January 29, 2010

China Housing Not A Bubble

Calls for China’s crash usually happen at the start of the year and 2010 is no exception. This year’s blame China crowd includes the usual editorial boards (Financial Times, Wall Street Journal), a Nobel prize winner (Paul Krugman) and more usual suspects such as Gordon Chang (is a near 10 year old prediction still relevant?). Hedge fund manager Jim Chanos made a big splash warning to stay away from China because he said Beijing’s stimulus created a housing and property bubble. Chanos has since backed away somewhat from his comments but warnings of a China property bubble persist including from the World Bank.

The predictions however do not take into account that the indicators of a housing and property bubble as burst in the USA and EU are not the case in China. Chief among the differences is building construction in relation to demand. The housing bubble and commercial real estate bubbles in the USA and EU were not driven by demand. In the USA whole suburbs of empty houses and strip malls stand vacant. In some areas such as Victorville, California, neighborhoods are torn down and plowed under. In cities across America and Europe holes and vacant lots mark the spots of cancelled buildings.

Yes China is in a building boom. Property sales rose 75% last year alone. In 2007 China accounted for half of all new building areas on the planet. How is this not a bubble? Consider the transformation of Chinese society from rural to urban. The housing stock in China remains woefully inadequate. In the USA nearly a fifth of the housing stock was built before 1940. But China’s housing stock was devastated by continuous war until mid century and deteriorated further in the 1950s as private households neglected properties fearing state confiscation and housing was lost to industrial development. Any traveler visiting outside China’s cities can attest to the poor state of rural housing. All the new migrants to Chinese cities will need housing. And current city dwellers want better housing.

A similar comparison exists for commercial real estate. Half the commercial buildings in America were built prior to 1970. China’s building boom began with commercial buildings in the 1980s and ‘90s but still has a long way to go. Typical indicators for commercial property viability such as vacancy rates do not fit the Chinese market. It is not at all unusual to see 50% or greater vacancies at the peak of office space building cycles for example.

The primary category of residential building in China is multi-family low and high-rise. Add to that the demands for high-rise commercial buildings for offices and hotels. The materials required for such construction create huge demand for everything from steel and concrete to carpet and computers. Yet as a percentage of GDP the building construction industry in China (around 5-6%) is not much greater than in the USA (4.6%-4.1% between 2004-07).

Beijing is responding to world opinion and investor concerns. New policies introduced recently include 20% down payment requirement on property and 50% on land. But as to rumours that China will implement a property tax (currently there is none) the State Administration of Taxation said this week it was only in the “research and preparations” stage. Potential speculation in property on tropical island province Hainan alarmed the Financial Times but the report failed to mention that the governor of Hainan has suspended new land leases and development plans.

Property remains a barometer and important component of China’s economy. And many analysts continue to find property stocks attractive. The Changjia Group will IPO on Hong Kong in March and Sun Hung Kai properties is a media and investor darling. Foreign investment continues in the commercial sector too. Starwood Hotels says it will double its portfolio in China over the next two years to over 100 hotel properties.

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