China’s Housing Crisis: Will it end?

Inherent Risks and Investment Considerations in China’s Property Market

China’s housing industry drives one-third of its economy, yet the sector is in a crisis. In this article, I argue that China’s housing market crisis is a perpetual phenomenon due to China’s regionally competitive economic system: the central government must intervene to influence public demand.

This article illuminates unique aspects of the Chinese economy that may interest those whose investments overlap with China’s property market. I shall endeavor to go beyond typical quarterly reporting and provide you, dear reader, nuanced insight into this far-away sector.¹

My argument consists of four premises. First, China’s economic and historical origins facilitate competition between local economies. Second, this competition ties Gross Domestic Product (GDP) growth to land sales. Third, land sales are influenced by public demand, and fourth, this relationship is risky because the central government must intervene to influence public demand due to the nature of the Chinese economy. My argument, simply stated, is that the Chinese housing industry is inherently risky because of the absolute necessity for government intervention.

Definitions:

• Please consider the terms housing market, property market, and real estate market to be interchangeable and able to be used concurrently with crisis, e.g., housing crisis, property crisis, and real estate crisis. 
• For simplicity’s sake, land and property are used interchangeably. For instance, a local government sells land to a property developer, who then builds property on top of the purchased land. 

The article proceeds as follows: 

• Section One starts by outlining an approximate housing crisis pattern, as shown by news cycle trends and search traffic queries;
• Section Two then gives a brief overview of the 2022 China housing crisis and how it was caused by a decrease in consumer demand;
• Section Three asserts that domestic provincial competition, which underlies China’s economy, ultimately ensures that GDP and land sales are inextricably linked;
• Section Four describes why the issue is difficult to fix;
• Section Five expounds upon the implications of this linkage from a business and philosophical perspective;

1 The Hype: Search Traffic Patterns

China’s housing crisis pattern is visible from news coverage over the past two years. If one recalls, in the Summer of 2022, the news cycle adumbrated doom for China’s housing crisis (e.g., the Economist). In the Spring, however, news coverage of the issue was harder to source. In fact, Google search traffic dropped dramatically: the graph below shows the query “china housing crisis” sharply declined in the Fall:

This graph shows a spike in traffic for “china housing crisis” in August of 2022, immediately followed by a massive dip and then successively smaller spikes. Another way of thinking about this is that global attention on their housing crisis suddenly dropped off, for some reason, in the Autumn of 2022.

This drop in attention was reflected in social media, too. As a fun and un-academic example, suggested videos on my YouTube feed went from serving up grossly edited (and oddly provocative) thumbnails of a certain Chinese leader to the normal thumbnail assortment of athletics and dogs (examples below):

Admittedly, the melange of China affairs and running training that is my YouTube algorithm may not be similar to yours, but you get the point. 

It’s now the Winter of 2023/2024, and I’ve noticed that news coverage of China’s housing market is ramping up again: doom and gloom, tensions of collapse, and the typical buffet of fear-feeding and mongering associated with a 24-hour news cycle that aims to keep us simultaneously stressed and engaged…why is China’s housing crisis back in focus?

Concisely, this is China’s housing industry pattern I’ve noticed:

1. Market tension
2. Something happens
3. Market silence
4. Something happens
5. Market tension…

As a counterpoint, one could say the bipolar market-moodiness aspect of the Chinese economy is a banality and simply a simulacrum of the broader capitalist market phenomenon, i.e., a capitalistic economy self-heals its crises. I’ll term this the normal market argument: a (normal) capitalist economy is one that usually seems to narrowly avoid complete market collapse and lives to fight another day.² In other words, the above pattern is a normal trend in capitalist economies, so it’s a banal discussion. The “something” in the pattern above could be anything, but what matters is that the market continues. I’d agree with this point if it weren’t for the glaringly obvious: China isn’t a capitalist country nor a socialist one. It’s an amalgamation of the two. Their system aims to take advantage of the best aspects of capitalism and socialism while avoiding the worst aspects.³ There’s a great future discussion of how this does and doesn’t work. Still, the important thing is this: their economic system is too complex and heavily involves socialist elements to normally self-heal as a laissez-faire system might; it wouldn’t be normal for the economy to self-correct given the socialist elements. The concept of a self-healing market is the antithesis of being socialist and command-controlled. I digress with this counterpoint because it’s crucial to highlight that the “something” in the above pattern isn’t natural, it’s external. It’s artificial, not from within the economic system but external to it: government intervention. 

2 China Housing Crisis 2022: How It Bubbled

The 2022 crisis, in a nutshell, was a massive drop in demand for real estate because homebuyers came to the realization that their homes weren’t being built. One’s downpayment on a home or apartment (which was sometimes 100% up-front) was being used to pay for the development of previous development projects. So, people stopped paying their mortgages and started rioting, and faith in the property sector crumbled—this was problematic because the property sector drives ⅓ of China’s GDP (The Economist, 2022; Wakabayashi, 2022; Wolf, 2021). 

A few months later, in the Spring of 2023, the Council on Foreign Relations reported the demand issue appeared to be on the mend, owing to the central bank incorporating a flexible and potentially floorless mortgage rate. A Bloomberg article noted how land prices had actually increased 6% in the past year. To briefly summarize the bubble, decreased demand caused market tension, and then the government intervened to boost demand and mitigate the tension.

However, there’s something beneath the surface of this apparent recovery, which the Bloomberg article gave a taste of: the real crux of the issue is the reliance of local governments on real estate to drive their respective economies. This reliance creates a problem because of how China’s regions interact.

3 Historical Causes of China’s Housing Crisis: Internal Competition and Land Sales

This reliance on land sales to drive local GDP growth is problematic because local competition unharmoniously incentivizes regions, reinforcing existing issues. So, over time, a bubble that doesn’t seem capable of shrinking has formed. 

Firstly, China’s regions don’t act in unison. They act in competition with one another for rank. As Qiao (2017, p.118) asserts, the better a region’s GDP growth rate, the higher it ranks due to its fiscal contributions to the center. Consequently, he furthers that higher-contributing regional leaders are promoted to higher roles faster and more frequently. In other words, regional leaders are incentivised to grow their regions’ economies. 

Secondly, China’s regions have a degree of autonomy. Xu (2021; 2015) describes the overall functionality as a Regionally Decentralized Authoritarian (RDA) economy, where the central government makes a decision, and the regions are free to figure out how to best enact it.⁴ 

Thirdly, land sales have been the de facto way to raise local capital for the past thirty years. The 1994 tax reform prevented local governments from issuing debt—yet they had to maintain growth—and land sales were one of the remaining ways to raise local revenues (The Economist, 2021). For context, in 2010, land sales delivered 70% of annual regional incomes, albeit with regional variance (ibid).

In essence, this economic model functions as a pseudo-autonomous sales team, complete with peer rankings and preferential treatment, and the main way for the team members to generate revenue and rank above their peers is through local land sales. This is why land sales are inextricably tied to GDP growth.

How tied? Today, estimates are that the real estate sector accounts for 30% of China’s overall GDP (The Economist, 2022). This would be fine, except for when homebuyer demand drops. When homebuyer demand was high, developers had no issues relying on flat pre-sales to fund land purchases and construction; however, as demand naturally shrunk over the decades, developers turned to shadow and local government loans (The Economist, 2022; 2021). To illustrate, Figure 1: shows how GDP growth is linked to real estate investment:

The housing bubble’s formation over the past few decades is relatively straightforward: increased demand from developers and acquiescence from local governments drove asset prices up above their intrinsic valuations, and eventually, homebuyer demand dropped, so everyone became exposed.

4 The Challenge of Fixing the Housing Crisis

It needs to be said that the central government has tried to fix the growing housing bubble. In 2010 and 2020, the central government enacted two policies—the housing purchase restriction and ‘three red lines’—to cool down the property market bubble by reducing speculation, housing demand, and debt (Briscoe and Huang, 2022; Zou et al., 2022; Lu, Zhang and Hong, 2021).⁵ Unfortunately, although the policies were designed to limit developers’ speculation and reduce their overall leverage, the policies didn’t drastically impact them.⁶ 

I posit that one key issue here is the RDA economy: the competition among local governments drives them to issue more debt to fund their respective property markets (Han et al., 2022), and if the central government implements debt restrictions, these restrictions harm lower GDP cities that rely on the debt to stay competitive (Qu, Xu and Zhu, 2019). Thus, since it is tied to the property market, the RDA system creates a positive feedback loop that generates debt. Furthermore, since real estate is increasingly unproductive, increasing debt to fund it means declining growth rates (Wolf, 2021). 

One could argue that changing the system—i.e., incentivising the ‘sales team’ differently—could ameliorate some of these issues. I think that’s unlikely to happen: the central government benefits greatly from this real-estate-driven economy. They don’t want to upset the boat unless absolutely necessary. As mentioned at the beginning of this article, the floorless mortgage rate was only introduced when the boat really started to rock. When the crisis was in full swing in the summer of 2022, reports showed that the government pushed responsibility for solving the bubble onto local governments (Bloomberg News, 2022; Ziwen, 2022). Generally, China’s leadership seems hands-off until the issue is politically unavoidable. For instance, Shih (2022b) finds that China’s 2018 policy decisions became focused on the housing market only when housing prices escalated. Jaquet (2020) describes China’s housing industry as a delicate dance of balancing its risks with its financial benefits. In other words, the housing market mutually benefits the central and local governments, so the central government intervenes minimally and reactively.

As of writing this article, in the early days of 2024, the housing bubble is ostensibly in the same situation as it was two years ago (described in Section 2): consumer demand is the lynchpin. Therefore consumer demand is what the central government needs to fix. A recent Nomura report reciprocated these thoughts, further projecting that 52% of pre-sold flats (approximately 10 million flats) across the country will suffer construction delays over the next year unless the government enacts policies to improve confidence.

5 Investment Considerations Related to China’s Housing Market

In summary, the housing market seems perpetually beholden to the government to improve. In theory, central government policies that could ameliorate the market would be those aimed at improving consumer demand and overall confidence in the sector. Inherently, from a business perspective, relying on a central government to positively affect public demand seems risky. However, China is often the exception to the rule, so let’s assume that boosting consumer confidence is within their wheelhouse.

I’m going out on a limb to say that policies will likely soon be enacted to improve this issue. So, if one is considering participating in the sector, these are two questions to mull over:

1. Could the new policy effectively boost public demand for flat (pre-)purchases?
2. Is the policy effective in a way that would facilitate long-term stability in the sector and, therefore, the economy as a whole?

Even as I write this article, Bloomberg reports the central government has injected $50B into policy banks, likely as a stimulus for the housing sector. Depending on the specifics, the policies may increase consumer confidence and be good for long-term stability—one will need to assess them.

Some Thoughts

• Shrinking Time Horizon: 26 years passed from the 1994 tax reforms until the Three Red Lines were implemented in 2020. It’s been only three years from those policies until the new mortgage rate-lowering policies. In my view, this trend indicates that the time between market turbulence and a corresponding need for government intervention is shrinking. The central government will likely be forced to enact more policies expeditiously. 
• Public Sentiment: apartment ownership is viewed as a form of stored value, like a token to collect. Not necessarily something for consumption or investing. People will happily have an empty apartment as they feel it will only accrue value. However, looking at 2022’s mortgage protests and the fact the government aims to reduce speculation (As Xi famously said, “apartments are for living in, not speculation”, I’m curious if public sentiment or housing perception could wane over time. When one’s savings become a sunk cost, is an apartment the token it once was?
• Long-Term Bets: How do you envision China’s economy to progress? This article posited that China’s RDA economy has essentially cemented the housing crisis to where the government must intervene. Recent media reports have concurred that the crisis is a massive issue and requires central government intervention (The Economist, Business Insider, Nikkei Asia). Consequently, the IMF’s World Economic Outlook (p.12) updated China’s GDP Growth Projections for 2023 to 2024: 5% to 4.2%, respectively. According to World Bank and Statista projections (below, Figures 2 and 3), negative GDP growth will likely continue. 

Conclusion

What does all this mean? It means China’s housing crisis is a complex issue with deep historical roots and wide-ranging economic implications that the central government must intervene to fix. 

Over the past few years, there’s been much rhetoric around the changing world order. In international relations circles, it’s propagated that the post-Cold War world has shifted from unipolar (one hegemon) to bipolar (two hegemons). The gist is that the United States’ days at the top are declining, and they’ll soon be replaced by a growing China. This may well happen. Of course, if China isn’t growing, these internal economic forces might affect this prophecy. Time will tell.

– Jake

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References

Bloomberg News (2022). China’s Politburo Signals No Big Stimulus Despite Slowdown. Bloomberg.com. [online] 28 Jul. Available at: https://www.bloomberg.com/news/articles/2022-07-28/china-s-leaders-call-for-stabilizing-property-at-key-meeting#xj4y7vzkg [Accessed 23 Aug. 2022].

Briscoe, H. and Huang, B. (2022). China‘s three red lines. [online] ubs.com. UBS Asset Management. Available at: https://www.ubs.com/global/en/assetmanagement/insights/thematic-viewpoints/apac-and-emerging/articles/china-three-red-lines.html [Accessed 23 Aug. 2022].

Han, Y., Xiong, M., Cheng, S. and Guo, H. (David) (2022). Inter-city competition and local government debts in China: a spatial econometric analysis. Asia Pacific Journal of Public Administration, pp.1–20. doi:https://doi.org/10.1080/23276665.2022.2071305.

Heilbroner, R.L. (2000). The Worldly Philosophers. 7th ed. London: Penguin, pp.42–74, 136–169.

Lu, Z., Zhang, S. and Hong, J. (2021). Examining the impact of home purchase restrictions on China’s housing market. China Economic Review, [online] 67, p.101620. doi:https://doi.org/10.1016/j.chieco.2021.101620.

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Qiao, L. (2017). Political Mobility Of Chinese Regional Leaders : Performance, preference, promotion. Routledge.

Qu, X., Xu, Z. and Zhu, J. (2019). Local Government Debt and Regional Competition in China. SSRN Electronic Journal. doi:https://doi.org/10.2139/ssrn.3420523.

Shih, V. (2022). Economic Policy Decision-Making Under Xi. [online] UCDD. U.S.-China Economic and Security Commission Hearing. Available at: https://china.ucsd.edu/_files/victor-shih_testimony_20220127.pdf [Accessed 23 Aug. 2022].

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Wakabayashi, D. (2022). As China’s Economy Stumbles, Homeowners Boycott Mortgage Payments. The New York Times. [online] Available at: https://www.nytimes.com/2022/08/17/business/china-economy-real-estate-crisis.html [Accessed 23 Aug. 2022].

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Zou, Y., Meng, F., Zhong, N. and Zhao, W. (2022). The diffusion of the housing purchase restriction policy in China. Cities, [online] 120, p.103401. doi:https://doi.org/10.1016/j.cities.2021.103401.

1. I aim to inform, provide insight, and tease apart philosophical implications of an interesting phenomenon—the Chinese housing crisis—rather than simply define it, or its components, as good/bad, strong/weak. I’ve adapted this article from a portion of my Master’s thesis at the University of York, where it was awarded with Distinction. 
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2. I’m referring to the classic clash of Smithian and Marxist capitalist theories that economists have debated for nearly two centuries. For a very lovely and eloquent summary of this debate, I’d strongly recommend the chapters on Smith and Marx in Heilbroner’s The Worldly Philosophers. ↩︎
3. Defined by scholars as “party-state capitalism” (Pearson, Rithmire and Tsai, 2021). ↩︎
4. This is the internal functionality of ‘socialism with Chinese characteristics’. There’s another definition that outlines the political side of things, defined by scholars as “party-state capitalism” (Pearson, Rithmire and Tsai, 2021). ↩︎
5. Housing Purchase Restrictions: measures such as limiting the number of properties one can purchase or enlarging minimum down payments (Lu, Zhang and Hong, 2021). Three Red Lines: Briscoe and Huang (2022) summarise them as ‘policies which amount to forced deleveraging to improve financial health for the real estate sector’. ↩︎
6. Speculation was a large contributing factor to the housing bubble (Chen and Wen, 2017). ↩︎