Chinese real estate consulting firm World Union sees red; Austrian business cycle theory at work

With real estate transactions plunging in China, real estate agencies and agent aren't earning commissions. One firm, World Union, saw profits turn negative in the first quarter, with sales at a multi-year low. The first chart below is sales, the second profits. The numbers don't use notation, so they appear as all zeros, but the trends are clear. The chairman of World Union wrote a popular microblog post recently titled, "7 tricks killing real estate agencies," in which he discussed how the industry developed business practices during the 2009 bubble. Those once positive practices have turned destructive for the industry.

The simple answer is that there are too many real estate agents. The sidewalks in Beijing and other bubble cities are littered with agents and their sandwich boards advertising properties. On a 10-20 minute stroll down the street during business hours, one could easily come across 20-30 agents manning their sandwich boards. There are often 3-5 agencies all in one spot, on every single block. If the block is large enough, sometimes this cluster of agencies will occur two or three times.

Unemployment to come, in keeping with the business cycle

Financial repression in China and the undeveloped financial sector means savers have few places to put their money, and investment choices are limited. China has negative real interest rates and these low rates send the signal to borrowers to invest in capital goods. Interest rates are negative for deposits and loans, banks make money thanks to financial repression whereby deposit rates are extremely low. Saving money results in losses of at least 2-4% annually on purchasing power (going by official CPI numbers, higher if you don't trust them), while if you are borrowing for a home, your interest rate is also negative! A rational actor will then borrow to buy a home as an inflation hedge (as Lang Xianping pointed out,), while at the higher stage of production, the developers are borrowing to build these homes. This next point is very important: average Chinese borrowers can only obtain cheap mortgage credit, if they want credit for other purchases, or even for a small or medium sized business, they cannot obtain it. Thus, a part of the demand for homes is being driven by demand for an inflation hedge because aside from gold and art, Chinese don't have many investment choices and they're not buying stocks.

Unemployment is a lagging indicator because the higher stages of production have higher capital to labor ratios. Real estate is one extreme example. When interest rates rise, capital feels the pinch first. The investments and planned investments at the higher stages of production become unprofitable and are liquidated or canceled, and these adjustments move down the line. The Chinese government had been tightening monetary policy until this year and private market rates soared to 10% per month in Wenzhou, a center for private business. We are seeing real estate developers dump projects and land in order to raise capital, and those tumbling prices are slowly filtering down to the consumer level. At the consumer level we see the highest level of employment at the agencies, and the lack of turnover has killed profits even faster than price declines. It won't be long before there are stories of mass job losses. In the article linked below, one solution already being bandied about is to replace physical stores with more online sales......

房产代理公司被拖佣金 传统营销模式面临转型
A primer on Austrian business cycle theory.

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