Under enormous pressure from local governments starved of land revenue, developers staring at bankruptcy, and homeowners facing falling prices for the first time in history, the regime in Beijing is rolling out a raft of measures to try and reinvigorate China’s real estate sector.
How will these measures affect a sector responsible for about 30 percent of the economy?
China’s real estate economy works in a giant self-fulfilling circle. Local governments sell off local land rights to developers, raising, on average, about 30 percent of the government revenue and, in many cases, more than 50 percent. Lacking other stable means to increase revenue, local governments are desperate to keep real estate-driven revenue churning.
The real estate development industry—which is effectively bankrupt—is starved for buyers to sell its inventory of unsold and unfinished homes to, hoping to reduce its enormous debt. Households in China who now, on average, carry more debt than Americans and more than most households in developed countries are begging for relief.
The question is, what, if anything, will those measures accomplish?
The measures announced by Beijing focus on lowering interest rates for homeowners, reducing their monthly payments, and making it easier to buy a home. For example, new policies allow existing homeowners to qualify for the benefits accorded to first-time homebuyers, such as reduced down payments and lower interest rates. Another policy measure allows existing homeowners to refinance into lower-rate mortgages.
According to Chinese real estate brokerage, homeowners could reduce their monthly payments, on average, by about 850 yuan, or about $120. To the average urban resident with an average monthly income of about 3,750 yuan, an 850 yuan monthly cut would be significant.
So the question becomes, what will be the behavioral response to these policies by Chinese homeowners? Put another way, will they jump back into the real estate market buying homes, and what will they do with extra money in their pocket?
I should caution readers that predicting behavioral responses to changes in government policy is hard and risky, but let’s put forth some informed analysis based on how we’ve seen Chinese homeowners behave previously.
The first question is, will Chinese home buyers jump back into the market, swallowing a significant amount of unsold inventory?
This seems very unlikely. In the past few years, prior to the current market slowdown, most homes sold in China were for second, third, and fourth homes, not the primary residence of buyers. Put another way, there appears to have been very little primary demand from buyers even before the current issues. Coupled with the fact that there’s an ongoing major price correction that officials are trying to prevent, buyers seem unwilling to buy at prices that would satisfy real estate developers, Communist Party cadres, or sellers.
Now that homeowners have been burned with stagnant prices and are enormously indebted, there’s likely little appetite for jumping back into the market. While there’s likely to be some small effect, we'll unlikely see a significant change in the broader market.
Will homeowners use the income boost from lower interest payments on their homes?
Based on how Chinese consumers have behaved, we can expect that income to be split in some portion between paying down debt, savings, and consumption. What the exact proportion will be is largely speculative. Still, I would expect paying down debt and increased savings to be the two biggest responses by Chinese consumers, with the boost to consumption being the smallest portion.
With unemployment pressures, a rapidly aging population, and heavily indebted households, it’s difficult to see this income boost resulting in significantly higher household consumption. Chinese households that don’t see a strong economy and rapidly rising asset prices are unlikely to go on a spending spree.
Although this is unlikely to cause a significant change to the Chinese real estate market or consumer spending, this is actually reasonably smart or the least bad of available policy choices from Beijing. However, it does carry some significant risks. Beijing knows that real estate developers and related sectors present an enormous risk to financial stability.
Authorities are hoping that easing requirements on real estate consumers will effectively bail out developers by buying unsold homes and allowing them to finish the units that remain unfinished. It should also help the banks that have faced rapidly rising foreclosures and delinquencies on mortgages. It acts as a type of tax cut by putting more money in consumers’ pockets without drawing from already strained public funds.
Although it’s unlikely that consumers will bail out the developers, it may at least buy some time, help the banks a little, and provide a small boost to spending.
The risk Beijing is running here is a macro risk. The Chinese continue to use a variety of inventive methods to move money into U.S. dollars. With the yuan falling and under enormous pressure to fall further, lowering interest rates requires even tighter capital controls to limit hidden outflows to prevent a downward spiral. Beijing has built its entire economy by attracting large foreign investments, running massive trade surpluses, and keeping savers’ capital domestically to fund its enormous infrastructure model.
It'll be vital for Beijing to prevent that money from leaving to prevent additional pressure on the yuan. The larger long-term problem is, given Beijing’s long-term low-interest rate stance, how does it reconcile this with higher U.S. interest rates that, even after they come down in the next few years, will, at best, only equalize, lacking the 3 to 4 percent premium China enjoyed that allowed it to attract capital for many years?
Overall, this isn’t a poor policy, but it fails to address the fundamental structural problems and seems unlikely to make a significant change. This isn’t a bad policy, but it simply can’t correct a falling population, massive home oversupply, and household indebtedness. Those problems remain.
