Chinese Housing Market Correction Update

Nicholas Borst (Federal Reserve Bank of San Francisco)



The housing market correction we analyzed in November continues apace, but it appears to still be in the very early stages.

Tightening measures, first implemented in early 2010, are slowly reducing super-elevated levels of housing investment and forcing developers to lower their prices to clear inventory.

One of the most important trends underway is the change in expectations. Over the last decade, buying a house has emerged as a preferred form of investment for households because the rates of return were so much higher than interest on bank deposits. Housing prices rose so steadily during the 2000s, particularly after the onset of negative real interest rates on deposits in 2004, that many people began to believe that housing prices in China could only go up. The correction that began to take hold in 2007–08 was not allowed to fully play out because policymakers stimulated the housing market during the Global Financial Crisis. As a consequence, unreasonable expectations about the housing market were not altered.

The change in expectations that didn’t occur during the last correction appears to now be underway. According to a People’s Bank of China (PBoC) survey (Chinese language), the number of people expecting housing prices to increase has declined from 45.8 percent during the last quarter of 2009 to 19 percent at the end of 2011. Moreover, the share of people who think housing prices will fall or stay the same is now 67 percent. Similarly, the number of people anticipating purchasing a new home in the next three months has declined by 14 percent.

This signals that expectations of perpetual home price increases may have finally been altered. Real estate may come to capture far less Chinese savings now that buying a house is no longer considered a guaranteed investment.

The graph above shows the tremendous rise in the share of household savings flowing into the property market. You can see the dip that was caused by the first housing correction in 2007–08 and then the rapid rebound after stimulus measures were introduced.

Relaxation of restrictions at this point would probably push the market right back into bubble mode. To achieve a lasting change in expectations, the government will have to be willing to bear quite a bit of economic pain. According to Patrick Chovanec, if the real rate of real estate investment grows at half the speed of last year, GDP will fall to just below 8 percent. If investment actually declines by 10 percent, GDP will fall to 5.3 percent. The first number is probably acceptable to Chinese policymakers, but the second is unlikely to be tolerated during a period of political transition and continued concerns about social instability.

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