Feeding the beast

Just how crazy are China’s house prices? The only reasonable answer is bonkers.

Take Beijing as an example. The average home in the capital now costs about the same as in Washington DC – US$300,000. A small, two-bedroom apartment in central Beijing currently fetches around US$600,000, three times what a typical US family would expect to pay for something substantially larger and almost certainly better built.

Beijing is, admittedly, a somewhat extreme example. Apartments in the city, on average, sell at 15-20 times the median annual household income compared with around 10 times for China as a whole. But the national-level figure is still more than twice the average of most developed markets. Chinese homes were once far cheaper than those in developed countries for the obvious reason that incomes are still far lower. Now, by any conventional measure, Chinese house prices are off the scale.

Does this mean that China’s property market is a bubble? Maybe, but then again maybe not. Sure, the prices are completely mad. There is, however, some reason in the madness, because a number of hidden subsidies in the system allow Chinese house prices to rise far higher than average incomes would suggest is possible.

The biggest subsidy came in the late 1990s, when state-owned enterprises began to sell off housing stock to their employees at rates well below true market values. When the private housing market started to take off, these workers discovered their homes were worth far more than they could ever have afforded on the open market. The smart investors rode the property wave and flipped their way up the housing ladder, becoming wealthy in the process. A very large proportion of property owners in places like Beijing and Shanghai now own two or three apartments. For these people, the staggering price rises over the past 10 years have been extremely good news.

The problem is what to do about those who missed the boat – the young families trying to buy their first home and the millions of rural migrants moving into China’s cities. The enormous gap between wages and house prices means that getting a foot on the property ladder is almost impossible, especially now that the minimum down payment for a mortgage has been raised to 30%. The gap between the haves and the have-nots is growing, and risks becoming an explosive social issue. The deeper this social chasm becomes, the more likelihood there is that Beijing will be forced to push though radical policies to bring down prices – most likely via a nationwide property tax.

The other question is what happens when the merry-go-round stops spinning. Home owners cannot keep flipping indefinitely because the quality of building in China simply isn’t good enough. The average home in China is only expected to stand for 30 years, compared with 200 years in the UK. Chinese cities are full of newish apartment blocks that look 20 years older than their real age.

What happens to those investors at the very end of the chain – the ones left with crumbling buildings? Even in the frothiest markets, no one is going to buy an obviously depreciating asset. Trading junk houses is lucrative, but only in the short term.

China’s loony property prices are probably sustainable for much longer than many people think: There are plenty of wealthy investors ready and able to inflate prices still further. But at some point the market will surely come tumbling down.