The China house bubble and the leverage behind

By | February 29, 2016

The home price in China’s tier one cities (Beijing, Shanghai, Guangzhou and Shenzhen) started another around of rally in the last couple months, and became “crazy” in Feb as described by the Chinese who form lines to buy the apartments everywhere.  When I saw this online commercial as below, I cannot help asking myself: Really?  This place can be sold as a “home” (I thought it’s just a kitchen), and at this price ($9k per sqf)?

lian jia

The ads is posted on the web site of China’s biggest online real estate agent Lianjia, showing a 6 square meters (65 sft) property which asks for RMB 3.8milion ($585k in total or $9k per sft).  Frankly speaking, this place has its good selling points: sitting at a good school zone, close to the subway and not subject to the real estate restriction policy. But really, $9k per sqf?  Maybe you think the tiny kitchen is an isolated case, but let’s look at the following general price data.

Chart 1: Tier 1 cities ended the YoY price decline since June 2015 and enjoyed a strong rally as it did in 2010 and 2013. 

Price YoY

Chart 2:  Absolute price level of tier 1 cities (Shenzhen, Beijing and Shanghai (RMB/sqm))

3 cities absolute price

Source: Wind, blue line: Shenzhen, red line: Beijing, and blue dot line: Shanghai

The median home price in China’s top 3 tier 1 cities ranges between $0.5k to 0.6k per sqf (RMB 33k to 43k per sqm).  Based on Trulia’s data in 2015, the median home sales in NY is $1.5k per sqf and that in San Francisco is $0.95k per sqf.  However, the median household income in Shanghai is only $15,400 per year while that in NY/SF is around $59,000/$84160, so the home price to income ratio in China’s tier 1 cities is higher than those in US tier 1 cities.

Chart 3:  Price change % of tier 1 cities in the last five years

Price range YoY

Source: Wind, from left to right, Shenzhen, Beijing and Shanghai

So will investing in the tier one properties bring you stable income?  Let’s take a look at the rent yield.

Chart 4: Tier 1 cities’ rent yield in the last eight years (%)

Rent yield

Source: Wind; Red: Shanghai, Blue: Beijing and Pink: Shenzhen

 The trend of rent yield has been declining and now the yield stands at only around 2%.  But if we take a look at real yield, it’s another picture

Chart 5: Tier 1 cities’ rent yield minus China 10 yr treasury yield (%)

Rent real yield

Source: Wind; Red: Shanghai, Blue: Beijing and Pink: Shenzhen

Apparently, you will have negative real income if you investing in China properties.  Your investment return comes from the next buyer/speculator or the people who are stupid enough to pay 20 to 25 times home price to house income (if they really can afford).

You must wonder how the average Chinese people can afford a living place as the home price to income ratio is so high.  Yes, you are right, the average Chinese people or even the white collar/professionals are not able to afford the home price in tier 1 cities, but they can “invest” in the property market just like they did in the A share equity market through leverage.  For the A share equity market, we can estimate the leverage through the level of “margin debt”.  However, there’s no such a matric to estimate the size of the leverage used in the property market.  But we can get a remote sense from another perspective.  We all know January new RMB loans hit a record high RMB 2.51 trillion, while the deposit of industrial corporate only increased RMB 800 billion.  It means that a decent part of the loans did not go into industrial corporate’s bank accounts to support the real economy.  Where did it go?  Apparently the margin debt in equity market was dropping in Jan, then you know the answer.

In addition to the leverage part, there’re more concerns in the equity part: down payment.  For speculator, they like to buy as many as home in the same area so they can “manage” the price through volume control.  Right now China’s real estate policy still mandates 25% to 30% down payment when you buy a property, so the equity part itself demands significant cash flows (tier 1 cities’ average home price is around $1.2 million to $1.5 million per unit, so 25% to 30% down payment for 100 units is still a big number in China.  Yes, it’s not wrong number, 100 units is a normal case for a group of speculators who will buy the whole apartment complex).  Here are two ways how the speculators get around this entry barrier:

  • The real estate agents provide margin for the down payment. To boost the transactions and earn the commission, the agents provide 50% to 70% lending of the down payment part and make sure the buyers have enough money to finish the transaction. In reality, the buyer may only pay 10% down payment (agents lend him 70% of the 30% down payment requirement) to buy a home.  The speculator’s leverage is loosened from 1:3 to 1:10 through this down payment leverage.  Right now, the buyer not only owns money to the banks but also the agents.  But it does not matter in a quick and steep upward market, as the speculators will turn over their inventory quickly and make a fortune of it.  All they need is big enough equity to leverage the bubble.  How big is the size of down payment leverage?  From the public information of three top agents (Lianjia, 5i5j, and Fang), we know that they provided this kind of down payment leverage for transactions with the value of around RMB 500 billion.
  • Some small individual speculators use “crowdfunding” to make the down payment. Per Wiki, crowdfundingis the practice of funding a project or venture by raising monetary contributions from a large number of people, today often performed via internet-mediated registries.  Crowdfunding is popular in the tech space, but in China, speculators use it to fund their bets in the property market.  Ironically, they use Wechat as the internet platform to organize the crowdfunding.  In these days, as long as you walk into any Starbucks in Shanghai, you will hear people discussing crowdfunding their “real estate investments”.  The problem is, it’s difficult to define ownership in a crowdfunding support down payment, because it’s impossible to put 100 or 200 people’s names under a property’s ownership.

Anyway, the current crazy bubble in China’s tier 1 cities smells the same as the A share bubble which was boosted by the margin debt in the last two years.  We know it will end badly when the margin debt bubble is pierced.

Leave a Reply

Your email address will not be published. Required fields are marked *