THE property market illustrates the growing divergence between rich-world and emerging economies. In most developed countries (with a few exceptions, such as Australia and Canada) governments are trying to breathe life into property. In developing ones they are trying to cool things down. In the West the question is when prices will stop falling. In the East it is whether they will stop rising.
For many institutional investors, emerging markets, however buoyant, are not worth taking big bets on. Thanks to the bust, the rich world offers high-quality properties in liquid markets at lowish prices. The developing countries are a riskier development prospect, with new homes, offices and malls being built at speed to cope with fast-rising demand.
That demand is undoubtedly enormous. Brazil is thought to be short of some 8m homes; the whole of India has fewer hotel rooms than Las Vegas; in Saudi Arabia a long-awaited mortgage law is expected to kickstart a residential boom. Yet the pitfalls are also cavernous. Legal issues are one source of uncertainty. Investors complain that China’s system is capricious, for instance. “China will be one of the biggest property markets in the world in five years’ time,” says one big fund manager. “But if you put millions into a building in China and sell it, it is not clear that you will be able to take your money out.” Retail lenders express similar misgivings about the process for repossessing homes in developing markets.
The biggest worry of all is the rush of new supply. The pace of development is often frantic, nowhere more so than in China. According to Barclays Capital, more than 40% of the skyscrapers due for completion in the next six years will be in China, increasing the number of tall buildings in Chinese cities by more than half. Landscapes are changing in a matter of days. One of the more hypnotic items on YouTube is a time-lapse video of a 15-storey prefabricated hotel in Changsha being put up in just six days. “The range of outcomes in London and New York is pretty limited,” says one investor. “In Shenzhen you can be building a block of apartments with four others going up alongside.”
One way to manage the risk of oversupply is to take capital out of emerging markets as quickly as possible. ING’s real-estate asset-management arm (soon to be part of CBRE) works with local firms to build flats and homes for sale in markets such as China, enabling it to realise profits in two or three years. Another is to go for the less crowded parts of the market. Mr White of CBRE thinks that the logistics sector is one of the more promising avenues for foreign investors, in part because the market is dominated by a handful of global firms based in America. Shopping centres are another area where foreigners still have an edge over locals.
But many investors who have raised funds for deployment in emerging markets will have trouble finding a home for their money. One reason is that these markets are thin: there is very little buying and selling of existing properties. Another is competition from locals. Mainland Chinese developers are wildly optimistic because they have seen values rise, says David Ellis of Mayer Brown JSM, a law firm. “They are using a different spreadsheet.”
All this helps explain why many people are nervous about the state of the Chinese property market in general, and the residential part of it in particular. High-profile hedge-fund managers such as Jim Chanos give warning (self-servingly) of a property crash even worse than Dubai’s. In January three of the ten biggest short positions in Hong Kong-listed mainland companies were held in property firms. Nationally, incomes in China have largely kept pace with rising prices (see chart 7), but an IMF report in December said that in some big cities prices “appear to be increasingly disconnected from fundamentals”.
Rationing the air supply
The Chinese government has unveiled a series of measures since April 2010 to mute house-price inflation. They include raising the minimum downpayment for first-time buyers to 30% of a home’s value, up from 20% before, and a stop on mortgages for people buying a third or subsequent home. These measures have had some success. The year-on-year price rise has slowed down: in December it was 6.4%, not that much higher than the overall inflation rate.
Even so, the market continues to look extremely buoyant on many measures. Total property loans outstanding last year rose by 27.5%, which at least was slower than in 2009. Policymakers lean towards further tightening. A property tax was announced in Shanghai and Chongqing at the start of this year, causing a rush to seal deals before it takes effect. Transactions in Shanghai in the first half of January reportedly jumped by more than a third year-on-year, according to local estate agents. Wen Jiabao, China’s prime minister, has said he wants to see the residential market return to a “reasonable level” before his term of office ends in 2013.
As well as dampening down demand, the Chinese have been trying to increase supply. That may seem counterintuitive in a country with a home-ownership rate of about 80%. But that startlingly high rate was the result of a huge, one-off transfer of government housing to private ownership in the late 1990s. Much of it is dilapidated and most people want to move out and up. “There is pent-up demand that has been building for 50 years,” says Michael Klibaner of JLL in Shanghai.
The problem for the average buyer is that prices have been driven higher not just by other would-be homeowners but by a complex chain of speculative activities that reaches right back to another arm of China’s government, the local authorities. Land sales are a big source of revenue for local governments, and by drafting development plans for the land the government can hike its value several times over.
Until recently, local governments would sell this land to developers for very little upfront. A firm could buy land worth 5 billion yuan with just 500m yuan ($75.9m) in working capital, says Jinsong Du of Credit Suisse. Even better, the developer could then offer that land as collateral for a loan of, say, 2.5 billion yuan from a bank. And instead of ploughing those borrowed billions into developing the site, they could use it to buy more land. Developers were not too worried about generating cash flow, because in a pinch they assumed they could always sell the land at a profit or flog as-yet-unbuilt flats to eager buyers on the back of blueprints alone.
The viability of this model depends on ever-growing demand, which often comes from speculative investors looking for a chance of quick capital gains. Some are wealthy private individuals; many are enterprises that have been diverting money from capital investment, hoping for juicier returns from property.
All of this is a big headache for the central government, which is aiming to keep property affordable for the masses. A huge social-housing programme will eventually bring lots of cheaper housing on stream. In the meantime the government is trying to draw the air out of the speculative part of the market (by restricting mortgages taken out for investment purposes, and by banning many state-owned enterprises from buying land) and to put developers under pressure to build and release properties quickly. Banks now have to put money into an escrow account instead of lending directly to developers. The cash is paid out when construction reaches certain milestones. Downpayments from developers to local governments have shot up, too, and now total 60-70% of the land’s value. That stretches developers’ balance-sheets, encouraging them to drop prices.
The slowdown in property-price rises suggests that these policies are having some effect. But the upward pressure is still immense. To get round the new rules, some mainland developers are reportedly borrowing money offshore and dressing it up as equity when it comes onshore. The restrictions are not always properly implemented, particularly in smaller cities. A 2009 law allowed mainland insurers to invest another wall of money in property for the first time. Individual savers keep an enormous amount of cash in low-yielding bank deposits and have relatively few investment options, which increases the appeal of property—as does rising inflation.
Nonetheless, in two critical respects, comparisons between China and places such as Dubai are misplaced. One is underlying growth in demand. Some places in China may well be getting ahead of themselves: for example, it is not clear whether so many industrial cities really need a brand new central business district. If prices were to turn, the amount of vacant property being held as investment would make a wave of forced selling more likely. But China, with urbanisation and income growth on a massive scale, is clearly different from Dubai’s model of “build it and they will come.”
There are better parallels in the Middle East. Emile Habib of GulfRelated, a property-development joint venture in the region, says Dubai is saturated and the best prospects are places with lots of internal demand like Saudi Arabia.
The second difference is the amount of leverage in the system. The IMF reckons that loans to developers and mortgages accounted for under 20% of total outstanding loans in late 2009, compared with 52% in Hong Kong and 57% in America. Again, nobody should draw too much comfort from this. In a cash-driven market, liquidity can flow out of the sector quickly; mortgage debt is rising fast from a low base; and a property bust could spill over into other fields to which banks have lots of exposure. But as Western policymakers would now wearily agree, less debt means less systemic risk for the banks if and when the property cycle turns.