The real estate industry encapsulates the transitional state of the Chinese economy – structurally distorted and unbalanced by the pressures of over-rapid expansion. What is more, the way the authorities try to address problems in the sector is illustrative of the government's general policy approach almost 25 years into its program of economic reform, which might be characterised as half-hearted intervention. It wants to respect markets, but it cannot leave them alone.
With real estate, this is because the sector plays a unique role in the country's development and in the lives of its population. It contributes an estimated 2.0-2.5 percent to annual GDP growth. At a time of rising unemployment, the construction industry is a source of many jobs. Housing has a direct bearing on quality of life and is a hallmark of prosperity among an expanding propertied class. The health of the property market is also crucial to the financial sector, which advances capital to developers and loans to purchasers. Despite its importance, however, forces in real estate pull in different directions, which means that the government must be circumspect in the way it exerts control.
Recently, the government has become increasingly concerned by the rapid expansion of the upper-end of the housing market and the rise in prices at the middle to low-end. Price inflation on an average property was 9 percent year-on-year in January-May 2003.
Real estate is sucking in increasing volumes of capital, with investment surging by one-third in January-March, to nearly RMBl98bn.
Developers have concentrated on luxury accommodation, where margins are widest, supported by the banks, which want their share of a lucrative market. Demand is strongest, however, lower down the residential property line. As individual incomes continue to grow, more and more people are looking to buy property. There is also strong investment and speculative interest because of the rise in prices and the dearth of savings and investment opportunities in China. The regeneration of city centers and the rolling out of new infrastructure is pushing urban populations to new suburbs further stimulating the demand for non-luxury housing.
Increase in interest rates
The government now worries that the top end of the market is taking too large a pro-portion of real estate investment, which is fuelling a glut. A late 2002 ban on new land leases for villas slowed the market to some extent. However, there was a 9 percent rise in unsold apartments in January-May this year, which suggested that the housing sector might still be running the risk of eventual collapse. On June 13, the People's Bank of China (PBOC) responded with a directive that interest rates on luxury properties should be raised. Mortgage rates for commercial housing were to be maintained at levels that would continue to stimulate this segment of the market. Minimum down-payment thresholds of 20 percent for first house purchases would not change, but higher levels would be set for subsequent purchases. Mortgages would only be advanced for completed properties, not where work was still in progress.
State-owned property developers may not be happy with the new constraints, but they will live with them. Kate MeMurtrie-Poulton, director of corporate real estate services in Europe and Asia for Chesterton International, reckons that most developers recognise the long-term benefits for the sector, even if the situation over the short-term is complicated by the PBOC's actions. She is generally positive about the pressure being exerted on the sector and on banks (see -below), saying it should encourage greater transparency and open opportunities for foreign entrants. Michael Hart, senior research manager for Jones Lang LaSalle in Shanghai, notes that local PBOC branches may have some latitude in the way they interpret the new guidelines. Conditions vary from place to place, so that it would indeed make sense not to apply inflexible rules to fit all.
Failure to Consult the industry
To the extent that the new restrictions are intended to encourage better lending practices, they must be a good thing. There have been dissenting voices, however. Pan Shiyu, chairman of real estate developer Soho China, is reported to have been unhappy about the failure of the authorities to consult the industry before issuing the directive; he would have welcomed the opportunity to put across his view that the new restrictions were unnecessary. Pan is a private developer and this sector has generally found it hard to secure bank credit and has relied on pre-completion sales as one means of making up capital shortfalls.
Notwithstanding the need to correct imbalances in the residential property market, the government's chief concern may actually have been the exposure of China's state-owned banks to developers and top-end purchasers. The government has struggled to turn the big four banks into credible and competitive institutions. Some RMB1,400bn in non-performing loans (NPLs) – well short of the total understood to be on the banks? books were transferred to asset management companies in 1999. But the banks have continued to accumulate NPLs since, many from real estate.
The trend is unsustainable. At the end of April, China's banks were carrying RMBl,836bn in outstanding loans to the real estate sector, just under 18 percent of their total loan portfolios. The banks are bush with cash deposits, and the rate of advances has been rising. Between January and May, RMB19.7bn was extended to property developers more than during the same five-month period in 2002.
The risk for banks is not confined to developers. At the end of April, outstanding personal loans for housing were RMB924.6bn, or 8.9 percent of total bank loans. Although viewed as a relatively safe business for the banks, most of these loans were extended in the past two to three years, and have not run a long enough course for borrowers to establish reliable credit records or for lenders to project the cost of defaults. In addition to an estimated 10 percent of loans that are granted in defiance of regulations, a further amount relating to the real estate sector will therefore represent high, but concealed risk. Malpractice, misconduct, embezzlement, corruption and fraud have compounded problems at China's banks, and highlighted the danger of over-close relations between developers, bankers and local government officials. While the central government can only put pressure on the banks to improve their procedures for credit assessment and risk management, here it intervenes directly and forcefully to break down overlapping interests. Property magnate Zhou Zhengyi and former head of the Bank of China in Shanghai and Hong Kong, Liu Jinbao, are under investigation. The authorities are also trying to clear tip corruption cases in Wen-zhou, the city pioneering liberal banking reforms, and Hangzhou, involving the alleged cheap sell-off of land by officials for personal gain. The government now insists on public land auctions to replace tendered bids, which officials could circumvent for their own ends.
Shanghai is at the centre of the current clampdown, with land transactions there under review. In the first five months of this year, the property sector accounted for nearly 20 percent of all bank lending to companies. However, similar problems characterize relations between developers and bank and local government officials across China. The temptations and rewards are bigger in the larger cities. Audits at the major banks have exposed extensive abuse. The cozy relationships between individual companies and individual banks, effectively freezes out the competition. At the other extreme, purchasers may also be exploiting weaknesses in the systems designed to steady the market, hiding multiple purchases or poor credit records, or buying to sell on for profit.
It is far from clear that the PBOC's new restrictions will divert activity towards the mass housing market – as the government would like – a point made in Jones Lang LaSalle's June Shanghai Economic Insight analysis on the impact of the directive. In Beijing, however, the real estate services company notes an increased interest in mass housing and the possibility that incentives will be introduced to stimulate this segment of the property market. The central government has earmarked RMB324bn for the construction of housing for low- and middle-income households in 2003-04. But it needs more developers to take an interest in afford-able housing.
Price remains a sticking point. In March, Shanghai mayor Han Zheng said the city government would aim for RMB3,000-4,OOO per sq meter, which still seems high to be widely affordable. The central government would like to see properties selling at under RMB3,000 in a city like Shanghai, where most properties fetch over RMB3,500. There is very little new property in Beijing for under RMB4,000, while RMB3,000 is roughly the lower limit in Hangzhou.
The struggle to get families into housing is matched by the need to increase per-capita living space, which currently stands at close to 22 sq meters for urban residents. Impoverished residents have as little as a quarter of this area.
Developers' ability to source their capital requirements from elsewhere may also take the edge off any incentive to switch to the mass property market. Loans were relatively easily to come by.
They may now rely increasingly on internal funding, novel channels such as real estate trusts, or more creative borrowing and the discrete (mis)application of finance, where they can get it. With Zhou Zhengyi's predicament in mind, however, they will be careful not to cross the authorities, by stretching rules to their limits.