The Chinese authorities have hit on an idea to turn around a worrying oversupply of property that has been dragging down prices — buy them up and convert them into social housing.
The plan comes on the back of worrying signs for a key sector for China’s economy. Falling property prices are an indicator for falling land values, a key measure of the health of local government finances that have become reliant on land sale revenues.
And, as a note from Barclays makes clear, the government is finally starting to react to the ongoing weakness (emphasis added):
Although a disorderly correction is not expected, given that the real estate sector is too important (to the Chinese economy) to fail, many look for a multi-year adjustment process and say that a gradual slowdown in property investment is their base case…The government’s latest plan to purchase unsold residential properties and convert these units into low-cost public housing is seen as a practical way to reduce inventory levels.
The plan was also picked up in a note from real estate services provider Savills last month. It suggested that Beijing had begun “encouraging the assimilation of excess commodity residential stock to social housing as a way of reducing inventories and rebalancing the supply-demand equation in some oversupplied markets”.
This would be good news both for the living standards of China’s rapidly urbanising population and for the property market that had looked set to continue its grind downwards.
Since the late 1990s, investment in China’s real estate sector has been outpacing the country’s impressive GDP growth, rising from around 4% of GDP in 1998 to around 14% of GDP by 2012.
However, chronic over-investment in the property market for more than a decade has left a huge overhang of stock, leading to a sharp downturn in the sector. Sales fell by 10.8% over the first nine months of 2014, according to the country’s National Bureau of Statistics. Prices in the lower tier cities are expected to fall even further in 2015, although declines in the country’s top tier cities appears to have been halted for the moment.
This has led to new investment in property — a good guide for the market’s expectation of its future growth potential — falling sharply. A weakening property market could drag down China’s growth and pose significant risk to local government balance sheets in the country, which rely heavily on land sales to developers for revenues.
As local governments were prohibited from borrowing themselves they created off-balance-sheet companies known as Local Government Financing Vehicles (LGFVs) that would then borrow from banks, trust companies, or the bond market. Much of this borrowing was guaranteed against land sales and by the end of 2010, the debt held by these off-balance sheet companies amounted to RMB 4.97 trillion ($US812 billion), according to IMF estimates.
So what’s happening now?
The value of land sales has been falling off a cliff:
The weakness of the property sector and the consequent drag on GDP is a problem for the Chinese government as it seems to re-balance its economy away from its historical reliance on export-led growth. In order to achieve this thoroughgoing structural reforms would be necessary, which could knock the country off its already lowered growth targets and threaten the delicate trade-off the government is attempting to strike with rising living standards for the majority the payoff for centralised control by the Communist Party.
As Barclays puts it (emphasis added):
While structural reforms remain at the top of the policy agenda, the recent cyclical slowdown has made advancing them less urgent than was the case six months ago. But most speakers think the government’s commitment to reforms is the best way to ensure China’s long-term sustainable growth. Nevertheless, there is no clear indication of how fast this area may progress in the short term, except around combating corruption, where the government has highlighted it will do “whatever it takes”.
In other words, the government’s support for the housing market is good news for the country in the short term but is likely to be a distraction from the reforms required to ensure long-term sustainable growth. For China watchers, this will be a cause for concern.