China's property demand hides a dark reality

Housing sales are down in Beijing but prices are still climbing. Photo / Kenny Rodger

BEIJING - Yu Jiang looks into the front window at his two-bedroom apartment in the center of Kangbashi, in China's Inner Mongolia, and says he may buy another.

The place has been empty for three years, as are as many as 90 per cent of the units near it.

Designed for 300,000 people, Kangbashi, the new urban centre of Ordos prefecture west of Beijing, may have only 28,000 residents, Bank of America-Merrill Lynch said in a May 10 note.

Standard Chartered Bank called it "the Dubai of northern China" for its vacant skyscrapers and more than 1.1 trillion yuan ($237 billion) worth of new public buildings and local wealth.

Unlike in Dubai, where home prices have fallen more than 50 per cent since mid-2008, buyers are still piling into Chinese housing. Yu says he sees no reason why the threefold gain on his investment shouldn't grow.

"The future of Kangbashi is bright," said Yu, 52, who runs a house-decoration business. "Government offices have moved here so the economy will develop well. Prices will rise."

Investors are stockpiling empty apartments because there are few alternative investments, undermining government efforts to deflate a property bubble, said Patrick Chovanec, an associate professor at Tsinghua University in Beijing.

"Money is being dumped into property because there are no alternatives," said Chovanec, adviser and former vice-president of the Hong Kong venture capital firm Asia Mezzanine Capital Group. "Policy makers are nibbling around the edges of the core problem."

A recovery in the stock market may encourage some investors to switch to equities, which were boosted this week after the central bank indicated it would let the yuan appreciate.

That would leave developers with unsold projects and may cause loan defaults. Although the Government has restricted pre-sales by developers and curbed loans on third-home purchases, average property prices in China have risen more than 10 per cent from a year earlier for four straight months.

Policy makers are considering a property tax in some cities to increase the cost of holding empty homes. About 50 per cent of apartments are bought with cash, said Glenn Maguire, chief Asia-Pacific economist at Societe Generale in Hong Kong.

Fund managers James Chanos and Marc Faber, Citigroup economists Willem Buiter and Shen Minggao, and Harvard University professor Kenneth Rogoff are among those who have warned of a crash in China if the Government can't stop the property bubble. Buiter and Shen say it may take three years for the boom to bust while Faber says it could happen within a year.

The result will be "pretty horrendous", slashing economic growth to less than 5 per cent over two years and saddling banks with more than US$400 billion ($584 billion) in bad loans, said Jim Walker, chief economist at Hong Kong-based Asianomics.

Banks are at risk because they often use land as collateral for loans from developers. A 50 per cent fall in property prices would mean the loans are no longer covered by the land's value, calling into question "the solvency of the entire banking system," Chovanec wrote in a blog in January.

The nation's 13.6 trillion yuan of new loans in the past 17 months, bigger than the economies of South Korea, Taiwan and Hong Kong combined, is "unprecedented in 400 years of economic history," said London-based hedge fund manager Hugh Hendry, co-founder of Eclectica Asset Management.

Risks associated with home mortgages are growing and a "chain effect" may appear in real-estate development loans, the China Banking Regulatory Commission said in its annual report. The Beijing-based regulator told lenders to report their real-estate risk by the end of this month.

Chinese investors have few appealing options. Capital controls prevent citizens from investing overseas; bank deposits yield 2.25 per cent, less than the 3.1 per cent rise in May's consumer price inflation.

China's wealthy switched their focus to property in 2007 because of the stock market's poor performance, said Rupert Hoogewerf, founder of the Shanghai-based Hurun Report, a luxury publishing and events group. The Shanghai Composite Index has slumped 59 per cent since peaking at 6092 points on October 16, 2007.

"The underlying sources of the property bubble remain," said Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong.

"Savings deposits for households and corporates combined are worth 146 per cent of GDP and earn 2.25 per cent and are trapped inside the country. Equities have performed poorly, while the bond market is underdeveloped."

Few places illustrate the boom in wealth and lack of investment opportunities better than Ordos, population 1.5 million.

Demand for coal from the desert region to fuel China's factories has boosted the area's gross domestic product by an average 25 per cent for the past decade, said Lu Ting, an economist with Bank of America-Merrill Lynch in Hong Kong. Coal contributes more than half of Ordos's GDP, he said.

"Ordos has basically been bought up by miners who have got plenty of cash," said Hurun's Hoogewerf. "They're buying up the properties ... and basically just sitting on them."

Construction of Kangbashi new town, 560km from the capital, began in 2004 and the Ordos government moved most of its offices there in 2006 from Dongsheng, a 40-minute drive away. With few shops, restaurants and other amenities in the new city, most government workers still prefer to live in Dongsheng and commute.

That hasn't stopped the Government from investing more than 1.1 trillion yuan in Kangbashi.

Government efforts to slow the real-estate market have had some effect. Bank lending fell 31 per cent to 4 trillion yuan in the first five months from a year earlier as the Government raised banks' minimum reserve requirements three times.

That helped curb housing sales in Beijing, Shanghai and Shenzhen, the nation's wealthiest cities, which fell as much as 70 per cent in May from the previous month, the official Shanghai Securities News reported.

The decline had little effect on property prices, which rose 12.4 per cent in May from a year earlier, the second-fastest pace on record after April's 12.8 per cent gain, the statistics bureau said on June 10.

Demand for housing in China will withstand bank lending curbs, and further declines in the nation's property stocks may be an opportunity to buy the shares, said Mark Mobius, Templeton Asset Management's Singapore-based chairman.

Policy makers' tolerance for property price declines is no more than 30 per cent for "fear of too much economic weakness," said Shen Minggao, Citigroup's Hong Kong-based chief economist for Greater China.

If China's 8 per cent growth target for this year is "challenged", policies to cool property may be softened or even reversed, said Shen.

Property investment contributed almost 11 per cent of China's GDP directly last year and Shen estimates that with the spillover effect into other industries, the total contribution is double that.

"You can't address a bubble by preventing people from owning two apartments," said Michael Pettis, a finance professor at Peking University in Beijing. "The money has to go somewhere."

- BLOOMBERG