hina has made the world’s capital markets nervous.
Evergrande, the largest real estate developer in China and one of the largest
in the world, is on the ropes. It is very likely to go bankrupt (it has already
defaulted on some interest payments on its bonds). Some people are debating
whether this is the “Chinese Lehman Brothers.” Are we on the verge of a new
global financial collapse?
Let’s begin by analyzing the health of the sector in
which Evergrande finds itself. What is the state of the housing sector in
China? Are there signs of a housing bubble?
The Chinese Housing Bubble and Empty
The Chinese housing bubble has been reported for over a
decade. The primary evidence is the existence of ghost cities, cities that are
practically empty. For over ten years, ghost cities have not appeared to be
causing a systemic problem, although they undoubtedly pose a local problem.
However, the vacancy rate has continued to grow in China’s secondary cities.
Even in Beijing, the vacancy rate has reached 20 percent.
China’s housing vacancy rate is relatively high when
compared with other countries, although in 2017 it was lower than that of Spain
The data on the vacancy rate are not alarming, but when
this indicator (and the existence of ghost cities) is combined with other
indicators, the Chinese housing sector’s situation does indeed look alarming.
Housing is a durable capital good, and as such must be
valued. How is the price of a capital good determined? The most common way is
to base it on the income the good is capable of generating. In the case of
housing, the income it generates is the rent (either through the market or
through the rental payments the owner avoids). Accordingly, it is crucial that
the value of the house be a reasonable multiple of the rental value.
The housing-price/rental-price ratio gives a sense of
how inflated a housing market is. When the indicator is very high, purchasing a
house cannot be justified by the income it will generate. The only reason
someone will buy a house in this case is if they hope to sell it for a higher
price (and if everyone operates on the same expectation, we are facing a bubble
The housing-price/rental-price ratio in the Chinese
real estate market is incredibly high. It is exceeded only by the real estate
market in Turkey and Taiwan. Purchasing a home in China and renting it out is a
very poor business plan, as it takes a whopping forty-eight years to recoup the
The Profitability of Purchasing a
The profitability of investing in housing can be
analyzed in a similar manner. The income of a house is divided by the house’s
sales price. The result (once costs are deducted) is the profitability of
investing in the housing sector. An analysis reveals that investment in real
estate in Chinese cities is less profitable than in cities almost anywhere
Further, the returns from investing in China’s housing
market are much lower than the country’s prevailing mortgage interest rate. So
purchasing a house in China does not make economic sense. This is a clear sign
of a housing bubble.
Homes’ Purchase Price versus
Citizens’ Median Income
Another way of analyzing whether the housing market is
in a bubble is to determine whether the average citizen can buy a home. The
main purpose of a house is to be lived in (final demand). If the price of
housing grows well above the purchasing power of the average citizen, the
demand for housing (which drives the price growth) may well turn out to be
purely speculative and collapse in the future when it becomes clear that the
final demand does not exist.
China’s ratio of housing price to per capita income is
the second highest in the world (behind only India’s). It would take the
average Chinese citizen 146 years to pay for a home if they were to devote all
of their income to housing.
The previous indicator could be problematic as a means
of comparing countries since it relates national per capita income to the price
of urban housing (despite this, it is worth discussing it because of the huge
contrast between China and other countries). If we disaggregate the indicator
by city, we reach the same conclusion: the price of housing is too high
relative to the income of Chinese inhabitants.
The Housing Sector’s Contribution to
Another way to assess whether the Chinese housing
market is in a bubble is to look at the housing sector’s contribution to GDP. A
high contribution indicates too many resources are allocated to housing. This
indicator is the logical corollary of those discussed above: if house prices
are high, producers react by increasing supply, in the process drawing
resources from other parts of the economy.
The contribution of China’s housing sector to its GDP
is greater than the corresponding contribution seen in the huge Irish and
Spanish housing bubbles of the 2000s. Nearly a third of China’s economic
activity is linked to bricks.
The Disproportionate Concentration
of Wealth in Housing
Another sign of a bubble is the concentration of wealth
and investment in a single sector. Real estate is a favorite investment among
Chinese citizens. The recent increase in the income and quality of life of Chinese
citizens have exponentially increased their ability to save and invest. The
asset in which they invest has almost exclusively been real estate. In 2018, 76
percent of Chinese household wealth was invested in housing (in Japan this
figure is 41 percent, and in the United States it is 27.7 percent).
The concentration of assets in the housing market makes
Chinese households vulnerable to shocks in that market. The valuation of the
Chinese housing market today is double the valuation of the US housing market,
even though China’s GDP is 25 percent lower than the United States.’ In the
Japanese housing bubble that burst in the 1990s, the market valuation at the
peak was also double that of the US housing market.
The huge demand for housing is generating a housing
supply far greater than the housing needs of Chinese citizens (a typical bubble
trait). In 2008, only 30 percent of new housing was bought by people who
already possessed at least one home; in 2018, this figure was 88 percent.
Chinese Authorities Want to Burst
The problems discussed here are so evident that the
Communist Party leadership has taken action. They have implemented relatively
restrictive financial measures such as debt ratios and capital requirements for
housing developers. These measures have meant that the most financially
irresponsible developers are prohibited from increasing their debt by even a
single yuan. The Chinese housing bubble is enormous; various economic
indicators leave no room for doubt. Evergrande’s problem is not an isolated
issue but a systemic problem with the Chinese economy.