Reflections on RE and China

The love-hate relationship goes on. For almost two years China’s leaders cracked down on borrowing to build and bet on property, plunging the market into a crisis. Now that the economy has been weakened by the failures of the “zero-covid” policy, the government is racing to rescue real estate. Ni Hong, China’s housing minister, has said his ambition this year is to restore confidence; a series of measures announced in the past few months seek to make it easier for developers to raise capital. These efforts are reviving the property market. Unfortunately, they leave it just as vulnerable to boom and bust as ever.

That’s The Economist, in January of this year. China’s RE problems are well known, of course. But the economics of how the Chinese government is “managing” this market is a fascinating story. As most economists (but not all!) will tell you, managing markets in general isn’t that easy. And “managing” the Chinese RE market is about as challenging a task as you can imagine.

As with diseases and doctors, so with problems in a market and its management. Getting the dose of the medicine right is tricky, and figuring out how long to keep the dose going is trickier still. As the same Economist article points out, “technocrats tend to respond to crises with lots of liquidity”. In other words, they apply too strong a dose, and keep it going for too long. This has happened in the past with many markets, but especially with the Chinese real estate market back in 2014. That led to a predictable boom, with predictable consequences.

The current crisis isn’t just bad for real estate buyers and sellers, however. It is also bad for government, because a slump in real estate markets takes away the chief source of revenue for local governments (land auctions). And so the real estate market needs to grow, but well, isn’t.

And that comes through not just in the case of the market for RE, but also in the labor market associated with RE:

In 2013, architecture was named the top career choice for Chinese graduates in education consulting firm MyCOS’s annual report. Architects not only enjoyed the highest employment rate and job conditions, they also reported the greatest career satisfaction scores. But by 2015 it had disappeared from the league table completely, and it has never featured in the list since.
When technology media outlet 36Kr asked over 1,200 Chinese graduates whether they regretted their choice of major this month, architecture students were among the most likely to say yes. “Architecture may have fallen from the throne faster than any other major,” the newspaper Southern Weekly commented in a recent report.

And there are two factors to keep in mind from a long term perspective. First, of course, is the fact that China’s population has almost certainly peaked, and that will of course have a knock-on effect on the RE market in the years to come. Second:

Another parameter also showed signs of peaking. The average urban residential area per capita in China was only 18.7 square meters in 1998, but reached 41.76 square meters by 2020. As a reference, the average residential area per capita in major developed European countries falls within the range of 35-45 square meters. Based on this information, the future space for growth under this metric is limited in China.

You could fire three arrows, or throw in a fourth. The market is likely to be a challenge in 2023, and will continue to remain so for some time. What the Chinese would like, in effect, is a moderation of prices with not much impact on demand. A soft landing, in other words. Easier said than done, as Michael Pettis says:

And the reason this matters is because the real estate sector was a major source of employment, investment, tax revenue, and a way to save for millions of Chinese folks. That’s a dangerous mix!

Is there no way out? Are there no bright spots? Well, consider Chengdu:

What explains this success? Since 2016 officials in every Chinese city have been able to devise their own measures for cooling or heating local property markets. Most of the rules employed are restrictions on who can buy a flat, how many they may purchase and the size of the downpayment required. In most large cities, only people with local hukou, or residence permits, are allowed to buy homes. In Chengdu, high-level purchase controls remain in place. But officials have sought to attract families as a way of expanding the city and increasing demand for homes. Residents with two or more children are, for instance, allowed to buy additional homes, and local hukou-holders may buy up to three. Even those without a hukou may buy two. Since the start of the year, elderly parents who move to Chengdu to join their adult children may also purchase a flat.

There are other factors at play too in Chengdu, but my biggest takeaway is that Chengdu is attempting to raise its population, and therefore the demand for RE. But that will only work by pulling people away from other parts of China – and so it’s a band-aid solution at best. As the Economist article itself points out “there simply aren’t enough people in China for another population boom”.

I’ve said it before, and I’ll say it again: the Solow model remains underrated!

Which begs the question: how should we use the Chinese experience today to think about the Indian RE market of, say, 2040?

That would need us to be familiar with the trajectory and current status of the Indian RE market – and if any of you have any information or stuff worth reading about this, please do share. Thank you!