Ten things you need to know by pengxiang



Ten things you need to know
about China’s housing market

When monitoring China’s housing market, as opposed to those of developed countries, you may need to track different market parameters. This is because certain features of China’s previous centrally-planned economy still exist, some 30 years after it began its reform towards a market-oriented economy in 1979. In late June 2009, after home prices staged a robust rebound, the central government tightened financing for the purchase of second homes, in terms of down payments and mortgage rates. Since then, the market has been eager to know when and how the central government will further scale back its stimulus measures. What are its major policy goals and what are the dilemmas it faces? How will local governments and commercial banks respond to the possible changes in property market policies, given their interests are not always aligned with those of the central government? How will the interaction among developers, speculators and homebuyers impact on the formulation and implementation of central government policies? All these questions have implications on the possible direction of the market in the coming year and this paper highlights ten important things to note when tracking China’s housing market.


Knight Frank 1 China’s housing market is heavily regulated
Social stability is a major policy goal of China’s central government, and because rapid rises or falls in home prices affect social stability, the housing market is heavily regulated. Moreover, land and housing policies are often used to fine-tune China’s macro-economy. For example, between 2004 and 2007, when home prices in coastal areas were rising rapidly amid rampant speculation, some measures were announced almost every month to squeeze speculators and control capital flow into the housing market. Banning the resale of pre-sold residential units; levying business, capital gain and deed taxes; cutting land supply for villa projects; restricting foreign investment in the property sector and limiting bank credit for developers, were just a few of the policies introduced. On the other hand, in late 2008 and early 2009, when the global financial crisis hit China’s economy, the central government reversed a substantial number of tightening measures in a bid to arrest the decline of home prices in major cities. Mid-2009, after home prices had rebounded quickly, policymakers tightened lending for the purchase of second homes, but stopped short of pushing ahead with more drastic tightening measures. However, if a visible recovery in the export sector is seen, the central government will probably adopt more policies to restrain investment demand. Most likely, these measures will not be limited to raising interest rates, but will also involve administrative adjustments.

Land and housing policies are often used to fine-tune China’s macro-economy.

2 Local governments respond asymmetrically to central
government policies
In China, the promotion prospects and income of local government officials are linked to the economic performance of the areas they are responsible for. This goes some way to explaining their asymmetric responses to policies introduced by the central government to adjust China’s macro-economy and property market. When the economy and property market are overheating, most local governments resist tightening measures, as these will inevitably hurt their financial and employment positions. When China witnessed a property investment boom in July 2003, for example, the central government tightened the land-use approval process, demanding local governments stop approving the set-up of new development zones or the expansion of existing ones. However, some local governments tried to circumvent such policies by endorsing large-scale projects as if they were a number of small separate projects. It was not until April 2004, when the State Council sacked local officials in Jiangsu Province and dispatched inspection teams to 31 provinces, that such irregularities were curbed. In contrast, local government officials always fully support the central government’s stimulus measures. When the central government announced a stimulus package of RMB4 trillion at the height of the global financial crisis in early November 2008, to be implemented between 2009 and 2010, local governments had come up with proposed investment projects requiring RMB10 trillion within ten days of the announcement. Such examples underscore that the effectiveness of China’s macroeconomic policy is not always consistent, and this should be taken into account when trying to time the market.

Most local governments resist tightening measures, as these will inevitably hurt their financial and employment positions.



3 Bank lending is bonus-driven
Commercial banks heavily influence monetary policy implemented by the central bank, and knowing the incentives that drive bankers helps us understand how monetary policy affects China’s business cycle and market dynamics.

China’s banking sector has a tendency to over-lend.

In China, the bonuses of banking staff are directly linked to the profitability of banks. More importantly, for most Chinese commercial banking staff at middle-management level or above (including sub-branch managers and credit managers), bonuses are larger than basic salaries. This is a more aggressive approach than counterpart systems in the US. Under such an incentive-based system, China’s banking sector has a tendency to over-lend. Though commercial banks have to meet some targets on NPLs (non-performing loans), this is a secondary consideration for some branch managers and credit managers, as it may take years for NPLs to surface. However, bonuses calculated from expanding business volume are distributed annually.
Figure 1 50% 45% 44% 40% 35% 30% 25% 20% 15% 10% 5% 0%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 44% 38% 39% 32% 42%

New loans extended quarterly as a percentage of annual loans drawn down







Source: The People’s Bank of China / Knight Frank

China’s commercial banks also have a tendency to achieve their annual lending target early, before potential tightening measures that could disrupt their lending business are announced by the central government.

China’s commercial banks also have a tendency to achieve their annual lending target early, before potential tightening measures that could disrupt their lending business are announced by the central government. Between 2004 and 2008, China’s banking sector extended an average of 40% of its annual loans within the first quarter of each year. For 2009, an annual loan target of RMB5,000 billion was set, but the target was fully achieved within the first three months of the year.

4 Certain property developers are smarter than others
There are more than 30,000 property developers in China — not a particularly high figure considering that there are 655 cities on the Mainland. After ten years of rapid development and keen competition in the industry, a few market leaders have emerged. These leaders have proved adept at reading property cycles and are usually the first to move in the market. Vanke, whose residential sales revenue accounted for 2.3% of the national total in 2008, is one case in point. In mid-2007, Vanke’s outspoken chairman Wang Shi warned that China’s residential market bubble would inevitably burst. In December 2007, he also said that the turning point in the housing market had already been passed and the


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market would soon head south. Both predictions came true and at the start of the market downturn in late 2007, Vanke became the first developer in China to cut new home prices aggressively and adopt a ‘cash-is-king’ policy. Events that followed showed that Vanke had read the cycle correctly and was able to survive the property market slump in 2008 better than its competitors. When tracking China’s property market, it is worth taking particular note of what market leaders like Vanke, China Overseas and Guangzhou R&F Properties are saying and doing.

5 Chinese investors favour bricks and mortar
Chinese people like investing in property because they consider it a tried-and-tested method of generating profit, and there is a lack of alternative investment channels for their savings. An overwhelming majority of homeowners in China have profited from the housing reform that began 1998, when the country’s residential sector was privatised. In the past ten years, home prices have consistently soared, except for a short respite in late 2007 and 2008. In many cities, home prices have increased more than threefold in the past decade, on the back of strong economic and income growth.

Chinese citizens’ high rate of savings and their fixation with investing in bricks and mortar may mean that China’s property market upcycle may last longer than those in the west.

Such positive investment experiences have made the housing market a sure bet for most Mainland Chinese, especially since the local stock market is well known for its volatility and there are restrictions on outbound investments. The country’s surging productivity and high savings rate also mean that increasing numbers of Mainlanders can afford relatively expensive property. China’s national savings rate amounted to 52.2% of GDP in 2008, according to statistics from Asian Development Bank. According to a recent survey conducted in Beijing in the first half of 2009, about 30% of homebuyers did not require a mortgage to purchase property. Many indigenous inhabitants in China’s key cities, after having purchased their own home, acquired second and third residential properties to lease to migrants from other provinces and cities. Chinese citizens’ high rate of savings and their fixation with investing in bricks and mortar may mean that China’s property market upcycle may last longer than those in the west, though the risk of an investment bubble should not be taken lightly.

6 China’s leading speculators come from Wenzhou
Wenzhou, about 600 kilometres from Shanghai, is an affluent city in the eastern Zhejiang Province. Wenzhou businessmen are renowned for their astute commercial sense and entrepreneurialism, and many captains of industries hail from the city. After making a fortune in the 1980s and 1990s running manufacturing plants, some wealthy Wenzhou businessmen have become involved in property speculation and underground lending. With the ability to mobilise tens of billions of renminbi by acting collectively, property speculators from Wenzhou have reportedly helped drive up home prices in Shanghai and the Yangtze River Delta to record highs in recent years. Wenzhou businessmen have become leading real estate speculators in China, with their property investment activity being widely reported by the media and followed by other investors. Since early 2000, Wenzhou has become an established underground finance centre, filling the gap left by commercial banks unwilling to lend to small and mediumsized enterprises. Interest rates for underground lending in Wenzhou are occasionally monitored and reported by academic and government institutions. The rates are good


indicators of monetary conditions in China, varying from two to ten times the benchmark rates, depending on market conditions.

7 Not all statistics are created equal
Western media is often sceptical of statistics originating from China. That the sum of provincial GDP in China is always larger than the national total, is a point often cited by doubters.

The compilation of China’s statistical data has been improving and astute China observers are able to discern good material.

However, the compilation of China’s statistical data has been improving and astute China observers are able to discern good material. Official statistics widely regarded as reliable include those concerning external trade; electricity production; central government revenue; cargo traffic; money supply as well as loans and deposits.
Figure 2

M1 growth vs Guangdong residential sales growth
Residential sales area (YoY growth) 200% Money supply M1 (YoY growth) 40% 35% 150% 30% 25% 100% 20% 15% 50% 10% 5% 0% 0% -5% -50% Q1 Q2 Q3 Q4 2004 Q1 Q2 Q3 Q4 2005 Q1 Q2 Q3 Q4 2006 Q1 Q2 Q3 Q4 2007 Q1 Q2 Q3 Q4 2008 M1 Q1 Q2 Q3 2009 Home sales -10%

Source: National Bureau of Statistics / Knight Frank

More importantly, there are increasing avenues of reliable data that allow us to assess China’s economy. Financial statements, annual reports and interim reports of overseas-listed companies with operations in China provide excellent channels to examine the development of China’s economy across various sectors. In the property sector, registered secondary home prices are typically under-stated, as both buyers and sellers have a tendency to under-report actual transaction prices in a bid to reduce tax payments. However, the total floor area of new home sales is a relatively accurate indicator, as illustrated by the chart above, which shows that the growth of new home sales in Guangdong moves in tandem with the growth of M1 money supply (funds readily accessible for spending).

8 Monetary Policy Committee provides hints on policy directions
China’s central bank, The People’s Bank of China (PBOC), operates under the leadership of the State Council and its major decisions on money supply, interest rates and exchange rates have to be approved by the State Council before implementation. In spite of this, property market watchers should pay heed to comments by members of


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the Monetary Policy Committee, an official consultative body responsible for providing advice on China’s monetary policy. The committee comprises 13 members, who are key finance officials and prominent academics. Their views expressed in the media should be taken into account when analysing the direction of China’s monetary policy.

9 Central bankers favour constructive ambiguity
Central bankers around the world favour “constructive ambiguity” and those in China are no exception. Similar to their western counterparts like Alan Greenspan, China’s central bankers know that sometimes they need to make statements that are open to multiple interpretations. Imprecise statements give them leeway to change their policies in the future, while allowing them to discuss sensitive issues with ambiguity, in a bid to prevent markets from overreacting. Sometimes, we need to read between the lines to know their true intentions. In a policy statement released early August, in response to rapidly rising asset prices, the PBOC said it would engage in “dynamic fine-tuning” — a term that had never appeared in previous statements. On the one hand, relatively high home and stock prices could offset the negative impact of the weak export sector and hence help sustain domestic demand. On the other hand, the already-high asset prices, if allowed to continue to soar rapidly, could give rise to an asset bubble that would have serious ramifications. Policy makers were happy to see asset prices staying at existing levels, but this aspiration could not be explicitly made public. Against such a background, the PBOC coined the term “dynamic fine-tuning” that would allow it to either tighten credit conditions if asset prices continue to go up, or loosen monetary policy if asset prices go into free-fall.

Imprecise statements give central bankers leeway to change their policies in the future, while allowing them to discuss sensitive issues with ambiguity, in a bid to prevent markets from overreacting.

10 Central government flashes green, amber and red lights with
its economic policies
In China, market commentators often describe the central government’s economic policies in terms of whether they are flashing ‘green, amber or red lights’. When a ‘green light’ is on, local governments rush to secure bank credit to finance their pet projects; commercial banks are willing to extend credit to support projects that may not have passed strict tests of commercially viability; and the central government may tolerate certain irregularities. This is what happened in late 2008 and early 2009, when both the export and property sectors were in recession. Meanwhile, earlier this year, many investors were allowed to obtain mortgages at preferential interest rates meant for firsttime homebuyers. When the central government flashes an ‘amber light’, it usually reiterates that existing rules should be adhered to, but some market players may continue to ignore the warning. We believe this is what has been happening since late June 2009, when residential markets in many Mainland cities showed signs of overheating, but the export sector was still weak. Some banks have continued to offer the same preferential packages to buyers of second homes as for their first, though the central government has actually tightened financing for purchasing second homes since late June. We believe the central government will eventually flash a ‘red light’ when the export sector shows signs of full recovery, given that an evolving property market bubble has already caused concern among the public. When the central government considers it time to


get really serious, it will discipline certain market players to signal its determination to implement its policies.
Figure 3

Central Government’s macro control roadmap
Local property market Recession Stimulus + Supportive measures Q4 2008 – Q1 2009 Stable Verbal warning + Enforce existing rules Q3 - Q4 2009 Overheating


Export sector


Monetary tightening + Admin measures


Monetary tightening + Drastic admin measures

Source: Knight Frank

Closing remarks
Regulators in China believe a free market is subject to frequent failures, which require government intervention to rectify.
Regulators in China believe a free market is subject to frequent failures, which require government intervention to rectify. Government policies played an important role in cooling the overheated housing market in 2007 and 2008, and have helped engineer a strong recovery in home prices in 2009. By September this year, secondary home prices in China’s key cities, including Beijing, Shanghai, Guangzhou and Shenzhen, had rebounded to levels surpassing their peaks of the previous upturn by 6–9%. The asking prices of some super luxury units in Shanghai and Beijing recently reached RMB130,000 and RMB90,000 per square metre, respectively. If not for poor external demand and a shrinking export sector, China’s central government would have pushed ahead with more drastic tightening measures by now. China’s housing market is likely to face increasing policy risks in 2010. For one thing, the central government will try to cool the property market with additional measures when the export sector shows more visible signs of recovery, probably some time in 2010. More importantly, certain policies on the property sector, which hinge on the implementation by local governments and commercial banks, may not be as effective as intended. This will eventually induce the central government to resort to more drastic measures. We believe mortgage rate hikes, coupled with certain administrative measures, will be adopted to curb the rise in home prices in the coming year. One interesting point to note is whether the banking sector will again rush to lend in the first quarter of 2010, in anticipation of potential tightening measures, and how the central government will react if this happens. In the coming year, the authorities may not be as tolerant towards excessive bank lending as in early 2009, when the global economy was in deep crisis.




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