Risky Property Investment

Market insiders have started to warn investors that the asset price inflation has moved to a stage where property is becoming a risky short-term investment

Like other Asian countries, property prices in China have rebounded sharply since the beginning of this year, fueled by loose monetary policies and aggressive bank lending. Experts’ asset bubble concerns have not dampened their optimism toward investing in China’s housing market in the long run. However, market insiders have started to warn investors that the asset price inflation has moved to a stage where property is becoming a risky short-term investment. Xia Bin, Director of the Finance Research Institute of the Development Research Center under the State Council, expressed his opinions in an article recently published in Economic Information Daily. Edited excerpts follow:

Despite the room created for price growth in the long term, China’s property sector may be nearing its short-term peak and could end up teaching home investors who take mortgage loans an expensive lesson.

Factors backing a more prudent approach include the property market’s short-term uncertainty, the fact that the growth of people’s purchasing capacity takes time and the government’s determination to tackle property speculation based on lessons learned from the property meltdown in the West.

Long term versus short term

The Chinese media often compares home prices in Shanghai and Beijing with those in Hong Kong, concluding that mainland asset prices will continue to rise. Their basis surrounds speculation that China is likely to maintain its fast economic growth and that the average income level will continue to rise. China’s urbanization will also gain momentum as a result of globalization, causing the population of big cities, like Shanghai and Beijing, to grow.

However, they usually fail to consider the disadvantageous factors like the adjustments of economic cycles, an immature asset market, single children’s property inheritance from their parents and possible mistakes in macroeconomic policies that have the potential to dampen economic prospects. Taking these into consideration, the asset prices might plummet in the short term, causing serious losses for those betting on further inflation.

China’s decision makers have gradually realized that housing is not only a commodity, but a basic right. The government has realized that the macro-control over the property market should be based on the provision of affordable housing for the low-income groups.

Considering that Chinese people’s income levels are relatively low and that the improvement of a country’s welfare level takes time, people should not put too much expectation into the residents’ purchasing capacity for second homes or college graduates’ capacity to buy housing through a mortgage.

Lessons from the West

The property sector is beyond doubt a pillar industry in China. Meanwhile, home purchases can be considered either a form of consumption or an investment. During speculative asset price inflation, housing’s nature as an investment tool is more conspicuous, which might worsen the macroeconomy’s fluctuations during economic cycles.

As far as housing investment’s negative impacts on the macroeconomy are concerned, China has learned from other countries, like Germany and France, which experienced relatively mild fluctuations in their economic circles as assets are less of an investment tool there. By contrast, economies like the United States, Japan and Spain, which suffered from turbulent economic downtowns during the last economic cycle, are more tolerant toward viewing housing as an investment.

A major barrier to China’s sustainable economic development is its high saving rate and low consumption, a structural defect that has become even more obvious in the wake of the financial crisis. Thus China lists consumption expansion as a key task of its macroeconomic control policies. However, giving residents incentives to spend more should not go beyond control. Boosting consumption should be based on the growth of residents’ disposable incomes. In the context of a hot property market, slow growth of residents’ disposable income and frequent adjustments to interest levels, people buying homes at a lower mortgage rate may find themselves unable to pay their mortgages after interests experience an upturn. Therefore, the Chinese Government also needs to take measures to prevent a consumer credit explosion, like that experienced in the United States.

Suggestions to market supervisors

Property market supervisors in China should adhere to three long-term policies. First, the government should distribute rental subsidies to low-income groups and guarantee the construction of affordable housing by providing efficient construction land and capital while trafficing infrastructure support. The government will have more leeway to adjust property market policies after guaranteeing people’s basic needs and social stability.

Second, the government must adopt taxation and financial tools to reduce investments in the property market. This should be a long-term policy. To achieve this goal, state-holding companies should be required to enlarge their capital dividend programs and their programs to sell part of their state-held shares. Therefore, large state-owned enterprises can no longer repeat a vicious investment cycle of putting their extra money in the asset market, making money and enlarging their investment in housing. When state-owned enterprises became land buyers of the largest deals in many Chinese cities, their speculation further pushed up local housing prices. The second tool is to limit foreign investment in China’s property market and encourage foreign capital into management- and technology-intensive projects. The third tool is to increase the taxation burdens on property investment, including procedures to levy property tax.

Third, the government must strictly supervise the implementation of financial regulations of the property market. Second homes’ higher down payment ratio must be implemented, and property development companies must meet the requirements on the ratio of their own capital.

The government and companies should not frequently adjust their policies over the definition of second homes, down payment ratios, mortgage interest rates and taxes on property sales.

The popular public opinion that activeness of the property market is mainly decided by government financial policies is wrong, dangerous and in need of change.

When the economic cycle fluctuates most violently, the government should be warned against the excessive use of monetary policies, which could spur speculative investment in the property market.

While using financial tools to stimulate credit consumption, the government should not ignore the property’s dual nature as a form of consumption and an investment tool, while overlooking the risk of the property market boom on the macroeconomy. Therefore, the macro-control policies on the property market should be measured against the long-term development of the economy, consumer product prices, credit supply and the balance of international payments.