Chinese property crash: what are the odds?

The Chinese property market's crash potential has been described as 'Dubai times a thousand – or worse', but the limited data available makes forecasting exceptionally difficult. 

China’s 'Golden Week' national holiday ended a week ago. Traditionally, it’s the buying season for residential property, but this year the market was quiet.

Buy one, get one free

According to China Daily, sales volume shrank in 16 of the country’s 20 largest cities, and by more than 50% in eight of them. In Beijing, sales fell 23%; in Shanghai, they were an astonishing 80% below the 2010 level. In Nanjing, things were so bad that some developers tried to entice buyers with buy one, get one free deals – buy a house, and get an apartment free.

Analysts have predicted a Chinese property price crash for years. By 2008, the Chinese government was already imposing sales taxes on flipped properties, demanding larger deposits on loans and implementing increased bank reserve requirements, in an attempt to let a bit of air out of the bubble.

Crash potential

Yet prices in the major cities continued to rise: up 10% in 2009 and 21.5% in 2010, the year hedge-fund hero Jim Chanos (the man who called the Enron collapse) described the market’s crash potential as 'Dubai times a thousand – or worse'. So far, we've seen a mild scrape but no crash. So why’s it so hard to predict?

The Chinese market’s built on different foundations from our own. People have been buying property for only 21 years, and the government runs the banking system and owns the land. As a result, the residential property market is only 'free' to a limited extent. Beyond that, it functions as a government tool with which to massage the wider economy.

Furthermore, because the government effectively runs the market it controls the flow of data. When the figures might cause panic, it can simply withhold them.

S&P's assessment

However, by all conventional methods of measuring the market’s sustainability, house prices are inflated, with tiny city flats selling at more than 20 times the average household (two-earner) salary. And it’s been teetering on the brink since before the summer, when Standard & Poor's, fearing a price war among developers who were keen to offload property before government moves to restrict lending fed through to volume, downgraded the country’s property development sector from 'stable' to 'negative'.

Developers must have been hoping that inflation would drop, allowing lower interest rates to at least support the industry through difficult times. But some food prices are up 30% on the year.

The UK, European mainland and the US have all seen property price falls. They’ve all mattered, but the Chinese property market really matters.

Property as a government tool

The fact that the Chinese property market has been allowed to become such a significant tool for economic control means the repercussions of a crash would be particularly serious. Some 14% of the workforce is employed in construction, an industry that accounts for 12% of GDP. Some analysts estimate the real figure to be more than three times that, when taking into account indirect investment in house-building.

The banks are completely at the mercy of the financial health of the developers and local government, whose infrastructure projects – built on borrowed money – have been compensating for the country’s shrinking exports. Meanwhile, land sales and property taxes have been allowed to become a vital proportion of generated revenue.