Xi Jinping’s to-do list has seen a lot of ticks in recent months: more flights into Taiwan’s defence zone; suppressing dissenting voices in Hong Kong; clipping the wings of tech barons; outlawing the out-of-school tutoring industry. The list goes on.
However, one key initiative – introducing a local property tax – has attracted fewer headlines but is apparently so controversial within China’s ruling Communist party that even Xi is still only able to deal in trial schemes rather than wholesale change.
The decision to pilot the tax on all types of property in selected regions for five years – most likely important cities such as Shenzhen and Hangzhou– was taken last month. It is seen as vital to reforming the country’s bloated property sector, a concrete-and-glass divide between China’s haves and have-nots which has been personified by the woes of the heavily indebted developer China Evergrande.
The property tax is controversial because local governments rely on land sales for at least 40% of their revenues. This has encouraged an aggressive sales policy, aided and abetted by property developers happy to take on massive debts to buy the land and build ever more apartment blocks for buyers convinced the market is a one-way bet.
This decades-long party saw China’s property developers build a debt mountain of around $5tn, according to analysts at Nomura, before Beijing called time by restricting what they could borrow. When the music stopped, Evergrande was stranded on the dancefloor with $300bn of debt, and it faces its latest pay-up-or-default deadline on 10 November.
Evergrande is just the tip of the iceberg though. Developers have to repay around $92bn in the next year, and analysts at S&P have estimated that more than a third could experience difficulties meeting those obligations.
Kaisa Group, second only to Evergrande in terms of issuing US dollar bonds, became the latest focus for concern when its shares were suspended in Hong Kong on Friday morning because of cash flow problems.
Xi has clearly had enough of the sector’s excesses. , But the question is whether the president’s property tax experiment to bring the housing market under control is too little, too late.
Real estate investment accounted for 12-15% of GDP in China between 2011 and 2018, the Harvard economists Kenneth Rogoff and Yuanchen Yang estimate. This compares with a 7% share of GDP in the US at the peak of the housing boom in 2005. Once related property market activity is added to the Chinese numbers, the proportion of GDP is more like 30%.
Such a large property market does not necessarily create a problem. After all, China has a population of 1.4 billion and needed to build millions of new homes because hundreds of millions of people have moved to urban areas in the past 30 to 40 years.
The notion that prices can only go up has made buying a house in China enormously expensive, with a house price-to-household income ratio of 19 in the biggest “tier-one” cities such as Beijing or Shanghai, 10 in tier-two and seven in tier-three cities, Canada-based BCA Research says. The average ratio in the UK is about 10 and in the US it is four, although mortgage rates are much lower in those countries, making it easier for households to manage the debt.
However, the speculative nature of the market is what really makes China stand apart. Between 2008-10, the proportion of people buying homes in China who were first-time buyers was 70%, according to the Survey and Research Center for China Household Finance. By 2018, after the property and construction sectors were jet-propelled by the 4tn yuan of post-financial crisis stimulus, that figure had dropped to 11.5%.
The same survey shows that first-time buyers were being replaced at a rapid rate by investors. In 2018, 22.5% of homebuyers already owned two or more dwellings, while 66% owned one. No wonder that Xi had said the year before that houses should be for “living in, not for speculating”.
Because these investors rarely rent out their properties, one-fifth of China’s housing – or at least 65m homes – lie empty. Rental yields are typically about 2% in China, which is way below the typical mortgage rate of 5.4%. In other words, the buy-to-let strategy that has proved popular for wealthy people in western countries such as the UK doesn’t make sense in China. Investors are instead buying the properties solely because they expect the value to keep going up.
“Clearly, housing in China has become an object of speculation which has made it unattainable for first-time homebuyers,” analysts at BCA Research wrote recently.
“Property developers have been building the wrong type of housing at the wrong prices and for the wrong type of buyers,” they said. “They have been building high-end houses and selling them at very high prices to high-income households who have been buying multiple properties as investments.”
The massive speculative bubble – China’s household debt is about 100%, or about the same as that of the US – has been magnified by property developers doing the same on an even bigger scale. While the cost of borrowing remained lower than the rate of house price growth, developers simply took on more debt to build ever more properties selling at ever higher prices while pocketing ever higher profits.
The catch is that with demand falling thanks to a declining population, fewer people starting families, and prices also tumbling, those profits have disappeared and may soon turn into massive losses.
‘The music has stopped’
It remains to be seen whether Beijing will allow Evergrande or any other large developer to fail. Most observers expect it to be a “controlled demolition” – in other words restructured in an orderly manner – and debts distributed via state-owned banks and institutions. Containing the impact of falling house prices in the wake of such restructuring and the introduction of a property tax could be more difficult.
Lower prices might be good for some people not yet on the property ladder, but with more than 90% of the urban population owning property and 40% of household wealth tied up in property, any disorderly collapse in values could trigger social unrest such as that seen during past downturns.
This is what Anne Stevenson Yang, co-founder of Connecticut-based J Capital Research and a China specialist, fears. She says the Communist party supported free market activity as long as it unlocked value for the state. Now it wants to rein in the excess but the process of deflating the market is freighted with risk for Xi and his government.
“The buying of new apartments has got to be coming to an end,” she said. “The music has stopped and all these people can’t find a chair. Then what?”