Coming into 2018, Lebanon’s real estate market was already sputtering. For several years, real estate developers have complained of worrying market

Is the current real-estate valuation bubble very dangerous for China?

Is the current real-estate valuation bubble very dangerous for China?

Real-estate valuation bubbles are very dangerous everywhere – except in China. Yeah, I know. What can I say. Life is not fair!

In order to understand why real estate bubble is dangerous, you have to first understand why the bubble formed in the first place. It always starts with interest rate cut, which makes a lot of houses affordable suddenly. OK, then, people borrow from the bank to buy houses at low interest rate. But you only have fixed amount of houses available in the market, so people bid the housing price up and up. Then the Central Bank says, gee, inflation is up. I gotta jack up the rate to fight inflation. Boom, the interest rate goes way up, and suddenly the monthly payment goes way up, and suddenly people can’t afford the monthly payment anymore. They run out of money, so they have to do a fire sale, which drives the housing price way down. This means that people who used to have “asset” on the books now are deep in the red. Crash!

The danger of a real estate crash is not limited to the housing market. The housing market is tied with a bunch of other industries – construction, furniture, household stuff, consumer product, etc. If the housing market crash, they all crash together. The whole country’s economy goes down. That’s why it’s so dangerous!

Now take a look at why you (I’m looking at you, the US and Japan) can’t control the real estate market. Because –

  • the domestic market is huge in dollar value (yeah, that’s what 30-year loan does – really jack up the total amount of nominal money tied to the abode)
  • the market is national and not local (because the banks are national and the real estate financing is national)
  • the only thing the government can do is to change the interest rate, which, when it scrimps the housing market, it simultaneously scrimps the businesses, the investments, the industries, the jobs. Everything together.

Aha! So you have different adverse weather in different part of the globe, and the only treatment you have is Ice Age or Global Warming. Got it.

Now let me tell you why the Chinese government has far better control of the real estate market, compared with other countries.

First of all, thanks to the Hukou system, China’s real estate market is NOT national, but local. Hukou is basically a permit for a person to live in a specific city. For example, if you want to live in Beijing, the Beijing government has to agree to it and give you a Beijing hukou. This means that the Beijing government decides how many people, in total, get to live in Beijing. If Beijing decides “I will cap our city population at 25 million and not one more”, then – you can’t go bid for a house in Beijing. You don’t have the permit to live there. The only people who get to buy and sell houses in Beijing are those with Beijing hukou. So effectively, the housing demand is local, its total size set by the local government.

Secondly, the Beijing government has a lot more control over the local housing transactions than the US government. If there is demand for labor, and they want to attract people to Beijing, the Beijing government can set the housing loan terms at 5% down payment. If Beijing doesn’t want more people, it can demand 50% cash down payment from buyers. Last year, when the Central Government went on a de-leveraging binge, within a two-month period, tier 1 cities capped their population, and tier 2 cities jacked up down payment requirement to 20%. The housing prices in those cities came to a screeching halt. Just like that.

Thirdly, there are like 500 ways for the local government to create inventory overnight, if it wants to hold down the housing price. For example, currently China has no property tax on residential housing, so you have people squirreling away like 20 units of housing at no cost. And the city knows exactly how many of these housing units are out there. So there is the plan that some tier 2 cities will start experimenting with residential property tax, something like “no tax below certain square meters per person, and a graduated tax rate above that”. So for the big property owners, you may find yourself suddenly have to pay a lot of taxes to keep your extra housing units, and if you don’t want to pay up, you gotta sell. This way, the local government can fine-tune how many units it wants to be in the market at any given time. And I’m not even talking about the land reserve that every local government has, to be released for development if the demand gets really high.

So you see, in China, the housing market is local, which greatly reduces systemic risk. You can deal with local housing market overheating one-by-one, without generating systemic risk. And you don’t have to tinker with the nation-wide interest rate to control the local housing market, because the city government can control both demand and supply by other means. And lastly, there are still 50% of the Chinese rural population which is in the process of moving into cities in the next 20 to 30 years. That’s the build-in buffer, the cushion and support for baseline housing demand. Plus, Li Keqiang, the Chinese premier, has repeatedly said that houses are for people to live in, not for people to speculate with. That’s a signal that if you try to speculate with the real estate, and end up losing your shirt because of a policy change, you can save your tears.

What the Chinese government is trying to do right now, is to cap tier 1 cities, de-leverage tier-2 cities, and drive growth in tier-3 and tier-4 cities. There is an optimal point in terms of city population, infrastructure, and management efficiency. There are already 40 cities in China bigger than Paris, and 150 cities with population of more than 1 million. List of cities in China by population and built-up area Beijing and Shanghai are big enough. Now it’s time for people, resources, and industries to grow in tier-3 and tier-4 cities. The goal is to “get rich together”, remember? That’s the promise the Chinese government made to the people back in the 80’s. So now it’s time for tier-1 cities to start helping the tier-4 cities to get rich. The mayor of Guangdong swore to set an example of that to the Central Government a couple years ago, and he’s been overall quite true to his word.

The Chinese government is in the business of managing systemic risks. It controls the housing market on the city-level granularity, controls both the demand and the supply. And what does the US government has? The interest rate. That’s it. There’s simply no comparison.