Regardless of access to credit, the fundamental challenge of creating a sustainable real estate market in China cannot be overcome by the finance sector alone. There is a reason why China is building empty office buildings in the first place. In addition to the lack of viable alternative investment instruments in a country with famously high savings rates, China’s building mania is also related to the budgetary dependence local governments have on land sales to pay for social services.
Bubble or no, construction in China is not driven directly by existing demand, or even by access to credit, but rather by the government’s need to raise tax revenue, said Stephen Chen, senior director of China investment properties at CB Richard Ellis.
While localities make a lot of money selling land, they make none once it is sold. Due to the lack of a property tax, once a building is constructed, the project’s recurring costs decline dramatically. If the building is rented, revenues from business taxes compensate for the lack of property tax revenue, but if the owner can’t rent it, it costs him little to leave it empty while the government gets nothing.
Nor is land banking allowed; developers are required to build on acquired parcels within two years of closing. These policies have produced an artificial rush to build on plots that might be better left fallow until genuine demand recovers.
The irony is, a downturn in business-tax generating activity can encourage local governments to sell land for commercial development to make up the budget gap left by declining revenues … caused by a lack of demand for office space.
Enter the taxman
Rumors that Beijing is considering introducing some sort of value-based real estate property tax are therefore important. Such a policy innovation would play a crucial role in the long-term sustainability of commercial real estate, more than any reactionary adjustments to credit policy. Local governments could rely on this tax as a steady funding stream, without being forced to sell land that developers are subsequently forced to build on.
Analysts disagree over how soon such a tax might be applied, if ever. However, it seems likely that Beijing will allow the conventional measures to run their course before to experimenting with a potentially destabilizing new tax policy.