The Need for Transparency in China
By Michael Hendrix
A series of articles have come out in recent months that might lead one to believe that something just isn’t quite right with the Chinese property market, like the finding that there are apparently enough vacant properties in China to house 200 million people. That 65 percent of commercial properties in Beijing are empty. That buildings are blown up soon after being completed simply so they can be rebuilt. Perhaps it is the stories of ghost cities. That Chinese developers have taken to hiring young Westerners to pretend to be heads of (non-existent) Western firms that are supposedly commissioning building projects.
Now, these stories aren’t necessarily new. One author described 1990s Shanghai as a “Potemkin City” – all show and little substance. 20 years have passed since then and by all appearances Chinese cities are now fully developed. Yet, serious questions remain. Who in China is allocating what investments are made where? How much of the investment is misallocated and at what cost? What is the degree of leverage and who bears the ultimate debt burden? Even with this information, to what degree is it reliable? What ultimately matters is not what we know, but what we don’t know. There are a lot of unknowns in China, all of which point toward a need for greater transparency.
Perhaps the fear of a bubble is overblown. As Martin Wolf of the Financial Times pointed out, even if we were to see a downturn in the property market, “a rapidly urbanizing country with an economy expanding at 8-10 percent a year will grow out of shocks, not least by absorbing excess capacity.” Additionally, growth in real estate is usually connected with broader economic growth, and in turn investment in fixed assets like real estate is a major force behind the Chinese economy. China has had lots of growth and government stimulus as of late, so investment in real estate shouldn’t be too surprising. Yet recent growth levels don’t seem to match the amount of investment seen. While GDP rose by 8.7 percent last year, investments rose by 30.1 percent. “Banks lent out a record 9.59 trillion Yuan last year, of which a quarter went to infrastructure construction.”
At the most fundamental level, the rise in real estate prices stem from the massive tide of emigrants washing on to the shores of China’s largest cities. It is expected that another 243 million rural residents will urbanize over the next quarter century, which should be more than enough to sustain demand for housing well into the future. Still, it does a migrant no good if he can’t afford a place to live. According to Goldman Sachs, housing price increases have outpaced wage hikes by 30 percent in Shanghai and 80 percent in Beijing. What does that look like in practice? Bloomberg News recounts the story of Gloria Gu, who earlier this year paid $483,000 for her Shanghai apartment. Six months later, her neighbor paid $615,000 for a place just like hers. As Gloria says, “The market is too good to be true.”
When deals start to turn bad you normally see a rise in non-performing loans, but according to Premier Wen Jiabao that number currently stands at a healthy 2.8 percent. Sometimes there are warning signs that foretell a rise in bad loans though, and the more significant ones are the average real estate price-to-income and price-to-rent ratios. In America’s priciest market, New York City, the price-to-income ratio stood at 9.5:1 and price-to-rent ratio at 39:1 as of November 2009. In Beijing, the price-to-income ratio has reached 27:1 and the price-to-rent ratio is nearing 500:1.
As we saw in many Western countries before the recent financial crisis, it can be incredibly difficult to differentiate a market bubble from a sustainable rise in asset prices. Yet, with free and open markets we know where to look for a bubble and can analyze a vast amount of trusted data in order to get an answer. In China, we don’t know what we don’t know. While Ken Rogoff declares that China’s property market is on the brink of collapse, Zhang Xin wagers hundreds of millions of dollars on Chinese real estate, confident that the world’s hottest property market is undergoing at most what the Asia chairman of Morgan Stanley calls a “micro bubble.” It’s because of a lack of transparency that there is no consensus on the extent, or even the existence, of over-investment or a property market bubble.
As real estate firm Jones Lang LaSalle puts it, a mature property market in China should be “characterized by the free flow of high-quality market information, robust regulatory enforcement and fair transaction processes.” Transparency is a fundamental feature of an efficient and effective market, and especially one that is stable and embedded within international capital markets. While China has made vast improvements in its level of transparency, it still has a long way to go. Let’s hope it’s not too late.
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