Asia | China | Emerging Markets | Monetary Policy & Inflation
Will China’s Real Estate Market Crash?
- By Sam van de Schootbrugge
- 7 min read
Summary
- A new NBER working paper, co-authored by prominent economist Ken Rogoff, highlights long-term imbalances in China’s real estate market.
- These problems are most pervasive in small- to medium-sized cities, where most of China’s economic activity occurs.
- The paper estimates a 30% reduction in real estate construction by 2035 and, as a result, a 5pp drop in the sector’s overall share of China’s GDP.
The China Real Estate Market Is Under Duress
By international standards, China’s real estate sector is exceptionally large. It accounts for over a quarter of GDP (Chart 1) – almost double that of the US (14%). The result of a multi-decade construction boom, China now has square meters per capita of housing comparable to many wealthy advanced economies.
This property-driven growth model may, however, be running into diminishing returns. Excess real estate stock and continued overbuilding have left local governments swamped with debt. And market pressures on cash-strapped developers could be signalling the start of a significant rebalancing.
Such a correction will expose vulnerabilities in finance, government revenue, and employment. A new NBER working paper, co-authored by Ken Rogoff, locates the most prevalent imbalances in the allocation of housing and construction and investigates how close China is to a real estate collapse.
Same Angle, New Data: Understanding China’s Housing Market
The paper’s USP is its data. And that, when it comes to China, is worth investing time and effort into. Most China-focused research suffers from agglomeration biases – it either uses aggregated data or is centred around major cities. This can significantly distort the overall picture, especially for real estate construction.
So, the authors turn to provincial records and new improved data from China’s National Accounts. This enables them to classify three tiers of cities. Tier 1’s are Beijing, Shanghai, Guangzhou, and Shenzhen. There are 35 large- to medium-sized cities in Tier 2, which include two municipalities directly under the central government (Tianjin, Chongqing), five cities under separate state planning, and 24 provincial capitals. All other cities, of which there are 646, land in Tier 3.
Tier 3 cities account for most of China’s GDP (Chart 2). According to the authors, these small- to medium-sized cities have a significantly larger weight than in the US, both for GDP and population.
These cities also account for most of China’s housing stock (Chart 3). To calculate this, the authors use data from the 2010 and 2020 censuses as a foundation. They then augment this with city-level information on residential constructions completed from across China to fill the gaps between census years (Appendix).
The data shows an unprecedented boom in housing over the last decade, with total housing stock increasing 40% from 2011 to 2021. Also, most of this boom has been in Tier 3 cities – a key punchline of the paper.
Despite this, an imbalance appears to exist between supply and demand in these cities. Using monthly house price data from the NBS in Tier 1 and Tier 2 cities, alongside national averages, the authors impute Tier 3 housing price developments, weighted by their respective floor space of housing sold.
Their estimates show house prices in Tier 3 cities have dropped almost 20% since early 2021 (Chart 4). This has wiped out nearly 15% of the housing market value in these cities. In comparison, prices rose modestly in Tier 1 and Tier 2 cities.
Worrying Real Estate Fundamentals
Tier 3 cities, although small in relative size, are not rural. Around two-thirds (66%) of China’s urban population live in these cities, and they host around 72% of all urban housing stock. These cities are huge in absolute terms but – another key punchline of the paper – are declining (Chart 5).
The authors estimate that urban housing demand in Tier 3 cities is likely to decline 3% annually from 2022 to 2035. This means real estate construction will need to shrink significantly – by roughly 30% in the paper’s scenario. Also, 60% of the demand that remains is expected to be replacement demand, not an increase in capacity.
This imbalance between supply and demand already appears to be manifesting in the data. The ratio of new constructions to completed constructions was six in 2011. Now the ratio has extended beyond 10 in Tier 3 cities (Chart 6).
Low completion rates, which also seem to be affecting Tier 2 cities, are a bad sign. They could reflect lower demand, an inability of property developers to carry out projects for lack of financing, delays in projects due to disputes over property rights, or quality issues.
If property developers are struggling to carry out projects, debt may prove burdensome. As the fallout from the Evergrande bankruptcy highlighted, debt is quite high among construction firms; it dwarfs that of the manufacturing sector (Chart 7). And the authors estimate this is even more true in Tier 3 cities, where debt to asset levels are nearer 80%.
Economic Impact of the China Real Estate Crisis
If the real estate contraction occurs, as the authors believe it will, there will be pressure on the country’s fiscal sustainability, financial stability, and labour market, especially for Tier 3 cities.
In 2021, the ratio of non-tax land revenues amounted to approximately 43% of local government fiscal revenues in Tier 3 cities – highlighting the importance of the housing sector to fiscal balance sheets. This unsustainable overreliance on land sales, which is windfall in nature, has incentivised local governments to overinvest in real estate and push up land and housing prices.
Households also depend on the real estate market. The China Household Finance Survey (Southwestern University of Finance and Economics, 2019) finds housing wealth accounts for over 70% of total household wealth in Tier 3 cities.
The broader economy would also be impacted by a real estate correction. While Tier 3 cities are home to almost 60% of housing under construction, they host over 90% of construction enterprises, which hire over 85% of construction workers.
Bottom Line: Real Estate in China Faces a Long Decline
Problems in China’s real estate sector run deep. Recent market pressures on construction firms, such as Evergrande, could have been interpreted as reflecting short-term policy tightening. However, the paper shows how large imbalances exist, which will require longer-term corrections.
Moreover, while these corrections are more likely to occur in smaller- to medium-sized cities, they will have large aggregate impacts. Construction in Tier 3 cities, which make up three quarters of the overall real estate market, will need to shrink 30% by 2035. This could remove as much as 5pp of housing’s contribution to China’s GDP, even in a modest scenario.
Appendix
Calculating annual housing stock estimates by Chinese city.
FAQ
→ How Much Of China’s GDP Is Real Estate?
China’s real estate sector is estimated to be 15-30% of the country’s GDP. As of December 2022, China’s real estate sector was reported at 1,846.57 billion RMB.
→ How Much Real Estate Does China Own In The US?
China owns sound 383,935 acres in the US as per data from the U.S. Department of Agriculture. This data is accurate as of 2021. The value of the real estate is thought to be around $1.1 trillion, which is over 5% of all U.S. real estate.
→ Will China’s real estate market collapse?
The real estate market is suffering from long-term imbalances that will likely lead to multiple corrections over the next five years. These, according to the research, will be concentrated in Tier 3 cities.
Sam van de Schootbrugge is a Macro Research Analyst at Macro Hive, currently completing his PhD in international finance. He has a master’s degree in economic research from the University of Cambridge and has worked in research roles for over 3 years in both the public and private sector.