East Capital’s Dmitry Vlasov asks: How real is the Chinese property bubble?

Dmitry Vlasov, senior analyst at East Capital and specialist on the Chinese property market says that there are a number of indications that the Chinese property market is not a bubble.

One of the concerns that we hear on a regular basis from our investors is about the affordability of the housing market in China. Looking at widely-used affordability metrics, such as price to income, an obvious conclusion comes to mind that housing prices in the Chinese first-tier cities are beyond the  affordability of most of the population. Investors are concerned that given the high prices and the high level of construction activity, the Chinese real estate sector represents a potential bubble.

While prices in the first-tier cities in China are indeed somewhat high, we do not believe that there is a serious threat of a housing bubble in China, as the definition of a bubble includes very aggressive and irrational utilisation of leverage. This is not the case in China, as home mortgages make up only 16% of GDP (vs. 70% in the US) and the average cash downpayment ratio is 44%.

Price-to-income ratios for the first-tier cities do look quite high, but this is also because an average income is somewhat understated, as many low-skilled and low-paid people are also included in the sample. These people are not likely to participate in the commodity housing market and that is why the government has been pushing through its massive social housing program. Excluding these people from the sample would significantly change the ratio.

Also, looking at price-to-income alone does not necessarily represent the full picture. In China, a substantial amount of housing demand comes from what are known as upgraders. Many of the upgraders received their houses from the state for free in the 90s as a result of the privatisation program. So, this group of potential buyers does not rely on income alone to finance the purchase of the new property. They sell their old houses (typically lower quality but better located) and buy new ones. In addition, many lower-income people get new houses as part of relocation compensations, either from developers or local governments. This is very China specific and is mainly due to the ongoing urbanisation.

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