Would you take this gold bar in exchange for buying a house?
How about this phone?
A new car maybe?
It might seem absurd, but these were just some of the actual incentives being offered
to Chinese homebuyers in 2023.
Property developers – such as the gold bar-giving Huafa Tianfu – were forced to get creative as they
became increasingly desperate to attract sales.
Stories like these were just the tip of the iceberg
in a crisis that involved hundreds of billions of dollars in developer debt,
trillions of dollars in local government debt, and at least tens of millions of empty apartments.
China’s real estate market is relatively young – only a few decades old.
And that’s because private property didn’t really exist in the country until the 1980s. When the
People’s Republic of China was founded in 1949, the Communist state did away with
private land ownership, saying it belonged to the Chinese citizens as a whole. Homes
were instead allocated to residents in cities through a socialist welfare housing system.
When China began to open up and reform its economy in the late 1970s,
there were virtually no private homeowners in the country. But that was about to change.
China’s economic experiments in the 1980s were largely successful. Its citizens began to make
good money from the businesses they were setting up, and its cities began to grow as more people
migrated from rural areas. But there wasn’t enough housing to accommodate this influx.
So, the state began to make housing reforms. In 1988, it began to privatize and commercialize
public housing – offering tenants the opportunity to buy their units at very low prices. In 1998,
the government announced the end of public housing altogether.
Whilst back in 1979, virtually no one owned their home in China, now,
80 to 90% of households own their homes, with more than 20% of households owning more than one home.
So where did it all go wrong? Let’s see how the property market works in China.
Like any market, the price of real estate is driven by supply and demand. When supply is
high and demand is low, prices fall. When supply is low and demand is high, prices rise. External
elements, like inflation, government policies, and interest rates, can all upset this balance.
But China is still a Communist country, so the State owns the land these cities are being built
up on. In its 1988 reforms, however, the government detached land usage from land
ownership – and gave what it called land-use rights to local governments. This enabled
municipalities to rezone land for commercial use. Then, they could sell land-use rights
to private and state-owned enterprises at a profit. These enterprises then sold on the
rights in a leasehold model to homebuyers.
This proved to be an incredibly lucrative
source of revenue for local governments, negating the need for property taxes
in China, unlike most countries.
Many economists agree that the seed
for the current housing crisis was planted then, in 1994. And that was the year Beijing
decided to overhaul its entire tax system.
The economy was growing, and the central
government wanted a bigger cut. So, it made tax reforms that helped the state take in a
lot more money, but it was at the expense of local governments. At the same time, municipalities were
being given ambitious growth targets, but no longer had the tax revenue it had used to fund
social services. And so, they were encouraged to increase revenue from land-use sales.
Thankfully for China’s cities, there was massive demand for these 70-year leases.
150 million Chinese citizens moved into urban areas in the 1990s, and they all needed housing.
Profits from selling land shot up and began to make up a huge share of local budgets. In 2010,
for instance, land conveyance revenue made up nearly 70% of local revenues. As a result,
municipalities became increasingly dependent on a euphoric housing market.
And so, the construction boom was born. Property development helped fuel China and
the world’s economic growth for 30 years. By some estimates, property in China was
worth $60 trillion at its peak, making it the biggest asset class in the world.
And property developers were getting extremely rich in the process,
including one you’ve probably heard of.
Founded in 1996 by Hui Ka Yan, Evergrande
was one of the many real estate companies that blew up alongside the property boom, as well as
others such as Country Garden, Vanke and Sunac.
In most parts of the world, prospective homebuyers don't purchase their property outright.
They instead put up a percentage of the property price,
known as a down payment or deposit, while the rest is covered by a bank. The buyer must then pay the
bank back, with interest, over time.
But in the Chinese housing system, it’s
common to require buyers to advance a large part of the sum to property developers, before they
even start building. This provided developers with loads of interest-free financing, which companies
like Evergrande used to fund new projects. This is well and good, as long as property
prices keep going up and people trust the system.
And that's what they did. Property quickly became
Chinese citizens’ investment vehicle of choice over alternatives such as the stock market.
The state’s economic stimulus in 2008, and an order to state banks to extend credit,
helped bolster Chinese demand for homeownership, with some citizens
buying their second, third or even fourth home.
Globally, investors piled in as well because they
saw Chinese property as a safe investment, assuming the state would never let the
sector fail. And developers leaned into this too. Evergrande, for instance, had an entire holding
company based out of the Cayman Islands, dedicated to raising finances outside of China.
This led to a massive property bubble, with speculation, price rises and uncontrollable debt.
A property bubble happens when there is an increase in housing demand for a limited
supply. Low interest rates, cheap credit and lowered standards for credit repayment
are some of the conditions that can entertain the demand. But when the demand has been met,
or one of the conditions is curbed, prices eventually decrease, leading the bubble to burst.
Chinese President Xi Jinping, who was elected in March 2013, didn’t like what was happening
in the property market. In a speech in 2017, he declared: “Houses are for living,
not for speculation.” It was a mantra he would return to often, and policy began to follow suit.
The biggest of these was the Three Red Lines policy in 2020. In an effort to curb unsustainable
borrowing, Beijing essentially capped the amount of debt property developers could have.
Evergrande and several other private property developers failed to meet the Red Lines criteria,
and as a result, could not contract more debt to fund their ongoing projects. This
meant they didn’t have the funds to finish off the properties they’d already sold.
It’s a disaster, the government engineered this on purpose because they were concerned that there
was a bubble which of course there is. So, this is not a surprise that this is going to happen in the
way it’s turning out. Now the issue is, the State that keeps pushing this idea of a stimulus as some
sort of a magic bullet. There is no magic bullet.
The property bubble had been exposed – and began
to deflate. But government policy wasn’t the only thing cooling down
the market. Demand was dropping off too.
Cities were no longer seeing an influx in
new residents. In fact, millions of people chose to leave urban areas and return home
after the Covid-19 pandemic. A few factors were at play here:
young Chinese were facing the worst job crisis in decades, and that lack of
stable income delayed home ownership. In addition, affordability, or house
price-to-income ratio, in China was amongst the worst in the world. The average price for a
property in Shanghai in 2024 was 48 times higher than the average annual salary. In comparison,
a Parisian would need 17 times their income to afford a place, and a New Yorker 11 times.
China’s population is rapidly aging too. The WHO estimated that by 2040,
nearly 30% of the Chinese population would be over 60 years old. Whilst this will create
demand for services, the demand for housing will decline alongside population numbers.
At the end of 2023, home prices in China dropped to their lowest point in nearly
a decade, and with them, investors’ confidence.
The government and developers have tried to manage
the crisis by selling off assets, liquidating businesses and providing emergency loans, as well
as seeking alternative ways to fund the state.
As of January 2024, the sector still had
$8.9 trillion in outstanding debt. Real estate represented 25-30% of China’s GDP,
making it a core component of the Chinese economy. And as the globe's second largest, China‘s next
steps to control the crisis won’t just be watched by its citizens. The world will be watching too.