Can Affordable Housing Sustain China’s Economic Growth?

China’s affordable housing program is considered by many to be a ray of hope in what is otherwise a bleak property market. CLSA’s China Macro Strategist Andy Rothman was memorably quoted as being completely convinced that the Chinese government was “going to spend a hell of a lot of money on affordable housing.”

The affordable housing program is one of the many initiatives started over the past several years aimed at offsetting the rapid increase in housing prices. The State Council has committed itself to building 35 million housing units during the 2011–15 period. The ultimate goal is to give 20 percent of urban households access to low-income rentals.

There are several different types of low-cost housing encompassed in the affordable housing program:

Two Restrictions Housing (两限商品住房)

Housing projects are approved by local governments with restrictions on unit size and price. Units must have two bedrooms or less and be below 90 square meters. Occupants own their homes, but face restrictions in reselling.

Economic Housing (经济使用方)

Housing is built on government allocated land and exempted from various fees and taxes. These exemptions are designed to lower unit prices to a level that lower-middle income families can afford. Occupants have restricted ownership rights over their homes. Medium units are 80 square meters or below and small units are 60 square meters or below. Occupants own their homes, but face restrictions in reselling.

Low–Cost Rental Housing (廉租房)

Housing units are owned by the government or government-affiliated organization, and are rented out at below-market rates to significantly economically disadvantaged residents. These units are sold with one, two, or three rooms and are 35, 45, and 55 square meters, respectively.

Policy Low-Cost Rental Housing (政策性廉租房)

Housing units are owned by the government or government-affiliated organizations and are rented out at below-market rates to specific social groups or in areas of particular economic hardship. The government provides a direct subsidy to these households to help them afford their rent.

Slum Reconstruction (棚户区改造)

These programs identify and tear down slum areas within cities. Resident are given new homes within the same area or relocated to a different part of the city.

The affordable housing program was announced with an ambitious schedule. Construction was supposed to start on 10 million units in 2011 and another 7 million more are scheduled for this year. Technically the program is on schedule, but this only because definition of “under construction” has been stretched to the limit.  Land plots with nothing more than a large hole in the ground have been classified as under construction and counted towards the annual goal for affordable housing.

Has the central government come through with sufficient funding for this project? Data from the People’s Bank of China (PBoC) provides some insight into the trends (Chinese language). Looking at the outstanding stock of property development loans, affordable housing appears relatively small.

However, when you examine the flow of property development loans, the rapid increase of money directed towards affordable housing becomes apparent.

Affordable housing loans have been the main component of growth in property development loans, growing over the year even while commercial loans contracted. This reflects the fact that affordable housing has received a boost while commercial housing projects have been subject to ever-tightening restrictions.

Some economists, including UBS’s Wang Tao, argue that affordable housing will offer a much needed cushion for the property market. The idea is that while the government is reluctant to reflate the property market, the real estate sector (and sectors linked to real estate) will not suffer greatly because affordable housing will drive demand. The key assumption behind this line of argument is that the amount of money directed towards affordable housing can continue to increase, offsetting the decline in commercial housing.

Below is a sensitivity analysis of how much affordable housing will need to increase to compensate for a slowdown in commercial housing. The assumption is that in 2012 total property loans will grow at the average pace of the last two years, 20.7 percent.

As you can see, a drop in the commercial housing loan growth rate has significant implications. If commercial housing loan growth drops to zero, the amount of affordable housing loans will have to more than double to pick up the slack.

As with China’s stimulus, the central government is assigning large mandates but putting up remarkably little funding to help local governments meet these goals. In 2011, the central government funded less than 10 percent of the total cost, leaving local governments to finance the rest through borrowing and revenues. Local governments are already significantly indebted and facing declining revenues due to lower land sales. This argues for a healthy degree of skepticism when evaluating claims that local governments will be able to offset a declining commercial housing market by further boosting affordable housing.