Risky Real Estate in China

Although upscale developers, speculators, and banks have made a fortune, there are signs the easy money could be coming to an end

Until a few years ago, few mainland Chinese would have understood the old English adage "as safe as houses." Property was owned by the state and where you lived depended on the whim of the local work unit leader.

Even after the private housing revolution of the mid-1990s, when many individuals bought flats at knock-down prices from their work units, property owners had no legal means of protecting their homes from the municipal wrecking-ball.

But last year's property rights law supposedly changed all that and, according to the Chinese Academy of Social Sciences, a remarkable 80% of urban Chinese households now own their homes.

Although your correspondent still has qualms about jumping into the fray mainly because so many new buildings seem to age faster than Keith Richards after a particularly heavy night that has not put off locals and speculators.

Property prices have risen rapidly. According to the latest figures, prices in the 70 major cities measured by the government's property index are growing annually at around 11% although prices at the top end are rising much faster than that. Two years ago, an apartment in Beijing's Central Park, one of the capital's smartest addresses, could be had for around US$2,000 per square meter. Now you would be lucky to get it for US$5,000, while the penthouse apartments cost over US$9,000.

High-end property developers, speculators and the banks that finance the whole shebang have made a fortune, but there are signs that the easy money could be coming to an end.

Stricter controls on property speculation and land-hoarding have made it much harder to ramp up prices, while the government's credit squeeze is already hitting developers. In Beijing, strict loan quotas have succeeded in cutting off credit to all but a handful of the biggest and best-connected developers, which can now only secure loans priced at 10% above the nominal interest rate.

Bigger developers have also been hit by the global credit crunch, cancelling bond issuances as demand from foreign investors has dried up. Shares in developers like Country Garden and Greentown are nearly 50% off their autumn peaks.

Rising inflation, higher interest rates and tumbling stocks are likely to make banks more cautious about their exposure to the property sector, which accounts for one-third of their loan books. The banking regulator recently warned banks to step up controls on lending to developers amid fears that unsustainable property prices may trigger a rebound in bad loans. According to the Shanghai regulator, US$280 million in property loans went sour last year, twice the number in 2006.

The upshot is that high-end real estate, once the safest bet for mainlanders with few other investment options, has become a risky play. Investment guru Jim Rogers expects a shake-out thatý results in some developers "going broke this year."

It may still seem unlikely, but what happens if the mainland property market follows America's and prices tank?

China Construction Bank, the country's biggest mortgage lender, reckons that a 10% drop in the market should cause no major problems, but a 20-30% drop would be very tough for the country's still fragile banking sector to handle.

With prices in Guangzhou and Shenzhen already softening, and those in the know predicting that prices at Beijing's top-end properties are reaching a peak, your correspondent is in no hurry to swap his humble cave for a fancy flat.

Before it's here, it's on the Bloomberg Terminal.