Analysis of the current high housing prices in China. and possible policies

Transcription

1 Division of Building and Real Estate Economics Department of Real Estate and Construction Management Royal Institute of Technology, Stockholm, Sweden Master of Science Thesis number 389 Analysis of the current high housing prices in China and possible policies Author: Li Xiaoling Supervisor: Hans Lind August 2007, Sweden 1

2 Master of Science Thesis Title: Analysis of the current high housing prices in China and possible policies Author: Li Xiaoling Department: Building and Real Estate Economics School of Architecture and the Built Environment Royal Institute of Technology, Stockholm, Sweden Master thesis number: 389 Supervisor: Professor Hans Lind Keywords: China, housing price, bubble, macro-policies Abstract From 1923 to 1926, real estate bubbles in Florida USA eventually lead to worldwide economic crisis in 1930 s. In 1990s Japan real estate bubbles burst and prevented Japan economy from stepping out of bubble shadow till today. In 1997 Asian financial crisis brought about by real estate bubbles give the whole world a huge hit. China housing prices also have surprised almost the whole world by increasing fairly fast and dramatically since 2004 in national scale. Many people fear that behind the high increasing housing prices, there are similar serious bubbles and fear that bubbles might burst sooner or later and bring disaster to China economy. The purpose of this thesis work is trying to analyze what are the factors that have pushed China housing prices to increase so fast and dramatically, and to figure out whether or not China housing market has already crossed the line between healthy growth and artificial prosperous bubble. Meanwhile, China government has made intensive efforts to moderate housing price hikes and cool down the overheated sector. In this thesis, the main policies and measures China government has taken are also going to be analyzed. It can t be denied that China housing prices have enough fundamental factors support, and also at a sudden glance it might seem very reasonable that high housing prices in China will last long because of the fast GDP increase, speedy urbanization process etc, yet the fact that in the long run China housing prices will have a trend of increasing does not necessarily mean in the short run there is no bubbles. Actually after deep analysis, we found there are real estate bubbles in China. A happy thing is that now the bubbles are not so big yet, but China government still has to pay great attention to it and take effective measures to control housing prices, so as to prevent bubbles from getting bigger and avoid the disaster when bubbles burst. We think housing prices in China should decrease for about 20-30%, and return to the housing price level before Only by squeezing away speculation capital, introducing more normal demand, can China housing market develop in a more stable and sustainable way. 2

3 Acknowledgement Firstly, I would like to thank Royal Institute of Technology (KTH) for giving me the opportunity to receive the advanced education here in Stockholm, to know the culture of Sweden and meet different classmates and friends from all over the world. Then I would like to express my sincerely and great thanks to my supervisor professor Hans Lind for his patient guidance encouragement and great help during my thesis work. His knowledge expertise perfect working attitude and sense of responsibility not only contributed invaluably to my thesis, but also made a very good example for my later career life. Also thank every other teacher for their excellent job and kind help during the process of my Master study. Thank them for their bright smile whenever I go to them for help. Thank my parents for their tremendous support and encouragement during my Master study and thesis work. Thank all my friends and the companies that contributed and shared their experiences and knowledge in this thesis. Last but not least, thank my husband Martin for his love and support during my study and thesis work. I love you all! Li Xiaoling August, 2007 in Stockholm 3

4 Table of contents Abstract...2 Acknowledgement Introduction Background Purpose Methodology Disposition Limitation China s current housing market situation China s housing system background Current situation in China s housing market Housing price theory: why housing prices in China are so high? Merchandise itself value Currency itself value RMB is considered undervalued Excess liquidity has caused inflation Market demand Chinese traditional attitude to housing People income increase very fast Huge potential demand because of the speedy urbanization process Huge practical demand since so many people want to improve housing Low interest rate have been imposed for a long time High deposit rate Limited investment ways Family structure is changing Huge wealth gap between the rich and the poor Real estate market is disordered and consumers are bounded rational Market supply Real estate has been treated as the pillar industry of national economy Unbalanced housing supply structure Wrong local government leading policies Bubble economy Definition Classification Why real estate can be the main carrier in bubble economy Prerequisite of bubble economy When bubble will burst

5 4.6 Bad effects that real estate bubbles bring about Are there real estate bubbles in China? Investment and speculation demand Three indexes to identify bubbles Housing price-to-income ratio Housing price-to-rent ratio Vacancy rate Macro-adjustment and policies Why real estate bubbles can easily exist in China? Purpose and necessity of government macro control Strengthen housing system, change housing structure Build more economic affordable houses Applied policy to improve the amount of small apartment Improve low rent housing market Improve second hand market Control land supply Strengthen tax system Shorten wealth gap between the poor and rich Strengthen legal system Marketization real estate development Increase information transparency Improve examination and check up system Strengthen financial system Tighten up bank loan Increase principal proportion Increase interest rate successively Strengthen credit control, increase proportion of developers own capital Control consumption credit Control international capital especially international hot money Stabilize RMB exchange rate Strengthen social security system Broaden investment ways Change expectations Final analysis and Conclusions...58 Reference...60 Appendix 1 Definitions...62 Appendix 2 Policy documents

6 1 Introduction 1.1 Background Since the reform and opening policy was carried out in 1978, China s economy has been developing at a dramatically fast speed. Especially after the housing reform was carried out in 1998, the welfare housing distribution 1 system which has last for more than 50 years in China housing market history has finally been abolished. Since then, China s real estate market began to form and real estate sector also began to be treated as one of the main pillar sectors in China s national economy. Through the past two decade from the reform and opening policy till now, every year China GDP has been increasing at a speed of about 10%. Social wealth has also kept increasing. All these have made solid base for China real estate sector s fast development. In recent years, especially since 2003, China housing price has been increasing very fast in national scale. There are a lot of reasons which can explain the fast increasing housing prices, including the development of China GDP and economy, the speedy urbanization process, government policy to stimulate and encourage domestic demand etc. All these factors have brought new energy to China real estate sector s development. However, if comparing the increase speed of China real estate sector with the increase speed of China economy and households income, we can see currently China real estate sector development speed has far exceeded the level which China economy and households income fast development can support. Unprecedented family debt is accompanying with the high housing prices. A case survey done by China National Statistic Bureau showed that current ratio between family debt and disposable income is 155% in Shanghai and 122% in Beijing. Yet even five years ago, very few Chinese families had any debt at all. In almost every city, housing prices are roaring. In certain cities like Shanghai and Beijing, housing prices are even higher for normal households to stand. The possibility of a "bubble" might exist in housing prices and the possible harm if bubble burst and housing prices collapse might bring about to the whole China economy therefore has aroused widespread concern and become a public topic. Though China s fast increasing GDP and urbanization process and other fundamental economic factors can show that the housing prices will keep increasing and have very good support in long run, but that does not mean that in the short run there are no bubbles in housing market. After making deep analysis and comparing China housing market with foreign market, we found there are bubbles in China housing market now. And at present, the bubbles are not so serious, mostly are just at the step of beginning to develop. China real estate sector needs soft landing. China housing market bubbles need to be prevented from getting bigger and bigger. In order to cool down the overheated real estate market, and make the whole society more in harmony and develop in a more sustainable way, China s government 1 More detailed explanation for welfare housing distribution can be found in Appendix 1 6

7 has put into practice a series of policies and measures including tightening control on the land and bank loans etc. More or less, these policies have some effects on controlling high housing prices. Although the prices continued to increase, the increases have decreased and the real estate market has been considered entering into a stage of adjustment. Since compared to other foreign countries, China real estate market is still on its beginning period of development, we believe that after the market become more matured and ordered, China housing prices are sure to follow a health way. 1.2 Purpose Housing prices in China s residential market is the main research subject of this thesis. Through this thesis we hope that people could know more clearly about the current situation of China housing market, and get a clearer idea of why currently housing prices in China could be so high. Also we hope the thesis could give them some more scientific instructions when judging if there are bubbles in China at present, and therefore they can keep alert to current housing situation. It is very important for the people to get the right idea of current situation, since it might change their behaviors and expectations when buying and selling apartment, which will greatly affect housing demand and supply. Moreover, by analyzing the macro policies and measures China government have taken to moderate housing prices and the policies limitations, we hope the thesis can have some positive influence on the public policy and help the authority to perfect the formulation of national real estate policies. Within the research capacity, the main research purposes can be summarized as the following four aspects: 1) introduce the current China housing market situation 2) reveal important reasons for the high housing prices 3) analyze if there are real estate bubbles 4) introduce the macro policies China government used to cool down real estate sector and those policies limitations 1.3 Methodology Method to collect data and information The main method used to collect data and related information is by using the internet, surfing a lot of websites for related E-newspaper, articles and E-journals, and refer to a lot of related former studies and research articles and books both in KTH library and Shanghai city library. A lot of statistical figures are collected from the homepage of China National Statistic Bureau and local government s homepage Method to analyze problems Both qualitative and quantitative methods are used to analyze problems in this thesis. The statistical and induction methods are mostly used when analyzing bubble phenomena. Empirical analysis and comparison analysis are also used in most discussion part of this thesis. 7

8 1.4 Disposition The thesis is begun by taking a general look at China s current housing market situation. We found there are overheated real estate investment and development in most of cities, and housing prices in most big cities are very high. Part 3 is the analysis of the reasons that can explain why China housing prices are so high. Some are fundamental economy factors, while some are speculation factors which are regarded worldwide as the origin of real estate bubbles. Part 4 and 5 explained a lot of general conceptions and theories about real estate bubbles, and then provides a series of standards that is often used internationally to tell if there are real estate bubbles in a housing market. By using those typical standards, the thesis made corresponding analysis to the housing prices in China residential market. Part 6 introduces a series of macro policies and measures which China government have taken to cool down the overheated real estate sector and moderate housing prices. Those policies reasons and limitations are also analyzed in this part. Part 7 presents the final discussion and conclusions. 1.5 Limitation This thesis was written by the early 2007, so the data collected and quoted and policies mentioned are only up to the end of New policies and changes might take place again in But in this thesis, new changes and updated macro policies published by government after Jan 2007 are not included. The data quoted in this thesis are mainly from China National Statistic Bureau website. Also this thesis focus on analyzing time period from 2003 to 2006, because Year 2003 is the beginning year that China housing market price began to increase dramatically in a big scale, and also since 2003 a lot of macro controls designed to adjust housing prices were published successively. There are different types of housing, but residential housing is the main force of China housing market and also in China nowadays, apartment takes up 90% of residential housing market. Therefore in this thesis, we only focus on commercial apartments 2. Lastly, though the thesis has tried to be objective, but since there are not so much quantity analysis in this thesis, instead the main analysis method used in the thesis is qualitative method. Because of the limitation of analysis method, the thesis will inevitably affected by some of my subjective view and opinions. 2 More detailed explanation for commercial apartments can be found in Appendix 1 8

9 2 China s current housing market situation 2.1 China s housing system background In 1949, nationalization started. Houses and land were nationalized when the People's Republic of China was established. To make China remain in harmony, government left some private houses ownership unchanged. In 1960, restrictions were loosened. China opened up to foreigners. And houses were provided almost for free to employees through State Owned Enterprises was a big year. A market emerged for commercial houses for foreigners with high incomes, and for non-state employees. Also, citizens could now hold and transfer legal rights to own buildings. Finally, mortgage loans were being offered through the China Construction Bank. In 1979, China began to carry out experimental housing unit in certain cities, to sell houses at full price. In 1982, China began to carry out experimental housing units that were sold out accompany with allowance. Government, State Owned Enterprises and employees each need to pay one third of housing prices was the next big year. The Chinese government started actively encouraging citizens to purchase their first house, either to purchase the welfare houses they were living at that time, or to purchase new-built welfare houses, at a nicely subsidized price nationally. Also, cities started providing lower-cost financing for workers who wanted public housing, through contribution and welfare housing funds. In June of 1995, the Chinese government established a housing reform program to help low-income and middle-class workers. The framework for collateral and for foreclosures was set into place. In 1998, new policies were introduced to help with housing reform. No more welfare housing would be built since then. The subsidized housing traditionally available to employees would be phased out. Employees were encouraged to buy their own houses with their own savings. China began to build up housing distribution capitalization and housing supply commercialization systems. Certain areas were set aside for housing for low-income households. Mortgage loans could now have a maximum loan value of 70%. Income verification was mandatory. 2.2 Current situation in China s housing market I work hard for a whole year, but my yearly salary can t even reach the increasing amount of an apartment within one or two months. This is a common complaint nowadays that can be heard from common people in China. Since 2003, China s housing price has kept increasing dramatically. Take one apartment in 9

10 Shanghai as example. This apartment was located in central city. In Oct 2001, the average selling price was 6000 yuan 3 per m2, in the end of 2002, the price has risen up to 7000 yuan per m2. In the end of 2003, the price jumped to yuan per m2. In the end of 2004, the price jumped further more to yuan per m2. And in Mar 2005, the price has jumped to yuan per m2. Within less than four years, the apartment selling price has increased 300%. This high and speedy growth rate is an epitome of Shanghai housing price change trend. According to report published by Beijing Construction Committee, in 2005, the average selling price was 6776 yuan per m2, which has a year on year increase of 1183 yuan per m2, and increasing rate was 21.2%. And this trend seems not to stop. Housing prices in big cities like Beijing, Shanghai and Shenzhen all still have about 30% year on year increase in Obviously, the phenomenon has spread trends. At first this happened just in big cities like Beijing and Shanghai and some big cities, and then broadcast to cover the whole country, and this has become the common people s huge pain. According to the data from China National Statistic Bureau, in the first half of 2006, housing price in Lanzhou has a year on year increase rate of 5.7%, in Huhehaote the increase rate was 14.9%. Since 2003, housing price in Chengdu has increased more than 100%, and there is a big gap between local people s income with too high housing prices. In April 2006, China National Statistic Bureau published another research result: after having investigated housing price and rent level in the main 35 cities in China, they found in the first quarter of 2006, average housing price in China has increased 9.8%, while in 2005 the increasing rate was about 8% and in 2004 the rate was 14.4%, which is the first time that housing price increase rate exceeds 10% and exceed household income increase rate, and also 10.6% point higher than the figure in According to an investigation carried out by China Central Bank (The Peoples Bank of China) at the end of 2005, about 53% people think current housing price is too high, among these 53 % people, there are 88% think housing price will continue to increase if no powerful macro control is imposed. 3 Normally, the exchange rate between SEK and RMB is almost 1:1, and the exchange rate between US dollars and RMB is around 1:8. E.g. on Jan 1 st 2007, 1 SEK=1.11yuan and 1dollar=7.73yuan 10

11 3 Housing price theory: why housing prices in China are so high? In recent years, especially after 2003, commercial housing price has been increasing dramatically in China. There are all kinds of reasons and factors that explain why housing price keep increasing so fast and so much. Some are reasonable, while some are not. In this part, we are going to analysis why current China housing prices can be so high. Factors that push merchandise price to rise: Under market economy, price level changes will follow certain rules. According to the Value Theory by Karl Marx, three factors will be the main determinant factors of the price changes: 1. Merchandise value 2. Currency value 3. Market supply and demand status for this merchandise. Housing price has been increasing in China nowadays are also the combination results of the above three factors effects Merchandise itself value China economy is developing at a very fast speed. According to the data from China National Statistic Bureau, China GDP average increasing rate per year during 1999 to 2005 is about 8.64%, and since 2002 GDP increasing rate has already been stabilized at a level of 10% per year. China average GDP per capita used to stay at the level of about 300 dollars since the beginning of 1980 until After innovation and open policies have been imposed since 1978, average GDP per capita reached 856 dollars in In 2003, the number increased more to 1100 dollars, which symbolized that China s economy has begun to step into a golden era of development. According to a report from China Central Bank, China GDP in 2005 is about 18 thousand billion yuan (=1,8* yuan). Compared with the GDP in 2004, the number has increased by 9.9%. GDP in 2006 is estimated to increase about 10.5%. CPI (Consumer Price Index) has increased by 1.4 % in 2006, and the number will increase to 2% in In the coming two to three years, China GDP will still keep at 8-10% increase rate. In future years, GDP per capita in China will breach 3000 dollars by estimation 5. Fast economy development and stable macro environment build up a great backup force for real estate development and houses, this kind of special merchandise value to increase. However, we must also notice that this golden development era might on the other hand mean that economic and social conflicts will be more obvious and complicated. Along with the economy development, resources consumed also increased, conflicts arise by resource limitations will be more obvious. Great changes also took place in social structure, especially along with the income and wealth differences expand, conflicts among different income groups will be more serious. All these 4 Chai, Qiang (2005), Several theoretical problem which affect housing price,journal of Beijing Institute of Civil Engineering and Architecture, 2005, Vol. 2 5 Figures here mainly come from two government website: China Central Government website and China National Statistic Bureau website 11

12 conflicts must be dealt with properly to keep sustainable economy development, otherwise, economy might stop developing for a long time, even worse, social turbulence might happen. Moreover, China s economic development to great extent relies on export and investment, which might also be very dangerous. This will be discussed in later chapters. According to the World Bank, when the average GDP per capita in a country reached 300 dollars, the country s real estate sector is at its beginning step. When average GDP reached dollars, real estate sector steps into fast-speed development period. When it reached dollars, real estate sector began to step into a stable increasing and development period. According to the data from China National Statistic Bureau, by the end of 2003, average GDP per capita in China has reached 1090 yuan, so theoretically real estate in China is at a fast speed development period. However, we should also notice that in China, average housing area per capita has reached 23.7 m2, which already equals to the level in medium and high-income countries. But actually by 2005, China average income per capita has just reached 1000 dollars, which is at the medium and low level among the world. Therefore there must be something needed to be analyzed since Chinese have the medium and low-income among the world, but have the average housing area per capita that equals to the level in medium and high-income countries 6. Also, we think the following questions have to be concerned: First of all, can current GDP increasing rate keep to stay at a high level forever without any doubt? The real situation might not be so optimistic. It s true that nowadays China GDP increase extremely fast. But China economy development mainly relies on export and investment while domestic demand is not enough. Along with RMB appreciation and other policies, unbalanced international trading will be changed sooner or later. Also, a lot of policies have been carried out to cure overheated real estate investment. So if both export and investment will be set a limitation, how can the current GDP increasing rate still stay at the current high level? Secondly, nobody knows the future. Now China s economy development environment rely mostly on the stable political environment. But if there are any reasons that affect the current stable political environment in the future, it will not be too hard to imagine what is going to happen to China economy and housing prices. 3.2 Currency itself value RMB is considered undervalued. One of the main reasons for high housing price is that the RMB exchange rate has been undervalued, which attract a lot of international capital and hot money 7 to rush into China s real estate sector to invest or speculate, thus increasing illusive demand for housing and help to increase housing price. 6 Xu, D. Q. (2006), Housing price and bubble economy : China Machine Press 7 More details about the meaning of hot money can be found in Appendix 1 12

13 Exchange rate actually refers to the price of all commodities and assets in a country relative to other countries. When RMB is undervalued, it is no difference that China sent out an all assets prices are low here invitation card to other countries investors. Heated investments are easily to be brought about by expectation for RMB appreciations. Currency appreciation expectation will directly cause all assets price that is measured by this kind of currency to increase also. Nowadays transactions of new built houses and second hand houses are both quite active, and the housing price kept increasing. Behind the strong demand, foreign people purchasing form a very powerful team. A lot of foreigners even bought several houses at the same time. According to the data from Shanghai Statistic Bureau, within 2004, among the foreigner companies or individuals who have bought houses, 13% of those people actually had more than 5 sets of houses in Shanghai. Within the same year of 2004, almost 20% of the houses have been transferred, which make speculation phenomena more and more obvious, since in international real estate investment, exchange rate fluctuation will dramatically affect investors profits. Imagine a foreigner that bought a house in China at a certain price, some time later when he try to sell the house, if the house price has been increased, but if RMB depreciated at the same time, then housing appreciation will offset RMB depreciation, thus lead to investment failure. On the contrary, if RMB appreciated, even if the housing did not appreciate, the person will also gain profits by selling the house and exchange the RMB into foreign currency. So when there is an expectation that one country s currency will appreciate, there will always be a phenomenon that all kinds of international capital rush into this country and invest in real estate which is a not so risky investment project 8. Since 2000, RMB currency value has been undervalued for about 7% to 25% if calculating by nominal effective exchange rate. In July 21 st 2005, China RMB appreciated for 2%, but this little percentage is not big enough to eliminate the expectations for further more appreciations. Fang gang, the superintendent of China national economy institute pointed out that RMB should appreciate for 3-4% point each year so as to alleviate international trading surplus balance. By estimation, RMB in the future several years will continue to appreciate by 30%, a lot of excess capital will push assets price to increase dramatically. Relative low assets value because of undervalued RMB and expectation for RMB appreciation makes international hot money keep flowing into China to arbitrage or speculate. At the same time, inflow of new hot money put more pressure on RMB appreciation in the future. Only when RMB appreciation level is big enough to kill more expectation for further appreciation, will speculation capital leave China s housing market, which is very benefit for squeezing the real estate bubbles and help moderate housing prices. So if RMB appreciation expectation is really part of the reason that caused bubbles in China housing market, China government should appreciate RMB as soon as possible and the level should be huge enough to kill more RMB appreciation expectations. 8 Huang,Yichao (2005), Develop the visual economy to enhance the ability against the hits by international shifting capitals, Journal of Xinjiang Normal University, 2005, Vol. 2 13

14 3.2.2 Excess liquidity has caused inflation. Excess liquidity is a kind of monetary phenomenon, and means that there is too much currency in a market. According to the European Central Bank, excess liquidity is defined as that the real currency stock deviate from expected equilibrium level 9. As we have just discussed above, the pressure that RMB will appreciate makes all kinds of foreign capital rushed into China by all means. How much international hot money has rushed into China? A popular saying is that about 300 to 500 hundred million dollars have rushed into China to bet RMB appreciation and to gain exchange profits. Some people think this figure is not so accurate, but anyway the accurate scale is not the point, the point here is it is the truth that international hot money has indeed rushed into China on a very huge scale, and this make the excess liquidity situation became even worse. To cure the problem of excess liquidity, it is vital to control RMB appreciation speculation first. The biggest risk that excess currency liquidity might bring about is inflation. Up to today, the ratio of M2 / GDP in China already reached 1.85 according to the data from China National Statistic Bureau. Normal consumptions prices including housing prices are all consistently increasing in a wide range. However, the main reason that helped China from stepping into deeper inflation cycle was that manufacturing sector expanded much more and much faster than the expending of currency supply Market demand Chinese traditional attitude to housing In May 2006, China Central Bank published an announcement, saying that after spot-checking 10 cities in China including Beijing, Shanghai, Tianjing etc, they found more households prefer to buying houses instead of renting. Among the ten cities being investigated, about 62% households even never think about renting houses. While in Beijing, the percentage was as high as 90%. Why is that? Firstly, rental houses are not so well equipped, can t give people the sense of security and ascription. Also rental houses give tenants not so much freedom. For instance, they can t decorate the houses as much as they want. Moreover, rental houses are not so cheap as well and rental market has always been disordered. However, the most important underlying reason is Chinese traditional way of thinking. Chinese people think they should buy and have their own houses instead of renting other people s house to live. But actually it is very dangerous that all the people want to buy houses. It will cause housing demand being exaggerated and push housing price to rise. 9 Guang, Qingyou (2006), Only one step between excess liquidity and inflation, Journal of Hainan Finance, 2006, Vol Li, Hongkun (2005), Effect of Hot Money Inflow and the Prevention Policies,Journal of Statistical Research, 2005, Vol

15 3.3.2 People income increase very fast Household income level has kept increasing, thus people have stronger desire to improve their living conditions. After China joined WTO in 2001, within these 5 years, Chinese people s living standard has increased dramatically. According to the data from China National Statistic Bureau, during 1999 to 2005, urban household disposable income increasing rate was about 10.83% per year, while after 2001 the increasing rate has all exceed 11%, and urban household s average monthly monetary income per capita used to be only 63.5 yuan in 1980, and 226 yuan in But according to the latest statistic data in July 2006, this figure has increased to yuan and in Oct 2006, this figure has increased more to yuan. In Beijing, this figure in Oct 2006 has reached yuan, which is the highest in China, followed by Shanghai, whose household s average monthly monetary salary per capita is only 9.56 yuan less than in Beijing. And in Oct 2006, in the aspect of the disposable income, Beijing was yuan, which is the second highest in China, while Shanghai was yuan, which is the highest in China. Urban household s average monthly monetary income per capita in Zhejiang province in Oct 2006 was yuan and the disposable income per month per capita was yuan, both help Zhejiang to locate in the third place of China. There are some other provinces in which the average monthly income per capita has exceeded 1000 yuan, such like Jiangsu, Fujian, Tianjin and Shangdong. However, we must notice that even though people income has been increasing at a very fast speed nationally, yet the income increasing speed is still lower than housing price increasing speed. Take Shanghai as example. According to the data above, Shanghai could be considered the richest city in China, but compared the average disposable monthly income per capita of yuan with the current average high housing price of 7000 yuan per square meter, it is still a dream for the average people to buy houses. In most cities of China, the middle and upper class households can t afford to buy houses considering so high housing prices and relatively low income. For those who bought houses, most of them have to take on a heavy debt burden to pay the bank mortgage back every month. The willingness to give bank mortgage loan money back is based on optimistic expectation for future income, yet once their income decreased or future income can t really reach their expectation, there might be a huge systematic risk for the banks. And that will definitely bring disaster to the whole society. This will be discussed more in later chapters Huge potential demand because of the speedy urbanization process China urbanization process is speeding up. New comers into the city also bring huge new demand for housing. Meanwhile, the combination of the long construction cycle and the construction lag make supply increase not fast enough to meet demand in time. At the present, China urbanization level is about 40%, there are about 5.1 hundred million people in town and cities. By estimation, China urbanization level will properly reach 55% by year of 2020, and there will be about 600 million rural people rush into cities. By then, urban population in China will be about 900 million. If this is true, every year there will be 40 million rural populations moving to cities from rural areas. If per person needs 10m 2 place to live, then every 15

16 year China needs to build 400 million m2 new apartments. Also in China, there are about 1 hundred million m2 housing needs to be removed down and rebuilt. Till 2020, at least 580 million m2 new housing needs to be built every year. China real estate market has huge potential demand for sustainable development 11. However, we have to admit that even urbanization speed is very fast, and it is reasonable for housing price to increase due to increasing demand, yet it is not reasonable that housing price has kept increasing too quickly and too dramatically in short period, and housing price in some cities has reached a too unreasonable level. Take Beijing and Shanghai such big cities with most fast urbanization process as example. According to the data from China National Statistic Bureau, in the year of 2004, the population in Beijing and Shanghai only increased for 370 thousand and 310 thousand respectively, with the population increase rate of 2.54% and 1.81% respectively, among which the population natural increasing rate was 0.07% and almost zero respectively. Under such urbanization circumstances, the current too fast housing price increasing rate was thought to be unreasonable, because in 2004, also according to the data from China National Statistic Bureau, national housing price increase rate has reached 14.4%, and the housing price increase rate in Beijing and Shanghai has even worse reached 27.5% and 23% respectively. Huge potential demand in the future can t fully explain why current housing prices can already be so high now. Demand caused by urbanization is a kind of future potential demand in the long-term; it won t be released in short period and can absolutely be solved by market step by step. Actually we think quite the contrary, too high housing price is not a result of speedy urbanization process, but actually is a balk that destroy and affect China urbanization process. Though there are lots of peasants waiting to move into town and cities, and the current urbanization process in China is quite fast, yet given so high housing price and so low peasants income currently, it is really a dream for peasants to be able to afford houses in cities 12. According to the investigation data from China Ministry of Agriculture, in the first half of year 2005, peasants yearly cash income per capita was 1586 yuan, while in 2004, China average commercial housing prices have already reached 2777 yuan per square meter. Considering the fast increasing rate of housing price in 2005, a peasant s yearly income can only afford half square meter. And in the short run, there is little possibility that current peasants incomes can be increased a lot. Since in China labor market, there is more labor supply than demand, which decided labor salary couldn t increase dramatically within short time. In this sense, China urbanization is not a reason for housing price to keep increasing, but actually a drive power to push housing price to drop down urgently. 11 Niu Fengrui (2005): Rural Modernization and Urbanization in China. 12 Xu, Jingyong (2002), Practical Thought on Rural Population Urbanization, Journal of Fujian Provincial Committee Party School of CPC,2002, vol.10 16

17 3.3.4 Huge practical demand since so many people want to improve housing The houses Chinese people are living now can be divided into 4 kinds 13 : 1. Inheritance privately-owned houses that are left till today from previous years before President Mao liberate China; 2. Reformed public houses (or welfare houses, but during housing reform, people have bought them at a subsidized price and got ownership); 3. Commercial houses 4. Economy affordable houses Although these years the development of commercial houses and economy affordable houses have increased a lot, yet their total amount still can t reach the amount of welfare houses that have accumulated in the first 50 years since People's Republic of China was established. According to the data from China National Statistic Bureau, by the end of 2003, there are about 8 billion square meters welfare houses in China, which took up 67.54% of the total amount of houses nationally. In different cities, situation might have little difference, yet in national scale welfare houses at least took up more than half of the total amount of houses. By 2005, among the families who own houses, private houses took up 9%, commercial houses and economic affordable houses 14 took up 37.3%, and welfare houses took up 53.7%. However, most reformed public houses are quite old now with not so good equipment. The housing types are also quite small and uncomfortable. People who now live in these houses also want to improve their living condition and move into the new commercial houses. Demolishing scale is expanding, passive demand also speed up. Along with the process of urbanization, more old houses are demolished and new houses are built. Although after the National Six measures were carried out, in 2006 urban house removing scale has decreased a bit, yet passive demand for houses because of urban house removing are still quite huge, and this also push housing price to increase. At present, China average living space per capita in cities is about 13.6 m2. Compared with the number in developed countries, the number in China is still very low. For instance, in USA average living space per capita was about 40 m2, in Germany it was 38 m2, 31 m2 in Japan, 30 m2 in Singapore and 28 m2 in Taiwan province. There are now about 5 hundred million people in cities. By estimation, in 2020, urban population will reach 7.7 hundred million, if per person needs to increase living space for 4 m2, then about 30 hundred million m2 will be needed Low interest rate have been imposed for a long time In the long run, low interest rate in banks has big responsibility for high housing prices. No matter real estate investment or consumption opportunity costs, or the effective demand for housing, no matter housing price level, or housing price changes, all of them are concerned with interest rate. When interest rate is low, housing price will increase; and vise versa. Low interest rate will decrease developers investment costs which will not necessarily push housing price to drop, but 13 This information comes from the China Construction Ministry website 14 More detailed information about economic affordable house can be found in Appendix 1 15 Niu Fengrui (2005): Rural Modernization and Urbanization in China. 17

18 at the same time, decreased interest rate will decrease people s purchasing costs, and this will stimulate more demand for housing. Easily to get a loan, plus low interest rate help the growth of huge amount of housing slaves. When there is increasing demand for housing, housing price will definitely increase. Since 1998, China has decreased interest rate eight times successively, which already made the current nominal interest rate reach the lowest point in history. On the other hand, increasing housing price also made real estate a very good choice for household to keep wealth and make wealth appreciation. Since housing price has kept increasing, banks are also willing to provide loans including mortgage loan to consumers and development loans to developers with very favorable terms. Thus more and more capital is flowing into real estate sector, which furthermore stimulate overheated real estate development and encourage housing price to increase more. In recent years, China housing loan market has increased dramatically. In 1998, housing loan provided by banks is about 426 hundred million yuan, while in 2005, the number is 4910 billion yuan. Within 7 years, housing loan provided by banks has increased 115 times. By the end of 2005, housing loan already occupied 10% of national GDP 16. In Dec 11 th 2006, BIS (Bank for International Settlements) published quarterly report, saying that China housing loan has reached 2270 hundred million dollars and the scale is so huge and make China listed in first place of Asian countries. This phenomenon is very dangerous, since financial disaster might be brought about. But under the temptation of huge profits, banks tend to ignore the horror behind. Since the end of 2004, government had increased interest rate three times, trying to control high housing price. This will be discussed furthermore in the later chapters High deposit rate China is the country that is famous for having the highest household deposit rate of the world at present. According to the data from European Union Committee in 2005, household deposit rate in America, Japan and European Union Committee were only 4%, 11.5% and 11.1% respectively. While according to data from China National Statistic Bureau, the rate has been above 35 % in recent 20 years, and the peak in history was 46%. Urban household deposit money has doubled within 4 years since According to China Central Bank, till the end of Dec 2005, urban household deposit break through 14 trillion yuan, while this figure used to be only 7 trillion in Till Mar 2006, the number has reached 16 trillion yuan. On the other hand, China household consumption rate has kept decreasing in recent 5 years. Within the recent 10 years, China average consumption rate was 59.5%, which was 20 percent point lower than international average level. Why is current deposit rate so high? There are several main factors that affect households savings rate, includes households income increase, population age structure in society, relative CPI, 16 Lu, Huimin and Mei, Sen (2004), The analysis of real estate financing channels, Journal of construction management modernization 2004, vol.5 18

19 interest rate, inflation rate etc. Also high deposit rate has something to do with China traditional culture of saving, family conception etc. here we mainly analyze the following two aspects: 1. Imperfect social security system: According to the investigation carried out by China Central Bank in 2005, currently household s purpose to save money in turn are for children education fees, provided for the aged, medical treatment, buy houses and decorations respectively. To low-income households, since the lack of perfect social security system, even if they have got some money, they will still control consumption. To middle-income households, everyday consumption needs already have been met, new luxurious consumption have not yet formed, plus high housing price and high education fees, this part of household more tend to deposit money. To high-income households, big part of their income was used to invest, but due to limited investment methods, these households have to deposit money in banks or invest in real estate sector. 2. Current income and expected long-term income in the future. Uncertainty about future income and other factors make households tend to deposit in huge scale. Currently, high percentage of the population in China is workers. Old-aged retired population is not so big. Since people can t know exactly the future income and consumption when they are young, so expected future income and consumption will affect consumption plans. Also China used to be a quite poor country. The households who are just getting rid of poverty since new China was established in 1949 are content with the increase of living standard. Even now when their income can support them to live in a very high standard or luxurious life, inertia effect still push them to keep the original consumption habits, or only consume part of their income, while the rest are deposited in banks just in case. Lots of Chinese still have the memories of old poor China. They tend to deposit to prevent from stepping into poverty one day again in the future. Why high deposit rate is also a reason for high housing prices? At a first glance, people are easily to think that more deposit in banks is a good thing, since everyone deposits money in banks so that they won t use the money to buy houses or speculate houses, thus can lower the demand for housing, and draw housing prices down. Yet the case is not that simple. High deposit rate also contribute to high housing prices. The reason can be illustrated in the following aspects which every aspect connected with each other: 1. High deposit rate helps lead to overheated real estate investment. Huge amount of savings in banks forced banks to increase loan to make profits, and in order to have more loans out, some banks loose the credit condition checking, thus bad account or bad debt loss occurred, which is very dangerous and easily lead to financial disaster. High deposit ensured there is always enough money in banks for real estate developers to borrow as development loans. Also Since interest rate has been stayed at a low level for a long time, so costs for loans are very cheap. Once developers have successive inflow of capital, their development scale will become bigger and bigger, which partly explained why real estate development could be overheated for so many years. Since in China, normally only 30% of the 19

20 development capital was developers self-owning capital, the rest 70% are from the bank loan. Only if there are enough capital keep flowing into banks, banks will have stable financial support, and the capital chain of banks will not break. However, high deposit rate can t be long lasting. There are sure to be one day the deposit rate will decrease. And once the capital support is not enough, financial disaster will be the most dangerous thing. Also since Dec 2006, foreign banks began to have the right to deal with RMB deposit business, and this will more or less diffluent RMB in China national commercial banks, and make financial disaster more possible. So it is important to catch time to carry out financial sector innovation before the high deposit rate disappears to prevent financial disasters. 2. High deposit rate is considered one of the main reasons for unbalanced economy development structure. China s economic development rely so much on export and investment, while domestic consumption is so low since 40% of the income have been deposited in banks. Because of high housing price, Chinese people s enthusiasm to consume was destroyed. All the people have to save money trying to afford houses. Insufficient domestic consumption will put pressure on more export, while more export will put more pressure on RMB appreciation. RMB appreciation expectation will attract more foreign capital to rush into China housing market to speculate and push housing prices to roaring more, and this will go round and round in a cycle. In this sense, encourage domestic consumption, and lower deposit rate will be a matter concerned about whole national economy stabilization Limited investment ways In Dec 2005, China Central Bank published an investigation result, which showed that although almost all the people think current interest rate level is quite low, yet households willingness to save up money and deposit in banks are still increasing. According to the data from China National Statistic Bureau, currently about 39.5% of the households think it is better to deposit under the current given CPI and interest rate level. To great extent, one of the main reasons for increasing willingness to deposit when interest level was thought to be very low in national scale is that current China has very limited investment alternatives. In recent years, both China stock market and future market are not so stable and profitable, limited investment ways make all excess capital rush into real estate sector to pursue high profits. Stock market used to be very hot in China, but the high fluctuation in stock market also make medium and small investors loose faith in stocks and change to real estate investment, a kind of investment which is considered relatively more safe and stable. According to the same investigation result done by China National Statistic Bureau, only 5.1% of households think it is wise to invest in stocks nowadays. On the other hand, China national bond has limited supply, which can t meet all the needs. Under such circumstances, normal households have to deposit money in banks passively, while rich people will use the excess deposit to invest in or speculate real estate, and both help push housing price to increase more. We think China government has to do something to cure the situation, provide some methods to 20

21 diffluent these floating capitals. For instance, promoting invest in education or urban facilities etc. Only when huge amount of capital stuck in real estate sectors begin to move can overheated real estate investment be cured from essential, and so can housing prices return to a reasonable level Family structure is changing In old China, living condition used to be all family members including father, mother, children, grandmother and grandfather living together in a big apartment. As the family structure becomes smaller and smaller, living habit changed, nowadays in China there are only 1.67 persons in a family on average according to the data from China National Statistic Bureau. Especially when younger children grow old and get married, they no longer live together with a big family; instead they tend to live separately by themselves. Smaller family structure needs more apartments available. Young people rush to buy houses released a huge demand for housing in advance, which pushed housing prices to increase more Huge wealth gap between the rich and the poor Now in China, small population of rich people possessed most of the money and wealth. In the initial stage of socialism, in order to realize all the people become rich, China carried out a policy in 1987 saying that let small amount of people to become rich first, then rich people help poor people, and finally reach the goal of whole society being rich. Under the instruction of the innovation and open policy, China has always put economic development to the first place of everyday working. Now the situation is there are some people become rich already, while also a lot of people still very poor and the wealth gap between the rich and the poor are very big. How to bring along all other people to be rich also, especially help those who are still quite poor to get rid of poverty is a vital task in front of China government. Since 1998, China Social Science of Academy has already carried out national scale household investigations for three times, which were in 1988, 1995 and in 2002 respectively. The investigation results show that: in 2002, 10% of the whole population is highest-income population, and they possessed 32% of the whole society income. According to National Statistic Bureau report, the average yearly income possessed by 10% of the richest people are 10 times of the income possessed by 10% of the poorest in % of the richest people possessed 45% of the national wealth, while 10% of the poorest people possessed only 1.4% of the national wealth. According to 2006 China living condition report published by China National Conditions Research Association, if we define those people whose yearly income exceed 110 thousand yuan as high-income population, then 40% of those people have already bought more than 2 sets of houses, among which 22% still plan to buy more houses in the future. Some institutions also reported that Geordie coefficient 17 of China household income has expanding from 0.33 in 1980 to 0.45 in 2005, while 0.4 is considered to be international precaution line 18. What s more, at present, to high-income people, the main function of housing is changing from 17 More detailed explanation for Geordie Coefficient can be found in Appendix 1 Definitions 18 Zhang, Hui (2006), Looking at China's income distribution from Geordie coefficient, Journal of Special Zone Economy, 2006, vol.9 21

22 living to investment. Quite a lot of rich people have bought more than one apartment. The illusive demand also pushed housing prices to increase. China has limited investment channels, and real estate sector is still a very good investment method with relatively high return and low risk. Under the current circumstances that housing price keep increasing, if those who can t afford house are majority, while those who can afford house purchase more than one house, then real estate will become a convenient way for rich people to accumulate more wealth, and thus make wealth gap between the rich and poor even bigger. Besides the great investment demand and speculation demand supported by rich people, lots of low-income household also become the major demanders for housing. But the reason why they hurry to buy houses now is totally different. In 2006, housing price-to-income ratio in main big cities in China has kept increasing. According to the data reported by China National Statistic Bureau, if based on a 90 m2 commercial house, the housing price-to-income ratio in Shenzhen was in 2006, while in 2005 the ratio was 9.83 and 6.52in 2004 ratio. In 2006, the ratio in Shanghai, Guangzhou and Beijing was 11.67, 9.51 and 9.11 respectively, which are also higher than the ratio in 2005 and 2004 respectively. Housing price-to-income ratio increase showed that household s purchase power is dropping down. Reasonable result should be less demand for housing, but actually the reality is quite opposite: since housing price kept increasing, low-income people worry that if they don t buy houses now, housing price will increase more, which make them can t afford more. This also explained partly that why the higher housing price is, the more demand for houses Real estate market is disordered and consumers are bounded rational There are different kinds of illegal behavior in the process of real estate development, transaction, agency service and property management. For instance, false and misleading real estate advertisement, commercial apartment give wrong measure, housing purchase contract cheating etc, are very common in China market nowadays. What s more, it is actually the big real estate companies control the medium,asymmetric information makes consumers stay in a relatively weak position. In order to sell out houses as much as possible and as fast as possible, and knowing the customary psychology of buy in rising and not buy in lowering, real estate developers united with real estate agencies, by using lots of injustice measures such like stocking up land and apartments, making up false transactions, broadcasting false price information and etc trying to make a supply strengthen atmosphere artificially, and mislead the market expectation so as to induce people to compete to buy houses as fast as possible, and this also encourage speculation demand for housing, which push housing price to increase dramatically in a short period. Normally no one can have a perfectly accurate expectation about future. M ost people are normal and bounded rational. They are very easy to be affected by the misleading information that are actually faked by real estate developers and other profit group who are eager to sell out apartments. Also when deciding to buy a house or not, most people just made their decisions according to the current situation, and think the trend will go on. For instance, since the innovation and open policies were imposed in 1978, China economy has kept increasing, and most of Chinese think this optimistic economic situation will last for at least another 30 years from now on. In recent years, housing prices keep increasing, most people also think this is going to be continue. So 22

23 under the help of misleading market information, almost all people have more or less take it for granted that housing price will definitely increase in future, and therefore rush to buy houses, a lot of people even borrow to buy houses now. Demand for housing is therefore pushed bigger and bigger. 3.4 Market supply Real estate has been treated as the pillar industry of national economy Real estate sector has been considered the pillar industry of national economy and the precondition to realize China 11 th five-year national economy plan. The whole country especially local government tried every method to encourage real estate development. In 2003, in Beijing, the contribution that real estate sector has made to GDP has reached 73% according to the report from China Construction Ministry. Too high percentage showed China economy rely too much on real estate sector, which is not so good for economy to develop in a healthy and sustainable way. Actually, real estate sector should not be the pillar industry of national economy. We admit that real estate do bring along other sectors development. The effects mainly reflect on the fact that real estate sector need the production materials provided by other sectors directly or indirectly. However, the effects that real estate sector can bring about to the whole economy are exaggerated. Some people say that more than half of steel in China are used for real estate development, so real estate directly affect steel and colored metal market, which will affect gas, electricity, oil, and transportation etc furthermore, so to say real estate helps all aspects of China economy. But we think all sectors affect each other more or less. If all the indirect help are counted into real estate sector contribution, it will be too ridiculous. Real estate sector itself can t solve all the unemployment and income problems. Without the people s income increasing due to stable national economy development, real estate sector can t develop in a sustainable way. So real estate sector is a special sector that actually relies on the development of other sectors, and this character determined that the real estate sector should not be treated as pillar sector. Real estate sector is the third sector in National economy, and third sector can t radically produce wealth, it can just help to produce wealth indirectly by stimulating consumption through the development of first and second sectors. So real estate is a sector that divides cakes, instead of making a new cake. Recent years, housing price has kept increasing, lots of developers and speculators have made a lot of money. But this is just the redistribution of social wealth, in this process there is no new wealth produced. For instance, the price of an apartment has increased from 500 thousand to 1500 thousand. But actually the apartment is still the same; no new substantial wealth has been produced. The profits speculators gained are based on transferring other people s wealth Unbalanced housing supply structure On one hand, demand for housing nowadays in China is very huge; on the other hand, there are so many vacant big houses and the supply of small apartment is not enough. The unbalanced housing structure helps to make high housing prices situation even worse. At the end of 2005, among the 40 main focus cities being investigated by China National Statistic 23

24 Bureau, there are about 23 cities have more than 50% of the new apartment that was over 120 m 2 per unit, in some cities this percentage even exceeded 60%. Among the 40 main focus cities, 16 cities have less than 10% of new apartment that was below 80 m 2. Average housing area in 40 main cities is about 113 m 2. In Beijing, average housing area of per unit apartment has reached m 2. Too big houses have increased the total selling price, which make the low-income household can t afford. According to one investigation done by China Academy of Science, after investigating Beijing, Shanghai, Guangzhou, Dalian, Chengdu, Xian and some other big cities, they found that there are 40.6% of the households prefer house area of 71 m 2 to 100 m 2, while only 17.3% of household choose to live in house area of 100 m 2 to 140 m 2. The market need and prefer small apartments, but why the supply of small apartment is so limited? Why real estate developers turn a blind eye on market demand and build so many big apartments? The reasons are: 1. Big apartments have lower costs Given almost the same construction costs, small apartment needs more installation costs, since more toilet and kitchen, more water pipes and electrical wires, more walls are to be built. And less cost will bring more profits to developers. 2. Big apartments can get operation capitals back much faster To sell one big apartment is much easier and faster to help developers to get capitals back compared to sell two sets of small apartments. 3. Less sale pressure The same project, there are only 300 sets of apartment if big apartments were built, but if changing to build small apartment, there are might 500 sets of apartment. 200 sets more apartments mean more sale pressure. 4. Much easier to increase housing price Big apartment very often also means high standard equipment, decoration and service. So it will be much easier to ask for much higher price for the apartment. Also, buyers who bought big apartment are always richer, and less sensitive to housing price. 5. Have something to do with location Land price in golden area of city center is higher than suburbs, in order to maximum huge profits as much as possible, developers only want to build big apartment Wrong local government leading policies Local government directly control the land, thus the real estate sector has strong local and monopoly characteristics. Nowadays in China, many cities use economy index to define whether the present local government is qualified or not. Under such circumstances, local government tends to encourage city development and especially real estate development to make the city appear prosperous during his position periods. By bidding and rent out land, local government also wins a lot of money. Actually 30-40% of local government fiscal income comes from real estate sector directly or indirectly 19. So improving real 19 Xing, Mengjun (2005), Analyzing on the relationship of playing chess between local government and central government during the period of society s transformation, Journal of Tribune of Study, 2004, vol.11 24

25 estate development is a main measure for local government to increase its fiscal income also. Not just encourage real estate development, local government also encouraged people to buy houses. In some cities the local government even came up with promotion policies to encourage people to buy houses. For instance, Shanghai local government once promised that those who bought an apartment in Shanghai can get Shanghai Hukou. Hukou is a very special product in China and Shanghai Hukou is considered very precious, for it symbolized a local people identity, and Shanghai local people can enjoy other welfare and favorable policies. For instance, Shanghai local people can go to Shanghai famous university with lower exam scores etc. This policy once induced lots of people to come to Shanghai to buy houses. Nowadays this policy has been abolished though. 25

26 4 Bubble economy 20 With all the government s new policies and all the media analysis, I am really afraid that bubbles might burst after I buy the house However, the housing price is still getting higher and higher. My money prepared for the initial payment may become inadequate again if I wait for another couple of months -----Current housing market has left ordinary buyers more bewildered. (Source: China Daily Oct 5 th, 2004) 4.1 Definition An often quoted definition is presented by Joseph E.Stiglitz in 1990: If the reason for the price is high today is only because investors believe that the selling price will be high tomorrow when fundamental factors do not seem to justify such a price then a bubble exists. According to the definition from Contemporary Economy, the bubble can also be simply defined as the asset market price deviated significantly from its fundamental value. The definition implies, however, that identifying a bubble as it is developing will not be so easy, since the fundamental value of the asset is generally unobservable. 4.2 Classification Bubbles are actually a phenomenon that assets market price increased unreasonably and deviate from the fundamental value they should be. Mostly the bubbles are caused because the illusive demand or speculation demand expanded too much. There are basically three types of bubbles if classified by different causes that lead to bubbles 21 : 1 The bigger fool theory: People are willing to pay more than what is reasonable because they expect to be able to sell it at an even higher price before the bubble bursts 2 Irrational expectations: People get carried away and have irrational expectations about the future 3 Irrational institutions: Buyers expect to be able to shift eventual losses to someone else (e.g. banks or the government) but keep the profits if there are any principal-agent problems According to the different serious extent and the disaster bubbles might bring about, we can divide bubble into these types: 1 Safe bubble 2 Precautious bubble 3 Dangerous bubble 4 Very dangerous bubble. If the bubble is dangerous bubble or very dangerous bubble, it will definitely burst and bring huge 20 Joseph E.Stiglitz (2005): Symposium on bubbles, Standford University, USA 21 Lind, Hans (1998), Bubblor och beslutsunderlag: Fastighetsvärderingar under boomen , Ekonomisk Debatt, 26 (1),

27 disaster to economy. Safe bubble can sustain for a long time more. Precautious bubble might get bigger and become dangerous bubble, and also might get smaller and squeeze to safe bubble. It will depend on a lot of situations. China current situation can be seen from the following two tables: Type Price index Specific index Selling price Price increase rate Increase range Rent level Investors psychology Table 1 Housing price index Bubble reference standard China current situation Little bubble Serious bubble Housing price to income Housing price to income Almost 1:8 ratio<1:6 ratio >1:10 Housing price increase Housing price increase Housing price increase rate/average income increase rate>30% rate/average income increase rate per capita>1 rate per capita>1 All kinds of property price All kinds of property price All kinds of property price increased nationally increased nationally increased nationally Rent level index/cpi Rent level index<100 Rent level index/cpi index<1 index<1 Quite optimistic Very optimistic Quite optimistic Table 2 Housing supply index Type Specific index Bubble reference standard China current situation Little bubble Serious bubble Supply index Proportion of investment 10%<the amount of investment/the whole amount of housing purchased<20% the amount of investment/the whole amount of housing purchased>20% 10%<the amount of investment/the whole amount of housing purchased<20% Development increase rate 2<development increase rate/gdp<3 development increase rate/gdp>3 development increase rate/gdp>3 Development debt loan increase rate 1<development loan increase rate/total loan in banks increase rate<2 development loan increase rate/total loan in banks increase rate>2 1<development loan increase rate/total loan in banks increase rate<2 Housing construction area increase rate 1<Housing construction area increase rate/selling area increase rate<2 Housing construction area increase rate/selling area increase rate>2 1<Housing construction area increase rate/selling area increase rate<2 Vacancy rate 10-20% More than 20% More than 20% (Source: the report from China Academy of Social Sciences in 2006) 4.3 Why real estate can be the main carrier in bubble economy To be the carrier of bubble economy, at least three characteristics need to be fulfilled: 1. Equilibrium is not very easy to be reached between market supply and demand. 2. Low transaction cost. 3. Involve in huge amount of capitals that are huge enough to hit financial sectors. 27

28 Some goods, bond, stock, real estate, artistic, coins, stamps, antiques all used to be the carrier of bubble economy in history, since it is impossible to increase their supply in a short period. But antiques, stamps and artistic need high techniques to identify, and also need to pay high transaction costs, thus can t attract a lot of people to speculate. Correspondingly, real estate and stocks, due to standard transaction, low transaction costs, no need very high technique to identify, impossible to increase supply in a short period due to limited land resource, construction lag and other characteristics, have been the main carrier of bubble economy. 4.4 Prerequisite of bubble economy There are five prerequisite for the formation and development of real estate bubble 22 : 1. People s optimistic expectation 2. Low transaction costs 3. Short time to use speculative capitals 4. Easily to get bank loan support 5. Bank can provide enough capital 4.5 When bubble will burst In the long run, even if there is no monopoly involved in, real estate bubble will still burst sooner or later. How long it will take from the formation of real estate bubbles until they burst, the whole period will depend on three factors: 1. Economy scale. In a big economy, it takes a long time to form bubbles. To small economy, less time are needed for bubble formation and burst as well. 2. Development of financial systems. If financial systems are very developed, well equipped financial employees, financial institutes have quite good stability and discharge ability, it will take long time for bubble formation and burst. 3. A country or a city s economic power. If it has very powerful export ability, or it can attract a lot of capitals from abroad, bubble will last longer until it bursts. 4.6 Bad effects that real estate bubbles bring about Illusive prosperity is destined to disappear some day, either disappear in a way of sudden crisis, or in a way of economy recession for a long time. No matter in which way, economy will be destroyed. Moderate speculation and bubbles will be good to activate economy, encourage competition, improve real estate sector and the whole national economy development. Also moderate bubbles can be solved by the asset s value appreciation. However, once there are speculations, it s very hard to control bubbles within rational range, and too big bubble and the risk of a burst is quite dangerous to the whole society. The main bad effects are: 1. Wealth transfer effects which lead to bigger wealth gap. According to the report Urban families wealth investigation published by China National 22 Li, Tao and Wu, Jianping (2004), Discussion of real estate bubble causes and precautions, Journal of Shangdong University of Technology,2004, Vol. 2 28

29 Statistic Bureau in 2002, real estate takes up more than half of urban family s average wealth. Normally rich families possessed more than two sets of high price houses, while low-income families either have no houses at all, either have just possessed a cheap house. If the housing price increases too fast, wealth difference between the rich and the poor will be bigger. 2. Inflation risk Overheated investment will make currency supply in the market kept increasing, which is very easily to lead to inflation in the whole society. 3. Financial disasters Even rent is not enough to pay the interest to loan, investors or speculators still keep buying real property, with the only hope of gaining huge profits in the future. Compared with before, accompany with the recently rising property price is the rising mortgage loan in financial institutes, which implies increasing possible financial risks. 4. Unstable macroeconomic environments Too fast real estate price increase will make the companies business and investment cost increase and lower investors interests to the city since companies need buildings to be their offices, new movers and workers need to find houses to live in. On the other hand, real estate mortgage take up such big part in banking mortgage, thus lead to squeeze out effect, which make the other sectors don t have enough capital to develop, thus lower a city s competition power and make the unemployment more serious. Another concern about house price bubble is that gains in housing wealth either unrealized gains or gains extracted through home sales or refinancing--may be partly responsible for relative strength in consumer spending. If there are bubbles and then burst, causing housing prices to fall, an important prop for consumption will be gone. 5. Increase local government fiscal risk. The main part of local government s fiscal income comes from land rent. To greater and greater extent, local government has to rely on real estate than ever. Since government spending is not so flexible, once real estate sector was adjusted,local government might fall into deficit trouble. 6. Inefficient and un-harmony society To build a harmonic society is our macro planning purpose. However, there are still a lot of factors that seriously affect this goal to be reached, of which the most annoying problem is high housing price. High housing price also limited people s other consumption since housing takes up big part of people s savings and income, which is not so good for improving people s living standard. Once real estate bubble bursts, all kinds of sectors that related to real estate will also be destroyed. 7. Unsustainable societies Overheated real estate development and bubbles will induce excessive use of natural capital in society. For instance, more forest are destroyed to build houses, but destroyed forest might bring people flooding and other natural disasters. However, under the temptation of huge profits, real estate developers build so many houses without thinking of possible disasters to natural resource 29

30 and its bad effect to future generations. 5 Are there real estate bubbles in China? Whether there are bubbles in China s real estate market in recent years has aroused a huge debate since housing price has been increasing dramatically in a national scale. To identify bubbles, the first and foremost task is to tell whether it is real demand that support the main market, or illusive demand or speculation demand that support the main market. 5.1 Investment and speculation demand Some people say that increased housing price shows that there is sufficient demand for housing, and since there is demand, housing price increase is thus reasonable. In economics, price is indeed the result of balancing demand and supply. However, a lot of demand on the market does not necessarily mean that price increasing is sure to be reasonable. Real estate property is quite different from other products. Real estate property or housing is not just consumption, but also investment. As a kind of consumption, in a perfect competition market, equilibrium housing prices should equal to Marginal Product Cost (MPC), the equilibrium price which is determined by supply and demand in market should be the basic value. Price=MPC As a kind of investment, according the Capital Asset Pricing Model (CAPM), the value of the asset should equal to the discounted future expected cash flow. When it comes to a house or an apartment, the basic value therefore should equal to the discounted rent every year in the future and discounted the salvage value in the last year. Price=Rent/discount rate + salvage value/(1+discount rate)^n Seeing from the supply side, housing market is seller s market, and those who sell the houses control the right of offer price, while the normal consumers who bought the houses actually have to passively accept the price. If this is the case, the real selling price will definitely be higher than MPC. The first and foremost point to determine if there are bubbles or not is to tell which kind of demand mainly push housing price to increase. In economics, demand can be divided into real demand and illusive demand. Real demand includes self-using demand, investment demand and herd demand. Self-using demand is to buy houses for its own use; Investment demand is to buy houses with the purpose of renting out later to gain profits; Herd demand is to buy houses just in order to follow other people s behavior without clear purchasing purpose; Speculation demand is to buy houses with the hope that may sell it out in the future to gain the price difference profits. Self-using demand and investment demand plus reasonable vacancy rate is real demand. All the others are illusive demand. Housing price increased by herd demand and speculation demand will not be stable and consistent. Here we assume that economic actors are perfected rational, so that 30

31 we omit following demand here and put our emphasis on speculation demand. In most circumstances, real demand and speculative demand exist together. If it is real demand that push housing price to increase, this phenomenon is normal business cycle that is very easily to be adjusted to back to normal situation. However, if it is mainly speculative demand, there might be bubbles, and more emphasis should be put on and try to prevent possible disaster when bubble burst. How big the speculation demand is to great extent decide how big the real estate bubble might be, so speculation demand is the focus point of our analysis on bubbles. In China real estate market, since in most cities more than 80% of the population already have their own houses, so bubble will exist even if investment or speculation demand for housing exceed for just 10%. Speculation demand for housing will bring the society an illusive prosperity. The reason is quite simple. If everyone has an optimistic expectation about future, housing price will definitely increase. If somebody gains huge profits during the speculation process, all the others will also follow herd behavior and try to gain huge profits as well. Transaction amount will increase, mortgage loan in banks will also increase, and banks profits will also increase. People s unreasonable optimistic expectation about future housing price make more and more money are invested into real estate, which in turn stimulate real estate development. Everywhere there are new houses being built. Advertisement and all kinds of media also help to make an easy-to-be-rich atmosphere. And this is the typical symptom of real estate bubbles. Another main character of speculations is a short-term perspective. Speculative demand push housing price to rise dramatically to the highest point in quite a short time, and then bubble bursts also in quite a short time which arise the whole society economy disaster. In history there are many bubble economy cases: In 1990 Japan bubble economy, 1992 China Taiwan real estate and stocks bubble, 1995 Thailand bubble economy and etc, all of them are very typical bubbles due to short term speculations, and all these bubble economy just take a maximum 5 years from the beginning to the burst. There was a sampling survey done by Shanghai Jiefang Daily. The survey result showed that among the households in 25 communities, there are 3885 households, or 26.5% buyers are speculators or investors. More households rent out their old apartments as soon as they bought new apartments, and use the rent income to pay back the mortgage loan for new apartment. And this is also a kind of investment. According to some related research done by Shanghai Academy of Social Sciences, in Shanghai, housing investment and speculation ratio is 17%. If taking into account the old and second-hand apartment renting, housing investment and speculation ratio will be much higher. Actually, it was a common saying that in Wenzhou city there were about 150 billion RMB waiting to step into and speculate in Shanghai housing market. Plus the international hot money which rushed into China due to the stimulation of RMB appreciation, currently China speculation capital has already been in a huge scale. 31

32 5.2 Three indexes to identify bubbles The saying that housing price increase too fast, housing price increase too much etc are often used to evaluate if there is real estate bubble. Yet strictly speaking, these sayings are far from accurate. To tell if there is real estate bubble, we need to analyse whether real estate market price has been consistently higher than the theoretical price level that it should be. Some indexes are often used as a reference. Those indexes are housing price-to-income ratio, housing price-to-rent ratio and vacancy rate Housing price-to-income ratio Currently Chinese people are facing the same housing price level as in America. (Source: Morganstanley Report in 2005) 1. Definition: Housing price-to-income ratio equals to average housing price divided by average yearly income in one family. Housing price-to-income ratio is one of the most common indexes used to measure real estate bubbles internationally. This index is often used to measure people s purchasing power and effective housing demand sustainability. The main character of bubble is that housing price has kept increasing that has made the price far away from its value and it is mainly the unreasonable factors that has led housing price to increase too much. According to the standard provided by the World Bank, housing price-to-income ratio in developed countries normally ranged from 1.8 to 5.5, ranged from 3 to 6 in developing countries. But in China, current has already exceeded 7.8. In Shanghai, Beijing and Guangzhou and some cities, the ratio would be much higher. According to the data from China Social Science of Academy data, in Shanghai, an 80 m2 apartment will cost 27.5 years yearly disposable income in one family. 2. Analysis on people s purchasing power and affordability Recently there are data from China National Statistic Bureau showing that citizens in Shanghai and Beijing have carried much higher debt ratio burden than the average debt ratio that American citizens have ever experienced. The generally accepted definition of affordability is for a household to pay no more than 30% of its annual income on housing. Nowadays, China households purchase power is decreasing. Among the families who have bought new apartments, more than half have to pay more than 30% of their monthly family income on monthly mortgage loans. While about 30% of families have to pay more than half of their monthly income for monthly mortgage loans. Seeing from the average level, currently Chinese increasing housing prices have made households purchase power especially low-income families purchase power relatively decrease a lot. While 32

33 the main reason is still that high-income households income increase rate is faster than low-income households income increase rate and big gap between the rich and poor. From 1995 to 2005, only medium and high-income families income increase equals national average level, high-income families income increase will be much higher than average level in the future, while the low-income families income increase will be much lower than average level. And the poorer the family is, the less their income has increased. According to the data from China National Statistic Bureau, currently the average yearly income of 10% of the richest people is 10 times the income of 10% of the poorest people. 10% of the richest people possessed 45% of national wealth, while 10% of the poorest people only possessed 1.4% of national wealth. Thus we can see, rich people s purchase power is several times of the common people s purchase power. Provinces in China Table 3 Statistic results from China National Statistic Bureau on August 24 th 2006 Number of Households investigated Average number of persons in one family Average persons in one family working Average monthly income per capita (yuan) Average Whole country Beijing Shanghai Zhejiang Guangdong Jiangsu Fujian Shangdong Sichuang Hebei Shanxi Neimenggu Niaoning Jilin monthly disposable income per capita (yuan) (Source: China National Statistic Bureau website) 3.Current situations In China, there used to be local real estate bubbles in Hongkong, Beihai of Guangxi province and Hainan. According to the statistical data from China National Statistic Bureau, in 1992 the land price in Hainan increased from 1400 yuan to 5000 yuan per square meter, with an increasing rate of 257%. In 1993, the land price kept increasing to 7500 yuan per square meter. Similar situation happened in Beihai of Guangxi province. In 1992 there are serious land speculations in Beihai, which caused land price to increase 20 times within half a year, and reached the peak of 1.2 million yuan per unit of area. According to the data from China National Statistic Bureau, from 1987 to 1993, China national 33

34 housing price-to-income ratio has been increasing each year. China average housing price-to-income ratio used to be 7.8 in 1991, 7.6 in 1992 and reached the first peak since After 1993, the ratio has a decrease trend. During 1997 to 2000, the ratio fluctuate around 6.8. During 2001 to 2003, the ratio has a decrease trend again. After 2003, though household income has been increasing, yet housing price increase much faster than household income, thus the ratio was on its way to increase again. In Shanghai, Beijing and most big-and-medium sized cities in China, the ratio is too high that some has even exceeded the average history level for more than 10 times, which already arise all people s complaint. In Shanghai, housing prices are more than 14 times of local households income, while reasonable housing price-to-income ratio should be around 6, and even in 1997, when Hongkong real estate bubbles burst, the housing price-to-income ratio was just 14. In 2004, average yearly disposable income per capita in Shanghai was yuan. If calculating by using statistic data that there are average 2.9 persons in each family, then average yearly disposable income in one family will be yuan(=16683*2.9). From the aspect of structure, in 2003, only 5.6% of the whole households in Shanghai whose average yearly disposable income per capita was more than 35 thousand yuan, which means there are 94.4% households whose average yearly disposable income per capita was below 35 thousand yuan, or to say yearly disposable income per family will be yuan(=35000*2.9). If calculating by housing price-to-income ratio of 10:1, the endurable housing price should be 483,800 yuan(=48380*10), and the highest housing price which can be afford is 1 million(=101500*10) or so. But the fact is housing price in Shanghai city central area has far exceeded this level, which means 94.4% of the Shanghai people can t afford the current housing price 23. From the Table 4 below, we can see that besides Shanghai, the other three main big cities housing price has also increased more or less in Housing price-to-income ratio in all cities in 2006 has exceeded 10, and Shenzhen is the highest, which showed that housing price is times of family yearly disposable income. Shanghai located in the second place with the housing price-to-income ratio of 15.55, while Beijing is 13.55, and Guangzhou is Fan, Liangliang and Liu, Hongyu (2005), Econometrical Analysis of Factors Affecting Homeownership Rate of Urban Resident in China, Journal of Shenyang Jianzhu University Natural Science,2005, Vol.4 34

35 Table 4 Housing price-to-income ratio in four main big cities in recent years (unit: RMB) City year Averageyearly disposable per capita income Yearly income in a three-persons family Commercial apartment average selling price Total price of a 90 m2 apartment Housing price-to-income ratio Beijing Shanghai Guang zhou Shenzhen (Source: China Real Estate Market Report in 2004, 2005 and 2006) In 2005, the average selling price of new commercial apartments in eastern area of China is about 3943 yuan per m2, average living space per capita is about 26 m2, average population in one household is 3.16 people, average working population in one household is 1.67 people. Average yearly disposable income of urban household is about 10.5 thousand yuan. Based on these data, the housing price-to-income ratio is far more than 10:1. Considering that about 70% of the urban households disposable income is lower than the average number, so definitely most of the urban households don t have the economic ability to buy new houses. Reasonable housing price increase rate should not be more than family disposable income increase rate, otherwise this increase is not sustainable. According to China Construction Ministry, reasonable yearly housing price increasing rate should be 3%. However, since 2003, housing price has been increasing at a much faster speed. In 2004, housing price has a year on year increase rate of 13.4%, which exceed average disposable income increase rate of 8.7% for almost 5 percent point. 4. Things needed to pay attention to There are several problems we must pay attention to when using this ratio as an index: Firstly, Average data actually shouldn t be used to calculate the ratio. Wealth gap affects the reliability of average housing price-to-income ratio. Since there are huge wealth gap between the rich people income and the poor people income, the average figure can t reflect China people real purchase power. 1. Housing price-to-income ratio in low-income families is quite high. In 2005, the ratio in the lowest-income families has reached 22.69, which is more than 3 times higher than national average housing price-to-income ratio level. And in low-income families, 35

36 housing price-to-income ratio is also as high as 14.74, which is more than 2 times higher than national average level. 2. Housing price-to-income ratio in high-income families is quite low. In 2005, the ratio in highest-income families is only 2.45, which is only 36% of national average level. 3. Big gap between the housing price-to-income ratio in highest-income families and lowest-income families. In 2005, housing price-to-income ratio in the highest-income families are only 10.8% of the lowest-income families. 4. The gap between the housing price-to-income ratio in the highest-income families and the lowest-income families are expanding very fast. In 2000, the ratio in lowest-income families was 5 times of the highest-income families, while the figure expanded to 5.4 in 2001, 8.5 in 2003, 8.9 in 2004 and 9.25 in Housing price-to-income ratio in low and medium-income families is on an increasing trend, while the ratio in high-income families is on a decreasing trend. Especially the ratio in the lowest-income families has increased very fast, which is deviate from the general trend of China national average housing price-to-income ratio. Medium value is more reliable, which means choose the most common income in current society as the standard figure when calculating the ratio. But unfortunately current China statistic data are all on average basis, which made the analysis less reliable. Secondly, Targets chosen also affect the reliability of average housing price-to-income ratio According to the forum, housing price-to-income ratio equals housing average price divided by people s average yearly income. But actually in some big modern cities, it is not the local people who bought the most houses, but the people from outside of the cities or even foreigners from abroad. However, when calculating residence s income, normally just the local residences income is included, while those outsider and foreigners are excluded. If those who actually purchase the houses are not or partly not the objects when calculate residence s income, how can the housing price-to-income ratio be reliable? This showed imperfect sides of China statistical system. Thirdly, is there really a so called international standard precaution line? Although housing price-to-income ratio is an international index that is used universally, however, is there really such a so called reasonable range for this ratio which can be applied universally? In 1998, after the World Bank had investigated 96 cities and areas, they found housing price-to-income ratios in different places highly deviated. The highest ratio was 30, lowest ratio was 0.8, and average ratio was 8.4, while the medium ratio was 6.4. The highest housing price-to-income ratio was more than 30 times of the lowest ratio in the world. More than half of the countries investigated have the housing price-to-income ratio of more than 6; Part of the countries housing price-to-income ratios are below 3, and there are only small amount of countries whose housing price-to-income are between 3 to 6. Since the percentage that countries whose housing price-to-income are between 3 and 6 are very small, why this range should be treated as an international rule when determine if there are bubbles in developing countries like China? So to some extent, it is quite debatable to come to the conclusion that China has real estate bubbles just based on the fact that China housing price-to-income ratios have exceeded 6. 36

37 Actually we can t compare China s housing price-to-income ratio with other countries, since when calculating the ratio, different countries have different statistical objects and methods, different definition to housing price, different way to calculate house s space, different definition for income etc. One thing also needs to be pointed out is that in China, after buying the houses, people can just own the houses for 70 years, which is equal to yearly discounting rate of 1.4%, while in America, people get the permanent ownership for the houses. For example, it is quite debatable to say that Americans only need to spend 3 years income to purchase a house, but Shanghai people need to spend more than 10 years income purchase a house, since two countries have so much difference in the aspects stated above. However, we can still compare a city s historic ratio data with the present data. For instance, we think there are bubbles, because before 2003 China housing market especially in most big cities is normal and most of the residence can afford to buy houses, but after 2003, housing price has increased dramatically and people s income have not increased at the same speed, which make nowadays a lot of residence can no longer afford to buy houses. 5. Discussion Since China has so big wealth gap, and also considering China different living condition, housing price-to-income ratio can not be put on too much emphasis when deciding if there are real estate bubbles or not, unless certain adjustments can be made when calculating the ratio. For instance, substitute average income with medium income level, or calculate different housing price-to-income ratio in different income level respectively etc. But one fact that can t be neglected is that most of common people can t afford to buy houses nowadays in China. No matter the average housing price-to-income ratio is high or low, no matter there are bubbles or not, the fact that most people can no longer afford to buy houses is really serious and need to be solved. 37

38 Table 5 China housing price and income level in 2004 Rank City Yearly disposable Yearly income in a Yearly Total price for a 70 Years need to spend Housing price income per capita three person family surplus m2 apartment to buy apartment per m2 (yuan) (yuan) (yuan) money (yuan) (year) 1 Wenzhou Shanghai Hangzhou Nanjing Qingdao Tianjin Dalian Beijing Ningbo Xiamen Xi an Nan ning Kunming Guiyang Guangzhou Taiyuan Shenyang Lanzhou Suzhou Wuhan Chongqing Fuzhou Ha er bin Shijiazhuang Zhengzhou Chengdu Ji nan Hai kou He fei Shenzhen (Source: China Real Estate Market Report 2004) 38

39 5.2.2 Housing price-to-rent ratio Housing price-to-rent ratio is another important index often used internationally to measure real estate bubbles. Housing price-to-rent ratio is similar to the P/E ratio commonly used in stock market. In some sense, this ratio is more reliable than housing price-to-income ratio. 1. Definition Housing price-to-rent ratio refers to the housing price divided by monthly rent. In normal real estate market, there should be a certain proportional relationship between housing price and rent. 2. Why this ratio can be an important index to tell bubbles 24? We can t tell that there are bubbles just by telling if housing price has been increasing dramatically. Actually housing price has deviated for a long time away from its real value should be the main clue of real estate bubbles. Housing price-to-rent ratio is the index that shows the degree that housing price has deviated from its value. Normally, there are should be reasonable range of proportion relationship between housing price and rental income given rent is determined by market, and social economy is developing in a normal way. In China, the reasonable housing price-to-monthly rent ratio range should range from 150 to 200. How come the range between 150 and 200? We can first take a look at the process of people investing in real estate. Actually the main reason that determines whether investing in buying a house is reasonable is to tell whether housing yearly rental income return rate can exceed social average capital return rate. Currently, the face interest rate of 10 years China national bond was 4.44%, since long-term national bond interest rate is the best reference for social average capital return rate, so normally we think 4% is the current social average capital return rate. In this sense, if an apartment has the rental income profit rate of more than 4%, it will be profitable. If taking into account other factors such like mortgage risks, rental tax, housing vacancy etc, reasonable rent profit rate should be around 6% approximately (yearly rent/housing price=6%). Or to say, China reasonable housing price-to-monthly rent ratio should be around 150 to 200 (housing price/monthly rent=100/6*12). However, according to data from China National Statistic Bureau in 2006, among the 37 main cities in China, current housing price-to-rent ratios are between 230:1 to 290:1, almost no city ratio was below 200. In most hot cities like tourist cities, and cities located close to the ocean etc, the ratios are more than 300. For instance, in Qingdao the ratio was about 340, in Shanghai the ratio was around 360, in Hangzhou the ratio was around 470, in Wenzhou the ratio was more than 500. Take Beijing as a detailed example. According to related statistic data provided by Beijing Municipal Bureau of Statistics, in 2006 Beijing average monthly rent for a one-bedroom apartment was 1526 yuan, the average selling price for the apartment was 370 thousand yuan, so the housing price-to-rent ratio was 242:1; The average rent for a two-bedroom apartment was 1751yuan, the average selling price was 490 thousand yuan 25, so the housing price-to-rent ratio was even worse to 280:1. 24 Xu, D. Q. (2006), Housing price and bubble economy : China Machine Press 25 This information comes from Beijing Municipal Bureau of Statistic website 39

40 More accurate way to identify bubbles is to compare housing price change trend with rent change trend. If rent has not increased too much, or even on a decrease trend, while housing price keep increasing at a fast speed, then bubble might exist. Since 2004, housing prices in Shanghai have increased for more than 10%, while rent level has decreased for more than 10%. In Qingdao, from 1998 to 2004, housing price there has increased for 50%, but rent has decreased for 7%. In Beijing and some other big cities, the same phenomena can be observed. 3. Things needed to be pointed out Firstly, the relationship between housing price and rent. Some scholars think the profits of investing in real estate come from two parts: rent and house value appreciation, and given the fast housing value appreciation, the percentage that rent income take up in the whole profits is quite small, so they think rent deviate from housing price can t show that there are bubbles. However, we think rent shows the intrinsic value by owner-occupied housing. From the classic formula that housing price equals to net rent divided by interest rate (P=R/i), we can tell that rent and housing price should not deviated too much from each other in the long run. If for a long time housing price has deviated from rent, bubbles might already exist. If the deviation degree becomes more serious, it shows bubble might have become bigger. Secondly, the factors that may affect this ratio Mortgage interest rate is a very important factor to be concerned when calculating property owners cost. Obviously, if interest rate is decreased, owners purchasing costs are decreased, then less people will tend to rent house and more people will tend to buy house. Since in real estate area, supply don t have so high elasticity,so more demand for housing will drive housing price to increase. Theoretically, housing price should equal to the discounted capital flow of future rental income. Before Hongkong real estate bubble burst in 1997, the average loan cost per month is 2.2 times of monthly rental income. However, by 2005 Shanghai, average monthly loan cost was already 2 times of monthly rental income. There is a huge possibility that bubbles might exist now 26. Another factor is people s expectation for future can also dramatically change ownership costs. If people are very optimistic about the future housing price, ownership costs will dramatically decrease. Given that average rent remains stable, housing price will increase. So when valuating housing price, we should use long-term average ownership costs instead of current ownership cost. If housing price times long-term ownership cost is higher than rent, housing price can be regarded to be higher than it should be. 26 Liu, Dang and Zhang, Liang (2004), Mechanism and Regional Characteristics of Economy Bubble in China Real Estate Industry, Journal of Chongqing Jianzhu University, 2004, vol. 4 40

41 5.2.3 Vacancy rate In Shanghai, about one sixth high standard apartments are vacant; In Beijing, the vacancy rate was one fourth, while in Shenzhen the rate was one third. In the future, housing vacancy rate will definitely increase more China housing vacancy rate has exceeded international precaution line of 15% (Source: an abstract of an article from New York Times in 2005) 1. Definition Just like talking about market profit rate in Stock market and clicks ratio in Internet market, when real estate problems are talked about, vacancy rate is often quoted. What is vacancy rate? However, there is no standard definition in economics at present. According to current conception used in China statistics system, vacant housing areas refer to the commercial housing areas that have finished construction and are available to sell or rent, but haven t been sold out or rent out during report period. Vacant housing areas include both the housing areas that have finished construction in previous years and during the report periods, but do not include during the report period the housing areas that has finished construction but are not available to sell or rent, for instance the demolishing areas that are built to pay back, public facilities building areas, real estate companies self using housing areas etc. Vacancy rate is therefore the vacant housing areas divided by total amount of housing exist in market. Vacancy rate reflects housing demand in the market, and affects the expectation for future housing prices. When vacancy rate remains at a very high level, while at the same time housing price in market also remains stable or even increase a lot instead of decreasing, it shows there are unreasonable investment or speculations in market, and there might exist bubbles. 2. Current situation in China 27 China commercial apartment vacancy rate from year of 1999 to 2003 are 41.13% 36.48% 34.78% 31.88% and 28.46% respectively. However, international precaution line for vacancy rate is just 10%. In recent years, vacant housing areas in China are always more than 100 million m2. Also according to the data from China National Statistic Bureau, China national vacant housing areas are 112 million m2 by Oct 2005, and 121 million m2 by August 2006, which shows a year on year increase of 14.4%.Commercial apartments that have been vacant for more than one years are thousand m2, which take up 65.6% of the total amount of vacant commercial apartments. In Shanghai, it seems to be prosperous both in housing demand and supply, but in fact, at night lots of houses that have already been sold out are vacant. Investors coming from Hongkong Taiwan and foreign countries who are the owners of those houses are just waiting for a good selling point. 27 Soufang real estate webpage 41

42 3. Things needed to be pointed out Nowadays some scholars say that China national vacancy rate has reached a very high level, which has far exceeded the international precaution line of 10-15%. However, some people say China vacancy rate is just 1%. Why there are so huge differences between the results? Firstly, we need to pay attention to the different definitions to vacancy rate Some people think vacancy rate equals vacant areas divided by construction areas completed in a certain time period. Some people think vacancy rate equals vacant areas divided by construction areas completed within three years, while some think vacancy rate should be vacant areas divided by all urban housing areas available. Of course different numerator and denominator will lead to different results. Secondly, we can t compare China s vacancy rate with foreign countries Actually China has not set up a vacancy rate index yet, thus it is impossible to compare China national vacancy rate with foreign countries. Also actually China government authority has never published any national housing vacancy rates formally. Normally, in foreign countries, vacancy rate has a fixed definition, saying that vacancy rate equals the houses waiting to be sold or rent during the report periods divided by all the houses available to be sold or rent in the market including stock houses and new increasing houses during report periods. But in China, there is no fixed authority definition for vacancy rate yet. One reason for it is that China statistic system is imperfect, since nowadays the statistic system is still the old one that has been applied for many decades in the old planning economy era. Another reason is that in western countries, big scale urbanization process has already finished, while in China urbanization is just at the beginning step. In China, construction areas finished within one year almost equal the construction areas finishes within one year in all western countries. Huge construction areas increase statistical difficulties. From the definition of vacancy rate in foreign countries, we can see that in foreign countries, the vacant houses include new built houses and old houses. But in China vacant houses only refer to new built houses. Since it is not scientific to compare two different conceptions, so it is not reasonable to say China vacancy rate has exceeded international precaution line. Actually if using the method foreign countries often used to calculate China vacancy rate, China national vacancy rate will be only 0.83%, far below the so-called international precaution line of 10% or 15%. 4. Great potential disaster behind huge vacant housing areas Though there are some conceptual difference between China s vacancy rate and international vacancy rate, yet high vacant housing areas in China can still reflect some profound problems that need a lot of attention. Currently, China vacant commercial housing areas are more than 100 million m2, among which more than half have been vacant for more than one year, and occupied capitals for more than 250 billion yuan. Since most of the developers are mainly supported by loans from financial institutes 42

43 or commercial banks, so many vacant houses will definitely affect the operation of financial institutes, and make a possible financial disaster more serious. A lot of vacant houses in China are due to too much speculation in market. People bought the houses not for self-using or renting out to gain rental income, but waiting for a good selling point and sell the houses out to gain profits. When more and more vacant houses are not a kind of consumption but actually a kind of speculation tool, precautious bubbles might already exist, and develop at a fast speed to turn to dangerous bubbles. So China should take great emphasis on the huge vacant housing areas. 43

44 6 Macro-adjustment and policies 6.1 Why real estate bubbles can easily exist in China? Early in 1980s, China once exist very serious economy bubbles which started with Changchun lily flower bubble, and later developed to more serious extent that hundreds of kinds of special local products were popular in the international market. But later the illusive prosperous situation was followed by sudden decrease of products price and production. Since the 1990s, financial area and some other social area all exist bubbles, including internet bubbles GDP bubbles stock market bubbles car bubbles beauties economy bubbles pyramid selling bubbles and etc. Up to now, most of all those bubbles have burst already, yet real estate bubbles are still on its way to develop from precaution extent to dangerous extent. Moderate and safe bubbles can stimulate economy, but dangerous bubbles will bring the disaster to economy. So why China real estate bubbles can grow and develop so quickly within such a short years? We think the following aspects can partly explain the reasons: 1) Chinese people don t like the old planning economy, and put so much blind trust on market economy, and think market economy can solve all the problems by itself without any macro adjustment. So the current situation in China is: the new market economy doctrinarism substituted the old planning economy doctrinarism, which means if there are some problems in market, people tend to blame all the reasons to the fact that market economy is still imperfect, instead of doubting the Chinese socialism market economy system itself. Actually, behind the so called China socialism market economy, there is very serious power-capital movement. 2) Those who should be responsible for real estate bubbles, for instance, international hot money, speculators, real estate developers etc, actually gain huge profit. Attracted by the huge profits, they tend to produce more faked expectation for further price increase, and real estate bubbles therefore grow more. 3) China has a huge population. Also there are unbalanced development between cities and sectors. If some small amount of people became sudden rich by speculating houses, more people will tend to follow with the only hope of become rich also. 4) In most cities of China, especially in Beijing and Shanghai such big cities, real estate sector and the sectors helped by real estate sector contribute a lot to GDP. It is very common that local government competed with China central government for more power to control financial and land resource, so as to help to keep real estate bubbles for the sake of keeping illusive local economy prosperity in certain period. 5) Financial institutes and banks support real estate sector even when knowing this sector already overheated because of the profit attraction also. More loans out, more profits for banks. 6.2 Purpose and necessity of government macro control Since 2003, China central government has already taken a lot of measures to cool down the overheated real estate sector. The purpose of government macro control to real estate market is not to keep housing price stay at a very low level and prevent housing price from increasing at all. 44

45 Instead, the purpose is to control housing price in a normal level and within a normal increase speed, so to help real estate market develop in a more healthy way. China real estate market is not a normal merchandize market like clothes or food; it is an oligarch monopoly market that is strongly affected by macro policies like land policy, monetary policy and etc. So the market has to be adjusted and controlled by China national government power. We can t totally rely on market itself to swift the worse situation to be better. 6.3 Strengthen housing system, change housing structure 28 The main conflict in current real estate market is the unbalanced housing structure. Most people can just afford low and medium price level houses, while supply of these houses is not sufficient. In March 26th 2005, the China State Council issued The Eight Measures to control the price of housing, regulate and adjust property market. The document asked local governments to control the growth of price and accelerate developing a healthy real estate market. After The Eight Measures, China State Council issued another document named New Eight Measures on April 27 th 2005 to strengthen the management of the real estate market. It pointed out that current main task is to enforce the price control of normal houses and economic affordable houses, and perfect the low rental house system and ensure the demand of low-income family to be met Build more economic affordable houses Building economic affordable house is a very important task during China urban housing system innovation. The main purpose is to solve low-income household living problems, not to make profits. Economic affordable house has economic attribute and affordable attribute. The economic attribute means the house s selling price is lower than normal commercial houses in market. The affordable attribute means low-income household can afford the house. Government cancelled the transferring cost of land, declined other costs and taxes to 50%, and set very strict limitation to possible selling price and limited developers profits to no more than 3%. However, just like a coin has two sides, in practice economic affordable house also has a lot of drawbacks: 1.Broaden wealth difference Low-income households should be the objects of economic affordable houses, but the actual market situation is: the so-called economic affordable houses are too big and expensive for low-income households to afford, and the amount of small apartments is very limited. Some economic affordable houses located in suburbs that are far from city center, where municipal facilities are imperfect and induce segregation. According to the report from Zhejiang province government in 2005, 70% of economic affordable houses are about 130 m2, the biggest house type even reached m2. In a lot of provinces, there is actually not so much difference between economic affordable houses and normal commercial houses when it comes to prices or the house types and areas. 28 Xiao, B. (2005, Spring), Eight measures from China State Department to control house price, Jinhua Times 29 Detailed content of these policy documents can be found in Appendix 2 45

46 On the other hand, how to define low income is also a problem. Firstly, it is impossible to have a definitely accurate national standard to measure who are low-income households since different cities economy and income level are different. Secondly, even among low-income household, different family condition requires different treatments. At present, local government has no accurate standard to define low-income household, just by taking advantage of this, a lot of rich people become the actual buyers of economic affordable houses. The real low-income households can t afford economic affordable houses, while many rich people had taken advantage of system leak and bought a lot of economic affordable houses, this will inevitably make wealth gap even bigger between the rich and the poor. 2. Mix government role in economy, and encourage bribe activities The role of government is supposed to protect market competition system, prevent excess speculations and ensure housing price increasing follow a health way. Government has the responsibility to take care of relatively weak group in society, but if government directly involved in housing transactions or affect market by administration power, social welfare will be mixed with market economy, housing price system will be disturbed and economy development will be destroyed. Moreover, if government can use administration power to interfere with resource distribution, power will look for its price in market, and therefore encourage government bribe activities Destroy social credit, lead to inefficient and unequal society Efficiency and equality are the two main goals in economy development process. Yet economic affordable house tend to make the whole society inefficient and unequal. Benefits of economic affordable house come from land transfer cost cancellation and taxes decline. Government give up the fiscal income it should get to help developers to build cheaper economic affordable house with the hope to help low-income household, yet rich people actually become the main buyers, and developers got the huge sudden profits. In some cities, some developers decreased their construction costs and made more profits by lower the quality of economic affordable house. Some developers still build big and high price level apartment, after they enjoyed the favorable policy and benefits from government, thus transferring the tax income and all other benefits that should belong to government fiscal income into developers private pockets. So we can see, the idea of building economic affordable houses itself is good, yet the real estate market still needs to be improved and standardization to put the idea into practice more smoothly Applied policy to improve the amount of small apartment In May 2006, the National Six Measures announced that land supply for low price level small apartments which are less than 90 m2 should not be lower than 70% of whole land supply for residential houses per year Miao, Tianqing (2004), The game of rent seeking in China s city land lease, Journal of Commercial Research,2004, vol Detailed content of this policy document can be found in Appendix 2 46

47 Later in 2006, China Construction Ministry further published Several opinions about carrying out new built house structure proportion (or the so called No.165 document). In this document, it further explained that here in National Six Measures, the Taoxing construction area of 90 m2 refers to one apartment s construction area. The 70% here is aimed at the total area of commercial houses newly examined and newly started construction within one year. The policy is supposed to increase the amount of low price apartment on a piece of development land, to meet low-income household living need, at the same time, to restrict rich people from occupying too much land resource. But in reality there are still some difficulties when putting policies into practice, of which the most serious one is that it makes bribe possible. Since 70% is aimed at the total area newly examined and newly started construction within one year, in practice, thus giving more power to local urban planning bureau. They can decide which developer and in which land big apartment can be built. Too much power gathered to local government, will easily lead to bribe if there is not enough transparency Improve low rent housing market Low rent houses are a kind of houses with social security nature provided by government to the lowest-income households. The purpose is not for commercial selling and making profits, but for renting to low-income household to solve their basic living problem. Government determines the rent level according to different living costs in different cities. For example, Shanghai now is carrying out low-rent house plan. The object is the lowest income household whose monthly income per capita is below 290 yuan, living area is below 5 m2 per capita. The government use fiscal income to give these household rent allowance. Households go to second hand house market to rent house by themselves with the government allowance. This way to carry out low rent house is better than the way that government directly organized to build low rent house building and let lowest income household to move in. Firstly, different household can choose different location and house type to rent and have more freedom; secondly, giving people rent allowance and let themselves find house to rent instead of building houses in an area can prevent segregations Improve second hand market At present, in European and American countries, 80% of real estate transactions are second hand house transactions. Each year, there is 5% of housing stock go to second hand market. While in China, second hand house transactions are much less. Take Beijing for instance, according to Beijing Real Estate Bureau report, in 2006, second hand house transactions in Beijing are just about 100 thousand sets, and this number is not commensurate with about 3 million sets housing stock at that period. 6.4 Control land supply According to the statistic data from China National Price Bureau, China land price takes up about 37 % of housing costs. Not only to China, but also to all other countries in the world, land is a kind of unregenerate rare resource. China has one of the biggest populations in the world, which makes land resource more precious. Land is rare and precious, thus we can t sell land cheaply 47

48 without any limitation, but if land price is too high, it will add more burdens to developers costs, and affect housing price. So a proper balance should be found. The measure is to increase land price. In Nov 2006, China Finance Ministry, China National Land Resource Ministry united with China Central Bank published an announcement, saying that since Jan 1 st 2007, prices for new construction land will be doubled. This is to cool down the overheated real estate development and investment. The second measure is to charge unused land fees. According to a new rule published by China National Land Resources Ministry in June 2006, after obtaining the right to use land, enterprises shall set about developing it in time. No enterprise is allowed to leave the land unused or uncultivated. Whereas a land is left unused for one year, the investor shall pay land unused fee and begin construction and complete within certain periods. If the land is left unused for two years, with the approval of original organization, the government is entitled to call in the land gratis. For those land that have begun construction but development areas are less than one third, or invested capital is less than one fourth, and pause construction for more than one year without permissions, apply to the same rule as land left unused. This is to make full use the land resource and prevent some real estate developers stock too much land. On the other hand, controlling land supply has drawbacks. Instead of having an effect on controlling fast increasing housing prices, controlling land supply will tend to push housing prices to increase furthermore because of the expectation that available housing supply in the future might decrease. At the same time, limited land supply will push bidding land price to increase, though local government gain more profits from land transferring, yet real estate developers will transfer the increased land cost to housing prices, which will make housing prices rise more. 6.5 Strengthen tax system Real estate tax can be divided into tax during development, tax during real estate trading process and tax when keeping real estate. Some tax can also all or partly be transferred, thus having little effect on housing price. Increased development tax will increase development costs and push housing price to rise. Increase real estate trading tax, for instance, contract tax will decrease demand for housing, and push housing price to drop. Increase sellers rate, for instance, land value-added tax will push housing price to rise. In June 2006, China National Tax Bureau published two important announcements: The first one is: Since June 1 st 2006, full operation taxes are imposed to those houses that are traded within 5 years since the houses are bought, operation tax will be charged based on the full selling price during the trade. To the houses that are traded 5 years after the houses are bought, operation taxes will be charged based on the selling profits. The second one is: Since August 1 st 2006, individual income tax will be charged when secondhand houses are transferred, and the tax rate will be 20%. The above two methods are designed to control speculations in real estate market. At present, taxes are mainly on real estate transactions, while there are no taxes on keeping real 48

49 estate, but China central government has begun to consider imposing tax on keeping houses that areas are more than 120 m2, by increasing the costs of keeping big apartments, it will lead to reasonable housing consumption. Now the tax is under discussion. Meanwhile, to shorten the wealth difference between the rich and poor, improve individual income tax system will be necessary. According to the announcement given by China National Tax Bureau, detailed methods on how to calculate individual income tax on those people whose yearly income are more than 120 thousand have been published Shorten wealth gap between the poor and rich. According to the data from U.N., China Geordie coefficient at the beginning of 1980s was 0.29, which showed China at that time was the second equitable country in the world. However, China Geordie coefficient jumped up to 0.47 in 2003, which showed China was the second least equitable country in the world. Normally, the international precaution line for social inequity is when Geordie coefficient reached 0.45, but according to the data from China National Statistic Bureau, current China Geordie coefficient has already reached Huge wealth gap has led to a lot of problems to real estate market and the whole society, which made it urgent to shorten wealth gap nowadays. There are several measures which can shorten the wealth gap. Firstly, to develop the economy is the necessary way to shorten wealth gap.no country can get rid of wealth gap by decreasing economy development speed, quite the contrary, the country has to develop, and then try to shorten wealth gap by means of tax and transfer payment etc. Secondly, to improve more private economies can help shorten wealth gap. Most people think private economy development will broaden wealth gap, but actually private economies can encourage competition, produce more job opportunity, and lower rent-seeking possibility. More competition will make enterprises profits become more reasonable, and more job opportunity will increase workers income. Government policy will also affect wealth gap. The higher percentage that medical and education spending take up in GDP, the lower the Geordie coefficient will be. So increase public expending and improve social welfare can lower poor people s living cost. Fourthly, it is very important to cure local government corruption and bribe. Rent-setting and rent-seeking make local government officers very rich, but common people s basic rights are destroyed, which lead to education and job opportunity unequal, and also make income and capital distribution unbalanced. Next one is to strengthen tax policies to adjust income distribution inequity. We should change the current situation that normal workers are the main body of tax paying. Improve the consumption tax rate imposed on high standard private car, luxury acoustics and other luxury goods. 32 Liu, Hui (2006), Improvement of tax system of real estate in China, Journal of Guangxi University of Finance and economics, vol.1 49

50 The last measure is to build up a more equitable social environment. It is very important to make sure all the people have the equal right to get access to land resource, information resource, and power resource. Build up an equitable and justice market environment is quite important. 6.7 Strengthen legal system Housing price is not only an economic issue, but also reflect social, policy and system problems. Market economy has not yet been fully constructed in China currently. The three leading power in market economy is competition, equality and legal system. Market economy call for perfect competition, but perfect competition needs the condition that each competitive actor are equal, which means every market actor could equally get access to all kinds of information and resource, and there should not be any hidden rule, black box operations or bribery etc. How to ensure fully equality? Legal system. But in China today the legal system is not so advanced Marketization real estate development. We should admit that China s real estate market is a very special market that is affected by government actions and policies. In the aspect of housing supply, government controlled the land and credit, so it is the government who controlled the housing supply. In the aspect of demand, government demolish houses in cities and speed up urbanization process, thus produce huge demand for housing, also the housing loan credit in banks made such huge demand have necessary capital support. Obviously, if a powerful authority can control both demand and supply for housing, housing prices will be affected greatly. Also because of all kinds of drawbacks in land regulations, policies and management, and there is no equitable and transparent land market, so from the beginning housing price has the possibility to be distorted. Measures should be taken to increase transparency in land transferring, and also realize marketization of real estate development, including land supply and capital supply Increase information transparency Whether or not a real estate developer can control housing price not only depend on the scale of the real estate company, but also depend on developers ability to control information. Information monopoly is a very important characteristic about present real estate market. Asymmetric information not only lies between consumers and developers, but also lies between developers and local government. If there is no information asymmetric, and market future is foreseeable, people in the market will act more rationally. But now the fact is that asymmetric information makes people have no idea of what housing price will be look like in the future. Authority information in real estate market is public product, and government and related authorities should be responsible to provide more reliable information and increase the transparency in real estate market. Transparency includes land transferring information, housing costs information, etc. In Sept 2006, China State Council published an announcement named Rules on the Agreement-based Assignment of State-owned Land Use Right. This document was designed to adjust land supply and manage land transfer process. After that, a lot more politicians who are related to real estate bride were discovered and put to prison. Actually year 2006 is a turning point, at which real estate market is not only the object of national macro economy adjustment, but also 50

51 an important front for anti-bride Improve examination and check up system. Firstly, set up special examination and check up department to check the source of rich people huge sudden income to tell if the income is legal. We should protect the income made by hard working, but the income made by power and bribe should be thoroughly examined and confiscated. Secondly, speed up the construction of democracy, advance anti-corruption, check up commercial bribe, and make sure local government carry out central government policy seriously. Thirdly, improve real estate statistic and information disclosure systems, and prevent real estate developers release false information to the public. 6.8 Strengthen financial system Tighten up bank loan China has increased deposit reserve requirement 33 in bank for three times within Required reservation is one of the traditional monetary policy tools. Increasing reserve ratio can freeze commercial bank capital, and prevent bank loan from increasing too fast. On Nov 15 th 2006, reserve ratio in China commercial banks has been increased by 0.5 percent point for a third time. Nowadays it will be more difficult for developers and individuals to get loan from banks. Banks will examine developers and individuals credit more carefully, trying to cure overheated real estate investment and prevent the precaution bubble from growing into big dangerous one Increase principal proportion In China, for a long time, the buyer just need to pay 20% of the total selling price at the beginning when buying a new apartment, the rest 80% will be supported by banking mortgage loan. People can choose to reimburse the loan within 10, 20 or 30 years. But since June 1 st 2006, China Central Bank announced that from then on the principal proportion should not be lower than 30% of the housing price if the houses are more than 90 m 2. But the self-using apartment whose construction areas are below 90 m 2 would still apply to the old 20% rule. This will decrease financial risks for banks. Also decrease the demand for big apartment and encourage people to buy small apartment. And prevent more real estate speculations as well Increase interest rate successively On Oct 29 th 2004, China Central Bank decided to increase lending and deposit benchmark interest rate, broaden RMB lending interest rate floating range, and allow RMB deposit interest rate to flow downward. One-year deposit benchmark interest rate was increased from 1.98% to 2.25%; one-year lending benchmark interest rate was increased from 5.31% to 5.58%. All other interest rates were increased at the same time. Since Oct 29 th 2004 up to now, China has increased interest rate for 4 33 More detailed explanation for deposit reserve requirement can be found in Appendix 1 51

52 times, medium and long term loan interest rate has increased for about 1.8%. This is the first time that China has increased bank deposit interest rate since From 1996 to 2002, China has decreased bank interest rate for eight times, which is rare in history. In late April 2006, China Central Bank raised the benchmark one-year lending rate to 5.85% from 5.58%, in response to the faster-than-expected economic growth of 10.3% in the first quarter, but it kept bank deposit rates unchanged. Currently there are two kinds of opinions about increasing the interest rate: one is to say increasing interest rate will limit demand for housing, and therefore effectively control housing prices; another opinion is that real estate developers will transfer the increased financing costs to consumers anyway, and therefore push housing prices to increase more. When analyzing the effects of increasing interest rate, we shall notice the following factors: 1. Increasing interest rate will prevent loans from increasing too fast, and cool down the overheated real estate investment, but on the other hand, increasing interest rate will induce people to give back loan capital in advance, and also limited demand for housing and other merchandises consumed. After interest rate was increased, postponed buying houses, squeezed banking loan become the choice of most people. To those who already bought houses are not happy to hear that interest rate has been increased since they need to pay more mortgage loan afterwards. 2. Increasing interest rate might furthermore strengthen the expectation of RMB appreciations, which will attract more foreign capitals to China real estate market. If the international hot money wants to realize the profits caused by RMB appreciations, in short time there will be more speculation demand for housing in China, which might lead housing price to increase, or at least offset the effects that demand for housing decreased because of high interest rate. And the final effects will be no big difference in housing prices, and make the policy of increasing interest rate lose its effect. Since Dec 2006, foreign banks began to deal with RMB business in China. Under such circumstances, China government increase interest rate might have less effect on control housing prices, since people can go to foreign banks to borrow money. 3. Frankly speaking, the measure of increasing housing mortgage loan interest rate is very risky since the degree is very difficult to control. In simple way, the risk is like this: if interest rate increasing degree was too little, this measure will have little effects. But if interest rate was increased too much, then China will have the risk to experience the crisis that real estate bubbles might burst just like Japan in Under the circumstances that the public have weak psychology condition, all kinds of policy changed will have unpredictable effects on housing prices. Increasing interest rate, some famous government authority and economists foretell etc all will have butterfly effect, which add more unpredictable factors to real estate market future and China macro economy. However, increasing interest rate is still a very important signal to show tightening monetary policy is imposed anyway. 52

53 Table 6 History of the interest rate changes in China commercial banks Time Deposit yearly interest rate (±) Loan yearly interest rate (±) May 15 th % +2.18% July 11 th 1993 Keep value for fixed account that are more than 3 years longer Jan 1 st % +0.24% May 1 st % -0.75% Aug 23 rd % -1.2% Oct 23 rd % -1.5% Mar 25 th % -0.6% July 1 st % -1.12% Dec 7 th % -0.5% June 10 th % -0.75% Feb 21 st % -0.5% (+: increase ; --: decrease) (Source: The Peoples Bank of China webpage) Strengthen credit control, increase proportion of developers own capital The presale mode is popular in China, which also means real estate developers almost don t need to take any development risks, and stimulate new speculation capitals rush into real estate sector. Also the marginal profit rate in real estate sector is much more than the marginal profit rate in other sectors, which helps to gather more capital in real estate sector. We have to solve the current problem caused by the fact that real estate developers rely so much on bank capitals, expand new financing channels for real estate companies while tight up credit loans that real estate companies can get from banks. By doing this, risks that are accumulated in banks can be decentralized. In many foreign developed countries, their real estate market is matured, and real estate developers have a lot of ways to accumulate investment capitals besides bank loans, including real estate investment funds, trusts etc. and banks loans just take up less than 40% of the capitals that real estate investment and development needs. However, in China, things are quite opposite. When it comes to the capitals, besides the self-owning capital that real estate developers have, all the other capital comes from the banks. Currently, more than 60% of real estate development capitals are from bank loans. In some real estate companies, more than 75% of the capitals come from the banks 34. System should be strengthened that banks are not allowed to give loans to real estate developers whose own capital is less than 35%, so to strengthen real estate development credit condition, and prevent developers stock land and houses by taking advantage of loans from banks. 34 Li, Xia (2003), Analyses of the circulating funds situation and ways of the real estate development enterprises in our country,journal of Henan Social Sciences, 2003, Vol. 6 53

54 While the best solution is to improve direct financing in market, which make developers directly take the risks come with market financing channels. For instance, issue stocks in market, issue company bonds, real estate investment funds and trusts. Also those commercial houses that have been vacant for more than three years are not allowed to be credit mortgage Control consumption credit There are big leaks in China financial system, especially when it comes to the risk management when deciding credit loans. Huge amount of capital rushed into real estate sector, which helps housing price to increase furthermore. Government imposed a lot of policies to control consumption credit, including impose real name system when buying and selling houses, charge high tax to people who bought a second house, all the banks increased principal proportion and mortgage interest rate, and shorten the required time period of giving back the loan. For instance, China Construction Bank has increased the mortgage loan interest rate up to 6.33% to the loans which are more than 5 years old. To carry out those policies more smoothly, the People s Bank of China is now busy preparing to build a database system, which can connect the data information between different banks, so to improve information transparency, and prevent people from taking advantage of in-transparency information between different banks and bought one house by using the mortgage loan provided by one bank, and then bought another house by using the loan provided by another bank Control international capital especially international hot money Firstly, impose foreign capital approving and check-up policy: In July 24 th 2006, China Construction Ministry published an announcement, saying that it s time to impose approving and authorising system to foreign capitals in real estate market. National citizens treatment will be imposed to foreign capital real estate companies. Real-name registration system will be imposed to institute or individuals abroad who buy houses in China. Secondly, strengthen financial management Another main reason why huge foreign capital flow into China is the financial system in China is imperfect. Just because huge amount of small and medium sized enterprises lack enough financing methods at home, they have to turn to foreign capital for help. So speed up China financial system innovation is quite urgent, eg, improve company bond market, and improve stock market etc. For a long time, China only focus on capital outflow management, while neglect capital inflow management. Billions of hot money flowed into China in a short time without being noticed showed that big problems or leak lie in China foreign exchange policies and management 35. In Sept.2006, China National Foreign Capital Administration Bureau united with China National Construction Ministry published an announcement named <Circular on some issues concerning the foreign capital administration in the real estate market>. This announcement is designed to restrict foreign capital within certain limits. In order to make hot money give up hitting RMB, the key point is to kill the expectation of further RMB appreciation. After a lot of macro policies 35 Wang, Jun (2004), International hot money s impact for our country s economy and countermeasure, Journal of Hainan Finance, 2004, vol.7 54

55 designed to control housing price were imposed in the first and second quarter of 2006, hot money seemed begin to flow out of China, which is a great turning point in China foreign capital market situation. Thirdly is to impose Tobin tax. Tobin tax is a tax imposed on currency speculation, once per transaction. The idea and name came from James Tobin, a Nobel laureate economist. The purpose is to deter volatile short-term or overnight trading and its destabilizing effect on country currencies, restoring national ability to control its own currency. The proposed tiny percentage tax would only be imposed on speculative transactions. To effectively reduce volume, the tax percentage must be large enough to make overnight speculation unprofitable. Proposals range from 0.1% to 0.5% per transaction. Longer-term investments occur less often, so would not be adversely affected by this small tax, and the overall remaining volume would be enough to create sizable revenue. Those who are for Tobin tax think this policy can successfully nick international hot money by increasing transaction costs when it flowed in and out. Of course Tobin tax will also increase normal investment and transaction costs, but if arranged by proper system, for instance, return tax to those that have a stable capital accounting at a certain long period, speculations can be stabilized. Yet in reality, there are still some difficulties when it comes to charge Tobin tax 36. Only when all countries of the world began to carry out Tobin tax policy, will this policy be effective to control international speculations. If there are only several countries carry out this policy, capital will tend to flow into other countries, and bring side-effects to taxation country. In reality, Tobin tax can t be as effective as it is supposed to be. Once central bank began this policy, it will never want to cancel this policy to maintain certain profits. Also since the purpose of Tobin tax is not to increase government fiscal income, or to realize social equality, thus we can t restrict Tobin tax to a accurate tax rate, but have to be changed according to local real estate market situation quite often, thus also increasing the difficulties to carry out this policy in reality Stabilize RMB exchange rate We must notice that China can appreciate RMB to solve the problem of international trading surplus, but the appreciation degree can t be so high. There are three reasons: 1. Export enterprises need to apply to floating exchange rate, meanwhile government have to consider about employment problems. 2. Bank system also needs to get familiar with new exchange system, and it takes time to provide the market with new tools to protect national currency against foreign exchange risks 3. Keep RMB exchange rate stable will help China to continue to be a strong position in international trading negotiation. 36 Chen, Y.Q.(2005), Tobin tax and improvement of capital flow management in China, Journal of Hainan Finance, 2005, Vol. 4 55

56 Since there are huge relationship between export and exchange rate, China government has changed export tax rate several times, with the purpose to increase domestic company s product costs, so as to further control the speed of export and thus balance international trading and exchange rate. However, these could not solve the problem in an essential way. The radical solution is to expand domestic demand and consumption. Generally, there are two main reasons that can affect domestic demand: people s disposable income; social security system that affect people s sense of safety for the future. In this sense, to improve China social security system is a vital task concerned about whole country s future. Moreover, the government should reduce the promotion policies that encourage foreign capital inflow directly, and apply the same tax policy; credit policy and environment help policy to both Chinese enterprises and foreign capital enterprises. The policy that designed to encourage more export should also be adjusted, so as to reduce international trading surplus. 6.9 Strengthen social security system According to the data from China National Statistic Bureau, China households deposits in banks have exceeded 6 trillion yuan since After that, the deposits has kept increasing, and reached 14 trillion yuan by Why China has the highest deposit amount but the domestic demand for consumptions are so limited? Main reason is that most China people are not so sure about future because of the imperfect social security system. To most families, housing, children education, medical treatment are the main burdens at present, which directly affect people s real consumption power. By estimation, currently in China it will at least cost a family about 250 thousand yuan since a child was born until he finished university. Most peasants have to run into huge debt if their child needs to be supported to go to university. Unlike other countries like Sweden, education and medical treatment in China are not free. Instead, people need to pay much money for it. Along with thorough innovation, especially medical and education innovations, and a series of new financial policies, for instance, improving basic living insurance and the lowest salary level, improving social relief system, unemployment insurance system, and old age provision system, consumers will have a more optimistic and stable expectation for future spending. By then, domestic consumption will increase and the current high deposit rate will slowly decrease. And once domestic demand and consumption are increased, China economy development no longer needs to rely so much on export, RMB exchange rate can be stabilized. More domestic consumption will not only activate market economy, but also decrease bank deposit rate, thus reducing possible financial problems Broaden investment ways The fact that investment ways are limited in China is one of main reasons that caused huge amount of capital to rush into the real estate sector. Policies should be imposed to furthermore rebuild small and medium investors confidence to stock market; recover stamps collections and other antiques attraction to appeal more social capitals. Lower the standard to open private 56

57 business, and encourage more private business and companies, to prevent all the money stuck in real estate Change expectations Shaoluos pointed out in his article a un-equilibrium market that in real estate market, housing price and cost are not independent. The so called equilibrium price which is determined by housing supply and demand is just a relative equilibrium in static state when the market s expectation or to say the people s expectation conform with the basic situation. Actually the fact is not like that. The real fact is that once people have formed certain popular and common expectation for housing price in market, both housing supply and demand will be affected dramatically. Market power can t really decide how expectation and basic price will change. Wrong expectation for the future might bring housing price return to the basic price level, and can also lead housing price deviate much more away from its basic price. Since expectations can be led by man-made and faked market information, therefore it might be very dangerous. That partly explained why currently there are so many real estate developers and media keep shouting that housing price will continue to increase more. If most people believe that housing price will keep increasing in the future, they will all rush to buy houses, and once there is too much demand for housing than supply, housing price will increase, and this will furthermore confirm people s blindly optimistic expectation for future housing price to increase more. Since this kind of demand is illusive, when finally people found out that future housing prices are not like what they had expected, housing price will drop down. So in some sense, under market economy, it is market expectation and people s psychology changes that determine market behavior and condition, and furthermore determine housing prices. Therefore it is vital important to change people blindly optimistic expectation for future housing price increasing. It is very dangerous if all the people definitely think investing in real estate will bring about great profitable return. Real estate is a kind of consumable, and shouldn t be the main investment of all the people. If large amount of people who bought houses are to speculate, or to say their purpose is only to sell the house at a later time to make money, then there will be risk of bubbles. Take Hongkong for an example. Since Asian financial crisis in 1997, housing prices in Hongkong have decreased a lot, but during the whole process, no matter the amount of housing available, population in society, or social income level, none of which have big changes, then what on earth is the main reason that has led to such huge change in housing prices? The answer is people s expectation. Actually now almost all the macro policies and measures that have taken in China currently more or less aimed at changing people s expectation for future, since expectation is a most powerful and key factor. 57

58 7 Final analysis and Conclusions Since 2003, China s housing prices have been roaring in almost all big cities. There are a lot of reasons which can explain why housing prices can increase so much. Yet there still exist many factors that showed that so high housing prices are unreasonable and have not enough fundamental economy support. High housing prices have aroused a lot of complaint. At the same time, the debate that whether there are real estate bubbles in China behind so high housing prices has become a hotspot both in China and internationally. Though currently a lot of key statistic data and standard index are not available in China, yet a lot of facts still can t be ignored: high housing price-to-rent ratio huge amount of vacant houses most normal people in big cities can t afford houses, a lot of irrational housing purchase behavior, huge amount of housing speculations etc. Strictly speaking, nobody can exactly for sure tell if there are bubbles or not until bubbles burst at last. Also because of butterfly effect 37, it is also impossible to predict how China high housing prices may end up in the future, especially when a lot of policies and measures are taken one after another, and when nowadays everything is different from what has used to be and what has happened in history. In an accurate sense, only time can tell where China s housing market is heading, and if housing prices in China will keep climbing or fall back to the ground. Anyway, after so much analysis, based on the limited data and investigation results, we think behind the high housing prices, there are real estate bubbles. And we think that definitely not every city in China has real estate bubbles. The bubbles mostly exist in big cities like Shanghai, Beijing etc. We based our conclusion mostly on the following two phenomena: 1) The main characteristic of these bubble cities is that lots of speculation exist, which means people bought the houses with the only hope to sell them out at a later time point, and they believe that what they paid for the house can be earned back when later they sell it out at an even higher price to bigger fools. This is a typical kind of bigger fool bubble. As we have analyzed before, speculation to sell to bigger fools are very popular in most cites. 2) Under the instruction of the ill and faked market information due to imperfect market economy system, people can t get access to the real information, and are easily to have irrational expectations for the future, and this is another typical type of bubble which is caused mainly by irrational expectations. We found this type of bubble is also very common in most big cities. 37 More detailed explanation for butterfly effect can be found in Appendix 1 58

59 Fortunately, a lucky finding is that currently the real estate bubbles in most China big cities are not so big, and of course have not been so serious to reach the dangerous degree that almost ready to burst. However, huge attention should be put on it to prevent bubbles from growing bigger and spread to small cities and areas, and to prevent possible financial and social disaster to the whole society. For the sake of making China a more harmony country, it is also absolutely vital that China central government should do something to control housing prices. Of course considering the huge population in China and relatively limited land resource, it is impossible for every Chinese to afford a comfortable apartment within several years in the future, yet to make housing prices no longer a common pain for most common people is necessary and possible. Up to now, China s central government has already taken a lot of macro policies and measures to control housing price, cool down overheated real estate sector and cure real estate bubbles before they grow bigger and burst. We can t say all the policies are hundred percent perfect and effective, yet it is a sign that China government already put great emphasis on the high housing prices and try best to cure it. To some extent, whether or not the current real estate bubbles can be controlled or not is more meaningful than the development of real estate sector and whole China economy itself. Instead, to moderate too high housing prices is a vital task and test in front of China government, and it is a matter concerned the future of whole China. We believe that under the lead of China s government, with powerful persistence and determination, it will be possible to squeeze out the illusive speculation demand for housing, perfect market economy, more normal demand will be led into market. The young real estate sector in China will realize the goal of develop in a more sustainable way. 59

60 References Chai, Qiang (2005), Several theoretical problem which affect housing price, Journal of Beijing Institute of Civil Engineering and Architecture, 2005, Vol.2 Chen, Y.Q.(2005), Tobin tax and improvement of capital flow management in China, Journal of Hainan Finance, 2005, Vol. 4 Fan, Liangliang and Liu, Hongyu (2005), Econometrical Analysis of Factors Affecting Homeownership Rate of Urban Resident in China, Journal of Shenyang Jianzhu University Natural Science, 2005, Vol. 4 Guang, Qingyou (2006), Only one step between excess liquidity and inflation, Journal of Hainan Finance, 2006, Vol. 5 Huang,Yichao (2005), Develop the visual economy to enhance the ability against the hits by international shifting capitals, Journal of Xinjiang Normal University, 2005, Vol. 2 Li, Hongkun (2005), Effect of Hot Money Inflow and the Prevention Policies,Journal of Statistical Research, 2005, Vol. 11 Li, Tao and Wu, Jianping (2004), Discussion of real estate bubble causes and precautions, Journal of Shangdong University of Technology,2004, Vol. 2 Li, Xia (2003), Analyses of the circulating funds situation and ways of the real estate development enterprises in our country,journal of Henan Social Sciences, 2003, Vol. 6 Lind, Hans (1998), Bubblor och beslutsunderlag: Fastighetsvärderingar under boomen , Ekonomisk Debatt, 26 (1), Liu, Dang and Zhang, Liang (2004), Mechanism and Regional Characteristics of Economy Bubble in China Real Estate Industry, Journal of Chongqing Jianzhu University, 2004, vol. 4 Liu, Hui (2006), Improvement of tax system of real estate in China, Journal of Guangxi University of Finance and economics, vol.1 Lu, Huimin and Mei, Sen (2004), The analysis of real estate financing channels, Journal of construction management modernization 2004, vol.5 Miao, Tianqing (2004), The game of rent seeking in China s city land lease, Journal of Commercial Research,2004, vol.11 60

61 Niu, Fengrui (2005), Rural Modernization and Urbanization in China, Journal of Shenzhen Science&Technology, 2005, vol.12 Stiglitz, Joseph E. (2005): Symposium on bubbles, Standford University, USA Wang, Jun (2004), International hot money s impact for our country s economy and countermeasure, Journal of Hainan Finance, 2004, vol.7 Xiao, B. (2005, Spring), Eight measures from China State Department to control house price, Jinhua Times Xing, Mengjun (2005), Analyzing on the relationship of playing chess between local government and central government during the period of society s transformation, Journal of Tribune of Study, 2004, vol.11 Xu, D. Q. (2006), Housing price and bubble economy : China Machine Press Xu, Jingyong (2002), Practical Thought on Rural Population Urbanization, Journal of Fujian Provincial Committee Party School of CPC, 2002, vol.10 Zhang, Hui (2006), Looking at China's income distribution from Geordie coefficient, Journal of Special Zone Econom, 2006, vol.9 INTERNET Website of Beijing Municipal Bureau of Statistic URL: Website of China Central Government URL: Website of China Construction Ministry URL: Website of China National Statistic Bureau URL: Website of Soufang real estate URL: 61

62 Appendix 1 Definitions Hot money: or floating capital, or refugee capital, is the money that is moved by its owner quickly from one form of investment to another, as to take advantage of changing international exchange rates or gain high short-term returns on investments. Its main characteristics are short term, arbitrage and speculation of foreign currency. Just because of hot money, Asian financial crisis could be so serious that almost break down all southeast countries financial systems in Geordie coefficient: This coefficient is used to measure income distribution difference. If the coefficient is less than 0.2, we think it social equity; if the coefficient is more than 0.6, we think it highly inequality. And 0.4 is the precaution level point. Welfare oriented public house Until 1999, most of people in China s urban area had lived under the welfare housing system in which the government provided nearly free housing for urban residents. All employees that work in state-owned companies received allocated housing from the government or their company. Commercial residential building Through permission Real Estate Company builds the house for selling in the market. Economic affordable house Economic affordable house is the commercial house that is supposed to sell to low-income households with little profit. This idea was first showed up in No.23 document published by State Council in This document pointed out that from 1998, China began to carry out national housing distribution system innovation. Cancel welfare oriented public housing system. Build up new housing supply system. New housing supply system includes three parts: 1.Encourage high-income household to buy or rent commercial houses; 2.provide low-income household with economic affordable houses; 3.provide the lowest income household with low rent house. Deposit reserve requirement: or deposit reserve ratio, refers to the legal amount of money and liquid assets that financial institutions are required to hold in cash or on deposit, usually a specified percentage of their demand deposits and time deposits. People s Bank of China (PBOC), China Central bank can affect financial institutions credit ability and money supply by adjusting required reserves rate. Butterfly effect: A name given to the extreme sensitivity of chaotic systems, in which small changes or perturbations lead to drastically different outcomes. A common example of this phenomenon is a butterfly flapping its wings in California, and thereby initiating a change in weather patterns that results in the formation of a thunderstorm in Nebraska. 62

63 Appendix 2 Policy documents The document of The Eight Measures is: (published at ) 1. Pay more attention on the stabilization of house price. 2. Government should take on the duty of stabilizing the house price. 3. Modify the structure of house and land supply. Increase the supply of normal commercial house and the land for economical house. 4. Control the passive demand of house, mainly control the amount of demolition of old house and move of residents. 5. Lead the rational consumption of house of civilians. 6. Survey the running of real estate market roundly. 7. Carry out the real estate policies actively. 8. Execute the supervision and inspection carefully. The document of New Eight Measures is: (published at ) 1. Strengthen macro-adjustment, control urban planning and improve commercial house structure. 2. Strengthen macro-adjustment and control to land supply. Put more attention on land management. 3. Strengthen macro-adjustment and control to the price of commercial houses and economic affordable houses. Make sure the effective supply of low price housing and medium-and-small-sized housing. 4. Improve Urban Subsidized Housing system for Families with the Lowest Income and assure their basic living demand. 5. Make full use of tax and other economic measures to adjust real estate market. Especially strengthen adjustment to real estate transactions. 6. Strengthen financial supervision. 7. Rectify and regulate the order of market economy. 8. Strengthen market supervision. Improve market information disclosure system. The document of Six Measures is: (published at ) 1. Adjust housing supply structure. Focus on the development of low or medium price housing, small or medium sized commercial housing, economic affordable housing and low rent housing. Locally formulate and carry out housing construction layouts, in which, for newly built houses, the concrete proportions of each type should be indicated. 2. Further exert the control effect made by tax, credit and land policy. Strictly carry out policies on housing development and sale; improve tax policy on housing transfer; separately fit the credit policy for different cases, and adjust housing demand. Scientifically plan the supply of land for real estate development, strengthen the supervision of land use, prevent land hoarding for speculation. 3. Control the speed and scale of urban housing demolition and relocation. Slow down the increase rate of passive demand for housing. 4. Further regulate real estate market. Strengthen supervision to real estate development process. Prevent deeds of changing project without approval, illegal transaction, stocking up housing 63

64 supply and inflating house prices. 5. Speed up low rent urban houses construction. Develop economic affordable housing, second-hand housing and rent market. Gradually solve the housing difficulties in low-income families. 6. Improve real estate statistic system and information disclosure system. Enhance transparency of real estate market information; publish market supply and demand information comprehensively, promptly and accurately. Adhere to right orientation of public opinion. 64