China's Real Estate Bubble

By Arthur Pinkasovitch | July 07, 2011 AAA
China's Real Estate Bubble

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.)

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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.)

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