Now China Has a Two-Speed Property Market, Too

  • Central Bank Governor Zhou is proposing tailored policies
  • Property imbalance is a key constraint on economic outlook

Call it China’s tale of two-tier cities. As property prices fell 3.9 percent in the port city of Dandong near the North Korea border in the past year, those in the southern hub of Shenzhen soared 57 percent.

QuickTake China's Pain Points

The nation’s fragmenting property market is forcing diverging policy responses from local authorities and the central bank. On one hand, they want to stoke sales in smaller cities to cut oversupply and have lowered interest rates six times since November 2014 to help that happen. On the other, they’re worried about a renewed price surge in the biggest cities, with local authorities in Shenzhen and Shanghai among those taking steps to cool red-hot markets.

China’s top housing official warned last month that the “substantial gap” between top cities and lower-tier regions is challenging government policy. People’s Bank of China Governor Zhou Xiaochuan has suggested regulators take a more tailored approach instead of a one-size-fits-all solution.

"The PBOC can’t raise or lower interest rates because that would be a national level policy,” said Larry Hu, head of China economics at Macquarie Securities in Hong Kong. "In Shanghai, the problem is there isn’t enough supply, and for most lower-tier cities the problem is oversupply, so the policies have to be different."

‘Bubble’ Concern

Facing sluggish exports, overcapacity and deflation in industries like coal and steel, and weakening manufacturing, China’s policy makers have flagged additional fiscal support and room to act on the monetary front. Yet they’re also being vigilant about possible financial stability threats brewing in the housing market, an unwelcome risk for an economy that last year posted the weakest pace of expansion in a quarter century.

“The government has already noticed the price bubble in the tier-one cities and they’re trying to channel the money to the second- and third-tier cities,” said Patrick Wong, senior real estate analyst at Bloomberg Intelligence in Hong Kong. “If prices keep going up and up, there could be a bubble that bursts and that could make the economic situation even worse.”

China’s cities are divided into four tiers, depending on their population and significance to the economy. First-tier cities include Beijing, Shanghai, Shenzhen and Guangzhou, while second-tier cities include provincial capitals such as Nanjing and Hangzhou.

Policy Guidance

Nationwide, real estate markets face major pressure from efforts to reduce excess inventories, and officials should strengthen property policy guidance, the PBOC’s Zhou said at a briefing in Beijing during the National People’s Congress last month. He told banks to reduce risk by better assessing customer credit worthiness in mortgage lending and said unauthorized loans by real estate agents increase the chances of bad debts. He also called on city officials to tailor responses based on their unique circumstances.

"Since China is such a large country, the People’s Bank has always been calling for a better role of the city level to make judgment on the situation of its own property market and offer policy guidance," Zhou told reporters.

China’s market isn’t unique in experiencing a divergence in property prices. The U.S., for instance, has seen an uneven recovery in housing prices in the years following the subprime crisis. Areas with stronger economic growth -- coastal cities, especially -- have seen prices rebound faster, while regions with more modest growth have lagged behind.

Unlike the U.S. Federal Reserve, which has 12 district reserve banks that supervise banks in their region, the PBOC directly administers its local branches. The PBOC has 36 subsidiaries across China. Local offices are charged with implementing monetary policy, maintaining financial stability, and other responsibilities required by the central bank. They don’t have much leeway from Beijing to make regulatory decisions.

‘Haven Assets’

Cheap credit, fueled by a streak of cuts to benchmark interest rates and banks’ required reserve ratios, flowed to real estate in top-tier cities like “haven assets” as returns of most other investments have disappointed, said Shanghai-based analyst Zhang Chenghang at advisory firm CEBM Group. Liquidity surged, with new credit jumping to a record high at the start of the year, even as China’s stock market faltered and government bond yields remain near historic lows.

Fearful of a devalued Chinese currency and facing restrictions on the movement of money out of the nation, investors have also had renewed incentive to seek out quality property assets, according to Liu Yuan, a Shanghai-based research director for Centaline Group. Since February, Chinese regulators imposed new restrictions on insurance policy purchases by mainlanders that had been used to evade capital controls.

Residential building is key to the economy’s prospects for a sustained pick up in growth. Real estate, including goods such as electric machinery, chemicals and metals used in construction, accounts for more than a quarter of final demand in the economy, according to UBS Group AG estimates. 

A pick-up in the real estate sector is probably the force behind a rise in the construction sub-index in China’s official non-manufacturing purchasing managers index, which in March jumped 2.8 points to 58.0, Bloomberg Intelligence economists Fielding Chen and Tom Orlik wrote in a note on Friday. Still, the pick up may be short-lived amid oversupply in smaller cities and tightening measures in bigger cities, they wrote.

At the heart of China’s property malaise is an imbalance between supply and demand -- the new building is taking place where there’s less demand, while supply is short in the most popular, largest cities. Last year, 61 percent of new-home building starts were in third- and four-tier regions, while only 5 percent were in first-tier hubs, according to China Securities Co. calculations based on government data. 

Transaction Defaults

In Shanghai, there already are signs tightened lending rules announced March 25 are having an impact. Sales volumes slumped in the next two days, according to China Real Estate Information Corp. As many as 30 percent of the home transactions that had been agreed in the prior week may be returned or default, Zhang Hongwei, a research director at Shanghai-based Tospur Real Estate Consulting Co. forecast.

Yet historically, demand-side controls including higher down-payment requirements have proven ineffective in the long run, China International Capital Corp.’s Beijing-based chief economist Liang Hong wrote in note Mar. 28, citing a 44 percent home-price surge in Beijing since tightening measures in the city in 2011, faster than the 20 percent national average.

The billionaire chairman of Evergrande Real Estate Group Ltd., which has assets split between first, second, third and fourth-tier cities, remains bullish. “The market will see both price and sales volume increase in 2016, and the property inventory will reduce,” Hui Ka Yan said March 29 after releasing full-year earnings that beat analysts forecasts.

To try to ensure that outcome occurs without accompanying bubbles in the biggest cities, policy makers will need to keep up their juggling act of stimulus and restraint.

"The current policy for this year is very simple: they’ll do whatever it takes to maintain economic stability," said Macquarie’s Hu.

— With assistance by Jeff Kearns, and Emma Dong

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