Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market

May 11th, 2010

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In our previous article, What if China crashes?, we wrote,

? the Chinese government seemed to be getting really serious about cracking down on property speculation, even to the extent that it is giving the impression that it wants the property bubble to burst.

Will the Chinese then rush to gold should their government succeed in cracking down in property speculation? To answer this question, we must first understand some things about the Chinese mindset on property and investments. Currently, interest rates in China are pathetically low- so low that they are below the price inflation rate. Because of their currency peg, the People?s Bank of China (PBOC) is constrained from raising interest rates (see Can China raise interest rates to control its property bubble?). Also, the Chinese are known to be savers.

So, that creates a problem. Imagine you are a typical Chinese saver. What if you want to save and the cash at bank is yielding returns that are below the rate of price inflation? That results in a very great disincentive to save your money in the bank and pushes you to ?invest.?

The next question is where can you ?invest? your money? Remember, a lot of other people are facing the same problem because the Chinese government?s policy of force feeding credit into the economy is creating a gigantic rain of freshly printed money- a lot of people are having too much money on their hands. Unfortunately, in China, with its underdeveloped financial system, there is not much avenue to ?invest? your money.

The range of financial instruments in the stock market is limited. There are hardly any derivatives available for you to short the market (but currently, stock index futures are on the trial phase). Not only that, the standard of disclosure and reporting has too much to be desired. Most average mum and dad stock investors in China can only take long positions on a stock market that is highly volatile and speculative (due to lack of disclosure). No wonder investing in stocks is not that popular in China.

Thus, the only investment outlet for this mountain of freshly printed money is the property market. There are a few characteristics of the Chinese property market that most foreigners will not know. Perhaps these characteristics explain why the property bubble in China is so enduring.

Firstly, the Chinese property bubble is definitely bigger than the property bubble in Australia. But you may be surprised to learn that the consumer leverage in the residential property market in China is in fact smaller than Australia. In China, you need at least 40% deposit to qualify for a mortgage loan. As Patrick Chovanec wrote here,

According to the latest statistics I?ve seen, approximately 50% of all residential purchases in China today are financed with mortgages, which are mainly provided by the big state banks.  That?s a sharp increase from just a few years ago, when nearly all such purchases were made in cash.  In theory, the rules allow 30-year mortgages, but anything longer than 20 years is rare, and the presence of high prepayment penalties tend to push buyers towards mortgages with even shorter terms (our own mortgage was, believe it or not, 3 years, which is more like an instalment plan!).

A lot of residential real estate transactions in China are made in cash!

Secondly, the secondary market for residential real estate in China is extremely weak. As Patrick Chovanec wrote here,

What we see in China, though, is an extremely weak secondary market.  In the U.S., the ratio of secondary to primary residential property transactions for the first half of 2009 was 13.45; in Hong Kong it was 7.25.  In China as a whole, that ratio was 0.26 (four times as many new home purchases as secondary sales).  Even in China?s most developed markets the ratios were just 1.30 for Beijing, 1.56 for Shanghai, and 1.35 for Shenzhen.

If you combine these two characteristics together, you can conclude that a lot of real estate purchases in China are made with relatively little borrowing (or none at all) on brand new homes. As a result, the Chinese are, as Patrick Chovanec wrote,

? in that sense, the people using real estate as a store of value, a place to stash their cash?

That explains why there is a lot of idle and empty apartments in China as more and more of them are being built by property developers.

But the fact there is relatively little consumer leverage in the Chinese property market does not mean that there?s little leverage in the property sector. In China, the leverage is placed on the shoulders of property developers. In other words, the Chinese property ?investors? are de-leveraging the developers!

Now, what if the Chinese government succeeded (whether accidentally or deliberately) in smashing the store-of-value function of property? We will go into that in the next article. Keep in tune!

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  • One of our readers has this comment:

    One common practice here in China that you didn't mention, is the “personal loan”. Sure, many people pay for their apartments in cash, but the cash is borrowed from within the family. Uncles, grandparents, parents – all are hit up for the money. When you have family around you who can do the
    same thing, the idea of going to the bank for a loan is foreign to the Chinese mentality. The concept of family is much stronger here than in Australia.

    The other thing that happens, as a result of the wealth storage phenomenon, is that it is very difficult to negotiate deals in the secondary market or rental market. Even when there is a glut of empty apartments, landlords are not interested in reducing rents. Personally, I find it amazing that they would not want to have a tenant in the apartment and collecting rent on their investment, but no, most private landlords look only at the long term capital appreciation.

  • Matto

    Some more china info & opinion

    http://georgewashington2.blogspot.com/2010/05/i

  • Matto

    Beijing house prices down 31.4% in the last month!

    http://www.capitalvue.com/home/CE-news/inset/@1