Are Property Booms and Busts Unavoidable?

Below is my abbreviated translation of a recent article by 徐滇慶 on titled “Developers Collude to Push Up Prices, Rendering Control Measures Futile”, which seeks to identify the underlying causes for persistent and rapid price rises in China’s property market and the possible causes that could lead to a reverse course.

It is interesting to see that those listed causes for price rises all have something to do with human nature and what Henry George referred to as the fundamental principle of the law of rent: that “men will seek to gratify their desires with the least exertion”. After all, who wouldn’t want wealth that comes not from hard work but simply from just owning a piece of land or property?

Empirical evidence shows that the causes cited in the article are not indigenous to mainland China, but apply to most places with a capitalist system including Hong Kong, although the “developer collusion” cause may be less obvious in western countries. The key concern here is that going overboard in property will always induce an economic bubble and usually leads to painful consequences when it deflates, as history has repeatedly witnessed. While the Japan and Hong Kong property carnages are still fresh in people’s memory, a similar scene is unfolding in the U.S. with credit complications. It is anyone’s guess if China will be able to avert what looks like a natural but unpalatable feature of capitalism.

Translated Article:

“Between 2000 and 2004, property prices in western markets except Germany and Japan shot through the roof and have become a hot topic for research and study.

Given the painful lessons from the Japanese economic debacle in the 1980s and the Asian financial crisis in 1997, a lot of academics have focused their attention on analyzing how speculative demand leads to a housing bubble being formed, as well as on the relationship between financial crisis and housing speculation. Some of them have been studying the basic factors that cause property prices to bloat and some have been analyzing the inherent link between rapid rises in property prices and a bubble economy. These studies are still ongoing and have reached interim conclusions. The results of these studies should lend some light on the investigative study of the internal mechanism by which China’s property prices have been skyrocketing.

What have caused China’s property prices to rise incessantly? Apart from the demand factor, there are four other factors that have caused dogged upward movement in prices:

(1) Properties are a durable commodity and can last up to 50 years with low depreciation rate. In most cases, purchasers buy properties just because they are worried that prices will keep rising and thus it makes sense to buy sooner rather than later. Once they have bought a property, they naturally wish the price to go further up. Therefore, it is not practical to expect purchasers to restrain their buying desire and help cool down the market; on the contrary, they would actually be a pushing force.

(2) For most homeowners, the property they own is their core asset. When the price of their core asset rises, they would feel rich even though they are not thinking of selling it and this feeling makes them happy and hopeful of further price appreciation. Such expectation often has a self-fulfilling effect on the price trend.

(3) Property price rises bring extra profit to developers. No doubt developers are the major pushing force behind the housing market. Most developers’ gearing ratio is 75 percent. That means only one-quarter of the total investment fund is the developer’s equity, while the remaining three-quarters are borrowed funds. For every price rise of 1 percent, the developer’s return on equity will grow 3 percent.

Another point is that in a rising market, even when a project is completed, a developer can choose not to sell out the completed units all at once if they expect future price appreciation will be greater than their carrying cost. They will simply hold on to the units, thereby squeezing the available supply, to maximize their return.

There are a number of prodigious developer groups who are known to manipulate the property market by collusion, enabled by their dominating market shares. Unless something can be done to restrict their market shares, none of the cooling measures such as raising interest rates and other administrative controls like regulating land grant procedures is going to be effective. As long as they can exercise dominance in the market, they can easily pass on to consumers any additional costs like interest rate cost and land cost.

(4) Local government officials are prone to take a rising property market as a sign of economic prosperity. Besides, it also brings them higher tax revenue and other grey area income. So they would only be happy to see an upwardly mobile property market.

On the other side of the coin, there are factors that could cause the market to reverse, apart from wholesale appropriation of assets, natural disasters, economic depression and financial crisis, and these are:-

(1) If some drastic negative economic fundamentals surface, like an abrupt rise in long-term real interest rates or dramatic changes in the tax system, these could cause the property market to tank. However, given the serious lag in reforming China’s tax system, all the various taxes that have been introduced as cooling measures are in fact useless as such.

(2) Relaxing land supply may apply some pressure on prices in the short term. In big cities like Beijing and Shanghai, the increase in land supply in 2006 was seen as an effective coolant. However, in the coastal cities where land is becoming very scarce, this measure is simply not workable.

(3) Experience shows that short-term restrictive measures like tightening monetary supply, directly taxing speculators and some price rise capping measures can have a cooling effect. However, such measures cannot be effective over the long term, as these would be off set by people’s natural expectations of price appreciation.

To make a final judgment on the causes of property price rises and falls would be crucial to improving and regulating China’s property market and preventing a financial crisis. The most urgent thing to do now is to establish a high quality research institution to collect and analyse all relevant data.

Generally speaking, it appears that all the abovementioned price rise causes are present and strongly visible in the property market, whereas none of the price fall causes is obvious. Based on this observation, we can conclude that property prices will continue their upward trend in the near future.”