Comparing China’s real estate market with Japan’s

Bank of Japan has a very decent series of short research notes called BoJ review series. I was reading this short note on recent surge in real estate prices in China. The authors compare this rise to Japan’s price rise in 1970s and 1980s and the eventual bust.

Real estate prices have surged in China. They declined in this crisis but increased as crisis eased. The large Chinese stimulus promoted bank lending also played a major role. The prices of premium homes has risen much more compared to economic homes which are under State’s control.  This let State to pass some measures to control the rise:

As a result, house prices at the higher end of the market have risen to a level that is unaffordable for average local citizens. In Beijing and Shanghai, for instance, average house prices have reached as high as 20 to 30 times the annual income per household; in Shanghai, the ratio of house prices to income shot up during 20091 (Chart 5). Given the fact that real estate speculation tends to target high-class property, the recent surge in property prices in China may have been partly supported by speculative demand based on expectations of higher prices in the future.

In response, the Chinese authorities have introduced a series of measures to prevent the property market from overheating, especially since the beginning of this year; the measures taken so far include raising the reserve requirement ratio, intensifying window guidance on bank lending, and raising the minimum down-payment requirements on second houses

What lessons from Japan?

In Japan prices started rising in 1970s because of rapid growth and urbanization. They declined in Oil crisis in 1974 and again started rising till the bust in 1990s. In 1970s the house price rise was more natural because of high growth and hence recovered quickly after oil crisis. In 1980s however, as growth and urbanisation slowed but house prices kept risisng. Hence, it could not recover as there was no economic base and slumped into a prolonged crisis.

So economic structure is very important to understand when analysing whether there will be correction in housing markets and recovery afterwards.

Taking these lessons to China we see 2 factors that will push prices further upwards:

  • High growth and still low urbanisation compared to Japan
  • Household and corporate leverage levels are still low (around 110% of GDP) compared to Japan (180% of GDP)

However, certain factors could lead to overheating of these markets:

  • First, local governments have a strong incentive to develop real estate. The revenue sharing arrangement between centre and state has changed. States are severely constrained for funds and see real estate taxation as a source of revenue. Real estate related income is expected to be 40% of total state incomes. Hence, the government welcomes regular transaction in this market. This  also dampens the efforts of centre to curb rise in prices
  • Second factor is the influx of funds from overseas. Despite controls speculative foreign flows in Chinese property market continues.

Nice analysis. Though China is in high growth phase one should be careful of not letting the price rise become a giant leveraged bubble. In good times it is all too easy to become one. Chinese policymakers have acted to prevent it so far. But they should be careful.

One could immediately draw similar parallels for India as well. Property prices have increased in many places. RBI Governor in a recent interview says:

beyondbrics reader: Why does a house in India cost more than three to four times what it used to cost in 2003-04? Did any significant changes in affordability happen in the last seven years … ? What do you say to people like me for whom a mortgage now looks out of reach, especially with inflation now in double digits?

Duvvuri Subbarao: It is true that the cost of a house is higher now than it was in 2003-2004. House price indices suggest that prices in Chennai, Mumbai, Delhi and Kolkata have more than doubled since 2007. This is also the case in some of the non-metro cities like Bhopal and Lucknow. But this price increase has happened in pockets and cannot be generalized to the all-India level.

The increased price level of houses in India is a function of many factors – growth from a very low base for housing, better access to financing and some speculative build up. As per the Wholesale Price Index, the general price level of all commodities has gone up by about 45 per cent since 2003-04. House prices have risen faster than this. Some factors that explain this are increased raw material costs, rising incomes and hence a demand for better quality housing, urbanisation in the face of limited land availability and improved access to institutional financing.

In the Reserve Bank, we are sensitive to the financial stability implications of rapid build up in house prices. We have had quite a credible record of preemptive regulatory tightening to prevent unnatural asset price build up. In our latest policy statement on November 2, we capped the loan to value ratio (LTV) at 80 per cent, increased the risk weight for residential housing loans of Rs. 7.5m and above to 125 per cent, and increased the standard asset provisioning by commercial banks for housing loans with teaser rates from 0.4 to 2 per cent.

Unlike China where prices of economy homes have not risen, here prices have surged in all kinds of homes.

Most new projects these days have luxury facilities which automatically lowers space for economy home projects. When people do not have basic water to drink builders are getting approvals for swimming pools. What is worse is that in many places none of these facilities get maintained and it is just a cost for everyone.

Like China , both factors will lead to higher prices:

  • High growth and urbanisation.
  • Low leverage

And like China we have both factors leading to overheating

  • Local governments have a strong incentive to push prices of real estate. Unlike China where there is some development here poor urban development policies ensure prices only keep rising. High corruption and opacity in these markets just make things worse. You get a house loan scam but nothing happens afterwards. We waste opportunities to clean up the system
  • Second factor is the influx of funds from overseas.
  • China’s policymakers are still concerned about th issues. Here barring RBI, no one seems to be interested.

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    3 Responses to “Comparing China’s real estate market with Japan’s”

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