An Analysis of the Bubble in the Shanghai Housing Market

Transcription

1 Department of Real Estate and Construction Management Division of Building and Real Estate Economic. Royal Institute of Technology Master of Science Thesis 397 An Analysis of the Bubble in the Shanghai Housing Market Author: Lou Kai Supervisor: Professor Hans Lind Stockholm 2007

2 Master of Science thesis Title: An Analysis of the Bubble in the Shanghai Housing Market Author Lou Kai Department Department of Real Estate & Construction Management Division of Building and Real Estate Economics Master Thesis number 397 Supervisor Professor Hans Lind Keywords Bubble, Real Estate, Housing, Shanghai Abstract The Shanghai real estate sector has entered a prosperous stage since the start of the 21 st century; the proportion of the added value of real estate sector in GDP has risen from 5.5% in 2000 to 8.4% in As the underpinning industry of the Shanghai economy, the real estate sector is vital. But since 2003, housing sales witnessed rapid price growth for years. Especially in the first quarter of 2005, the growth of housing price has reached the surprising rate of 19.1%. Much concern has arisen on the real estate sector with more insiders and outsiders on the topic of bubble phenomena. Although the phenomenon are caused by many rational factors such as the urbanization, large number of population, policy and finance influence, undeveloped capital market, market expectation and so on, there s still quite a lot of doubt if the bubble really exists in the real estate market, especially the housing market. Based on the information from National Bureau of Statistics of China, Shanghai s Bureau of Statistics etc, and an in-depth market investigation, this paper analyzed Shanghai s real estate market s general development and investigates whether there is a real estate bubble in housing market and concludes that there was a bubble in past few years, especially in

3 Acknowledgement I would like to thank my supervisor Prof. Lind, for his patient guidance, ceaseless support and encouragement during the period of my thesis project. The inspiring advice and insightful criticism from Prof. Lind are extremely essential and valuable in my research and my thesis. This dissertation could not be completed without his effort. I wish to express my sincere gratitude to him. In addition, my special thanks must go to my family who has given me the greatest support, understanding and encouragement, so that I can keep concentrated on my study. 2

4 Contents Abstract 1 Acknowledgement 2 1 Introduction Background Purpose Method Disposition The development of Shanghai real estate market Introduction of Shanghai The situation of Shanghai real estate market Investment Construction Second-hand housing market EAV Living condition Bubble theories Definition of bubble Cause of real estate bubble Expectation Psychology Speculation Development of real estate bubble The end of real estate bubble Absorption Transformation How to identify real estate bubble Traditional economical theory

5 3.5.2 Indicators US housing bubble in history Weather bubble exists or not in Shanghai real estate market Rational factors Demand in Shanghai real estate market Supply in Shanghai real estate market The debate of bubble in Shanghai real estate market Positive viewpoint Negative viewpoint Discussion about the debate of bubble Discussion about positive viewpoint Discussion about negative viewpoint The proof of bubble in Shanghai housing market Price-to-income ratio Growth rate of housing price to GDP growth rate Summary Why bubble exists in Shanghai housing market Policy inertia Financial pitfalls Undeveloped capital market International influence Market expectation Conclusion 57 Reference 58 4

6 1. Introduction 1.1 Background Over the last two decades, China has achieved rapid economic growth, accompanied by rapid development of the real estate market. Although the Asian financial crisis damaged the real estate markets in Southeast and East Asia, it had little impact on the real estate markets in Shanghai. As a result of rapid economic growth and urbanization, demand for urban land and new dwellings have increased accordingly, leading to the sustained growth of real estate prices. The rapid increase of Shanghai real estate price over the past several years has raised concerns about the existence of a speculative bubble in this asset market. Indeed, real estate price have been rising rampantly. Since 1995, real estate price has increased around 18% annually, roughly double the increase of previous real estate price booms in the late 1970s and late 1980s. Moreover, real estate price continued to raise strongly during the 2001 recession, the sluggish recovery through mid-2003, and from the 2004 even more rapid growth. 1.2 Purpose As the underpinning industry of the Shanghai economy, the real estate sector is vital. The possibility of a bubble is crucial because the economy will be harmed once bubble bursts. Bubble bursts in the Japanese real estate market in late 1980s led to a ten-year depression of its economy. Bubble brought by financial crisis in 1997 made great negative impact on South-east Asia. Shanghai housing market is experiencing a likely bubble; this thesis is made to ascertain if the growing price is caused by rational fundamentals as well as measure if a bubble exists or not in the past few years. 1.3 Method This thesis paper analyze with economical theories mainly on Shanghai housing bubble instead of the entire Shanghai real estate bubble. The process of analysis is 5

7 based on macro economy of Shanghai. There is neither comparison of housing in different districts nor micro perspective such as analysis from enterprise, building or consumer perspective. The method is mainly with theoretical analysis, quantitative analysis, qualitative analysis and indicator analysis. When discussing the situation of Shanghai real estate market, quantitative comparison analysis will be used. Then the concept of bubble will be brought out with theoretical analysis. While in the process of measuring housing bubble, quantitative analysis and indicator analysis will be further used. 1.4 Disposition By reading many related articles and referring some database, this thesis would start discussion on the real estate bubble problem, discuss the shape, the development and the bad effect of the real estate bubble and analyze the present real estate condition. Some methods would be used in order to estimate the bubble in Shanghai real estate sector. The topic is settled as below: In the first place, with the help of database from Shanghai Statistic Bureau, I state a background introduction of Shanghai s real estate market in recent ten years. Afterwards, the concept of bubble will be introduced, and the theoretical analysis of real estate bubble would be processed and the present research method about real estate bubble would be also summarized as well as the notable real estate bubble in late 1980s in the US. Further attention would be paid on the Shanghai real estate bubble mainly on the topic of Shanghai residential housing market. The thesis would focus on the supply and demand of real estate on the basis econometric theory to separate rational factors and bubble factors. Then the debate on Shanghai real estate bubble would be brought out. Several methods would be used to finally determine if a bubble really exists in the market in the past few years. Why the bubble exists in Shanghai housing market? From several aspects, such 6

8 as policy inertia, financial pitfalls, undeveloped capital market, international influence and market expectation, many reasons that cause Shanghai housing bubble will be given. In the end, as an analytic paper, I will give a brief conclusion about this thesis paper and show the areas which could be further developed. 7

9 2. The development of the Shanghai Real Estate market 2.1 Introduction of Shanghai Shanghai is in the southeast of China, facing the east sea. It was opened up in 1843 and used to be the largest port of east and Southeast Asia decades ago. In China, Shanghai is now the biggest city, largest port, the trade and financial centre and the most important cultural, industrial and commercial city. Rising from a fishing village, Shanghai is one of the four municipalities directly under the central government. Aside from Pudong New District, Shanghai has jurisdiction over 13 districts and six suburban counties. The entire administrative area of the city, including surrounding suburbs, townships and farmland, covers a total area of 6,185 square km. The total population is around 20 million, of which around ten million live in the city proper. There is a huge floating population of itinerant workers, probably numbering 3 million. It is universally regarded as the bastion of China s economy today and according to the industry respected emerging trends in real estate Asia pacific 2007 report from the Urban Land Institute and PricewaterhouseCoopers, it is one of the most exciting cities in the entire region for both property investment and development. 2.2 The situation of Shanghai real estate market Thanks to the fast development of the economy in China, Shanghai s real estate market has made remarkable progress and witnessed great-leap-forward development in all the regions of investment, construction, market transaction and economical contribution Investment The housing problem has been one of Shanghai s most serious social problems due to the huge population. The development of Shanghai s real estate investment has experienced several stages. During the preliminary stage from 1988 to 1993, Shanghai s real estate investors were paying a lot of interest to real estate investment, 8

10 which caused the ratio of real estate investment to total capital assets investment to rise. After the year 2000, for the first time the amount of investment in Shanghai s real estate market exceeded 100 billion Yuan, reaching billion Yuan, which occupied 38.1% of total capital assets investment Shanghai real estate investment (x in 100 million Yuan), Shanghai total capital assets investment (y in 100 million Yuan) and the ratio of real estate to total capital assets z (%) is shown in graph 2 1 and 2 2. investment in real estate development investment in fixed assets Graph 2 1 investment in real estate development and investment in fixed assets in many years 9

11 the ratio of investment in real estate development to investment in fixed assets Graph 2 2 the ratio of investment in real estate development to investment in fixed assets in many years Construction In 1991, the constructing and completed area of commodity housing in Shanghai were 3.2 million square meters and 1.1 million square meters respectively. These figures reached the peak in 1996 in the 1990s, and were 19 times and 11 times as much as those of There was a fall between the year 1997 and 1999 due to the diminishing amount of investment. After the year 2000, Shanghai real estate market once again got into a fast growing stage. The constructing area which maintained 10 20% growth rate kept going up all these years and reached 109 million square meters in Meanwhile the completed area was also accelerating; it reached the peak in 2004 with 34 million square meters, the growth rate was 38.2% year on year. After a small falling in 2005, it went up again in 2006 with a 6% growth rate. Hopefully it could reach a new peak in The soaring growth of sold area and price of residential building is evidence that Shanghai real estate market is developing fast. The sold area of new completed 10

12 commodity residential building in Shanghai had been going up year by year since 1995 to 2004, the average annual growth rate over 20%. In 1995, the sales area of new completed commodity residential building was 5.7 million square meters, while this figure increased by 6.1 times in ten years which reached million square meters in Sold price was also maintaining an upward trend besides small downfall in 1997 and 1999; the average annual growth rate was beyond 10%. The price of newly completed commodity residential building was 2.57 thousand Yuan per square meters in 1995 and 7.04 thousand Yuan per square meters in Constructing area of commodity housing (X in 10k m 2 ), completed area of commodity housing (Y in 10k m 2 ), sold area of commodity housing (Z in10k m 2 ) is shown in graph 2-3 and 2-4 Constructing area of commodity housing completed area of commodity housing Graph 2-3 the constructing and completed area of commodity housing in many years 11

13 completed area commodity housing sold area of commodity housing Graph 2-4 the completed and sold area of commodity housing in many years Second-hand housing market In 1996 there was only 0.82 million square meters of sold area in Shanghai second-hand housing market, while in 2004 it reached 27.3 million square meters the sold area of second-hand houses is shown as follows. Traded area of second-hand houses (X in m 2 ), traded area of residential second-hand houses (Y in m 2 ) is shown in graph

14 traded area of second-hand houses traded area of residential second-hand houses Graph 2 5 the traded area of total second-hand houses and residential second-hand houses in many years The economic added value (EAV) of real estate industry. In the past decade, the added value of real estate industry has been accelerating increasing because the fast real estate development and soaring housing prices in Shanghai. When back in 1993, EAV was merely billion Yuan and took 1.75% of GDP. But in 2004, EAV was billion Yuan and took 8.4% of GDP. These figures show clearly that real estate is playing more and more important role in the national economy. In recent two years, the EAV of real estate industry relatively decreased and the ratio was also fallen down The EVA of real estate industry in Shanghai (X in 100 million Yuan), the GDP of Shanghai (Y in 100 million Yuan), and the ratio of X to Y (Z) is shown in graph 2-6 and

15 EVA of real estate industry (100m) GDP (100m) Graph 2 6 the contrast of real estate EVA and GDP in many years ratio of real estate EAV to GDP Graph 2 7 the ratio of real estate EAV to GDP in many years Living condition People living in Shanghai could have a feeling that their housing conditions have been improving a lot. In 1992, the per capita dwelling area was merely 6.9 m 2, while this 14

16 figure has changed into 16 m 2 in Especially after 1995, the change was marvelous with the annually growth rate of per capita dwelling area of 0.7 m 2 or so. The average dwelling area (X in square meters) in urban district of Shanghai in different years is shown in graph 2-8 per capita dwelling area in urban district Graph 2 8 per capita dwelling area in urban district of Shanghai in many years. 15

17 3. Bubble theories 3.1 Definition of bubble Before discussing the existence of a bubble in Shanghai s housing market, we need to define the term firstly. The term bubble is widely used but rarely clearly defined. In its widespread use the term refers to a situation in which excessive public expectations of future price increases which cause prices to be temporarily elevated. Here we subscribe to the definition from Stiglitz (1990): If the reason the price is high today is only because investors believe that the selling price will be higher tomorrow---when fundamental factors do not seem to justify such a price---then a bubble exists. When the bubble occurs in equity markets, it is called a stock market bubble; when the bubble occurs in real estate markets, it is called a real estate market bubble; During a housing price bubble, homebuyers think that a house that they would normally consider too expensive for them is now an acceptable purchase because they will be compensated by significant further price increases. They will not need to save as much as they otherwise might, because they expert the increased value of their home to do the saving for them. First-time homebuyers may also worry during a housing bubble that if they do not buy now, they will not be able to afford a home later. Furthermore, the expectation of large price increases may have a strong impact on demand if people think that home prices are very likely to fall, and certainly not likely to fall for long, so that there is little perceived risk associated with an investment in a home. Accordingly, the key features of a bubble are that the level of prices has been bid up beyond what is consistent with underlying fundamentals and that buyers of the asset do so with the expectation of future price increases. On one hand, the increasing price 16

18 causes irrational expectation of buyers who think they can t afford the house in the near future if they don t purchase it while they can now, so that the demand for house will consequently go up. On the other hand, the soaring demand results in soaring price, which makes buyers more positive on the thinking that the price will keep rising. If expectations of rapid and steady future price increases are important motivating factors for buyers, then house prices are inherently unstable. Prices can not go up rapidly forever, and when people perceive that prices have stopped going up, this support for their acceptance of high home prices could break down. Prices could then fall as a result of diminished demand: the bubble bursts. 3.2 Cause of real estate bubble Form the economical perspective, the bubble is a phenomenon that occur while the economy is in an unbalanced condition. The cause of unbalanced economy could be various; the speculative behavior triggered by unrealistic expectations is the direct reason. Generally speaking, the causes of a real estate bubble are several, as follows: Expectation Traditional western economists believe that expectation has an impact on the demand and supply of commercial goods and to the real estate market this rule is more remarkable. First from the perspective of demand, consumers will postpone their purchase when they have expectation that the prices of commercial real estate are going down, which reduces the purchase in the market and then further reduces the demand from expectation; On the contrary, consumers will accelerate purchasing commercial real estate when they have expectation that the prices are going up, which increases the purchase and then further increases the demand from expectation. That s so called in Chinese buying up not down. Second from the perspective of supply, we can make analysis from the process of producing and organizing in real estate 17

19 enterprises. While enterprises are operating projects of real estate, based on the principle maximize the profit as well as the market situation and their capability, they draw up operating plans for projects and then carry out till the products show in the market, which makes the supply to the market. While in a real economical society, enterprises driven by profits would like to slower the supply of real estate or even consider postponing the development of real estate if they make sure that the real estate prices are going up in the future, which causes relatively shortage of supply and eventually makes real estate prices go up. Obviously from the simple analysis about the influence of supply and demand mentioned above, we could find out that when there is such expectations that the real estate prices is going up, on one hand consumers will have higher demand for real estate which stimulates the prices to go up, on the other hand with the interest of higher profits the enterprises will tend to decrease the supply which also stimulates the prices to go up. The combination of these two aspects eventually causes the real estate prices increase. That s so called self-fulfilling in economics. The prices will keep going up because this kind of price increase has no self-restraint Crowd psychology As a matter of fact, the analysis above has an important implication: crowd psychology. Crowd psychology is a theory that people usually based on the information from the others activities to make the similar decisions because of information asymmetry or difference in information identification capability. The more crowd psychology in the market, the more fiercely market prices will fluctuate, which makes a higher portion of irrational behavior in a speculative bubble Speculation Speculation is a universal behavior in the market. It refers to the behavior with prediction adjustment of some asset prices, investors with their acquired market information make adjustment on buying and selling to gain the price difference. It has 18

20 an intrinsically difference with normal investment, shows as following aspects: (1) these two have different purposes. Investment which is corresponding to actual economical growth, aims to appreciate the capital by operating of assets. Speculation which has no corresponding to actual economical growth, aims to gain the price difference of assets. (2) These two have different market performances. The behavior how long these two will hold the assets and the behavior after these two purchases the assets are totally different. Investment is long term stable and consistent, while speculation is short termed and uncertainty. (3) These two have different market risk and features. In general, investment is only influenced by the management risk which depends on manager s situation and his judgment of the market, so that the risk is relatively small. Speculation is another case; it mainly depends on speculator s subjective prediction. It has a relatively high risk which requires speculators have higher capability of predicting. Higher risk results in higher benefit, so if speculation succeeds, the benefits will way higher than investment. Different activity levels of speculation have different impacts on the growth of the economy. Appropriate speculation based on investment could have positive impact on real estate market development and macro economics growth. Appropriate speculation could boost the prosperous and activities, although it might also bring a bubble. This kind of bubble could also boost the development of real estate market and macro economics, if it is a rational bubble. While real estate speculation exceeds some level, appropriate speculation transforms into excessiveness and brings new speculation to get involved in this market, which eventually make the real estate prices soaring and later the real estate bubble will burst along with the accumulative market risk. 3.3 Development of real estate bubble In this part I will briefly discuss the principles about real estate bubble developing into a bubble economy. Real estate bubbles can stimulate consumption and investment as well as boost social demand. Complying with central bank s measures such as expanding money supply and reduces interest rate; real estate bubble could 19

21 cause the total supply going up. Real estate bubble and finance have two connections; one is that real estate prices soaring more rampantly because increasing real estate benefits bring more capital into the real estate market. The other is that real estate bubble may gradually change into a bubble economy. That will happen if investors use expanding real estate as mortgage to apply for loan to reinvest into real estate which makes more floating money in the market and eventually cause higher and higher total supply. Excessive economical bubbles could distort the allocation of resources which is harmful of social departments development. Once bubble bursts, there can be financial crisis because of a lot of bad assets afloat in the banks. In addition, the failure of government s policies is the subjective reason that real estate bubble turns into a bubble economy. Along with globalization, international financial system could make real estate bubble a new vicious circle. If the demand of one country is relatively insufficient, excessive capital will stimulate investment abroad which gives high pressure on currency appreciation. When the appreciation is over, along with a lot of capital going abroad which will cause relatively diminishing inputs of national constructing, the development of real estate market will further deteriorate. 3.4 The end of real estate bubble When real estate bubbles burst, it has a devastating impact on people. In history, the burst of bubble economy made Japan suffer over ten year s depression. Lots of bad assets, stagnating economy, soaring unemployment and unstable political situation, which caused by bubble bursts make people scary of a bubble. But in reality, a bubble is a quite usual phenomenon in economics and it is merely a small probability event that a bubble bursts. 20

22 3.4.1 Analysis on real estate bubble absorption. Real estate bubble absorption is a situation that the level of real estate bubble steps down because of the improvement of the macro economical environment, industrial environment and market environment. It implies that not only the potential real estate value increases because of the improvement of infrastructure, faster speed of industry growth and accelerating urbanization, but also the real estate bubble could decrease with more rational expectation. The soaring growth of economy as well as the improvement of macro environment will make an adjustment to the level of real estate bubble to make it go down which shows that the macro environment has an absorption function to the real estate bubble. The rationalization of industry chain and raising growth rate of industry would also have a bubble absorption function. In addition, the raising ratio of individual residence purchases is also an index to the real estate market environment improvement, because real estate bubble will decrease if this ratio goes up which is favorable for bubble absorption Analysis on real estate bubble transformation. The transform of a real estate bubble is caused by different efficiency of assets utilization. Bubble of low yield assets will increase because of the bubble decrease of high yield assets. For example, there can be some complex transformation in real estate bubble and stock bubble. If the yield of real estate market is higher than that of stock market, the level of real estate bubble will go down, and vice versa. 3.5 How to identify real estate bubble In attempting to identify whether a bubble exists or not, there are mainly two measures: one is traditional economical theory, by which could measure the level of bubble through economical theory analysis; the other is indicator, which could be one or massive indexes to reflect the situation of a real estate bubble. 21

23 3.5.1 Traditional economical theory The measure of traditional economical theory is to analyze and assess the inner value (theoretical price) of real estate and compare the figure to the market price for measuring the level of real estate bubble through some basic economical theory analysis. The key to this measure is how to get the inner value accurately. Using fixed real property to assess the real estate inner value is one of the methods. One classic tool of using this method is by capitalization of income to assess the inner value of real estate: if one purchases a real estate, from which people could get annual benefits, the present value of income flow should equal with the price cost. This method supported by classical economy theory has a very clear advantage. It could relatively reflect the base price of real estate which is described by economical theory. Tightly combined with capital investment decisions, it could also reflect the inner value of real estate. But this method also has obvious pitfalls. On one hand, it s quite hard to predict income flow of future which could be easily influenced by subjective factors. On the other hand, future s income flow itself is a random event, not as fixed or stable growing as we assumed it to be while calculating the value. In addition, valuing interest rates is an even harder case which could influence the real estate price a lot Indicators. The second measure is indicators, which are indexes relevant with real estate bubble. Many indicators can be used to evaluate whether houses in a given area are fairly valued. By comparing current levels to previous levels that have proven unsustainable in the past, we can make a guess whether a given real estate market is experiencing a bubble. There are many indicators used to measure real estate bubble, such as real estate price growth rate, land price growth rate, residence vacancy rate, price-to-income ratio and real estate growth to nominal GDP growth. Some indicators are relevant with the measure of real estate bubble, such as mortgage loan growth rate, individual income growth rate, population, number of families and so on. 22

24 Indicators describe two aspects of a housing bubble: a valuation component and a debt component. The valuation component measures how expensive houses are relative to what most people can afford, and the debt component measures how indebted households become in buying them for home or profit. (i) Housing affordability measures The price to income ratio is the basic affordability measure for housing in a given area. It is generally the ratio of medium house prices to medium class disposable incomes, expressed as a percentage or as years of income. It is sometimes compiled separately for first time buyers and termed attainability. This ratio, applied to individuals, is a basic component of mortgage lending decisions. The deposit to income ratio is the minimum requirement down payment for a typical mortgage, expressed in months or years of income. It is especially important for first-time buyers without existing house equity; if the down payment becomes too high then those buyers may find themselves "priced out" of the market. For example, as of 2004 this ratio was equal to one year of income in the UK. Another variant of this ratio measures the ratio of median family income to the income necessary to qualify for a typical mortgage or a typical house; this is what the National Association of Realtors calls the "housing affordability index" in its publications. In either case, the usefulness of this ratio in identifying a bubble is debatable; while down payments normally increase with house valuations, bank lending becomes increasingly lax during a bubble and mortgages are offered to borrowers who would not normally qualify for them. The Affordability Index measures the ratio of the actual monthly cost of the mortgage to take-home income. It is used more in the United Kingdom where nearly all mortgages are variable and pegged to bank lending rates. It offers a much more realistic measure of the ability of households to afford housing than the crude price to 23

25 income ratio. However it is more difficult to calculate, and hence the price to income ratio is still more commonly used by pundits. (ii) Housing debt measures The housing debt to income ratio or debt-service ratio is the ratio of mortgage payments to disposable income. When the ratio gets too high, households become increasingly dependent on rising property values to service their debt. A variant of this indicator measures total home ownership costs, including mortgage payments, utilities and property taxes, as a percentage of a typical household's monthly pre-tax income. The housing debt to equity ratio also called loan to value, is the ratio of the mortgage debt to the value of the underlying property; it measures financial leverage. This ratio increases when homeowners refinance and tap into their home equity through a second mortgage or home equity loan. A ratio of 1 means 100% leverage; higher than 1 means negative equity. (iii) Housing ownership and rent measures The ownership ratio is the proportion of households who own their homes as opposed to renting. It tends to rise steadily with incomes. Also, governments often enact measures such as tax cuts or subsidized financing to encourage and facilitate home ownership. If a rise in ownership is not supported by a rise in incomes, it can mean either that the buyers are taking advantages of low interest rates (which must eventually rise again as the economy heats up) or that home loans are awarded more liberally, to borrowers with poor credit. Therefore a high ownership ratio combined with an increased rate of sub-prime lending may signal higher debt levels associated with bubbles. There are several formulas for the rent measures: The price-to-earnings ratio is the common metric used to assess the relative valuation of equities. To compute the P/E ratio for the case of a rented house, divide the price of 24

26 the house by its potential earnings or net income, which is the market rent of the house minus expenses, which include maintenance and property taxes. The price-rent ratio is the average price of an owned house divided by the received rent income (if buying to let) or the estimated rent that would be paid if renting (if buying to reside). The gross rental yield, a measure used in the United Kingdom, is the total yearly gross rent divided by the house price and expressed as a percentage. The occupancy rate is the number of occupied units divided by the total number of units in a given region (in commercial real estate, it is usually expressed terms of area such as square meters for different grades of buildings). A low occupancy rate means that the market is in a state of oversupply brought about by speculative construction and purchase. In this context, supply-and-demand numbers can be misleading: sales demand exceeds supply, but rent demand does not. 3.6 US real estate bubble in history U.S. history is replete with stories about housing and land booms and bursts. Most had a common feature; a new territory was opened up, with perceived desirable economic opportunities. Often more people arrived than could possibly exploit the resources. Booms thus reflected excess demand by new residents for the supplies of new housing which was temporarily limited by transportation, gestation and other costs. The period of the 1980s and the declines in housing prices in many cities in the early 1990s are now widely looked back upon as an example, even a model, of a boom cycle that led to a bust. Housing prices in U.S. began rising rapidly in Boston in In 1985 alone, home prices in the Boston metropolitan area went up 39 percent. A pattern of sharp price increases, with a peak around 1990 followed by a decline in 25

27 many important cities around the world, including Boston, Los Angeles, London, Sydney, and Tokyo, looks consistent with a bubble. 26

28 4. Whether bubble exists or not in Shanghai housing market Although some people treat the rapid growth rate of real estate price as the most important evidence of a bubble, the definition of bubble in the chapter bubble theory dictates that such increases alone are only necessary but not sufficient evidence. Additional evidence that relates current real estate prices to their fundamental determinants is required to solidify any claim of a bubble. Measures described in the last chapter bubble theory have been widely used to support claims of a bubble. 4.1 Rational factors In a real estate market, the amount of houses supplied by the developer and the amount demanded by the buyer are dependent on the market price of the house. The law of supply states that supply is directly proportional to price, the higher the price of the house, the more the developer will supply. The law of demand states that demand is inversely proportional to price, the higher the price of the product, the less the consumer will demand. The law of supply and demand states that the market price of a house is the intersection of buyer demand and developer supply. If the price for a house is at a low level where consumers demand more of the house than developers are prepared to supply, there will be a shortage of this kind of house, and buyers will be willing to pay more for it. The developers will increase the price until it reaches the level where buyers would not buy any more if the price was increased. Conversely, if the price for a house is at a high level where the developer would like to develop more than the buyers will buy, the developers will be willing to lower the price. The price will fall until it reaches the level where buyers would be willing to pay more for the good. 27

29 Graph 4 1 the model of demand and supply Demand in Shanghai real estate market One of the most important factors that the real estate prices boost is due to the upward shift in demand. There are many determinants of the demand for housing. Such as demographic, income, price of housing, cost and availability of credit, consumer preferences, investor preferences, price of substitutes and price of complements. Among all these above factors, demographic is the most important one. Demographic The core demographic variables are population size and population growth: the more people in the economy, the greater the demand for housing. As the mayor of Shanghai said in the year 2003, Shanghai s population had surpassed 20million in that year. Since almost every family just has one child in Shanghai by the family planning of China, the population growth of Shanghai was negative in recent years (positive in 2005). But there is still huge demand for housing because of the large foundation of 28

30 population and millions of itinerant workers from the other regions of China. In addition, the average of urbanization rate in global is 50%, the developed countries is 75% and only 38% in China. The rate is increasing by one percent in China annually, which means there are more than 10million people move into cities. So it s no wonder that there s quite a huge demand for housing in Shanghai housing market with a huge amount of flow-in population. Meanwhile, with the sharp development of Shanghai, all the demand for office building, commercial building and the other real estate is going up along with the demand for housing. Income Income is an important factor to demand. From Shanghai statistic bureau, per capita disposable income of urban households and rural households in Shanghai is increasing by 10% annually and reached Yuan and 9213 Yuan respectively in the year As described in the second chapter, per capita living area in Shanghai before 1990 was very small. The increasing income enables more people to be able and be willing to afford bigger houses to have better living conditions. 29

31 Table 4 1 per capita disposable income of urban households in main years ( ) Yuan Year Average per Salaries Net Income from Property Transferre Capita Disposable Household Income d Income Income Business Note: Per Capita Disposable exclude income from selling properties and social security expenditure from

32 Table 4 2 per capita disposable income of rural households in main years ( ) Indicators Average per Capita wages Household Property and Disposable Income Business Transfer (Yuan) Income Income Note: The per capita annual disposable income before 2000 refers to the net income. From the two tables above, we can see that Average per Capita Disposable Income of Households in both urban and rural areas is keep increasing year by year. In addition to the overcrowded condition, people tend to purchase bigger house naturally so that the demand keeps going up. 31

33 Price of housing The price of housing is also an important factor to demand. The diagram 4-2 shows the effects of an increase in demand in the short run. Since the demand for housing is increasing in Shanghai s real estate market, the demanding curve shifts from D1 to D2. The market reacts with both the price and the quantity adjustment, so the price P1 goes up to P2 and the supply should also increase from HS1 to HS2. Graph 4 2 the model of demand and supply Cost and availability of credit Because of the huge saving capital of Chinese, the government was always keeping the interest rate in a pretty low level. The cost of mortgage is thus not high for people of Shanghai. Consumer preferences Chinese people are tend to have their own dwellings. Not like in many countries, home means a lot to Chinese. There are only a few Chinese would like to live in a rental room which doesn t belong to them for a relatively long time. That s another important reason that demand went up in Shanghai housing market. Especially for the people who suffered bad living condition for many years in Shanghai because of the 32

34 huge population and limited area. Along with the higher income and the rapid development of Shanghai, no wonder the demand of housing is soaring Supply in Shanghai real estate market Housing supply is produced using land, labor, and various inputs such as electricity and building materials. The quantity of new supply is determined by the cost of these inputs, the price of the existing stock of houses, and the technology of production. As the demanding for housing surging in Shanghai, the investment in Shanghai real estate market has maintained a growth rate of 20~30% for years. The features are quick increase in supply, large vacancy rate, fast-rising price and many large flats which are unaffordable to ordinary citizens. 33

35 Table 4 3 total floor space of construction and completed buildings ( ) Year FloorSpac of which Floor Space of which Constructi of which eof Residentia Completed Residentia on Residenti Constructi l Housing (10000 l Housing Completio al on sq.m) n Rate (%) Housing (10000 sq.m)

36 Construction completion rate is in the trend of going down, which means the developers are becoming more and more desired for this market with an optimistic expectation. This phenomenon could be brought by escalating demand as well as higher capability of supply. Cost of inputs Generally speaking, rapid growth of investment in real estate supply may lead to inflation. However, the problem of excess capacity in China s manufacturing sectors has been serious ever since As a result, the rapid increase in investment has not resulted in quick price rise of some materials relevant with real estate. The Shanghai housing market has found that the low supply elasticity of housing units is an important factor behind the larger price increases in the market. In particular, real estate price are much higher than construction costs throughout China. The price of the existing real estate Normally, if supply increases rapidly, real estate price won t go up continuously. This abnormal phenomenon has to do with the speculative demands of domestic and overseas investors: first, the rich Chinese people would like to buy real estate as an investment rather than the place they live in. For example, if they make money in a country, they prefer buying real estate in a city, if they make money in a city, they prefer buying real estate in a provincial capital, if they make money in a provincial capital, and they prefer buying real estate in Shanghai or Beijing. Among these people, many of them treat the real estate (mainly housing) purchase as an investment. Second, there s no restriction on foreigners purchase of real estate in China. Some foreigner s speculate that the RMB to appreciate, so they convert foreign currency into RMB and invest them in real estate. For these two reasons, real estate price keeps rising up and developers are willing to build more buildings even though the prices of the existing real estate are abnormally high already. 35

37 Table 4-4 Investment and operation in real estate development in main years 100 million Yuan Indicators Total Investment Investment in Commodity Housing Investment in Land Development Of Total Investment Residence Villas and apartment Office building Commercial Building Others Newly Increased Fixed Assets Total Capital Source Balance at End of Previous Year Sub-total Capital Source of this Year Domestic Loans Foreign Capital Utilized Foreign Direct Investment Self-Financed Capital Other Capital Table 4 5 Macroeconomic index in Shanghai ( ) Index(billion) 1-5 month Increase rate by the same period last year Total capital assets investment % Real estate investment % Real estate investment/total 33% -7.70% investment Source: Shanghai statistic bureau 36

38 The table above shows that the real estate investment takes up a big ratio in overall investment in Shanghai, and a little drop down compared to last year. 4.2 The debate about the bubble in the Shanghai real estate market Sine the year 2004, real estate bubble has been developed into a bitter quarrel in the Chinese real estate market. There are two completely different perspectives: one claim that there s no bubble in Chinese real estate market and the real estate price will keep going up although some problems truly exist in the real estate market; the other claims that the situation of real estate bubble is already there at a so severe level that people should pay more attention to it. While talking about Chinese real estate bubble, Shanghai always will be the focus of debate. In the year 2005, the central bank announced the first national real estate finance report Chinese Real Estate Finance Report in In the report, it said pay attention to the bubble level of second handed houses and high level houses in Shanghai, the speed of real estate price is upward too fast and could make the market prices deviate from the true value, which causing the real estate bubble. Once the bubble bursts, the real estate used as mortgage can depreciate a lot and do a great damage to banks. As the first economist in Morgan Stanley, Steve Roach claimed there is no nationwide real estate bubble in China. But from his acquired information he judged that in the region of Shanghai there were obvious speculative real estate investments. He also said that price will go up if the demand goes up and the bubble surfs up if the demand goes up way higher than the level of true value. He concluded that there s no bubble 37

39 in China except for Shanghai. As the first economist in Morgan Stanley Asian Pacific, Xieguozhong claimed in the year 2004 that the real estate bubble in China would burst in no longer than one year. Although it was proved that he made a wrong prediction, it doesn t mean there s no real estate bubble in Shanghai Positive viewpoint The viewpoint which claims there is a bubble in Shanghai real estate market is based on these factors. 1. The price is too high; the expanding of price is too huge and swift. From mid-long period, the increase of real estate prices is very much based on the rules of market. But if the prices surge consistently in short period, it could be the important sign of bubble. In 2003, housing prices in this city went up 21.35% year on year; in 2004 the prices went up 15.8% year on year. In the latest years the prices maintained on a stable growth rate which made the housing prices surge a lot. Before 2001, the disposable income growth was higher than the price growth of houses, but after the year 2002, the prices growth was much higher than the income growth. The price to income ratio kept going up. 2. The contradiction of demand and supply One of the biggest problems in Shanghai real estate market these years is that there are too much investment put into high level houses such as villas; meanwhile the supply of low level apartments is not sufficient to meet the demand. In 2004, the constructing area of high level houses was 9.86 million square meters, with the whole constructing area million square meters. That is to say, the high level houses stranded for 13%. From the completed area, it also stranded for 9%, which the area of high level houses and whole houses were 2.63 million and million square 38

40 meters respectively. 3. The real estate investment is too rampant. The real estate investment is the direct reflection of the real estate supply to the real estate demand. Too fast growth of investment could cause the speculative demand and higher prices. The index to measure if the investment is too rampant is by the formula the growth rate of real estate investment divided by GDP growth rate; normally it should not exceed 2. In the year 2004, the growth rate of real estate investment was 30.43% which was close to 3 times of GDP growth rate. 4. The speculative demand keeps going up. From the investigation in 2003, 16% of total transaction of real estate was made by speculators, closing to the alarming level 20%. To the high level buildings in CBD, this ratio reached 30% to even 40%. And this ratio is not going down these years. 5. The risk of loan increases. The loan growth from the banks keeps at a high speed level. In the end of 2004, the commercial real estate loan growth rate was 41%, standing for 76% of total loan, which means real estate investment and consumption highly depends on the loan from banks and makes banks be tied to the fluctuation of real estate market Negative viewpoint The viewpoint which claims that there is no bubble in Shanghai real estate market is based on these factors. 1. Demand and supply are in equilibrium. Between the year 2002 and 2004, both the demand and supply were surging in Shanghai s commercial houses, with the demand a little higher than supply which makes the second-hand houses being consumed. In 2002 the completed area of commercial real estate was million square meters which made the growth rate 39

41 10.7 %., and the sold area of commercial real estate was million square meters which made the growth rate 9.1 %. In 2003 the figures were 25.6 % and 20.5 % respectively. In 2004 the figures were 38.2 % and 38.9 % respectively. 2. The vacancy rate is going down. Till the end of 2002, the vacancy area of commercial real estate was 6.77 million square meters and the vacancy area of commercial residence was 3.7 million square meters, it was going down by %. Till the end of 2003, the vacancy area of commercial real estate was 5.22 million square meters which made a reduction by % and the vacancy area of commercial residence was 2.58 million square meters which made a reduction by %. Till the end of 2004, the vacancy area of commercial real estate was 3.59 million square meters which made a reduction 31.2 % and the vacancy area of commercial residence was 1.26 million square meters which meant a reduction 51%. 3. The price growth rate of residential houses has an obvious reduction. The sold prices of the total real estate in the city grew by 20.1% in 2003, with price growth rate of commercial houses and residential houses 20.5% and 21.4% respectively. In 2004 the sales prices of the total real estate grew by 15.8% which had a small growth drop by 4.7%, the residential houses grew by 15.8% which had a drop by 5.6%. In the year 2005, this trend kept going. The average price of residential houses was 6698 Yuan per square meters which increasing by 313 Yuan. The sales prices of the total real estate in 2005 grew by 9.7% which had a drop of growth rate by 6.1 percent. The price growth rate of residential houses dropped by 6.6%, to 9.2%. 40

42 4.3 The discussion about the debate of real estate bubble in Shanghai Discussion about the positive viewpoint From the viewpoint that claims there is a bubble in Shanghai s real estate market, the outcome of analysis shows several problems that Shanghai s real estate market is facing. These problems could be the signs of bubble and in that case we might conclude that the bubble is on the way of expanding. But this viewpoint hasn t given too much real evidence that bubble exists or given some pragmatic methods to solve it Discussion about the negative viewpoint From the viewpoint that claims there is no bubble in Shanghai s real estate market, people get this idea based on the demand and supply is in equilibrium which makes the vacancy rate go down. But can we jump to the conclusion that there is no bubble because of the low vacancy rate? I don t think so. In fact there is a quite big danger behind this equilibrium, which is the prices of houses are beyond most citizens capability to purchase. Meanwhile in the market the demand is still a little higher than supply, the problem is on the demand side. Demand for houses has two different meanings, one is demand of consumption, and the other is demand of investment. Real estate is quite different from many goods because it has a feature of investment so we can t apply ordinary way to analyze it. The price of investment is not completely following equilibrium theory. To the investment, expectation determines whether the demand will go up or down. 4.4 The proof of bubble in Shanghai housing market The debate of real estate bubble is mainly on housing market, so I will focus on the housing market to see if there is a bubble. In previous part, we can see very clearly that because of the rampant development of Shanghai, both demand and supply have been going up for last decade. Many people would say it s reasonable to maintain a 41

43 fast price growth rate with the fundamental. In this part, I will investigate Shanghai s housing market with indicator methods to signify whether a bubble exists or not Price to income ratio The ratio of the median home price to median household income is one frequently employed measure of home ownership affordability. If this ratio is relatively high, then households should find both down payments and monthly mortgage payments more difficult to meet, which should reduce demand and lead to downward pressure on home prices. If this ratio rises above its long-term average, it could be an indication that prices are overvalued. In fact, in Shanghai the median house price is 15.5 times median household income in the year 2006, surpassing the previous peak in the year 2005, when there is arguably a bubble in the housing market. The price to income ratio is affected by three factors, the first is the average price per square meters; the second is average per capita living area; the third is average disposable income. Nowadays, the reasonable ratio worldwide is considered to be 3 to 6 times and some experts from the World Bank say 4 to 6 times. 42

44 Table 4-6 Figures of price to income ratio in Shanghai housing market Price index Price Price (K) ADI ADI (K) Family income (K) Average area Family area House price Price to income From Shanghai Statistic Bureau, the average family member was 2.8 between 1997 and The house area is calculated by discounting average living area. 20 average disposable income (K) price (K) price to income ratio Graph 4 3 the situation of per capita disposable income and housing price 43

45 price to income ratio Graph 4-4 price to income ratio From the table 4-6 and graphs above we could find out that from 1997 to 2001 the prices of housing was fluctuating consistently while the income was increasing consistently which made price to income ratio keep going down and reached 6.72 in Between the year 1999 and 2001, the price to income ratio was at the lowest level, which accounting for the income growth was higher than home price growth. But after 2001, with China engaged into WTO and Shanghai succeeded in gaining the right of holding World expo 2010 as well as the steady development of national economy, the situation started turning worse. The extent of housing price growth was beyond the extent of income growth. Especially in the fourth quarter 2004 and the first quarter 2005, the price grew by 30%. The price to income ratio reached 11 then. Nonetheless, the whole period 1995 to 2005, there was no big fluctuation, maintaining at the same level, 9 to 10 more or less. Generally speaking, the increase of home price and the growth of income are a relatively equilibrium. From the figures above we could already confirm that there was a bubble in Shanghai housing market if according to the standard of experts from World bank mentioned above. The expanding of bubble has been restrained by the policies enacted by government in But there might be one pitfall of this method as to a new rising market, which needs to be noticed. 44

46 As a traditional measure, price-to-income ratio has a pitfall. That s because this measure based on a stable perspective, which ignores the possibility of income raise. Once a home is purchased, the cost of home will be locked at such a figure. Meanwhile, the income could be increasing. In that case, the price-to-income ratio will keep decreasing, along with the consistent income increasing. From another perspective, that means the ratio of mortgage to all the income will keep going down. The home looks extremely expensive to purchase might be not a heavy burden in the next few years. In developed countries, the traditional index of price-to-income ratio or deposit to income ratio can be very good measures for assessing if the real estate market is healthy, thanks to the small income growth rate, the total income growth rate generally will not surpass 20% in six to seven years. But people can t simply put this measure to a fast developing country such as China, where the growth rate of income per capita is keeping at 8% annually. If one still studies the home affordability under stable perspective, there will be a lot of misleading about the real home affordability and the potential demand in the real estate market and so on. Taking a dynamic simulation as two tables below, imagine if one median household living in Shanghai bought a median home with the average price. The price of that home could be as ten times as their annual disposable income, with the leverage 80% debt and maturity 20 years, the mortgage would stand for 56% percent of their disposable income. That looks pretty tough, they might even find themselves be priced out in the first place. But what if they succeed in buying it? With the income growth rate from Shanghai Statistic Bureau, as long as this family maintains the same average growth of disposable income rate, after 4 years, their price-to-income ratio went down to 6.62 and the mortgage rate started off being under 50%, which in that case the home was affordable since then. If that family keeps on maintaining the average growth rate of disposable income, then another 4 years passed, we will find that their price-to-income ratio now is below 5 as well as less than 30% mortgage rate, they could find the home price easily affordable. 45

47 Table 4-7 The price-to-income ratio approach dynamically simulated for homes bought at 1995 Year Mean Bottom 10% 10-20% 20-40% 40-60% 60-80% 80-90% Top 10% Bottom 20% Top 20% Source: Shanghai Statistic Bureau 46

48 Table 4-8 Monthly mortgage payment as share of monthly disposable income for homes bought at 1995 Year Mean Bottom 10% 10-20% 20-40% 40-60% 60-80% 80-90% Top 10% Bottom 20% Top 20% Source: Shanghai statistic bureau With the analysis above, we can easily get to know that families above median, for example at top 20%, the price-to-income ratio and deposit to income ratio could decrease at a faster speed. Families below median, for example at 20% to 40%, if only they could purchase home with the help of government s efficient financial measures, and getting over the hardest time in the beginning several years, along with the stable growth of disposable income, hopefully they can get themselves affordable with less than 50% mortgage rate in the year But the bottom 10% people would always finding themselves hard to afford the home, they need the government s help for sure. The ratio of prices to household disposable income by itself, however, is not a sufficient metric to evaluate housing affordability. Indeed, home prices do not appear 47

49 to be linked to income by a stable long-run relationship, possibly because the cost of carrying a mortgage has varied over time. With the table above, I can t draw a conclusion right now about Shanghai is or is not in the midst of housing bubble or heading for housing bust, but I think it s safe to say that it requires some argument to justify such high ratios. As the price to income ratio in US in 1980s, we can find that the ratio there is way below Shanghai. However, some economists still claim that there s a bubble in American housing market at that time, let alone in Shanghai which with such high ratio figures. Ratios that are far above one-digit figure are worrisome because they are telling us that the people who live in Shanghai can t afford to buy a home that is placed in the same region of the distribution as their income, at least can t afford in the first place without considering fast income growth rate. There is also another fact that need to be considered. Comparing to developed countries, the ratio of median household are much less in China. Therefore, the price to income ratio is not enough for get to the conclusion, although the figures above seem quite volatile. And in the reality, the situation might be even worse Growth rate of housing price / growth rate of GDP The ratio of housing price growth to GDP growth is also an important method to see if there is a bubble in the housing market. Generally speaking, we could say there is no bubble as long as the price growth not exceeds GDP growth. This index is designed according to the meaning of housing bubble to measure housing growth and monitor the trend of housing bubble. The high index shows that housing growth exceeds economy growth, which could be a sign of bubble. If the index keeps going up in some particular period, it means people can t afford the housing with relatively lower economy growth which will bring them relative lower income. That will make the vacancy rate increase and trigger a bubble. 48

50 Table 4-9 The comparison of housing price growth rate and GDP growth rate in Shanghai Price index Price Price growth x None GDP index GDP growth y None *(x-y)/y None price growth x GDP growth y Graph 4-5 the comparison of housing price growth rate and GDP growth rate in Shanghai 49

51 ratio of price to GDP Graph 4-6 the ratio of housing price growth rate to GDP growth rate in Shanghai From table 4-7 and graphs above, we could see that Shanghai economy was in a steady development from 1998 to The GDP growth rate was maintaining 10 to 11%, while the housing prices were decreasing with a smaller scale year by year. From 2001, Shanghai housing prices were going up. The price growth rate almost equals with GDP growth rate in 2002, the development seemed promising. But from 2003 till 2006, price growth rate was way higher than GDP growth rate. In 2003 the gap was 81.09%. In 2004 the gap went down to 16.02%. Several real estate policies have been enacted after the gap went up again and hit 57.85% in From the analysis above, we could claim that Shanghai housing bubble arised in the year Bubble deflated after 2005 because of several policies been enacted and flourish of stock market although the housing price still kept moving upward. 4.5 Summary In this chapter from rational factors till bubble tests, we could find that Shanghai housing price was stimulated to go up by many different factors. Not only caused by fundamentals but also speculative investment. Clearly, one who supports the negative viewpoint can construct an argument that housing price increases in Shanghai have 50

52 been driven by fundamentals. For more than ten years, income growth alone explains virtually the entire increase in housing prices, and consistent low interest rates have reduced financing costs. To some people above median households, housing is actually more affordable than it was one decade ago. Nonetheless, the analysis indicates that housing price increase much higher than it should be caused by the fundamentals with people s strong investment motive and high expectations of future price increases. The ratio of housing price development to GDP development is quite high though meanwhile the vacancy rate is quite low, that means there is definitely speculative investment in housing market. Combining with the table and graphs in this chapter and the second chapter, we could clearly see the trace of housing bubble and make sure the bubble was most expanded around the year 2003 when the ratio of housing price growth to GDP growth was highest. The price to income ratio is much higher than US when they confirmed there was a bubble 20 years ago. Though price to income method has a pitfall which is not quite suitable for fast developing countries, the proportion of median households is also very small compared to US. In addition to the ratio of price growth to GDP growth, it was even 3 back in

53 5. Why the bubble exists in Shanghai housing market 5.1 Policy inertia Looking back on the history of Shanghai housing development, in the 1990 s the government enacted a series of policies to encourage the development of housing market. Actually it provided a support political platform for the price increase in the recent years. The policy from the announcement to being into practice needs time, so there would be some lags. Besides, the active policies established several years ago are still making great effect. All these factors result in policy inertia and neutralize much effect of policies which were set up later by the government which is attempting to lower the prices of the buildings. 5.2 Financial pitfalls The defect of both real estate finance and credits caused by the Chinese fragile financial system is one of the most important reasons why a bubble exists. This factor is widespread in China especially in Shanghai. As the Chinese bank business is fully opening to international capital, the government urges the reformation of the state-owned banks, so the banks are speeding up to solve both the doubtful and bad accounts for bettering the capital assets ratio. The figures considering the history and reality show that the real estate loan belongs to the superior credits. So the banks expand the scale of loan to the real estate, by which reduce the ratio of bad capital assets. That s why banks eager to loan to the real estate companies and individual house buyers. On the other hand, real estate speculators also need the banks support. That s the huge demand for the loan of banks. Both the demand and supply bring about the perfect combination of loans. The deposit in China is very large, which makes the speculators quite easy to get the loan. That all caused the rapid increase of Shanghai housing price. 52

54 Moreover, there is not much for Chinese to invest in except for real estate, the interest rate was very low due to the high deposit rate, and the stock and bond were not that attractive until Although the stock has been soaring and the interest rate has risen since this year, the bubble in Shanghai housing market has been set up long before. 5.3 Undeveloped capital market The bubble of Chinese real estate market has a close connection with its undeveloped capital market and especially in Shanghai. On one hand, the stock market can t attract the leisure capital as it did one decade ago, which makes the speculators swift to the real estate market to maintain and even hope to increase the capital. On the other hand, real estate companies find themselves hard to financing which result from the undeveloped capital market. The companies don t have appropriate channel to financing so that they swift to the legal but not appropriate channel, to speculate in real estate market and that makes the situation even worse. 5.4 International influence As the global interest rate goes down wehn the American dollar depreciation and the international expectation on the upward of Chinese exchange rate, a lot of international money is surging into Shanghai real estate market. From the aspects of interest rate, international investors could avoid the risks by purchasing real estate of Shanghai to benefit on investment. From the aspects of exchange rate, the confliction on the Chinese exchange rate between Chinese Yuan and American Dollar are getting intense. There is no doubt that there will be a reformation and the Chinese exchange rate will go up. The international investors bet on the rising of Chinese exchange rate to benefit more. Having relatively open market, the big foundation of population, the accelerating of urbanization, the APEC meeting in 2002 and will hold the world expo in 2010, 53

55 Shanghai is influenced by all these factors which provide the possibilities of expanding in real estate markets. The profits are very alluring so that Shanghai becomes the ideal place of investment for international capital. 5.5 Market expectation The expectation of rising price is the basic reason that the housing bubble exists. According to the structure of real estate demand, the rising price of Shanghai housing market results from the expectation on it. There are two phases in history: first one took place from about year 2001 to 2003 in which the prices of Shanghai real estate went upward in a rational way. Since Shanghai succeeded in holding the APEC in 2002 and win out the holding of the World Expo in 2010, these positive factors cause the expectation that the housing price in Shanghai will rise. In the second period which dated from year 2003 till now, the price expanding in an irrational way. In the latest three years, Shanghai housing price nearly doubles. The factors in the second phase are more complicated and fundamental, not just the simply political or historic influences. These are the main reasons: i. As the economic center of Yangtze River delta, Shanghai has strong influences on the surrounding districts. On one hand, Shanghai promotes the development of nearby cities and towns. On the other hand, the development of nearby districts economy brings about more and stronger needs of Shanghai s high-end services by which makes Shanghai as the center city further. The high-end services give a big demand for the persons of talent who belong to the class of high salary, and these people are expected to want to have the better housing to live in. That s the reason that the price surge of Shanghai housing market mainly focus on the high level buildings. ii. The price rising of Shanghai housing market brings about the expectation of even further rising of price. In recent years, China invest a lot in the capital assets such as iron and steel and the supply did not meet the demand, so that urge the real estate 54

56 price rising away from the rational way. Both the big development and the high price attract more and more companies that come into this industry which make the competition more fierce, so the cost goes up and then the high cost bring about the high price of real estate. iii. There are over 20 million people living in Shanghai, the area is more than 600 square kilometers and the constructive field areas have reached several thousand square kilometers. Apparently the effect of scale economy with the further expanding of the city would not be obvious. iv. There are many people who don t want to see the price reduction, so they make the expectation that the price will still be in an upward way: The government does not hope the housing price goes down for both the public sake and the private sake. If the price reduces, the economy of Shanghai will not be as good as before and the income of government will also go down; the real estate developers don t want to see the price reduction. They just can t accept that because there will be an expectation of a further price reduction if that comes true; Even the banks don t want to see that because there will be crises in their finance system; the real estate owners don t want to see that either. There are two kinds of owners. Ones is the speculator, price reduction will give a strong damage to there fortune. The others is the normal consumers, lots of them purchase the housing by borrowing money from the bank. The price reduction will make them have the negative equity. 55

57 6. Conclusion This paper has investigated whether there was a housing bubble in Shanghai in the past few years. The findings first indicate that Shanghai real estate market has witnessed a great development in past several years and the housing prices seem to have interacted with market fundamentals, such as disposable income and local GDP. Then the paper gives an introduction of the real estate bubble and provides several methods for identifying the bubble. With the methods used the results suggest that Shanghai seemed to have a housing bubble especially in 2003 as the figures show that housing was hardest affordable in that year. Since 2005, central bank enacted several efficient policies to cool down the real estate market. These policies functioned well and succeeded in making the growth rate away from its original trend. Though the real estate price still keeps going up higher and never turned back, the development of national economy and income growth are accelerating. With all the analysis above it s safe to say the worst time has passed. We may find it hard to say if there s a bubble right now because of the problem of data available, let alone if it will burst. But with the analysis it is quite safe to say back in 2003 or so there was definitely a bubble. This study has laid the groundwork for further investigations on the abnormal housing price phenomenon in Shanghai. There are possible areas for future research. First, future studies may further work on different methods for comparison, or on direct estimations of assets fundamental value which is proved to be very difficult, if not impossible, because of the lack of reliable data. This paper, however, is constrained by resources available. The current data set is used because it is available on the public domain, which means it is generally reliable and acceptable. 56

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