China: gigantic property bubble in the midst of exploding supply of vacant brand new homes

May 13th, 2010

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Today, we planned to continue from our previous article (Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market). But one of our readers, Paul, emailed us a couple of very informative comments (which we’ve posted on the comments section of that article). With his comments, we feel that we have further points and observations to add, which requires a separate article. Please note that our observations of the Chinese property market are made from the point of view of a foreigner, which may not be entirely accurate or correct. So, please feel free to correct us if we are wrong.

In Paul?s second comments, he wrote

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.

To add to his comment, we have some interesting observations that may perhaps explain such strange behaviour in China’s property market. You see, in Australia, when you buy a brand new home, it is mostly done up (e.g. complete with kitchen, oven, tiles) and ready to move in. In China, brand new homes are usually ‘raw’ (e.g. no tiles, concrete walls)- you need further renovations before that home is ready for moving in. Obviously, landlords cannot rent out ‘raw’ homes because they are unliveable. That’s where the Chinese mindset differs- if the ‘raw’ home gets renovated (so that it is ready for moving in), that ‘raw’ home is no longer ‘brand new.’ As our reader said,

… it is very difficult to negotiate deals in the secondary market or rental market.

Once a home loses its ‘brand new’ status, it loses value and goes to the secondary market. Given that the secondary market is extremely weak in China, it explains why Chinese property speculators rather keep their apartments ‘raw’ and un-renovated than to renovate it and rent it out (unless the rent is high enough to offset the loss in value).

Furthermore, we guess that the domestic rental market in China must be very weak because of the “account” system. In Chinese cities, families must own an city residency “account,” which qualifies them for government services, school enrolment, etc. The “account” is defined by the address of your owned home. The implication is that if you sell your only home (and consequently, have to rent another home to stay), you lose your “account,” which will be very disadvantageous to you. That probably explains why the rental market seems to be non-existent in China (except for foreigners and maybe for migrant workers who don?t have their own ?account? anyway). These characteristics explains why in China, there can be a gigantic property bubble in the midst of exploding supply of vacant brand new homes. It is very similar to what we wrote in Why oil cannot function as currency reserves?

Then the demand for tooth pastes will rise to the moon, not because the demand for oral hygiene increases, but because the demand for tooth-pastes as money increases. Not only that, no matter how much tooth-pastes Colgate produces, there will always be shortages because there will be mass-hoarding of them as money.

That is the consequence of monetary inflation, which undermines the store-of-value function of money. When residential property takes on the store-of-value function, the result is a gigantic price bubble in the midst of over-supply.

In the next article, we will continue the story from the previous article. Keep in tune!


P.S. Paul has this comment regarding this article:

Your comments about the condition of the home or office when sold new are true.?? For homes however, it is more usual to dress them.?? For offices, no.

But I want to pick up on your second part.?? By “account” I assume you mean “hukou”.?? If so, your facts are wrong.?? It is not based on the address of your owned home, but on where you were born.?? The original purpose of the hukou was to identify and control peasants.?? A person’s hukou identifies
whether they are a city person or a rural one, and is based on the province in which they were born.?? My Chinese wife was born in Xinjiang, but her parents came from Anhui and Henan.

Every Chinese citizen has a hukou.?? Rural migrants coming into the cities to find work still have a hukou.?? But it identifies them as being not from the city, making them ineligible for social security, schooling or other benefits.?? People with hukous from outside a city can buy property in that city.??? But the vast majority can’t afford to, because they are rural migrants looking for work.

One more point.?? Anecdotal evidence, but I present it just the same.?? My Chinese friends, and indeed my wife’s family, all wonder why I rent instead of buy.?? If possible, Chinese people will buy, as they see renting as a waste of money.??? They would rather scrape together the money from the family to buy a modest place than to rent.?? By the way, my wife’s brothers
own their own homes here in Beijing, despite them all having Anhui hukous.

If I may make one final observation, based on the work I do here.?? In a falling market, the Chinese will stay away in droves.?? They much prefer to wait and see how far it will fall, before making an investment or purchase decision.?? I consult to the global primary aluminium industry, and I see the same thing when it comes to raw materials.?? Any hint of softness in
price will cause the Chinese to stop buying.?? Conversely, any hint that the price is set to rise, and they will rush in.?? Hence why the Shanghai index has such wild swings.

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  • Wow, amazing. Thanks 🙂

  • Matto

    The crapper and the fan blades seem to be getting closer by the day.

  • Anon

    haha

  • Pete

    Informative article, and great comments from Paul.

    Thanks! 🙂