Chinese property: the mother of all bubbles?

In a recent report, New York-based property analysts Cushman & Wakefield point to a changed international property investment map at the end of 2009. An eye-watering residential real estate slump knocked more than $68bn off the value of US property, allowing China to take first place… the biggest property market on the planet.

But now – with US-style distressed sales on the rise, extravagant and whimsical Dubai-style developments appearing in the suburbs and one of the world’s most influential bubble-spotters confidently shorting the Chinese market for everything it’s (not) worth – the authorities have been forced to take note and ask themselves: how much free market is too much free market?

Investment in Chinese real estate doubled last year, and – in Shanghai – residential property prices rose a staggering 68%. Other regions have seen 20% increases per month, and in just 12 months, urban land prices have tripled. As recoveries from the economic emergency go, it’s been spectacular.

Rising prices on their own don’t make a bubble; but some of the foundations for these prices look dubious. In fact, they look a little like our own.

While it’s true that living standards have been rising in China, and a sweeping urbanization has brought 150 million Chinese into the cities in the last ten years, demand – on its own – can only push prices so high. Families are over-stretching themselves. It’s hard to argue that property remains affordable.

As China recognized the vital role of the construction and real estate industries in propping up the rest of the economy while exports slumped, lending standards were deliberately lowered. A giant stimulus package pushed Chinese lending up by 30% last year. Investors took paper profits off-plan; and developers themselves got into the game, holding back apartments to simultaneously drive house prices and profit from them. The combined ingredients for a bubble look all too familiar.

China has an excuse. It’s neither a society nor an economy that’s had much experience locating its own economic tipping point, so one should expect it to overshoot. But the authorities have now realised that they’re in danger of killing the goose by over-feeding it, and are taking measures to calm the market. Earlier in the year, they increased required bank reserves. A sales tax has been imposed on homes sold within five years of purchase, there’s a minimum deposit requirement of 40% for residential mortgages on second homes. Lending to developers is being restricted and, in Shanghai, a large-scale public housing program has been promised by the end of the month, along with cheaper, Government-subsidised starter homes.

The measures make sense, but what about the timing? There’s a theory that withdrawing liquidity from a market in the critical stages of inflating into a bubble is like sticking a pin in it, especially if its already starting to creak.

A recent Royal Institution of Chartered Surveyors report (its Global Distressed Property Monitor for Q4 2009) pointed out that the biggest recent rise in distressed sales in the world occurred in China. Meanwhile, shares in leading Chinese property developer China Vanke Co and its rival Poly Real Estate Group Co are both on the slide.

“Dubai times one thousand – or worse,” is short-selling hedge fund maverick and super-bear Jim Chanos’s view of the Chinese property market’s outlook. Obviously, it’s in his best interest to make as much noise about China’s inherent problems as possible, but a few alarmist statements can be forgiven. There’s a reason to be alarmed.

Property (and related industries) account for 17% of GDP and a quarter of investment in China. A property crash managed to lay waste to the Japanese economy in the 1980s. A failing Chinese property market is big enough, and dumb enough, to hurt us all.