Before investors can begin to understand the opportunities — and risks — that exist in China’s real estate market, they need to grasp its sheer size, said Ronnie C. Chan, president of Hang Lung Properties, a leading Asian real estate developer. Chan was addressing a symposium hosted by Columbia Business School in April. With Columbia professor and Nobel Prize laureate Joseph Stiglitz, Chan discussed the sharp contrasts between the American and Chinese real estate markets and offered insight into the challenges and opportunities facing both.
First, the numbers: Annual new home construction in China is 10 times that of the United States. Home sales are 25 times higher, and China’s total housing inventory is 7 times greater, much of which has been built in the last 20 years. “So the first point I want to emphasize is that the size is just humongous,” Chan said.
Then he layered on a second set of data: urbanization. A decade ago only 36 percent of the Chinese population lived in urban centers. Today, that number is 50 percent, and every year another 20 million people move from the country’s vast outposts into its cities. “So imagine the housing needs of 20 million people moving into the city every year, and project that out for another 10 or 20 years,” he said. “These figures are mind boggling.”
With Chan’s numbers as the backdrop, the opportunities in China are obvious. From construction to commodities to finance, China’s demand for housing will be a core driver of the global economy for years to come. But investors who bet on the Chinese growth engine in the past know that things are never as simple, or as clear, as they may seem on the surface.
Beijing has a long history of stepping in quickly — and unilaterally — to control the pace and direction of growth, and the real estate market is no exception, Chan warned. He joked about it, but the fact is that China’s government has a much bigger tool chest for controlling the economy than most central banks.
For one thing, the government doesn’t just control the country’s banks. It owns them. So if the housing market starts to overheat, it can shrink demand simply by raising the minimum down payment, from, say 20 percent to 30 percent. If that doesn’t slow things down enough, the government can pull out other tools, such as telling its citizens they can’t buy second homes. “That is limiting of individual freedom,” Chan said, “but it works very well when you want to control prices. These are the kinds of things that happen all the time.”
Finally, the Chinese government has say over every new development because it owns the land — all of it — and local officials control all sales. “So how the regional governments sell their land has become a very, very critical issue,” Chan said. “The structure that is in place encourages prices to go in one direction and one direction only: up.’
Keeping Up with Change
With the market growing so quickly, though, even China’s hands-on government has trouble keeping pace. “The market is evolving so fast that regulations, by definition, lag behind,” Chan says. That means government policy can change very quickly, often in the middle of a project. “So if you don’t have an appetite for changes, and if you don’t have an appetite for the government meddling in your business, China is probably not a good place for you,” he warned.
On the other hand, over the last two decades Chan has seen a gradual shift toward a freer, more open market, which is good news for long-term investors. “Most of us who have been operating in that market for the last 20 some years recognize that it is, overall, moving in the right direction,” he said.
The Free Market Experiment
Of course, open markets come with their own dangers, Stiglitz warned the group. In fact, he blamed most — if not all — of the world’s current economic problems on the United States’ market-driven housing industry. In his presentation, the World Bank’s former chief economist singled out two primary culprits: bank executives who chased an increasingly risky client base in search of higher profits, and equity market machinations that allowed banks to pass off that risk to unsuspecting investors.
In the past, banks held the mortgages they wrote, Stiglitz noted. That was all the incentive they needed to ensure mortgage clients were credit-worthy, he argued. Then Wall Street started bundling those loan portfolios, stripping the hard asset collateral — the property itself — away from the income stream and repackaging the risk in a complex system of derivatives. When this happened, the banks’ motivation shifted from quality to quantity. “When you have securitization, the consequences of the bad loan are not felt by the originator of the loan,” Stiglitz said.
Allowing banks to securitize these inherently risky loans created a cascading effect that pushed the global financial industry to the brink of insolvency, he says, and there are no easy answers to untangling the mess. But closer government oversight of the mortgage process will have to be part of the solution, he adds. “We’re going to be debating how we can get our housing market back to normal, which means a private sector housing market not on life support,” he concluded.The symposium was sponsored by the Chazen Institute of International Business; the Richard Paul Richman Center for Business, Law, and Public Policy; and the Paul Milstein Center for Real Estate.