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Interviews

Land Price Growth in Chinese Cities

Joseph Gyourko, Director, Zell/Lurie Real Estate Center
February 26, 2015

Martin Bucksbaum Professor of Real Estate, Finance and Business Economics & Public Policy, Nancy A. Nasher and David J. Haemisegger, Director of the Zell/Lurie Real Estate Center, Joe Gyourko discusses the decline in residential real estate construction in China and the implications for the Chinese economy

Overview

Executive Summary

Chinese real estate construction is slowing as private developers anticipate lower economic growth, reports Wharton Real Estate Professor, Joe Gyourko. While the reduced supply of real estate will help restore balance in the housing markets of major Chinese cities, the overall Chinese economy is slowing as a result of the decline in construction activity. And that economic slowdown is, in turn, weighing on the property markets, especially outside the major cities in the East region of the country. Professor Gyourko does not expect a downturn in the Chinese property markets to result in a financial crisis akin to what happened in the recent U.S. housing market bust. Chinese homebuyers borrow much less than Americans did, so there is a large equity buffer to cushion even significant declines in home values. However, this will reduce the ability of Chinese households to grow consumption as much as the government might like, as it tries to change from an export-led growth model to an internal consumption-driven one. In addition, real estate-related activity accounts for a very large share of the Chinese economy--more than 10 percent of Chinese national output--and Gyourko sees the slowdown in building as a portent of a further slowing in Chinese economic growth. That residential construction is poised to weaken further is indicated by the fact that the number of land parcels sold to private developers by local governments in the 35 markets tracked by Gyourko's index is roughly half of what it was two years ago. Wharton real estate professor Joe Gyourko follows the Chinese land markets and has created a land price index for major Chinese cities in collaboration with the National University of Singapore and Tsinghua University. A description of the index and the underlying data are available on his website.

Transcript

Interviewer: Joe, in your residential land price index for China, you're finding that a number of cities in China are having high land price growth and improving land price growth, though that is not true everywhere in China. What are the implications of this for the Chinese economy, which as you know, is slowing? Joe Gyourko: One of the reasons it's slowing is that outside of the major east coast cities a number of property markets are slowing. The real estate markets themselves are impacting the growth. It's not just that the growth is impacting the real estate. And the reason is, China's a developing country so, building and construction is a far bigger share of their national economy than it is in the U.S. It's a far bigger share than it was at the peak of our housing boom last time. In China, commercial and residential housing, which they don't break out in their data, is well over 10 percent of national output. At our peak in the U.S., it got to about six. So, both factors work. And they work to the deterioration of some property markets I think. Slowing real estate affects the economy. That causes less job growth, less demand for housing. That feeds back into the property markets, which then feeds back. And the Chinese government worries about this and has introduced a number of policies to try to break that link.
Sell more land to spur economic growth?
Interviewer: One possible thing I can imagine the Chinese government doing is selling more land to spur more construction to spur the economy. Do you see that as something they might do? Joe Gyourko: That's a local government decision. So, each local government owns its own land in the Chinese market. What we see is a general slowing of purchasing by private developers. Relative to two years ago, the number of parcels sold in the 35 markets that we track in our index is roughly half of what it was two years ago. And over the last three quarters, the number of land parcels sold to private developers in these cities is back to financial crisis levels that we saw in 2008 and the like. So, you do not see much evidence that they're not ratcheting down production. But I don't think it's the local government that's doing it. I think what's driving it is that private builder demand has fallen. They see the slowing in the markets outside of Beijing and the like and they just don't need as much land going forward.
Are there historic parallels between China and the U.S.?
Interviewer: So, one thing that you have found in your land price index is that some cities such as Beijing are growing tremendously. Others are declining. Is China as exposed to a property market decline in terms of its economy as, say, the U.S. was at the peak of its last housing boom in the mid-2000s? Joe Gyourko: In one sense, yes, but in a more important sense, no. The one sense in which it is heavily exposed is that new construction is a very big part of its economy. That direct effect will be important and it causes big spillover on the demand for many, many commodities and materials--steel, lumber, etc.--anything that's used in housing production. In a second sense though, I do not believe there'll be fallout anything like you saw in the United States. And that's because Chinese home purchasers are not nearly as highly leveraged as Americans were at the height of our boom. There's a lot of equity at the household level. So, if prices fall, there's no reason for those people to default. No, what that will do to the Chinese economy is what it would do to any economy. If your household or my household loses a lot of its equity wealth in housing, we're going to restructure our household balance sheets. We're going to slow consumption growth, and start saving more. And that's going to spill over. And if we all try to do that at the same time--in the economy we understand the fallacy of composition argument that Paul Samuelson made a long time ago--it will slow the overall economy. It is important. It will affect economic growth directly. But I do not believe you are going to see some massive financial collapse because of over-leverage. It won't be like what happened in the United States at all.

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