Cracks form in bedrock of China’s economy as house prices slip

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Nearly 300 kilometres north of Hong Kong, a coastal city is at the forefront of a worrisome new trend for China: falling house prices.

In May, new home prices in 62 Chinese cities edged downward from the month before, dragging down the Chinese average for the first time in nearly two years. The biggest decline came in Shantou, where prices fell 3.64 per cent from April, according to China Index Academy, a research arm of SouFun, which operates the country’s largest real estate portal.

China’s real estate market is the bedrock of its economy. Residential housing is worth some 12.5 per cent of GDP, and homes contain some two-thirds of Chinese household wealth. A fracture in Chinese housing, in other words, is a fracture in China’s financial well-being.

And the slowdown has come with remarkable speed. Last December, Chinese housing prices rose 12 per cent year-on-year, the biggest gain of 2013. By May, sales were down more than 50 per cent from April at Shantou’s Jiacheng Real Estate Agency. “Consumers are sitting back to watch the market,” said Zhang Chunseng, an agent with Jiacheng.

For buyers, the change may come as a relief, since China-wide prices in May were still up year-on-year by 7.84 per cent.

But for China more broadly, the spectre of housing weakness heightens the concerns already gathering over the country’s slowing economic expansion and vast accumulation of debt, sizable portions of which are rotten.

“When you see in the second and third-tier cities that developers are significantly discounting new-launch properties and holding very large inventories of unsold apartments, these are worrying signs,” said Rajiv Biswas, chief Asia economist for IHS Global Insight.

He now places the odds of the economic shock from a “hard landing” at 30 per cent in the next three years.

“It’s a reasonable risk,” he said.

But even by that calculation, odds remain good that China skirts disaster. Buyers may be staying on the sidelines, but out of a sense of opportunism rather than fear. “People are not so nervous in my city,” Ms. Zhang said.

In part, that’s because this isn’t entirely new. Though China’s economy has pointed upwards for three straight decades, its housing prices have not.

“It’s the third time in eight years it’s happened,” said Michael Spencer, chief Asia-Pacific economist at Deutsche Bank, of the price correction. But, he laughed, “it’s heretical to suggest it isn’t the end of the world.”

He doesn’t believe it is.

For all the growth in Chinese housing prices, “incomes go up faster,” Mr. Spencer said. In relative terms, an average Chinese apartment is cheaper today than a decade ago. “So the idea that this is a bubble about to burst seems absurd at the national level,” he said.

He points to official Chinese estimates that 10 million people move in to cities each year, a powerful demand pull that other markets where housing has crashed – the United States, and before that, Hong Kong – could not count on.

There may be some froth in the market, but it’s nothing a price war can’t clear out, he said.

“The truth is what we need is a market-clearing price. And when we get there, the market will clear and demand will return. And I don’t think that price is 40 per cent off where we are today.”

That’s not to say there are no reasons to worry, in particular because the Chinese financial environment is increasingly uncertain. The broader economy is on track for its worst performance since 1990. Manufacturing has been weak. Vast quantities of government debt, particularly among local municipalities, constitutes a drag on the existing system and hamstrings the ability of officials to intervene with stimulus dollars.

At the same time, intervening may not be difficult.

In early 2013, officials released a number of measures to cool the housing market in major Chinese cities, including the imposition of a higher capital gains tax and a ban on single people from buying more than one house. That plan has arguably succeeded. If the housing market slows too much, some of those measures can merely be rolled back.

“Housing, because of the credit element, is very sensitive to policy,” said Tim Condon, chief Asia economist for ING Bank N.V.

Beijing “will be very sensitive to the risk of a crash in the market, and they have the policy levers to avoid one.”

For now, Chinese officials remain publicly unflustered, with the state-owned People’s Daily reporting Wednesday that “the government isn’t expected to take any steps to boost the market.”

Outside government, meanwhile, China’s appetite for real estate remains robust.

In Shantou, even the slowdown can’t dim hopes for a strong year ahead. Yao Feng, who works in the Shantou branch for SouFun, expects the city will actually set a new a record this year for property sold.

There are powerful incentives for local officials to keep their housing markets roaring. Without it, in a country with virtually no property taxes, their revenues would vanish.

“As long as government still earns money by selling land, housing is impossible to cool down, no matter what the central government wants. If housing drops, how will local governments eat?” asked a man named Zhou, an executive at a Shantou advertising agency.

He owns nearly 10 houses, and is hunting for more. In part, that’s because there aren’t many other places to put money in China – “there are really few investment channels now. I don’t know how to play stocks,” he said.

And in part, it’s because he and many others still see the Chinese property market as indomitable.

“As long as there are opportunities, I will buy,” Mr. Zhou said.

“I will keep buying until I am out of money.”