Measuring the size of the property bubble in China by reference to the number of empty flats has become a hot topic of discussion.
Recent media reports citing information from China’s electricity authority claimed that 64.5 million urban electricity meters registered zero electricity consumption over the past six months, equating to enough empty flats to house 200 million people. The electricity authority has since denied the figure. Whether or not this sensational number is credible, obtaining a reliable figure should be a priority. Otherwise, national policies may be made in the dark.
Most property bubbles in modern history have been price bubbles because there are unique factors restricting property supply. First, property development is subject to government regulation, and established communities usually have regulations restricting building height and density. In that environment, it is virtually impossible for mature communities to increase supply quickly.
Second, infrastructure development takes time. Land shortage is always relative to infrastructure scarcity. Even on an island like Singapore land can be reclaimed from the ocean at low cost. Therefore, land shortage is usually a form of infrastructure shortage. Infrastructure development is time consuming and when property prices are high, even when money is available, infrastructure development usually stalls due to fears about a future drop in property prices. Hence, property supply may not respond to price increases even over an extended period of time.
A property quantity bubble is less common than a price bubble and usually is not long lasting. When supply increases in a quantity bubble, it exerts downward pressure on price. It just requires more money to prop up prices when supply is rising. This type of bubble is sometimes a construction bubble and generally doesn’t last longer than the construction cycle.
China is experiencing a property price bubble. What distinguishes China’s property bubble from others is its unprecedented quantity dimension. China does not have any constraints limiting supply. The stock of empty flats measures the size of the quantity bubble. Taiwan experienced a price-cum-quantity bubble in the late 1980s. At that time the market quantified the number of empty flats by obtaining data from the electricity supplier on flats without usage of electricity. The stock of empty flats measured this way was about 15% of total households. Some analysts are trying the same tactic to quantify the volume of empty flats in the Chinese mainland however the complexity of the mainland’s housing conditions makes it difficult to use this methodology.
Urban housing stock is mostly split between older public housing units and private housing units that have sprung up in the past ten years. The latter comprises about sixty million units. About twenty million are under development by property developers. The local government-owned land banks may account for another 20 to 30 million. A large number of public housing units have been torn down for redevelopment. The stock before the latest big wave of redevelopment was probably above 10 billion square meters. The amount of demolished units can’t be too large relative to the newly built housing stock. Otherwise, it wouldn’t make business sense for local governments. The remaining stock is probably around 9 billion square meters.
In addition to the development of regular commercial housing units, companies and government agencies have been building housing for their employees. Though this practice has been declining it remains significant in many cities, and it is hard to tell how many such units there are. A similar phenomenon is the development of dormitories. The most well known example is the dormitories at factories for migrant workers, where most of the over 200 million migrant workers may be living.
Rural communities have also been building massive amounts of housing units. In areas close to major cities such properties affect supply because when suburban farmland is rezoned into urban land, the rural houses are officially reclassified as urban.
While the data is not accurate, we can confidently conclude that China doesn’t have an absolute housing shortage and the per capita space is above the level in Europe and Japan. Indeed, if we adopt Japan’s standard, China already has sufficient urban housing space for everyone in the country, i.e., there is housing for every person in the countryside to move into the cities.
Far more important than the general housing data is the quantity of empty flats held for speculation and no other purpose. In a normal market, the vacancy rate should be equal to the number of households relocating times the average transition time, plus the number of new household formations times the average purchase time. While the government doesn’t publish vacancy data, I think that the vacancy rate for commercial housing stock is between 25-30%, at least 100% above what a normal market requires. The difference can be viewed as speculative inventory – people are hoarding flats just as people hoard copper for price appreciation. The value of this speculative inventory is probably around 15% of GDP.
The more frightening prospect is the massive amount of speculative inventory that could form in 2010-11. The recent credit tightening to squeeze second and third home buyers has caused transaction volumes to collapse across the country. I understand from intermediaries that most property demand falls into the restricted categories, i.e., speculative. It is reasonable to assume that the supply will be close to 15% of GDP in value in 2010-11. The tightening policy is holding back the market, and the supply is piling up on the developers side as inventory. When the policy is loosened again, speculation will probably revive. It could cause speculative inventory to double in value.
The chance of the current tightening policy to loosen is significant. In some cities banks are already loosening a bit. Local governments that depend on property for revenue will get into financial trouble if transaction volumes remain low. Many local governments are highly in debt. It is common to see local governments with debt five times revenue. If revenue collapses, they could default. The central government may loosen policy over this consideration. The loosening may be implemented without announcement. While such a change of heart eases the short-term government financial difficulties, it may double the trouble down the road when the property bubble bursts.
In addition to the commercial housing stock, vacancy rates could be high in other property categories. As they are not market driven, people who are in an advantageous position or have connections (e.g., suburban farmers and the employees of the companies that build their own housing) tend to have access. Hence, these categories tend to have a higher vacancy rate than the commercial market. While such properties don’t compete in sales, they compete in the rental market. They are part of the effective supply, so their vacancy rate should be taken into account when calculating the property market excess.
Even if China’s empty urban flats are less than 64.5 million, it could be half as many as defined by international standards. That would still be equivalent to 20% of the urban households, higher than Taiwan’s vacancy rate at its peak. Moreover, if the property tightening is loosened, the rate could rise above 30% of urban households.
China’s property tightening policy still appears to be an improvisation. Buyer discrimination policies are complex to implement and cause excessive market volatility. If the policy is changed under pressure, it would further embolden speculators and excess then multiplies, making the eventual adjustment so much more painful.
Raising interest rates is the best policy to cool speculative demand gradually and avoid market disruptions. Delaying an interest rate increase will only cause the stock of empty flats to surge and make a collapse inevitable.
A sustainable policy requires local governments either increase other sources of revenue or limit expenditures. The investment-led growth strategy that local governments all adopt inevitably leads to a search for revenue, which usually leads them to maximize land sales revenue. Unless some limits are put on the investment-led growth strategy, China’s property market cannot function normally. On the revenue side, property taxes could play a significant role. In most countries, property taxes go to local governments for financing local public services. China should adopt the same model to alleviate the financial difficulties of local governments. But, limiting expenditure, not increasing revenue is needed more.
China urgently needs a coherent property strategy, not periodic but unsustainable crackdowns on speculation. The massive overhang of empty flats should goad policymakers into taking action as it is a sure sign of trouble to come. The time to act is now. If the current policy is loosened without introducing a coherent policy framework, the eventual crash could bring down the economy for an extended period. What’s happening to the US economy now is a stark lesson for us. China could end up like the US.
Empty Flats Spell Trouble
Caing.com September 7, 2010