China Economy: 2012 and beyond (Part 2) – Real Estate Bubble7 March, 2012, 16:34. Posted by Zarathustra
Tags: Economy, Real Estate
This is part 3 of 5 in the series China Economy 2012 and Beyond
You don’t need that many properties
Needless to say that there is a huge bubble in Chinese real estate, just as Japan had twenty odd years ago. While it is almost ludicrous to say that there is no bubble, because of the poor quality of data (or sometimes, no data), it is difficult to tell exactly how big the bubble is.
One of the approaches we can potentially know what’s going would be some casual observation, just as I have already done for one of the extreme cases of Hainan. And indeed, I generally feel that the problems of having large number of unoccupied buildings exist almost in every city in China, to a varying extent, and the problems are not limited to supposedly second-tier or third-tier cities or small towns, but also first-tier cities. One obvious weakness of casual observation, of course, is that it is very hard, if not impossible, to generalise your findings in a very limited number of places you can ever visit to the whole of China, which is a very big country.
If we look at the data instead, I would be just as frustrated as everyone else because of the lack of reliable data. There are, of course, some pieces of data which are consistently with the general impression that real estate investment increased significantly after the 2008 financial crisis as the Chinese government put in massive stimulus to counter the effect of the global recession. For instance, we did see new constructions increase across the board towards the end of 2009 and 2010 after contracting in the first half of 2009.
Source: National Bureau of Statistics
But this is almost where consistency ends with official data. From various sources of official data with various calculations, we could establish, albeit in a convoluted way, that potential housing supply (i.e. existing housing stock plus those already under construction and those land that has been sold to developers but constructions have not yet been started) at the national level is far too much for the entire population to cope with. The existence of oversupply is a question of how much.
In deriving the future potential housing stock, the starting point is the housing stock that has already existed. In this part, I have largely got to the same starting point as Jinsong Du of Credit Suisse has. First, I took the reported Per capita urban residential GFA (which are different numbers from using the total housing stock divided by reported urban population), multiplied that by the non-agricultural population (hukou basis) to arrive at the existing housing stock for 2010 at 14,514 million square meter. On that basis, the annual net increase of urban housing on average was 816 million square meter per year from 2005 to 2010. For simplicity sake, the 2011 existing housing stock is estimated by adding the 2010 housing stock and the annual completion of residential floor area. This is not a completely accurate of doing so, as we would normally have to account for, among other things, the floor areas being demolished, etc, which should point to a lower net increase in GFA. However, as we can notice from the figure that the annual completion (per National Bureau of Statistics) is always almost invariably lower than the net increase, thus for the purpose of this exercise, the reported 717 million square meter completion is used.
With respect to future supply, one can base the following analysis on the 2011 third quarter report from the Ministry of Land and Resources, which stated that the land area for residential uses which was under construction amounted to 355 thousand hectares, and land area for residential uses of which construction has not started amount to 165 thousand hectares (note that there were latest figure which says that land area under construction by the end of 2011 amounted to 479.9 thousand hectares, but as that did not separate the portion for residential use, here I use a smaller and less updated figures of 355 thousand hectares). That means the potential residential GFA supply currently in the pipeline will come from the total of 520 thousand hectares of lands.
Note that these figures are in terms of land area, not actually floor area. Thus to get the actual potential housing stock, we must multiply the land area by an appropriate plot ratio. It would be difficult to say for certain which plot ratio to use. Some, like this report, suggests that 1.5x is the right ratio, while Jinsong Du used 2.2x. Here, I estimate the potential housing stock on various plot ratios assumptions, from the low of 1.5x to a probably unrealistically high ratio of 3.0x.
The resulting total housing if all the lands are developed under different plot ratios assumptions will be as following.
Now when it comes to demand side of the equation, instead of trying to classify various types of annual demand (e.g. first-time buyers, upgrade buyers, investment, etc), which is a flow concept (similarly, I focus on estimating the total housing stock in the future rather than annual new supply), I focus on the population growth and the rate of urbanisation as the main factors, which should give me the indication of total floor area required in the future.
The reason I focus on the stock concept of total housing stock and total floor area required as implied by total population in the future and rate of urbanisation is that, unlikely many other products such as food, which will most certainly disappear forever after the consumer consumes the products, is that real estate stays there after being bought, used, and subsequently abandoned by the owner (to be sold to others). Or to put it more clearly, upgrade buyers will most probably sell their existing homes, which should be subsequently on the market, and people who buy real estate as an investment will (eventually) have to sell it to someone else ultimately to realise on profits (if any), or let it out at the very least. That makes the analysis that focuses on, for example, annual investment demand vs. annual completion totally useless, because even though investment demand can absorb all completion in a given year, these real estate will eventually be on the secondary market at some point in the future, and that will (if using the flow concept) add to the “supply” in the future years.
For the forecast of total population, I use the forecasts made by the UN population division. In terms of future rate of urbanisation, the various scenarios are constructed as follow:
Additional assumptions regarding per capita GFA have to be made. As mentioned before, the per capita GFA officially reported by the government does not match the figures derived by dividing the total housing stock by total urban population, with the total housing stock being reported by the government till 2006. As a result, the reported per capita GFA appeared to have been overstated.
In estimating the total housing stock required, I use the derived per capita GFA as a starting point (which is invariably smaller than the reported figure, as state above), and assumed that it will simply go up to 30 meter per person by the end of 2020. With all these estimates (population, urbanisation rate, per capita GFA), rough estimates of total GFA needed can be found. And the result indicates that by the end of 2020, under various assumptions, the total GFA required around 24 billion square meters to around 27 billion square meters.
Based on the analysis, one can conclude that if developers completed all the constructions on all the lands which are currently under construction and those which construction has not yet started, the resulting floor area could easily accommodate all the residential needs for the urban population at least through 2017, in which one would take the most bullish assumptions for both plot ratio (at 1.5x) and urbanisation rate (65% by the end of 2020). Using a moderate assumptions of plot ratio at 2.2x and urbanisation rate at 58.5% by the end of 2020, all the potential supply in the pipeline will be able to meet the residential requirement beyond 2020.
Note that the population forecast from UN population division suggests that China’s population will peak on 2025 and decline thereafter. If that is indeed the case, and if the current potential residential supply in the pipeline can indeed meet the requirement through to 2020s, China will only need to complete all the constructions on these 520 thousand hectares of lands and stop doing any constructions whatsoever, and China will be able to meet the residential requirement pretty much forever.
Of course, one has to recognise that this is not meant to be a precise estimate. Indeed, the range of results we see show that it would be brilliant if we could only get it roughly right. However, we can establish from here that it is not at all an exaggeration to assert that the housing supply in the pipeline can meet the demand through 2020, even though constructions stop after all the current ones in the pipeline are completed. Certainly, it is not likely that construction will stop altogether, nor are we sure that all those currently in the pipeline will certainly be completed. for example, we could well imagine that some developers will run out of money, thus not able to complete the work. Also, we would find it difficult to quantify the exact amount of residential floor area that will be demolished over the next decade, as it will make the current estimate of future housing stock an overstatement.
Another source of in precision comes from the starting point of the whole exercise, namely the existing housing stock one of the big uncertainties here, in my view, is that no one is exactly sure about the occupancy of the existing housing stock. We have already seen that large number of flats are empty as people bought for investment, not for their own use. But these housing stock will have to be sold to real users ultimately, or at least be let out, in order for investors to realise any return. it could take extra years just to fill up these vacant homes, which further intensify the problem of oversupply.
Finally, another source of uncertainty comes from the rate of urbanisation. Although it has been progressing at a very rapid rate over the past decades, urbanisation in china still lags behind major developed countries, thus one might say that urbanisation will increase requirement for housing. However, as Jinsong Du pointed out, at least some of the urbanisation was happening simply by re-designate some areas from rural to urban, and people who have already been living there owned houses. as a result, that does not increase demand, but it adds to housing stock. Secondly, i doubt if china urbanisation will really catch up with other developed economies. Research has pointed out that agricultural land as a proportion of the total land surface of china is well below international average. Urbanisation not only reduces agricultural land as lands are developed, those lands not being developed are affected by urbanisation through pollution and others. Thus rapid urbanisation poses threats to food security of china. To ensure food security, China does not need more city dwellers, but probably more farmers. Although this will certainly be a contentious proposition to be made, urbanisation might have come closer to the limit than the consensus thinks. As such, we could not count on urbanisation to help absorbing oversupplied flats in cities.
Real estate investment now probably account for 10-13% of China’s GDP. With over-investment in fixed assets (not only in real estate, for that matter) in various parts of economy, it will be inevitable that investment will slow down. Just imagine for a moment that if the above mentioned residential supply in pipeline will all be completed by 2015, and those supply can meet the demand literally forever, there will be almost no point of building anything beyond 2015. It would certainly be preposterous to say that constructions will stop on the land surface of China, but construction will inevitably slow down in the years to come. If growth in the contribution of real estate to GDP went to negative, China’s GDP growth could easily tip into what most would regard as “hard-landing”.
Series: China Economy 2012 and Beyond
- China economy: 2012 and beyond
- China Economy: 2012 and beyond (Part 1) – Demographics
- China Economy: 2012 and beyond (Part 2) – Real Estate Bubble
- China Economy: 2012 and beyond (Part 3) – Debts
- China Economy: 2012 and beyond (Part 4) – Rebalancing The Economy