Commercial real estate is displaying a similar trend where construction is outpacing demand. What was once expected to be the largest retail mall in the world, the New South China Mall in Dongguan is practically empty as over 95% of its stores remain unleased since its construction in 2005. Although the "Great Mall of China" contains 9.6 million square feet of floor space, less than a dozen active shops remain in the mall. Also, due to the lack of customers the few active shops claim that they can go for days without making a single sale. (For more information on real estate prices, see The Truth About Real Estate Prices.)

Why Build?
Over the last 21 years China has maintained an average quarterly GDP growth of 9.3%, which is becoming increasingly dependent on the real estate market. According to The Atlantic, residential housing investments contributes to 6% of GDP, the same level as U.S. real estate at the peak of the housing bubble. Jonathan Anderson, an economist with UBS, estimates that 2010 property construction accounted for 13% of GDP. Investing in large infrastructure projects which provide no long term economic value has become a notable method of creating growth. By overbuilding to preserve the image of rapid growth, the Chinese government is applying Keynesian economic policies at wasteful rates.

Of note, the overall GDP data coming out of China is highly questionable. The Wall Street Journal states that every province in China reports a higher growth rate than the nation. Building ghost towns is just another way to artificially inflate this uncertain GDP figure.

Current Prices Are Too High
In contrast to the empty ghost towns, property prices in major metropolitan areas have risen to unsustainable levels. At the peak of the American housing bubble, the average new home price to annual disposable income ratio topped out at slightly over five, meaning that it would take five years of savings to fully purchase a home. The current corresponding metric for Shanghai is ... 57. Property values in some of China's major cities have already started to slowly fall. (For more information in identifying a bubble, check out 5 Steps Of A Bubble.)

Related Articles
  1. Stock Analysis

    The Top 10 Small-Cap Stocks for 2016 (ATI, ARCB)

    Discover the top 10 small-cap stocks expected to grow in 2016, complete with summaries and growth outlooks for each company and its expected price target.
  2. Investing

    Don't Freak Out Over Black Swans; Be Prepared

    Could 2016 be a big year for black swans? Who knows? Here's what black swans are, how they can devastate the unprepared, and how the prepared can emerge unscathed.
  3. Economics

    The Truth about Productivity

    Why has labor market productivity slowed sharply around the world in recent years? One of the greatest economic mysteries out there.
  4. Markets

    Is It Time To Buy Emerging Markets? (EEM)

    The majority of emerging markets are dependent on natural resources, delaying a long-term recovery until commodity markets end historic downtrends.
  5. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  6. Investing Basics

    The Complete Guide to Financing an Investment Property

    If you're considering adding an investment property to your portfolio, you need to know what your options are for financing its purchase.
  7. Stock Analysis

    3 Risks Emerging Markets Debt Faces in 2016

    Learn about the major risks for emerging market debt in 2016. Discover how low interest rate policies by central banks fueled the growth of debt globally.
  8. Investing

    Why Wal-Mart Stores Inc's Latest Closures Matter Less Than You Think (WMT)

    Wal-Mart Stores Inc closed hundreds of stores in January 2016—a move which should reassure investors, not scare them away.
  9. Economics

    The Delicate Dance of Inflation and GDP

    Investors must understand inflation and gross domestic product, or GDP, well enough to make decisions without becoming buried in data.
  10. Economics

    The 2007-08 Financial Crisis In Review

    Subprime lenders began filing for bankruptcy in 2007 -- more than 25 during February and March, alone.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  3. What's the difference between microeconomics and macroeconomics?

    Microeconomics is generally the study of individuals and business decisions, macroeconomics looks at higher up country and ... Read Full Answer >>
  4. Is Russia a developed country?

    Though it once reigned alongside the United States as a world superpower, Russia is not classified as a developed country ... Read Full Answer >>
  5. Is North Korea a developed country?

    North Korea is one of the poorest and least developed countries in the world. It is far from a developed country. Because ... Read Full Answer >>
  6. Is Mexico a developed country?

    As of 2015, Mexico is not a developed country. However, it beats the majority of its peers in the developing world on most ... Read Full Answer >>
Trading Center