Soaring Chinese House Prices Increase

Soaring Chinese House Prices Increase Fears of Property Bubble

The current economic recession has underscored a trend that is occurring in China. Where, they are keeping their currency artificially low against all the other major currencies, resulting in a trade surplus. The problem with using such a strategy is that they are making it difficult for Chinese investors to invest overseas. This has helped fuel the country's real estate boom, which is being pushed by increasing amounts of debt and a chasing type of mentality. Where, the government is essentially stepping in and filling the void in the market offering cheap real estate loans. This is causing the supply on the market to outstrip available demand. To fully understand how severe the problem is becoming requires that you consider how this is occurring in relations to the gross income multiplier, how true supply / demand determine market conditions, how pent up demand / affordability determine a reasonable cost for local consumers, how long consumers are planning on holding the property and what are the different tax consequences for first time home buyers / speculators. Together, these different elements will provide the greatest insights as to what challenges are facing the Chinese real estate market.

What do real estate investments do for the Chinese economy from a gross multiplier affect (6X)?

The gross multiplier effect will indicate how many times more the underlying value of the property is in relation to the overall amount of rent that is being paid. ("Gross Income Multiplier, " n.d.) Using the multiplier of 6X, it is clear that China's real estate market is overvalued by six times compared to the actual rent that is being paid for various properties. This is significant because it underscores the speculative bubble that is developing in the Chinese real estate market.

What is true demand and supply and how are equilibrium market conditions determined?

True demand and supply is the actual demand that is occurring with in the economy for a product or services. While the supply, is the actual number that is available to meet demand. Equilibrium conditions are determined when there is enough available supply to meet the available demand. ("Demand and Supply," 2010) Where, the available supply is easily being absorbed by the demand from buyers. In the case of China the true amount of supply is outstripping the true amount of demand. A good example of this can be seen by looking no further than office towers that sold for $400 per square foot in downtown Beijing. This is despite, the fact that the property was largely unrented. (Epstein, 2009)

What are the forces of pent-up demand and how do we measure affordability to incomes to measure reasonableness in cost of ownership for the Chinese consumer?

The forces of pent up demand is when, the forces of demand are so large, that they overwhelm all available supplies. Once this takes place, it causes prices to increase dramatically as this demand will create a shortage of available supplies in the market. The way that you measure affordability of real estate prices in comparison to the Chinese consumer is to compare the annual income with the average selling price for real estate. According the CIA World Fact Book, the average annual per capita income in China is $6,600. ("China," 2010) The average price for real estate in the Chinese market is currently $172,970. ("New Home Sales at Higher Average Price in Shanghai," 2010) The way affordability can be determined is by taking the statistic that is used throughout the real estate industry to determine the maximum someone could afford for a house payment. In general, the range that many loan officers will follow is between 31% and 38% of someone gross annual income. This number will tell you if the property is affordable to the potential buyers based upon their annual income. When you apply this number to the Chinese consumer, the maximum amount that can safely be used to purchased a home is $2,508 per year ($6,600 * 38% = $2,508). On a monthly basis the maximum amount that can be paid in the form of a mortgage is $209.00 ($2,508 / 12 = $209.00). Using the average price of a home and calculating a 30-year mortgage with no interest (which will not happen). The average yearly amount that would be required to be paid back with in the terms of the loan would be $5,733.33 per year ($712,970 / 30 = $5,733.33). On a monthly basis the mortgage payment would be $477.77 ($5,733 / 12 = $477.77). This is more than the average Chinese family could afford. What this shows is that the cost of ownership has become completely out of reach for the local consumers within the Chinese market. Where, the overall speculative atmosphere is driving prices higher.

How long does a consumer intend to own and hold?

The government is currently forcing the consumer to hold property at least five years. Evidence of this can be seen by changes in the government policy on real estate, where those property owners that are attempting to sell their property before this time will be required to pay a capital gains tax. ("Strong Growth in China's Housing Markets," 2009)

In addition to investment benefits what are the tax considerations in China for first time buyers and for speculators?

The biggest benefit of investing in China is the fact that foreigners are free to purchase property. However, the various taxes and regulations surrounding the market are changing. A good example would be restrictions imposed on first time home buyers, by having tighter lending standards and requiring a higher down payment (at least 20%). Then, in 2008 these restrictions were lifted and the taxes on purchasing a home were reduced. As far as the foreign investor is concerned, they can purchase property. Those who have lived in China for one year are only allowed to purchase properties that will be their primary residence. Like what was stated previously to curb speculation the Chinese government has imposed taxes on anyone who is selling their property before five years. (Chu, 2010) An example as to how severe the overall speculation has become in this market can be seen by looking no further than Hong Kong. Where, a builder was able to do a financing swap by raising $800 million in the public markets. The problem is the way that they are accounting for any kind of gains, as they are attributed them to increases in real estate prices. (Epstein, 2009) This is troubling because it shows that despite the various taxes to try and limit speculation, an overall attitude of greed run amok has gripped a variety of real estate markets around the country.