Is the Real Estate Cooling Down? – Part III

Is the Real Estate Cooling Down? – Part II got responses. I posted the following comments to the thread that is already hot. Please forgive me to abuse the right of more control on this blog so I can post at the top of the page while others who holds different oppinion can only argue at the end of the page. :-)

Disclaimer: Don’t treat me as an expert on real estate. I am not. I just copy what I heard from the conference, which I think is reasonable analysis.

After collecting some information, I think it is the time we pay attention to the following factors:

It is true that when all investors withdraw money from real estate market, the bubble will crash. But in a closed economy, people have not many choices other than putting the money into real estate and will continue to put in more money. In LA or HK, people can easily and quickly move the money from one country/region to another. It is not the case in mainland.

If you want to withdraw your money from real estate, tell me, where you put your money? You cannot put it into any investment abroad. Maybe you can, but majority investors cannot. You may not consider putting it to stock market in China – fewer people believe in the stock market in China now. Do you want to put it into investment like REITS? There is no such investment channel in China yet. It seems you only have to put it into bank and enjoy your 2-3% interest.

One day, the foreign investment channel will open to Chinese investors. When it happens, money will flow away as quick as possible and the bubble will crash. Before that, so many people with millions of dollars on hand have no where to invest. That is part of the reason why the real estate price raises so quickly – it is an indicator of the lack of other investment channel.

We do compare from apple to apple. The income v.s. apartment ratio is a key theory foundation for the argument that we should not compare Shanghai and NYC. The annual family income to average house price ratio is around 1:6 worldwide. It is 1:12 in Shanghai. That means, 12 persons working for year can get a house in U.S. (considering two persons with income per family) or 24 persons working for one year can buy a house in Shanghai. It reflects the ratio of the price of labor and the price of resources. Now the price of resources can be traded – all the goods that flows between China and U.S back and forth, so the price is comparable, but the labor price in China is much lower. Which means, it is quite reasonable that if the household income v.s. house raise from current 1:12 to 1:20 or even higher. The secret behind it is, labor is over supplied in big cities like Shanghai and capital is also over supplied (with huge amount of money flow in from around the country) but the construction of real estate properties does not catch the speed. So the price will continue to rise.

I don’t mean the price will continue to raise forever. I agree there is bubble, serious bubble. But who cares. People only care about the bubble before and after it crashes. The most important factor for the bubble to crash is:

More investment channel is open so people have more choices to move the money out of real estate.

The ratio of household annual income v.s. properties price will drop below current 1:12 only when the labor cost of China increase dramatically.

22 thoughts on “Is the Real Estate Cooling Down? – Part III



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    Foreign Investors Flock

    To China Real-Estate Sector


    Staff Reporter of THE WALL STREET JOURNAL

    January 19, 2005; Page B6

    Foreign real-estate investors are ramping up their activities in China’s biggest cities, even though prices have risen and there are signs of a coming downturn.

    The thinking is that Shanghai will beat out Hong Kong to become China’s financial and commercial center and emerge as one of the world’s great cities, on a par with New York and London. Investors in Beijing’s hot market believe it will benefit from a pre-2008 Olympic boom.


    [Asia’s Financial Markets]1

    See more coverage2 of Asia’s financial sector, from IPOs to banking to bond offerings.

    And most recently, currency speculators have helped boost prices, snapping up real estate as they anticipate that China will ease its currency’s peg to the dollar. That would drive the Chinese currency higher and raise the value of the investors’ real-estate holdings.

    It’s a risky game. Skeptics argue that property values are rising too fast, outpacing personal-income growth among China’s burgeoning middle class. Since 2000, residential prices in Shanghai are up an average of 85%. At the same time, rents have started to slide. Such an imbalance can’t last, says Peter Churchouse, a Hong Kong-based hedge-fund manager specializing in real estate.

    The upshot is that property developers accustomed to reaping 6% rental yields in Shanghai now are finding it difficult to eke out 3% to 4% gross, close to what real-estate investors expect in less risky markets, such as New York and London. Rents are unlikely to go up, Mr. Churchouse explains, as properties built to entice middle-class buyers increasingly become unaffordable.

    Michael Hart, head of Shanghai research at Jones Lang LaSalle, says he has seen rents fall in apartments ranging between $1,500 and $5,000 per month. In one complex outside Shanghai, rents have dropped around 10% in three months, said David Zhang, an analyst at hedge fund Dynasty Asset Management.

    Yet foreign investors are clamoring to expand in China. Although there is no exact calculation of foreign inflows into property, Mr. Hart says the available data indicate overseas investment is growing. In 1995, China real-estate investment totaled $38 billion, with a minuscule portion of that coming from foreigners, Mr. Hart says. By contrast, in 2003, $122 billion flowed into China’s property sector, and a 2003 survey by the Shanghai government revealed that 5%, or about $6 billion, came from investors in Europe and the U.S., as well as in Hong Kong and Taiwan.

    Shu Yin Lee, who manages a $25 million real-estate portfolio for Grand River Investments, says he isn’t worried about having to pay two or three times what he paid in the past to acquire new properties in Shanghai. In his view, higher prices are justified because Shanghai’s long-term prospects for becoming a world-class metropolis remain appealing. “In a way, we’ve taken the ‘Real Estate for Dummies’ approach,” Mr. Lee says.

    Many observers expect developers to manage risk by diversifying to other Chinese cities. “One of the reasons people are looking at other places is that the market in Shanghai is too crowded,” says Mr. Hart. As for that city, he says, some developers who chose wisely will do well, while those who bought land and developed projects indiscriminately may struggle to see a profit.

  2. A lot of people mentality is like who cares if the price is bubblish, as long as there will be a greater fool who is willing to buy it at a even higher price, whom the new buyer thinks the same way that there will be some other greater fool out there. Speculating in a market in it’s bubble phase is like playing musical chair, it’s all fun until the music stops, lights up, guess who will get caught without a chair to sit down? I don’t like that feeling myself. The ‘no investment options’ outside of real estate argument sounds reasonable on the surface, but it’s just an excuse for speculators in my opinion. To choose between 2% interest vs potential big loss when music stops, I choose the prior.. thank you.

    Another observation I have is in China, buyer pays premium for brand new buildings, there may be a high price tag but no willing buyer for older building unless the location is prime. Compound with the fact that a new building only get a 70 years lease, it’s like buying an option, as time ticks, value decrease. What kind of risk preimum should be added in this situation?

    On the other hand, if you are buying a place to live in for a long long time, the risk is a lot lower, as proven from history, money always lose it’s purchasing power over time. One more thing, make sure you can afford it based on your income. just my 2 cents

  3. Don’t let the impending property value correction haunt you due to factors beyond your control. Should such correction ever occur, it just represents the end of the market cycle and the new era will begin, more people seeking accommodations will pour in due to its affordability, as long as people need shelters, the real estate market always holds its value in the market. In the closed economy like China, the impact of the correction can be mild as the authority controls the interest rate, money supply and the availability of land.

    Just like you build a sand castle, the bottom layers always need to be compact before you can build upward.

    I never like to use the word ‘crash’ to describe the downfall of the market price, it means something fall to a bottom and never able regain its value.



  4. After so much discussions, basically, I think it’s unpredictable.

    What makes more sense for most people is, if you need a place to live, then buy it.

    If you already have a place to live, don’t get too greedy buying too many. Ask yourself this question: “Can you withstand a sharp downturn?”. If you can rent out your property that negates the mortgage payments, why care about the bubble? Just let it come. The only ones who needs to be concerned are those who borrowed too much money and extended their credits to the max. Those were the ones who got hit real hard during Hong Kong’s crash.

    Personally, Shanghai’s market scares me because of the 40% investor ratio. Despite so much price appreciation in the US, most US cities enjoy less than 10% investor ratio. All I have been saying is not to predict an immediate crash in Shanghai, but intended to point out the risk in a market like Shanghai, Emerging economy, Super high investor percentage. Usually this situation rings an alarm bell to a sane investor. However, Shanghai may be different from other markets due to artificial government control or limited money flow (also a result of government control). But that’s too complicated to predict.

  5. The one statement that has cost investors untold sums throughout history was “This time is different!”

    Go back to history and in all bubble and manias, this phrase is most often used an excuses always thought of as to why the mania would continue.

    Having said that, long term I am a bull on China but I think China is now at its cyclical peak.

    All emerging markets are characterized by sharp boom bust cycles and China is no different. To think the government can actually control this (even in a closed planned economy) is way too optimistic.

  6. Agree with PC’s comment. As long as human nature remains the same, no time is different. What goes up will come down, what comes down will eventually go up. Sometimes the cycle is very long, like 10-15 years, sometimes the cycle is shorter. I hope Shanghai is in one of those long cycles. But nobody knows when the peak will be reached. From the experience for prior bubbles in the US, the peak was usually reached when everybody all thought, I emphasize *all* thought, that time was different, or a new era was about to unfold, then the market was at its inflection point. The crash almost always caught most of everybody in surprise.

    I don’t think Shanghai has reached its peak yet, simply because doubters are still abound, including myself. :-)

  7. Since we are at it, let me point out one more observation I had between Hong kong and Shanghai. Besides comparing Shanghai to NYC, people really enjoy comparing Shanghai to Hong Kong, let’s compare one more factor – land supply between the two cities. In my opinion, Hong Kong enjoyed a housing boom not without reasons, she had very limited land supplies. Now look at Shanghai, land supply doesn’t appear to be a long term positive factor for this city. Basically, land supply is unbounded around Shanghai. As long as public transportation can catch up, people will be happy to migrate out into the ever expanding suburbs. Geographically, Shanghai is not bounded by sea or water. Sooner or later, cheaper land will be developed to compete with the prices in close-in area, dramatically increasing the supply of new housing to the area. To me, this is not a formula for long term price escalation.

    PC said it right, Shanghai is undergoing a typical emerging economy’s boom->bust->boom cycle. Currently it’s in a prolonged boom cycle, the first phase. Shanghai will run a full cycle just like other emerging economies. I don’t see anything different.

  8. After looking at the Shanghai Real Estate market in detail, it looks like it’s still got a few good years left before a bust. It is riding low interests (4-6%), high down payments (20-40%) and a massive secondary market this is happy to flip for 5 to 10% within 3 to 6 months. In about 2 years, I believe it is going to begin to slow down when the mortgage exceeds the rental cashflow because the majority of secondary market investors are individuals that can’t actually afford a monthly mortgage.

    This is not a market for the faint at heart though, nothing like doing out-of-state appreciation investing in California where you can simply hire a property manager to do everything for you. Professional services here are still very immature and under-developed and an absentee owner would have an ulcer – with the buying, managing and selling process.

  9. The article assumes that most buyers are locals or mainland Chinese. Is that really the case? I regularly see SH properties advertisements in the local Chinese channel (KTSF) here in the SF bay area. In the SH market, I’d assume there to be a good majority of Chinese immigrants (in US and other countries), Taiwanese, Hong Kongers, Singaporeans, Japanese, Koreans, Indonesians etc. I’d think there should be a good portion of foreign investment in SH real estate that has flowed in rapidly and that may flow out just as rapidly (Re: Hong Kong, Singapore, Malaysia, Thailand real estate market crashes during the Asian crisis)…and of course, this time may be different.

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  11. A few important “facts” to consider:

    1. Sophisticated real estate markets do not “crash”. They correct. Corrections can be significant, but real estate markets don’t bottom out (as equities can and do). Thus, a “bubble” is only a risk if your holding period is short, or if you are over leveraged (i.e. cannot make payments on debt).

    2. No one can predict the future. It has been shown time and time again that there have been less than a dozen (that’s right – 12) people on earth (ok, I mean fund managers, but whatever) who have ever beaten markets in the long-term. Those who are overly bullish, as well as those who are overly pessimistic, about the real estate market in Shanghai are purporting to be fortunte tellers. (Note: again, I mean this with respect to the short-term and to one’s ability to beat the market, not as a comment on ability to understand long-term market trend)

    3. There are indeed many value-drivers that indicate long-term growth in the Shanghai real estate market. Not the least of which is a price comparison to other major cities. My understanding (and PLEASE correct me if this is wrong) is that prices for luxury apartments in Shanghai are still less than half of what they are in HK, Taipei, NYC, and Tokyo. Sometimes 1/3.

    If indeed the market does start turning down, I will be there to buy (not sell). And in the meantime, I remain a buyer in this market.

    BTW, nice blog here!

  12. I heard that there is a web-site where you can look up the actual average selling prices for properties in Shanghai. Does anyone know the URL?

  13. The real estate in Shanghai is dropping according to the link below (dated May 5, 2005). Is this really happening?,3546,110505+112005050500081,00.html



  14. My observation is, the residential real estate market is not cooling down. Apartments are still selling very well. The problematic part is the commercial buildings. Anyone knows if the foreign funds are planning in entering this market with the expectation of the rising renminbi?

  15. I feel as long as you remain out of the clearly overinflated areas (Desert and Coastal Oriented Real Estate), the breakeven interest rate for shifting money back into stocks is around 7.5%.

  16. who does it mean, “i like to eat my own poop in my mouth?” as far as i know, you are the only person who came up with this sentence.

  17. My opinions are that The real estate may cool down for the rest of the year, but forcasted to grow next year. Turbulent year for real estate.

    Mortgage Advice Center

  18. If anybody telling you the price is going down, that is a lie. I am in the market and I know what is happening.

  19. Regardless of what self-appointed real estate experts say, one simple fundamental growth driver for the Shanghai real estate market is growing demand in the long-term.

    Shanghai continues to be the economic center of the country. At the same time, many Chinese go to Shanghai to try their luck there. This urbanization trend will keep on, so we need more low-end housing simply to offer enough shelter for all workers.

    With rising incomes, young people are striving to upgrade their current accomodation – possibly an apartment they’ve shared for years with their family – to a mid-end apartment. In the meantime, one perceivable trend is the necessity for a man to have an apartment or at least the plan and financial means to purchase one before the his fiancĂ©’s parents accept his marriage proposal => Demand for mid-end apartments grows.

    Shanghai is set to evolve into one of the major metropolises in the world. This will add to its attraction on a broader scale, and draw the interest of affluent people across the whole world. => Higher demand for high-end apartments.

  20. Its a very reasonable analyze,the only one investment channle which most people in China will consider about is real estate, i think lack of investment channle was the most important key.

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