Chinese Government Has Strong Incentives To Keep Property Prices High

Housing prices in China have risen dramatically over the last several years, creating booming real estate markets in the country's major cities and other areas. While its clear that the Chinese real estate market is in a bubble, it may be some time before the market declines since China's government has substantial financial incentives to allow the current market to continue. See the following article from The Mess That Greenspan Made.

A couple of reports today about the housing bubble in China must make some Americans long for the days of condo parties and Hummers about five years ago, this story in the LA Times no doubt spurring memories for hundreds of thousands of Angelinos whose lives have taken a decided turn for the worse since the housing bubble burst here.

Hundreds of miles inland from the booming real estate markets of Beijing and Shanghai, an unlikely property fever is gripping this middling industrial outpost.

Rows of half-completed apartment buildings rise over former farmland, each crowned with yellow construction cranes that seem to outnumber trees in parts of this dusty city of 5 million residents.

Taxi drivers boast of owning multiple flats for investment. Billboards hawk developments with names such as Villa Glorious and Rich Country. Frenzied crowds pack sales events with bags of cash, buying units that exist only on blueprints. Average home values in Hefei soared 50% last year.

China’s real estate rush, once confined to leading cities, has spilled into the hinterlands with a ferocity reminiscent of American expansion into exurbs like the Inland Empire.

The “bags of cash” are unique to China – that certainly wasn’t the case for the housing bubble in the U.S. – but we had our share of 50 percent property price increases. It was a flood of Southern California buyers that played a big role in pushing prices up by about that much in Las Vegas and Arizona at the height of the boom.

Cameraman Xi Zhou in the Times story notes that after a paper gain of 60 percent on his first purchase, he’s ready for more, though he appears to have stiff competition. XI notes, “For people of my generation, property is all we talk about. I felt a lot of pressure to buy because the longer I didn’t, the more likely I wouldn’t be able to afford anything.”

As was the case in the West, real estate sales people are adding to the excitement, in Andy Xie’s Bloomberg commentary today, one bubbly sales girl prodding potential buyers to take the plunge in suggesting, “You should buy two. In three years, the price will have doubled. You could sell one and get one free.”

Now, that sound like a plan and even the maids are coming down with real estate fever.

“My maid just asked for leave,” a friend in Beijing told me recently. “She’s rushing home to buy property. I suggested she borrow 70 percent, so she could cap the loss.”

It wasn’t the first time I had heard such a story in China. Some friends in Shanghai have told me similar ones. It seems all the housemaids are rushing into the market at the same time.

There are benefits to housekeeping for fund managers. China’s housemaids may be Asia’s answer to the shoeshine boy whose stock tips prompted Joseph Kennedy to sell his shares before the Wall Street Crash of 1929.

Another friend recently vacationed in the southern island- resort city of Sanya in Hainan province and felt compelled to visit a development sales office. Everyone she knew had bought there already. It’s either buy or be unsocial.

Pretty amazing stuff, that is, for 2010…

What’s so interesting about the China property bubble are the perverse incentives for government land sales. That was always part of the housing bubble in the U.S., but not nearly to the extent seen now in China as Xie explains.

When it comes to interested parties, Chinese governments are knee-deep in the bubble. They get all the money from land sales. Land values have risen to half of the development cost. In hot spots, land costs more than the development — the governments want to collect the future price gain immediately.When properties are sold, transaction and profit taxes kick in. Developers pay more levies to the governments than they earn. When developers finally book their earnings, they must put it to work, as good Wall Street analysts would recommend, so they buy land. As land prices are much higher, their measly earnings aren’t enough, so they have to borrow. The governments get all their earnings and debt repayments. Can you blame them for boosting the market whenever it slips?

Xie makes the point very clearly that, while China property markets are clearly in a bubble, that bubble may not meet its pin for some time to come.There are a number of powerful forces at work, not the least of which is the Chinese government that may not be so keen on popping this bubble despite their recent moves to limit lending.

This article has been republished from Tim Iacono's blog, The Mess That Greenspan Made.