Beijing Real Estate Transactions Plunge 18% in April, Average Price Down More Than 10%; Yet Bubble Still Intact?; Comparison to 2011

北京4月楼市成交均价下跌超10%

English coverage here: Home prices in 1st-tier cities begin falling

An apartment of around 90 square meters, worth around 3 million yuan ($479,400), could be sold at a discount of 100,000 yuan to 200,000 yuan in Beijing, according to Gao Yuan, a Beijing-based realtor at real estate agency Homelink.

Potential buyers are holding a wait-and-see attitude, which has greatly dented sales.

"An apartment used to have more than five potential buyers, but now there are only one or two," a Beijing-based realtor, who declined to be named, told the Global Times Saturday.

The property market in Shanghai is also cooling. Units in a new real estate project in Pudong district were being sold at a price discount of as much as 28 percent recently, media reports said.

But Hui Jianqiang, a senior expert at China Real Estate Association, said major price drops in first-tier cities will only be limited to specific projects and will not spread in the entire markets in the short term.

That comment I highlighted is the key to the real estate market in China. Price declines were mainly limited to new buildings in 2011 and never became a widespread phenomena. The cities that have seen widespread price declines since then are the ghost cities such as Ordos. This year, price declines are once again hitting new buildings coming on to the market because smaller indebted developers are under great financial pressure. Pressure is most acute in overbuilt areas such as Zhejiang province. Well funded developers are not at risk; for them this is an opportunity to push competitors out of the market. They have cut prices in some markets in response to market forces (better to sell early for a small discount than later at a larger discount), but are not facing an existential threat.

Tight credit (a mix of stable monetary policy, interest rate liberalization and growing risk aversion) is squeezing marginal developers and putting pressure on the housing market as some properties are dumped to recoup capital. This is not a real estate market driven event, but a credit cycle event.

Ben Bernanke thought subprime was contained because he (and many other economists using Keynesian models) ignored total debt. He saw the subprime market as small and limited, but didn't foresee the growing risk on bank balance sheets. Subprime was indeed contained to a degree, but there were a large amount of derivatives that created a direct transmission path from subprime into the heart of the financial system. Even without such a path, the financial system was fragile because of leverage: losses could quickly wipe out capital and tip the system into deflation.

Many people say there is less risk in China's financial system in part because there isn't this clear transmission path from home prices into the financial system. The evidence given is China's higher mortgage standards that require larger down payments and the lack of derivatives. This is all true and it does lower the risk of a systematic crisis, but the bigger story is and always will be the total credit market and leverage in the system.

Subprime was the straw that broke the camel's back, the snowflake that touched off the avalanche. Even without derivatives, the system was headed for a tipping point because the cost of additional debt exceeded the return. In the case of China, the return on debt has been quite poor post 2008, on par with the United States in the 1990s. China should not have returns on debt on par with the 1990s U.S. economy because the U.S. is a developed economy growing at far slower rates. The leadership recognizes this and has refused to repeat the mistakes. No stimulus this time.

Whether there is no crisis, China's Crisis Similar to U.S. Savings & Loan Crisis of the 1980s, or a much bigger crisis, will come down to the credit market. If the credit market increases at a sufficient rate, then a systematic crisis has been avoided. This still leaves the risk of real estate crash, the odds of which are much higher.

A bubble exists when the price of an asset far exceeds the price derived from its fundamental value. Since fundamental value is based on the present value of future cash flow, the present state of mind of the participants is highly important. In periods of rising social mood (optimism), future cash flows are inflated and discounted at a lower rate of interest. Time preferences are lower due to the expectation of a brighter future. Greed for future profits exceeds fear for present capital. In periods of falling social mood (pessimism), future cash flows are deflated and discounted at a much higher rate of interest. Time preferences are higher due the expectation of a darker future. Fear that presently existing capital will be destroyed far exceeds greed for future profits. People worry about return of capital, not return on capital.

Fueling the bubble is credit. In a non-credit economy, a bubble in one asset would be hard to sustain because it would cause price declines in other assets. Even if there was a purely psychological asset bubble, it would have a lifetime similar to that of cultural fads because the increase in price of one asset class would by be offset by the decrease in price of another asset class. Investors would quickly adjust their expectations for future returns. When credit is involved, the rising asset class can fuel a generalized boom in the economy. The change in asset values is relative, not absolute, obscuring the bubble. The bubble can continue as long as the credit bubble (or money supply) expands and/or market participants as a whole are increasingly optimistic (more people are joining the bubble).

China's interest rate reform involves allowing a greater role for the market in pricing risk. The government refuses to repeat the mistakes of 2008 and remains committed to a stable monetary policy: no fiscal or monetary stimulus is planned. The pressure from the credit market will continue and even intensify. May is crunch time for the real estate trusts. The PBOC has said some trusts will fail; that will put more pressure on the real estate market. Chinese home buyers are starting to get the message and have begun altering their expectations; real estate agencies are altering their behavior in response.

Here are some items I posted in 2012, right when the real estate market was last hitting its make or break moment. The crisis was over by summer 2012. The main difference between 2011/2012 and 2014 is the different policy approach: there were rescues from the banks and cities in 2012. This year there are no rescues. The other big difference is price and debt levels increased substantially.

These three are relevant to the Beijing news above.

Posted in April 2012: Average new home transaction price in Beijing down 20% from 2011

Beijing new home prices declined 7% from the start of 2011 to the end of 2011, and at the end of first quarter in 2012, prices are 20% below year-ago levels. 90% of the 16,000 housing transactions involved first-time homebuyers. Total housing turnover was 18,000 units and 1.8 million square meters, down 14.2% and 19.6% from last year and the lowest figures since 2007. Average price for all housing transactions was ￥19,516 per square meter, down 19.4%.

Those were big price declines in 2012, yet it never became a generalized trend.

Chinese housing: May Day! May Day! May Day!

Along those lines, there is still a steady stream of falling prices news. This weekend, a development in the Beijing suburb of Tongzhou slashed prices 50% (北京楼市降价战再打响 通州房源再现“5折”)—but it was just one apartment, a sales gimmick designed to generate media coverage—and the rest of the properties were sold for about 30% off. Elsewhere in Beijing and the rest of China, price cuts remain spotty and overall prices have held up. We see 20-30% price declines regularly in the press, but the citywide prices may only be flat or down less than 1%.

Anecdotally, the market is in a similar place to where it was in 2012, but in 2012 the cuts were in first-tier cities and even larger than they are in 2014.

Even though there were these cuts, transactions picked up in May: Property transactions increase in China

Here are some more posts from 2012.

June 2012
Rate of home price decline slowing in China
Chinese real estate bubble at risk of reflating (and it did reflate with gusto in 2013)

March 2012
Chinese luxury home prices continue to decline, reaching nearly 50%; Aoyuan project faces cash crunch? (Luxury properties were still selling well as of March 2014)
Beijing banks offer interest rate discounts (Today, mortgages are at a premium and halted in some areas)
Beijing real estate construction plunges 40% in Jan-Feb period (as of March 2014, there is a clear mutli-month trend underway, but the yoy decline in construction growth still hasn't hit the levels seen in 2012)
Chinese home buyers worry about losing their savings
This won't end well: China goes subprime; developers extend credit to home buyers (I was wrong, it did end well, at least for the first time. Now they are doing it again in 2014.)

February 2012
China social mood in a graph
Some Chinese cities ease housing policies (This hasn't happened yet in 2014)
Chinese banks discount mortgage rates

January 2012
Shanghai, Guangzhou report similar real estate freezes (Sales were down sharply during Spring Festival in 2012)
Layoffs hit Chinese developers; over $50 billion in trust assets come due, up to 15% at risk
85% of Chinese economists predict home prices will fall in first half of 2012
Shanghai land sales decline sharply