July 21, 2010
China land prices
Tell me if you think this story sounds familiar.
A new NBER working paper by Jing Wu, Joseph Gyourko, and Yongheng Deng (also discussed by Joseph Cotterill and Tyler Cowen), used recorded prices for 300 residential land auctions in Beijing to develop the first constant-quality land-price series for a Chinese market. The study concludes that inflation-adjusted constant-quality land prices have increased by nearly 800% since 2003:Q1, with half that increase occurring over the past two years.
Some observers had dismissed the apparent parallels between the Chinese real estate bubble and that in the United States based on institutional differences in the details of loan financing between the two countries. For example, Michael Kleist wrote last March:
Certainly there isn't a mortgage credit-related bubble. The majority of homes in China are purchased with down payments between 30-40%, which is required by the banks, and nearly 25% of homes are purchased with all cash. Only those qualifying for low-cost housing can purchase a home with a minimum down payment as low as 20%. For this reason foreclosures in China are practically nonexistent.
But Wu, Gyourko, and Deng provide this interesting additional detail:
There also is a statistically and economically strong positive correlation between land auction price in Beijing and the winning bidder being a state-owned enterprise (SOE) associated with the central government. All else constant, prices are about 27% higher when a central government-owned SOE wins a land auction, so these entities appear to be playing a meaningful role in rising land values in Beijing....
If these particular developers are superior investors and are able to buy unobservedly high quality sites, then part of this effect could be a proxy for quality. We certainly do not claim that our hedonic controls are perfect. However, in other regressions not reported here, we also find that Central SOE developers pay high prices relative to the values of nearby housing unit sales prices. That suggests these particular buyers simply pay more and that this does not merely reflect omitted quality effects. Moral hazard arising from these entities believing they are too important to fail, combined with their access to low cost capital from state-owned banks, also could help explain their bidding behavior.
Mike Shedlock also relays several troubling anecdotal reports about where the money for down payments comes from. Here's one of the more benign accounts that he quotes:
There are circles in neighborhoods, or churches, community groups that are kind of like informal credit unions. People pool money into a large sum and then bid for its use month by month. 5% a month is the typical rate of interest....
Parents lend to their children to buy their condo with the understanding it will be repaid or they will come to live in their old age under that roof. Almost no one has the 20 to 30% down to buy a place. The down payment is typically borrowed at terrible interest or comes from a "marriage gift" which had its origin in borrowed funds, not from savings....
A collapse of the bubble could cost lots of folks their life savings. This makes the financial aspect of Chinese society much more fragile than it appears on the surface. There is a lot of interconnected personal debt below radar.
Popular opinion remains that the current worries in financial markets began in Europe. But as I've noted previously the Chinese stock market decline began before that in Europe and coincided with measures in China to curb property speculation. As of the moment, the equity decline in China substantially exceeds that in Europe.
Posted by James Hamilton at July 21, 2010 08:25 AMdigg this | reddit
The Chinese stock market is likely providing a contemporary real-time view of economic activity in China - they've been slowing down, which is confirmed by U.S.-China trade data.
Posted by: Ironman at July 21, 2010 09:56 AM
I was reading something on the low downpayments that noted that although LTVs were just 50% on average, then years ago almost no one used any mortgage at all. So, while the absolutely level was much lower than here, the growth in average LTV was even greater.
Also, I'm sure everyone has seen the piece a survey of electric meters that concluded there were 64 million empty apartments.
Posted by: Bob_in_MA at July 21, 2010 10:12 AM
Although LTV is low, the Loan-to-income ratio is high in China.
The bubble mechanism at the demand side should be insignificant, which is why the land price will not plunge after the macro policy adjustment.
As long as the revenue source of local government continues to heavily rely on land sales, the land price will continute to be pushed up by the local government through limited supply.
The urbanization and industrialization process in China determines that we will see the longest and largest real estate boom of the world ever since the Industrial Revolution.
Posted by: Yu_in_DC at July 21, 2010 11:12 AM
This reminds me very much of residential property price increases in the major cities of the former Soviet Union, 2002-2007. Tenfold was typical.
It's very important to keep in mind that these numbers are for Beijing, not the whole of China. There are enormous differences between the elite neighborhoods of major cities and the national average.
Substantial down payments do not preclude mortgage-driven bubbles. With such a pace of appreciation, and if there is widespread confidence it will continue, and/or if rents exceed monthly mortgage payments, many people will risk large down payments on speculative housing investments. That is what happened in the FSU, especially the Baltics, where the boom in mortgages was bigger relative to small countries, inflating their entire economies, and further driving the bubble that way. Large down payments do reduce post-bubble defaults, but defaults aren't the only component of post-bubble trauma.
In the case of apartments built for laborers moving in from the country, which is a different, less dynamic market, down payments are generally not paid by the buyer, they are subsidized.
Posted by: Tom at July 21, 2010 12:50 PM
The proper value of land is a very hard thing to gauge. Its stream of returns is capitalized over a virtually infinite horizon and its supply is quite inelastic - "they ain't making any more of it." Consequently, market prices of land are notoriously uncertain and subject to dramatic swings. A dramatic appreciation can as easily be a shift to a new equilibrium level as a sign of a bubble. We can guess all we want, but a certain amount of humility should be apparent in any conclsuions we draw.
Posted by: don at July 21, 2010 07:29 PM
The premise that is never stated but seems to be assumed everyone understands is that "unusually" high real estate prices automatically mean a bubble. Look at the ownership and amounts due on the real estate. Note that unlike the US the owners are not mortgaged over 100%. There will be no default if land prices crash becuase the Chinese virtually own all the equity in the loan. This is something that most economists have lost sight of in the US. If you have no debt there can be no credit crisis. Even if Chinese land prices crash the people still have the land. The yuan price may have changed but the actual exchange value of the asset to other assets has not. If you understand this concept you will be beginning your journey away from the money illusion.
Posted by: RicardoZ at July 22, 2010 07:43 AM
Posted by: ivars at July 22, 2010 09:32 AM
This is out of scope. Bejing is now like New York or London or Tokyo. Who here can buy a two bedroom townhome in Manhattan? Only the uber rich can. Bad press, they are misleading what is going on in the vast majority of the REST OF CHINA....the largest epic movement of peoples in the history of mankind............the urbanization of hundreds of millions, not tens of thousands, of Chinese.
Posted by: Ken in Il at July 22, 2010 09:44 AM
The urbanizations of hundreds of millions into penthouse apartments?
Posted by: D at July 22, 2010 10:53 AM
Yes it's a bubble, but as the paper says prices paid by entities associated with the government are higher, not lower. That needs some thought because one might expect entitled groups to get property for less. After all, the more you pay the harder it is to reach profit targets, even if the profit targets are low. That suggests, at a minimum, that government favorites are either playing by market rules or they're do that plus funneling money through sales. This might be important in gauging the size of the bubble.
Posted by: jonathan at July 22, 2010 12:18 PM
When you say "the Chinese stock market decline began before that in Europe and coincided with measures in China to curb property speculation." I assume by the chart that you are are referring only to the recent decline beginning in April.
What I am curious about is the reason why Chinese property prices especially, but also the leading economic indicators and the stock market in China began to tumble into recession before we did, and began to recover before we did, by about three months. For that matter, among OECD nations, so did, Korea, India, Indonesia, New Zealand, and Poland (these six are the head of the pack).
So it's not just Chinese property prices, the timing of the economic cycle of the US economy lags significantly behind the economic cycles of two-thirds of OECD nations.
Posted by: Jeremy at July 22, 2010 08:01 PM
Mike Shedlock's evidence is kind of different from waht I know. Typically the downpayment is made by family funding, yes that is for sure. But there are several sources for the family funding. One important source is that the appreciated value of the family's old property. When China reformed its urban housing market in mid 1990s, urban residents can buy their living apartments at deep discounted prices. These old apartments are always located near the center of cities nowadays due to the expansion of cities. So the property values of old apartments grew several fold and many urban families saw their wealth growing significantly despite that their wages are still low. For most urban residents, this is the biggest funding source when their younger generations need to buy a new apartment.
The problem is that new urban residents coming as new migrants/new graduate are left to struggle with the high property prices.
Posted by: zjin at July 23, 2010 08:11 AM
Posted by: Barkley Rosser at July 23, 2010 02:43 PM
The negative shock in one country like US from subprime usually creates positive shock in another country like China.Without doubt, Dhina is facing asset price bubble. Not much different from 1997, when Asia faced financial crises and in 2000, US faced Tech bubble and burst.
The biggest concern is China policy maker still uses the wrong priscription. They are still not active to tighten policies both fiscal and monetary policies to discourage the speculators. Some policies after subprime crisis are supportive to more speculation such as real estate incentive.
Beijing and many major cities are in the bubble without doubt and China fails to tackle bubble. At the end these bubbles are forming the bigger bubbles and surely more dangerous than Tech bubble because Fed are vigilant to tackle bubble during 2000 with rate hike although the hike is not enough to prevent bubble but at least to prevent the bigger crisis. However, Fed failed to control bubble in subprime period; that is the biggest mistake to cause the economic severity especially in American people.
China must change policy aggressively if does not want to be like US. China must change growth target to lower level from 8% to less than 6% that would be suitable for long term economic stability and lesser finanical speculation.Surely, China is likely to face aging population after 2010 that causes the lower long term growth at the end. China must focus on welfare economy to support aging people to live without difficulty rather than focusing on economic boom. Surely, China GDP growth at 10% is still above the target because of speculative bubble.
At end, I hope China will not follow the mistake from US especially stimulating the bubbles both Tech and subprime because bubble never create long term economic stability and surely cost economic growth in the long run. Beijing bubble is at the stage of Tech bubble and if let it go, it will be bigger than subprime because in a few years price jumped more 100% that is uncontrollable.
Posted by: Young Economist at July 23, 2010 03:54 PM
There never was a tech bubble. That was just a upside boom in productivity from improved technology.
The word is called "credit bubble". The intial phases of the credit bubble always feel good and can be quite productive, but it is when the bubble is nearing its end, when desperation to keep the capital flows going, that the pain is recieved.
The best way through a credit bubble is luck in allocation and the world failed between 2001-07 as much as they succeeded in the 80's and especially the 90's in the United States.
Posted by: The Rage at July 23, 2010 04:54 PM
More than the chinese stock market it is that the chinese property index (http://noir.bloomberg.com/apps/cbuilder?ticker1=SHPROP%3AIND) that may provide some clues. It peaked prior to SSE and NYSE. And in the last few years, it was the first to peak and bottom way ahead of the sp.
On another front, base metals as well as grain contracts are indicating a potential bottom (lead, zinc, aluminim, tin all breaking out, copper and nickel a close call and many grains on an upswing including sugar). So if there was/is a bubble in China or somewhere else, this may now be ready to continue.
Posted by: Simpleton at July 24, 2010 03:06 PM
Although current incomes are significantly higher than they were just five years ago, and interest rates paid on savings are very low, we are supposed to believe that people making 50% down payments on properties priced at astounding multiples of annual income are being made without borrowing.
That just doesn't compute. Either the down payments are being borrowed through some shadow banking system, or a great many people have enormous shadow economy income. Neither of these possibilities bodes well for the future of the economy.
And even if the down payments are not being borrowed, the view that a collapse of prices will not cause a crisis is daft. Even if these properties are not being explicitly being pledged as collateral in other interactions, they are almost certainly being treated implicitly as collateral (as in, "He's good for it, he owns condos worth millions," or, "I can afford it, I own condos worth millions"). The negative wealth effects will be huge.
Posted by: jm at July 24, 2010 11:35 PM
A bubble is what it is. All is bought on speculation and for new rich (ie) those who buy the houses; a culture of capitalism doesnt exist. So this is why a problem exists.
Posted by: Kristian at July 28, 2010 03:32 AM