By Sheng Songcheng, Song Hongwei and Li Shoujun

China has embraced a new round of property-price growth since 2015. According to the National Bureau of Statistics (NBS), China's 70-city new home price index rose for 37 consecutive months from May 2015 to May 2018. During this period, new commodity housing prices (all housing prices below refer to new commodity housing prices) increased by a whopping 20.4% nationwide. Meanwhile, policymakers further stepped up property tightening, with new tightening measures introduced. There are six ways in which this round of price increases and tightening measures is different from previous measures. CEIBS Professor Sheng Songcheng, who is also Counsellor of Shanghai Municipal People’s Government and Counsellor at the People's Bank of China (PBoC), explains with his co-authors and looks at the impact of China’s skyrocketing real estate prices.

I. Six things to note about of this round of property price increases & tightening measures

First, Chinese housing prices have grown significantly over a sustained period of time. A look at the 70-city newly constructed residential property index released by the NBS shows that since the global financial crisis in 2008, China’s property market has seen two rounds of increases, one between March 2009 and September 2011 (31 months), and the other between June 2012 and April 2014 (23 months). The current round of increases began in May 2015. As of May 2018, the 70-city newly constructed residential property index remained in positive territory on a month-on-month basis. In the meantime, property prices rose for more than three years, the longest streak since 2008.

This round of price increases was concentrated in the period from May 2015 to September 2016. Home prices in tier 1 cities climbed 42.3% during that time, with an average monthly compound growth rate of 2.1%. The most spectacular increase was observed in Shenzhen, where new commodity housing prices jumped 177.5% to RMB62,000 per square metre in September 2016 from RMB22,000 per square metre in October 2014, implying an average monthly compound growth rate of 4%. Prices in tier 2 cities rose 17.1% between May 2015 and September 2016, with a monthly compound growth rate of 0.9%. Among tier 2 cities, national central cities saw prices advance 20.3%, with a monthly compound growth rate of 1.1%. House price growth hit historic highs in both tier 1 and tier 2 cities.

Second, for the first time ever, tier 3 and tier 4 cities have experienced substantial house price growth. Since China’s property market recovered from the 2008 global financial crisis, commercial housing prices in tier 3 and 4 cities have held steady, up only 1.5% in 2015 from early 2011, despite increases between June 2012 and April 2014. That said, housing prices in tier 3 cities have continued to rise since 2016. Among 70 large and medium-sized cities tracked by the NBS, tier 3 cities saw home prices jump by 15.9% from January 2016 to May 2018. The average selling price (ASP) for newly built commodity houses in 60 tier 3 and 4 cities monitored by Tospur increased by 28.1% to RMB8,976 per square metre in May 2018 from RMB7,008 per square metre in January 2016, according to CREIS data.

By geography, house prices in tier 3 and 4 cities close to and far from urban centres in eastern China rose 54.6% and 22.5%, respectively, while house prices in tier 3 and 4 cities close to and far from urban centres in central/western China increased 51.4% and 32.8%, respectively. The biggest gains were in tier 3 and 4 cities close to urban centres. The proximity to urban centres brought an extra 32.1 percentage points and 18.6 percentage points of growth to the housing prices in tier 3 and 4 cities in eastern and central/western China, respectively.

Third, the housing market in tier 3 and 4 cities has become hotter than in tier 1 and 2 cities. As the NBS’ 70-city home price index shows, tier 3 cities have sustained home price growth of about 6-7% year-on-year since the second half of 2017, tier 2 cities have maintained year-on-year growth of around 4%, and tier 1 cities have registered a year-on-year growth of close to zero. This is reflected earlier in the sequential data. In October 2016, tier 3 cities witnessed faster month-on-month price growth than tier 1 and 2 cities. In terms of house price growth, prices in tier 1, tier 2 and tier 3 cities increased by 0.5%, 6.2% and 9.3%, respectively, between January 2017 and May 2018. In the wake of strict property price controls in tier 1 and 2 cities, the housing market got hotter in tier 3 and 4 cities, an indication of capital inflows.

Fourth, the growth of housing prices has diverged from economic growth. Since 2000, the year-on-year growth in commodity housing average sales prices (ASP, calculated based on NBS data on commodity housing sales volume and GFA (sales area) has been largely in line with year-on-year GDP growth. GDP growth and house price growth had a positive correlation of 0.30 in the period between the first quarter of 2000 and the second quarter of 2018. Since 2015, however, economic growth has slowed down and home price growth has quickened. GDP growth eased from 7.2% in December 2014 to 6.7% in March 2016, whereas house price growth accelerated from 5.6% year-on-year to 18.3% year-on-year during that same timeframe. Correlation analysis showed a positive correlation (0.39) between GDP growth and house price growth during the first quarter of 2000 to the last quarter of 2014 and a negative correlation (-0.51) between them during the first quarter of 2015 and the second quarter of 2018. This means the growth of housing prices has diverged from economic growth since 2015.

Fifth, policymakers have ramped up tightening measures to unprecedented levels. Shenzhen and Shanghai have begun to step up property-tightening measures since March 2016. In October 2016, 21 cities, including Beijing, tightened property cooling measures. Since 2017, these measures have been further upgraded, as evidenced by the continued ramp-up in restrictions on housing purchases/lending/prices/sales and commercial property. By Tospur’s calculations, more than 60 cities (including counties) have rolled out property tightening measures such as home purchase and sales restrictions since 2017. Tier 1 cities have experienced an unprecedented intensity of tightening measures. For instance, Shanghai has raised the threshold for non-local homebuyers, demanding proof of at least five years of taxation or social insurance payment, up from two years. Meanwhile, Shanghai has hiked the down payment ratio for first and second home purchases from 30% and 40% to 35% and 50% (70% for non-ordinary housing), respectively. Some tier 3 and 4 cities have also introduced tightening measures. Non-local buyers in Zhangjiakou (in Hebei province) and Ganzhou (in Jiangxi province) are limited to one home.

Another reflection of upgraded tightening measures is the adoption of various means, including land, rental housing and finance, for cooling the property market. The 19th Party Congress called for “speeding up the establishment of a housing system with multiple types of suppliers, multiple channels for housing support, and encouragement for both renting and purchase”. China launched a pilot programme in 11 cities, including Beijing, Shanghai, Shenyang and Nanjing, to build rental housing on collective construction land. The Ministry of Housing and Urban-Rural Development and several other ministries and commissions issued a notice in July 2017 to accelerate the development of the housing rental market, with pilot programmes implemented to grant equal rights to home renters and buyers in 12 cities such as Beijing and Guangzhou. In the financial sector, efforts were made to clamp down on the flow of funds to the real estate market. In its guiding opinions dated April 2017, the China Banking Regulatory Commission (CBRC) called for implementing classified controls over property credit, cracking down on loans for down payment, bringing property-related lending under regulatory oversight, and preventing funds from illegally entering the property market.

Sixth, the public’s expectations for the property market have remained bullish because of a failure to manage expectations about tightening measures. Built on long-term observations of housing price movements, these bullish expectations stem from a constant pendulum swing between property tightening and easing policies. The reasons behind these swings are that property is often a hedge against economic downturns, and higher home prices are in the interests of local governments. Such mechanism has remained intact amid the ongoing tightening measures. As a result, the public’s positive expectations have not been reversed, despite the unprecedented intensity of this round of tightening measures.

What’s worse, due to the lack of expectation management, the implementation of some tightening measures has added to positive expectations. The imposition of home price restrictions has caused prices of some new homes to be lower than those of second homes, creating arbitrate opportunities, fuelling market speculation, disrupting supply and demand, and encouraging a partial overheating of the market. Reports of property development projects being sold out upon their launch and tens of thousands of people lining up for a lottery to buy new homes have strengthened public awareness about the boom in the property market, misleading household home purchase decisions and reinforcing the public’s positive expectations.

In addition, inadequate supervision and punishment of acts – such as price rigging – that disturb the order of the property market has made it hard to eliminate speculation and reverse expectations for higher home prices, because the benefits of market manipulation outweigh the punishments.

II. Three reasons for this round of property price increases & tightening measures

The property tightening measures were relaxed in the second half of 2014, when the economy continued to trend downward, and government debt and property developers’ funding problems became acute.

First, the domestic economy has faced greater downward pressure. GDP expanded by 7.1% and 7.2% in the third and fourth quarters of 2014, respectively, raising the spectre of growth falling below 7%. The property sector’s value added indicator grew by 1.3% year-on-year in the third quarter of 2014, down from 9.8% year-on-year in the first quarter of 2013.

Second, the government debt problem has grown worse. According to data from the Chinese Academy of Social Sciences, government sector leverage (debt/GDP) rose from 41% in 2008 to 57.8% in 2014, the highest during 1997-2007. Local government debt (including implicit debt) increased to RMB30.2 trillion in 2014 from RMB15.7 trillion in 2008.

Third, property developers have been exposed to greater funding risks. According to the NBS, the gearing ratio of property developers went up from a low of 72.3% in 2008 to 77% in 2014, the highest on record since 1997. The non-performing loan ratio of the property sector rose to 1.04% in 2016 from 0.47% in 2013, CBRC data showed.

III. Four impacts from this round of property price increases & tightening measures

The current round of home price rises that began in 2015 has had a negative impact on the economy and society.

First, the high-priced housing problem has further deteriorated. Property investment, output and prices have continued to rise since the marketisation of housing in 1998. According to the NBS, the quarterly cumulative year-on-year growth rate of value added of the property sector has remained in positive territory since 1998. The monthly year-on-year growth rate of property development investment has never turned negative since records of the data began being kept in February 1999. Housing prices have shown an upward trend, and this trend has remained intact despite short-term volatility. Therefore, the real estate sector remains on an uptick and has yet to go through recession/depression to form a complete cycle. The current round of price increases has further pushed up home prices.

Second, a short-term boost from real estate has proved detrimental to the long-term healthy development of the economy. High housing prices imply a heavier home-buying burden on residents, exerting a crowding-out effect on household consumption. High returns lead to the concentration of fund inflows into the property sector, which creates a crowding-out effect on real economy companies by making financing hard for them. The current property price increases are across the board with significant implications for the real economy, as the crowding out effect spreads from a few major cities to the entire country.

Third, big home price gains in tier 3 and 4 cities have exacerbated the build-up of risks. The heating up of the property market will attract a new round of property investment, turning “destocking” to “restocking”. However, an exodus of population from tier 3 and 4 cities increases the risk of excessive housing supply. Rapid home price increases in tier 3 and 4 cities push the cost of living higher, translating to higher costs of labour for businesses. Land prices rise in tandem with home prices, meaning higher land-use costs for businesses. These undermine the cost competitiveness of tier 3 and 4 cities, hindering the process of industrialisation and urbanisation and even leading to a “hollowing out” of cities. “Restocking” comes at the sacrifice of non-renewable, arable land, threatening arable land security in China.

Fourth, the shift in the public’s behaviour patterns has posed challenges to tightening the property market. On one hand, people’s expectations for higher housing prices have risen amid big price jumps. Home prices have risen for 20 consecutive years since the marketisation of housing in 1998. There is a deep-rooted belief that house prices always rise. This problem has been exacerbated by the lack of market expectation management in this round of property price increases and tightening measures. Helped by strong bullish expectations for property, robust demand for residential investment further drives up housing prices, making house price growth self-fulfilling. Furthermore, possible resistance on the part of market participants will present challenges for property tightening. On the other hand, the interests of home owners are directly linked to the increases in housing prices. These people are happy to see home prices go up and reluctant to see prices drop, producing a ratchet effect of continually increasing prices and adding to headwinds for property tightening.

Sheng Songcheng is a Counsellor of Shanghai Municipal People’s Government, Counsellor at the People's Bank of China (PBoC), a former Director General of the Financial Survey and Statistics Department at the PBoC, Adjunct Professor of Economics and Finance at CEIBS, and Executive Deputy Director of the CEIBS Lujiazui Institute of International Finance.

Song Hongwei and Li Shoujun are both researchers at Tospur Real Estate Consulting.

This article represents the authors’ views and not necessarily those of their respective employers.