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The Impacts Of China’s Real Estate Crash. A Hard Rain Is Gonna Fall.

Posted in China Business

This is part II of a series of an occasional series of posts we will be running here on what our lead China lawyer, Steve Dickinson, is seeing of China’s real estate market, based on his living “on the ground” in Qingdao. Here it is:

By: Steve Dickinson

There are two types of real estate investor in China. The first are pure speculators who treat residential real estate as a source of value, far removed from its original residential use. These investors purchase multiple properties without bothering even to remodel the units for actual use. They are responsible for the spooky flats of empty condo buildings that have become so common in all of China’s cities.

The second are the normal citizens who purchase real estate as their primary residence. The high prices of the real estate bubble created by the speculators have created much pain for these normal home-buyers. Recent policies of the central government designed to contain the real estate bubble have been designed to benefit this segment of “normal” home buyers. However, it is probable that the recent collapse in real estate values has damaged these normal home buyers as much as, or even more than, the speculators.

A recent story in the local Qingdao newspaper illustrates the situation very well. The article is about Mr. Li (age 31) and Ms. Zhao (age 28), both of whom are successful young professionals. Both are college graduates. Both work in good jobs in the visual design sector. Mr. Li earns RMB 6,000 per month and Ms. Zhao earns RMB 2,000 per month. These are good salaries for young professionals in Qingdao.

For three years, this couple has been planning to marry. The obstacle has been that they have not been able to purchase a home. Their families do not have the resources and they have not had the savings. Mr. Li proposed that they forget about owning a home and just live in a rented apartment after marriage. As is typical in this region, Ms. Zhao refused: no home ownership, no marriage. With great reluctance, Mr. Li agreed to work on purchasing a condo.

In April of this year, they found a suitable unit in Li Cang. Li Cang is a village to the north of Qingdao city. Services there are bad and transportation is inconvenient. However, they determined that a 90 square meter unit on the 15th floor of a sprawling condo project was just about the only thing they could afford in the Qingdao area.

They completed the purchase in April on the following terms:

  • The price of the unit was RMB 9,300 per square meter. Compared to the 20,000 to 40,000 RMB per square meter price in Qingdao, this seemed reasonable to them.
  • The total price was RMB 830,000. Of this, RMB 350,000 was required as a down payment.

The couple was able to come up with the down payment by using their savings, by Mr. Li moonlighting, and with a contribution from their parents. The down payment was accumulated from the struggles of the couple and both their families over the past 10 years. For payment of the remaining RMB 480,000 of the purchase price, the couple obtained a 20 year bank loan. Payments on this loan will be RMB 4,700 per month for the life of the loan, over half of their combined total income, before taxes.

Consider the following:

  • Their down payment was actually a deposit on an uncompleted unit. The project is far from completion. At best, the project will be complete at the end of 2012. Thus the down payment money is tied up and yet the couple still have to pay rent until the project is complete. If the project is not completed there is a substantial risk that the down payment will never be returned. This risk is never discussed in China, but the risk is substantial in a declining market as we know from our experience in the real estate markets around the world.
  • This young couple has now joined the ranks of the Chinese “house slaves” 房奴”, or what we call “mortgage slaves” in the U.S. The total household income of this couple is RMB 8,000 per month, before taxes and their mortgage payment consitutes more than one half of their monthly income. They are in their early thirties. How will they save for their child’s education? How will they save for retirement? How will they save for medical emergencies? How will they save for the care of their four parents? How will they even live a normal life with about RMB 3,000 per month in disposable income? No one knows other than to say that they will suffer.
  • The total price of this 90 square meter unit is RMB 830,000. This is ten times the annual income of this young professional couple. Most economists believe that the cost of housing should not exceed 3 to 5 times annual income. The unit is therefore about twice as expensive as recommended. All of this for a condo in a not particularly nice exburb of a second tier city. 

In October, the couple became uneasy when they heard rumors that units in their project were being offered at a 90% discount. At the end of November, the couple was shocked to see advertisements in the local newspaper offering units in their same project at the price of RMB 6,300 per square meter, a 30% discount off the price they had already agreed to pay. A group of buyers formed and demanded that their purchase price be reduced to the new price or they would cancel their purchase contracts. Some members of the group picketed the sales office. The developer refused their requests. Mr. Li states that he has reviewed the purchase contract carefully and concluded that none of the buyers have the right to a refund or cancellation. He is therefore resigned to his fate and sees no reason to participate in the protests.

Ms. Zhao calculates that over the life of the loan, the couple will pay RMB 400,000 in mortgage interest that is in excess of that amount that would be paid if the unit were re-valued at the new, lower price. This makes her sad. It makes her husband resentful that she insisted on purchasing the condo unit when he had proposed that they just rent a unit. Their excitement at becoming new homeowners is now drowned
by the sorrow of the economic disaster they face. The prospect of 20 years of “home slavery” is not a good way to start a marriage. The couple has not even considered the two additional disasaters that may
be waiting for them:

  • The price drop has only just started. The couple hopes that prices will recover over time. The more likely scenario is that prices will continue to fall next year after buyers truly face the fact that the bubble has burst.
  • Once it is clear the bubble has burst, the developer of their uncompleted unit will not be able to sell units at any price. This means the project will fail, and the units will not be completed. What will happen to the substantial deposit this couple has already paid? No one knows. Chinese law provides that it must be returned. However, there are no good controls in place to guarantee that will actually occur.

Our couple and their fellow buyers are already upset with the fall in price. What will happen if the project fails and their deposits are not returned? What will happen to their bank when their mortgage loans turn out to be worthless? What will happen to the development lender when the project fails and the development loan is not repaid?

The story above is being repeated in every city in the coastal provinces in China. The impact is personal and direct. Every person in China knows at least one person who has been impacted. The effect on the economy is incalculable. Just when the government is promoting a new program to increase domestic consumption, the collapse of the residential real estate market is pushing Chinese consumers in the opposite direction. The extreme uncertainty likely means that they will freeze up, greatly reduce their spending and move into an even more intense savings mode. The result will be to freeze up the economy for a considerable period.

I must emphasize again that what I have described has already happened. It is not a projection. The situation is China’s current reality. A government cannot prevent what has already happened. It is too late. All we can do is wait and see what will be done about the situation. Current indications are that nothing will be done at all. Given the way governments work, that may be the best possible result.

What will you do to adjust to this new reality?

UPDATE: China Bystander has a really good post on China’s real estate market and its likely impacts, entitled, “China’s Property Bubble: Bursting or Deflating?

  • Martin

    This is exactly what is happening and I thank you for calling it out. I have been seeing this for a while and I am glad it is finally getting some press. Thanks for running this.

  • Vivian Chang

    I am one of the unlucky ones. I bought a condo in Dongguan for about $280,000 two years ago and comparable condos in my building are now listing (and not selling) for about $170,000. The bottom has fallen out of the market and it is not yet clear even how deep the well is.

  • http://mikey@yahoo.com mike

    This is real mickey mouse analysis. I suspect it may be a english teacher masquerading as a “lawyer”. You know the subpar ones go to china. We have so many expert expats plagiarizing other EE’s analysis on china its a real telling sign of the quality of education overseas… Cut… Paste… change author… orange chicken!

  • Estelle

    This is some good information and it surely beats most of what is out there in terms of telling it like it really is.

  • Volker Müller

    I wouldn’t be that pessimistic.
    In China an annual increase of salaries of 10% is considered low increase for young professionals. This means their salaries will double by 2018.
    Prices of homes may further drop in 2012, but this needn’t be a concern for young people who have bought their own homes. The market in China is far from saturated. During the Asian financial crisis 1998-2000 prices dropped sharply, many projects were put on hold, but the market recovered very quickly in 2001-2002.

  • Twofish

    Harris: Once it is clear the bubble has burst, the developer of their uncompleted unit will not be able to sell units at any price. This means the project will fail, and the units will not be completed. What will happen to the substantial deposit this couple has already paid? No one knows
    One thing that about Chinese construction loans is that the lender does not advance the developer money until they have enough committed contracts to ensure repayment upon completion. So it is likely that the developer has enough contracts to complete the building assuming no one decides to renege on the contract, which is why they get worried when people start complaining about prices.
    One other thing to note here is that Chinese banks cannot and do not issue a residential mortgage against property that is under construction. If the property doesn’t complete then the mortgage will not be issued, and the Li’s will not own the bank anything. One good thing about the “been there, done that” is that the rule that banks can only issue mortgages against completed property came about the last time we had a property crash.
    If the developer skips town and everything shuts down, then the land use rights will revert to the state, at which point it becomes the city’s problem, and I suspect that the city will finish the project if there are enough angry people screaming at them.

  • Tony Xiao

    There is no denying that prices are falling and in some cases plummeting in the major cities.
    However there have been warning signs since 2010 when the goverment introduced measures in April of that year to halt the runaway property prices and ward off property speculators.
    More recently, the government and others have predicted that prices will drop a further 15-20 percent in 2012 which in effect will scare off buyers until it bottoms out. When that’ll be is anyone’s guess.
    The goverment also declared last week that they intend to stick to their measures to reduce home prices. Maybe they will be forced to fine-tune it. Who knows!.
    The big problem for new home buyers is ‘buying off the plan’ which is the case for all new homes in China plus full payment sometimes within 6 months. There isn’t much buyers can do about it except be careful.
    It’s still unclear as to whether the bubble has or will burst but it is sure deflating which should be good news for future new home buyers in the large cities.

  • Orange Chicken

    @Mike- The author of this “Micky Mouse” analysis is the lead lawyer in China for Harris & Moure, the law firm behind this fine blog. If ypu think so little of them to say they would hire an english teacher for that position then why are you wasting your time reading anything written here?

  • David
  • http://www.summitchina Marius Schutz

    Greed, greed and more greed.
    By the way, “no-house-no-marriage” is not at all a Chinese thing. Most couples marry without a house and just move in with one of the parents. They do that even after the emigrate!
    The husband should have dropped the bitch when she made her requirements known!

  • Jude Levenson

    As if Qingdao is the barometer of what is happening across China. That’s like suggesting what is happening in Charlotte North Carolina is the same across all the United States. Nice if you’re in Charlotte but useless anywhere else.

  • Festus

    Part II of this series is really spot on and describes the situation accurately. For Part III, one might delve into the actual lack of quality construction which will only exacerbate the overpricing problem in the near future. Many in the building industry and in government know full well that the expected useful life of these buildings are quite limited in comparison to those built in England, for example. Add another cherry on top, the poor urban planning where many of these building monstrosities are located, and things do not look so rosy for the poor Chinese home buyer. Good article, though.

  • Jonathan

    Living in China for quite a while now, I’ve been seeing this coming myself. I told my colleagues about the possibility last year and they looked at me like I said the sky is going to fall. They said the government would never let that happen. It hasn’t hit here as hard yet, but prices are still falling.
    FYI I think the lawyer’s/author’s credentials can be viewed clicking on his name at the top of the article.

  • http://Www.inpraiseofchina.com Godfree

    This will be a fascinating (and painful) lesson. Our own government and some major media are still in denial about the US bubble and have taken no effective steps to ameliorate the situation.
    Will the Chinese government do any better? They have all the levers in hand, unlike our government. Will they use them?
    Or will they wait it out by keeping the economy growing at 7-8%, and wait for the rising tide to lift the stranded boats? That is certainly an advantage they have over us.

  • Chris

    Great analysis… the young couple’s financial arrangements are similar to many of my younger Chinese colleagues. Sources including savings, family money and loans pulled together to fund the purchase of city fringe real estate. The tragedy of recent years in China is that there has been such a disconnect between real incomes of real people and the price of real estate. Despite the hype, it was inevitable that a readjustment was going to take place. Even at lower prices (a 50% slump scenario) it will take many years of stagnating real estate prices for incomes to catch up and for Chinese housing to again hit reasonable affordability levels.

  • Casualsurfer

    You know things are bad when Chinese real estate agent tells you “there’s no way China’s real estate market will crash like the US” – something I was told just a year ago in China when I was looking to relocate for work. My old condo in Orange County (CA) is now listed at half of what I sold it for, and having gone through one of the most painful downturns I’ve seen back home the similarities in China is a scary reminder what may come in the near future, and the Chinese people don’t have anything close to the social safety net we have despite claims of socialism from the central government. I’m afraid dark times are ahead for all. Our recovery from the Great Recession is shaky, Europe faces uncertainty over their own crisis, and now China…

  • Zhang Ying Jen

    Isn’t this from the same lawyers who suggested USD300,000 was too expensive to buy an apartment in Qingdao? Perhaps attempting to talk prices down so they can eventually buy one.

  • Eric

    I’m in Qingdao as well, and it’s amazingly common for ‘speculators’ to have 10 or 20 apartments to their name, with no interest in selling. Because they are not charged property taxes, they hold them as an investment and don’t feel particularly pressed to derive any regular income from them. It has been suggested that imposing a property tax in cities like Qingdao would help rein in some of the hoarding, but that would have freed up a huge amount of surplus and wiped out the demand for these new developments (seriously, there are high rise 20+-building complexes for miles in every direction, and local or national development agencies are typically invested in the projects).
    Another interesting side here is that this aggregate hoarding behavior has contributed to a renter’s market – that 90m2 in Li Cang that they’re paying ¥4,000 for every month would surely rent out for less than ¥2,000.
    I guess people like your young couple are willing to stake a lot on the guarantee that they’ll have a place of their own, safe from future price increases; it’s frustrating though that there’s this insecure period between when they part from their money and when there is actually a place to posess.

  • Myrick

    Thanks for the article Steve.
    I suspect ‘mike’ is involved in real estate and your analysis is too close to reality for him. Hence the poorly constructed ad hominem attack.

  • perspectivehere

    Thank you Steve for this report. The details are quite telling, and the figures on income, downpayments, mortgages and interest payments help give a good sense of how much of a struggle middle-class people go through.
    As with anything that one says about “Mr Market”, one day you look like a genius and the next you look like a fool. So hopefully what I write next will not sound too foolish.
    It seems the PRC government has been putting in place anti-speculation measures over the last 18-24 months intended to restrain what was widely perceived to be a “real estate bubble”. The current fall in the real estate prices means the market is responding to those measures, as well as certain other forces in the macro-economic environment.
    From the perspective of government policy-making, I would say this is a “successful intervention”. Housing prices have stopped rising (which was the objective of the policies) and are now more affordable than they were before, in cities like Qingdao.
    From the perspective of someone who is hoping to buy, the government measures have now made the market more affordable for them, at the expense of the real estate developers. However, from the perspective of someone who just bought, Mr Li and Ms Zhao regret their decision to buy because if they had waited, they could have paid less.
    I have friends who once regretted their decisions to buy in New York City in the late 80′s, and in Hong Kong just before the 1997 crash. They rued the day they ever bought their condo units. But they raised families in them, had successes in their careers, and eventually they got over their regret, and today are happy they bought. They would have been happier if they had waited to buy when prices were cheaper, but hindsight is 20-20; live and learn.
    For those couples who bought a few years later (New York in 1992 or Hong Kong in 2003) they got great deals and are happily raising their families in their homes now.
    The only difference it seems was that the couples who bought at the trough have more paper gains and paid less interest than the ones who bought at the peak; but as long as the latter were able to live in their properties and make the mortgage payments, they were fine.
    For couples who are buying now in Qingdao, they will be getting a 30% discount compared to those who bought a few months ago. Of course, the above article raises the possibility that things could get even worse, and the developer could go under, and prices could keep falling.
    I don’t think it will happen that way; I think the government will loosen things enough to prevent a general collapse of the market and widespread developer bankruptcies.
    Using the “bubble” analogy, I don’t think it is a bursting bubble + widespread panic + everyone rushing for the exits. I think there is air being let out of the bubble, and for a population that has been used to prices only going up, this is a huge cultural readjustment for them to go through, so it will take some time for them to digest the news.
    Maybe once people digest the fact that home prices can go down as well as up, they will give up the craziness of insisting on owning a home, and choose to rent instead.

  • http://www.summitchina Marius Schutz

    Greed, greed and more greed.
    By the way, “no-house-no-marriage” is not at all a Chinese thing. Most couples marry without a house and just move in with one of the parents. They do that even after the emigrate!
    The husband should have dropped the bitch when she made her requirements known!

  • Hans Muellers

    Hello China, welcome the the real world, the world we all live in. Why should you, China, be better off than most of us ? Europe has trouble, the U.S. has trouble, why should Asia be different ? Nobody puts me in the papers for loosing tons of money on the real estate I held and now can not sell ?
    Look at Florida, U.S., all the bargains you want down there. This real estate sceam happens everywhere, not just in China.
    Well, China, now you see how it is to live with ‘wealth’. Some get richer and some ( most ) lose big time when things go wrong. I can not blame the speculators, either. There is no perfect system of government, and I can not blame them either. We would not have seen this kind of report had the young couple doubled their money in real estate. To be ‘greedy’ and have a house, or to put that as condition of marriage was not a good idea, was it ? Now that they lost I should cry ? Reality is like that, Change is inevitable. It happens to me, it will happen to others. I and the young couple still live better than lots of people in Africa, for example.
    Not a great report, sorry !

  • http://www.foarp.blogspot.com FOARP

    @Mike – Seriously, you don’t know who Steve Dickinson is but you still feel free to pass judgement on who is and is not a good info source on Chinese affairs?

  • Chris

    But China has 5000 years of continuous history……isn’t that going to save them?

  • Mike

    Hmmm….I’ve been visiting Beijing/Shenyang at time intervals of 2-3 years for the last 15 years or so. Every time I visit, I see a snapshot of China. What you have written is a commentary on the social aspects of the real estate situation. Real estate pricing is largely an economic and financial phenomenon though. I think it’s important to be a bit more objective (although this may be impossible as the odd irrational market behavior suggest) when assessing the general situation or one’s own conundrum. There is a lot of investment theory at play here…

  • Adi
  • TCL

    The perceived after-effect scenarios is more compelling among cities in inner provinces, Said suburb of a 2nd-tier city just North of Qingdao in Shandong is on a higher profile & visibility. For this reason Shandong provincial officers will prevent breakout of chaos in the same level as what happened in the suburb of Shenzhen. Besides, Central authorities don’t took kindly on such public disturbances happening out of a major coastal area like Qingdao.
    Furthermore, as the writer had pointed out that the husband had been ‘resentful’ of his wife’s pre-nuptial condition. The old proverb of ‘marrying a dog entails one to live like a dog, same as it applies on chickens living like chicken’ apply here. Hence don’t underestimate the resiliencies of Chinese couples in such binding situations ~ either they save their marriage by ‘tightening their belts’ more forcefully OR… filing for legal separation as a practical solution! A big difference in marital philosophy between Occidentals and Orientals.

  • S`

    I have heard these stories many times over. However, I am living in a tier 3 city, and the housing prices here have suffered only a slight dip. It seems that the crash will be limited to those cities with the most accumulated wealth for speculation.

  • http://NIL Damien Wang

    I can not agree.
    I am a Chinese, and have live in Beijing for eight years.
    The most important reason for the price drop of the real estate is that the Party has been enforcing a policy called restricted purchase-in Beijing, for example, only the people with a Beijing Hukou (a certificate showing a person is a registered citizen of Beijing, very few have it comparing to the enormous population) or the people who have paid full income tax for the past five consecutive years are allowed to purchase a house. The other cities have also employed similar policies.
    The other reason is that the Party has ordered the bank not to loan to the developers.
    Then, it is quite obvious that if the party loosens the policy, every thing will come back because of China’s tradition to own a house for marriage, for living, and because China is a developing country that will continue to develop for many years-which will bring people with money to purchase house.
    I myself have not bought any house; I simply do not have the money. I however am not concerned over this because my belief is that I either will buy a house without any loan or do not but any at all. I do not want my parent continue to save all their money just for my “house”

  • David Lucerne

    Great stuff Steve. Thanks for running this. Change the word “Qingdao” to Tianjin and this is exactly what I have been seeing here.

  • eric

    all musical chair play must stop one day. China or australia are no different, we have seen market crashes, but people will never learn. Greed is good for them.

  • http://www.manhattan-condos-for-sale.com/ Jack Reade

    A great friend of ours, an American, has been interested in purchasing a home in Shanghai for about two years. Due to the strict policies that China has for foreign nationals, he has been unable to buy anything. This is mostly due to the fact that he would be required to place a large (I believe its a 40%) down-payment, which he simply hasn’t been able to come up with. I wonder if the bubble burst in China would cause these rules to be a little more loose in the future?

  • Ozy

    Wake up Chinese people! You have been thrown in stupidiness by years of exploatation there (5000?) Time to wake up and think for yourself. Stop acting like a herd, throwing yourself off a mounain cliff if others do that. Grow a brain for yourself and start thinking independently. It is hard? If you can’t do that, you my friends, will be also burned in Canada!!!! Don’t tell we have not told you!!! Unless you like to enjoy the pain and humiliation that will surely arrive from a bad decision: buying overpriced real estate -anywhere in the world!

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