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Tell me if you think this story sounds familiar.
A new NBER working paper by Jing Wu, Joseph Gyourko, and Yongheng Deng (also discussed by Joseph Cotterill and Tyler Cowen), used recorded prices for 300 residential land auctions in Beijing to develop the first constant-quality land-price series for a Chinese market. The study concludes that inflation-adjusted constant-quality land prices have increased by nearly 800% since 2003:Q1, with half that increase occurring over the past two years.
Some observers had dismissed the apparent parallels between the Chinese real estate bubble and that in the United States based on institutional differences in the details of loan financing between the two countries. For example, Michael Kleist wrote last March:
Certainly there isn't a mortgage credit-related bubble. The majority of homes in China are purchased with down payments between 30-40%, which is required by the banks, and nearly 25% of homes are purchased with all cash. Only those qualifying for low-cost housing can purchase a home with a minimum down payment as low as 20%. For this reason foreclosures in China are practically nonexistent.
But Wu, Gyourko, and Deng provide this interesting additional detail:
There also is a statistically and economically strong positive correlation between land auction price in Beijing and the winning bidder being a state-owned enterprise (SOE) associated with the central government. All else constant, prices are about 27% higher when a central government-owned SOE wins a land auction, so these entities appear to be playing a meaningful role in rising land values in Beijing....
If these particular developers are superior investors and are able to buy unobservedly high quality sites, then part of this effect could be a proxy for quality. We certainly do not claim that our hedonic controls are perfect. However, in other regressions not reported here, we also find that Central SOE developers pay high prices relative to the values of nearby housing unit sales prices. That suggests these particular buyers simply pay more and that this does not merely reflect omitted quality effects. Moral hazard arising from these entities believing they are too important to fail, combined with their access to low cost capital from state-owned banks, also could help explain their bidding behavior.
Mike Shedlock also relays several troubling anecdotal reports about where the money for down payments comes from. Here's one of the more benign accounts that he quotes:
There are circles in neighborhoods, or churches, community groups that are kind of like informal credit unions. People pool money into a large sum and then bid for its use month by month. 5% a month is the typical rate of interest....
Parents lend to their children to buy their condo with the understanding it will be repaid or they will come to live in their old age under that roof. Almost no one has the 20 to 30% down to buy a place. The down payment is typically borrowed at terrible interest or comes from a "marriage gift" which had its origin in borrowed funds, not from savings....
A collapse of the bubble could cost lots of folks their life savings. This makes the financial aspect of Chinese society much more fragile than it appears on the surface. There is a lot of interconnected personal debt below radar.
Popular opinion remains that the current worries in financial markets began in Europe. But as I've noted previously the Chinese stock market decline began before that in Europe and coincided with measures in China to curb property speculation. As of the moment, the equity decline in China substantially exceeds that in Europe.
Posted by James Hamilton at July 21, 2010 08:25 AM
The Chinese stock market is likely providing a contemporary real-time view of economic activity in China - they've been slowing down, which is confirmed by U.S.-China trade data.
As for Chinese real estate, well, if it wasn't in a bubble before 2008, it has been since thanks to China's massive (with respect to the size of its economy) stimulus effort....
Posted by: Ironman at July 21, 2010 09:56 AM
I was reading something on the low downpayments that noted that although LTVs were just 50% on average, then years ago almost no one used any mortgage at all. So, while the absolutely level was much lower than here, the growth in average LTV was even greater.
Also, I'm sure everyone has seen the piece a survey of electric meters that concluded there were 64 million empty apartments.
Posted by: Bob_in_MA at July 21, 2010 10:12 AM
Although LTV is low, the Loan-to-income ratio is high in China.
The bubble mechanism at the demand side should be insignificant, which is why the land price will not plunge after the macro policy adjustment.
As long as the revenue source of local government continues to heavily rely on land sales, the land price will continute to be pushed up by the local government through limited supply.
The urbanization and industrialization process in China determines that we will see the longest and largest real estate boom of the world ever since the Industrial Revolution.
Posted by: Yu_in_DC at July 21, 2010 11:12 AM
This reminds me very much of residential property price increases in the major cities of the former Soviet Union, 2002-2007. Tenfold was typical.
It's very important to keep in mind that these numbers are for Beijing, not the whole of China. There are enormous differences between the elite neighborhoods of major cities and the national average.
Substantial down payments do not preclude mortgage-driven bubbles. With such a pace of appreciation, and if there is widespread confidence it will continue, and/or if rents exceed monthly mortgage payments, many people will risk large down payments on speculative housing investments. That is what happened in the FSU, especially the Baltics, where the boom in mortgages was bigger relative to small countries, inflating their entire economies, and further driving the bubble that way. Large down payments do reduce post-bubble defaults, but defaults aren't the only component of post-bubble trauma.
In the case of apartments built for laborers moving in from the country, which is a different, less dynamic market, down payments are generally not paid by the buyer, they are subsidized.
Posted by: Tom at July 21, 2010 12:50 PM
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