The Unprecedented Real Estate Bubble In China by Gary D. Halbert

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

April 19, 2016

IN THIS ISSUE:

1. China Posts Slowest Economic Growth in Seven Years

2. China’s Dangerous & Growing Real Estate Bubble

3. Purchasing a Home in China is Usually a Family Affair

4. When the Real Estate Bubble Bursts, Look Out Below!

Overview

Most economists and financial writers agree that the US has the strongest economy among the developed nations, even though we’re only growing at about 2%. Despite the slow growth, most don’t believe we are facing a recession anytime soon. However, most economists and financial writers also agree that a serious external shock could quickly throw the US economy into a recession and take most of the rest of the world with it.

The question is, what kind of a shock might it be? Some point to Greece, others to Brazil, both of which have flirted with bankruptcy. Others worry about a hard landing for China’s economy, which some fear would be enough to throw the US economy into a recession.

Yet there is another totally different risk in China that most Americans know nothing about. It’s the bubble in Chinese real estate. Chinese citizens are up to their eyeballs in real estate and almost nothing else. Prices have skyrocketed in recent years into what some are calling a giant bubble.

If that bubble bursts and home prices plummet, millions of Chinese would see their net worth evaporate.

This problem is much larger and potentially more devastating than most economists and forecasters realize. My clients and readers need to know about this, so that’s what we will talk about today. But before we do, let’s take a look at the latest economic news out of China from last Friday.

China Posts Slowest Economic Growth in Seven Years

China is getting a slow start out of the gate this year, growing at its slowest quarterly pace in seven years during the 1Q. Gross Domestic Product expanded by 6.7% (annual rate) in the three months ended March, following 6.8% in the 4Q of last year, according to China’s National Bureau of Statistics. That was a tick above the 6.6% growth economists expected ahead of the report, according to the median pre-report consensus.

Real Estate Bubble In China

While this represents China’s weakest quarter since the dark days of the financial crisis in early 2009, it is still “a milder deceleration than many had feared until recently,” said Louis Kuijs of Oxford Economics. For all of 2015, the world’s second largest economy grew at a 6.9% pace, the slowest annual rate in 25 years.

The government reported that fixed asset investment (a measure of capital spending) rose 10.7% year-over-year (y/y), and industrial output rose 6.8% y/y. Both of these measures were slightly stronger than expected. Housing and infrastructure gains offset a slowdown in financial services in the 1Q.

Friday’s growth report suggests that China’s aggressive monetary stimulus is finally bearing fruit, according to Jing Ulrich, managing director and vice chairman for Asia Pacific at JPMorgan Chase. But Ulrich cautioned that she does not expect the People’s Bank of China (PBOC) to unleash more stimulus anytime soon, and is awaiting the GDP data for the 2Q.

The PBOC has lowered interest rates six times since November 2014, as well as slashing the reserve requirement ratio (RRR) for banks. The central bank’s last action was in February, when it reduced the RRR by 50 basis points.

China’s shrinking economy has long been a focus for global markets, as President Xi Jinping tries to engineer a structural slowdown to re-orient the country away from manufacturing and exports towards domestic consumption and services. The government is targeting growth of 6.5% to 7% for 2016, but it remains to be seen if the deceleration since 2010 has stabilized.

China’s Dangerous & Growing Real Estate Bubble

In order to explain this potentially scary development, we must start by looking at China’s incredible savings rates. Compared to the US savings rate of 2-3%, the Chinese on average save about 30% of their income. Only a handful of countries around the world save 30% on average. Affluent Chinese save more than double that amount!

Real Estate Bubble In China

The other thing to know about the Chinese who live in the largest cities (Beijing, Shanghai, Shenzen and other Tier I cities) is that owning your home is paramount. It is said that Chinese men have zero chance of getting a date if they don’t own their home. But as we’ll see below, home, apartment and condo prices have skyrocketed in recent years.

While the Chinese are to be applauded for saving, the problem arises when we look at what they do with their savings. The Chinese on average have almost 75% of their wealth invested in real estate. This includes their primary residence and in many cases a second residence and/or investments in high-rise condo developments (more on that below).

Real Estate Bubble In China

With almost three-fourths of their net worth invested in real estate (and the other 25% mostly in cash), Chinese investors have no diversification. They have overinvested in illiquid and overpriced assets that they wrongly believe can only go higher. In doing so, they have created what some call the greatest real estate bubble in history.

And just how expensive and overpriced is Chinese real estate? Relative to income, China has seven of the 10 most expensive cities in the world!

Home price to income ratios in the largest cities are off the charts. Beijing is 33.5 times income, Shanghai is 30.2 times and Shenzen is 30.0. In the US, by comparison, the home price to income ratio in cities is only about 6 times income on average. That’s a HUGE difference!

The average condo in most Tier I cities in China is only 650 square feet and would go for $460 per square foot, or about $300,000. In preferred locations, the prices for the same size condo can be double that or more!

If tiny condos in Tier I cities are selling for $300,000 at 30 times income, that suggests that many buyers are only making about $10,000 a year in income, which is borne out by government statistics. This raises the question: How in the world can they do it?

All through the country’s Tier I, Tier II and even some Tier III cities, housing prices are severely out of proportion with the incomes of the people who live there. However, the people of China can afford to buy these extremely expensive properties.

In fact, 90% of families in the country own their home, giving China one of the highest home ownership rates in the world. What’s more is that over two-thirds of these homes are owned outright, without mortgages or any other liens. On top of this, north of 20% of urban households own more than one home. How can this be?

Purchasing a Home in China is Usually a Family Affair

Before we can understand how people in China can afford its over-inflated housing market, we must look at where this market came from. Hardly 20 years ago China’s real estate market didn’t exist. It wasn’t until the

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