There are growing concerns across the global economic and policy communities regarding the decade-long housing market boom in China. In particular, critics are concerned that the soaring housing prices and the enormous construction boom throughout China might not be sustainable, and China might follow in the footsteps of Japan, which had an economic lost decade after its housing bubble burst in the early 1990s. These concerns are now much more pertinent as the Chinese economy seemed to be slowing down from its near double-digit growth rate in the past thirty years, a slowdown that, as Pritchett and Summers (2014) have recently argued, is inevitable based on historical data on cross-country growth rates. But, how much have housing prices in different Chinese cities really appreciated during the last decade? Did the soaring prices make housing out of the reach of typical households? How much financial burden did households face in buying homes?
In recent research, we address these questions by taking advantage of a comprehensive data set of mortgage loans issued by a major Chinese commercial bank from 2003-2013 (Fang et al 2015). Specifically, we construct a set of housing price indices for 120 major cities in China, which allows us to evaluate housing price fluctuations across these cities, in conjunction with the growth of households’ purchasing power. The detailed mortgage data also allow us to analyse the participation of low-income households in housing markets and the financial burdens faced by low-income home buyers. Our analysis suggests that China’s housing market is unlikely to be the direct trigger of the next financial crisis, even though it may amplify the impact of a sudden stop in the Chinese economy.
Housing price index
The methodology of our housing price index can be viewed as an analogue of the well-known Case-Shiller (1987) index which is based on the comparison of repeat sales of the same homes. Due to the nascent nature of the Chinese housing market, there are relatively few repeat home sales; however, an important feature of the Chinese housing market is that housing units are typically apartments in large developments. Apartment units in the same development that were sold at different months can be thought of as the analogue of Case-Shiller’s ‘repeat sales’, as they share similar characteristics and amenities.
Our indices are more reliable than the two widely used official housing price series reported by the National Bureau of Statistics (NBS) of China, the ‘NBS 70-city index’ and the ‘NBS Average Price Index’. The NBS 70-City Index is remarkably smooth and shows very little real housing price growth in 70 Chinese cities in the last decade, while the NBS Average Price Index fails to control for quality, as it does not account for the fact that the newly transacted units in a city are gradually moving to the outer-rings of the city, an important feature in rapidly expanding Chinese cities (Deng et al 2014).
How much have housing prices appreciated from 2003 to 2013?
Our price indices confirm enormous housing price appreciation across China in 2003-2013. In first-tier cities, which include the four most populated and most economically important metropolitan areas in China – Beijing, Shanghai, Guangzhou, and Shenzhen –housing prices had an average annual real growth rate of 13.1% during this decade. Our sample also covers 31 second-tier cities – autonomous municipalities, provincial capitals, or vital industrial/commercial centres – and 85 third-tier cities, which are important cities in their respective regions. Housing prices in second-tier cities had an average annual real growth rate of 10.5%; third-tier cities had an average annual real growth rate of 7.9%. These growth rates easily surpass the housing price appreciation during the US housing bubble in the 2000s and are comparable to that during the Japanese housing bubble in the 1980s.
Is the Chinese housing boom different?
The Chinese housing boom is different in many aspects from the housing bubbles in the US and Japan. First, as banks in China imposed down payments of over 30% on all mortgage loans, banks are protected from mortgage borrowers’ default risk even in the event of a sizable housing market meltdown of 30%. This makes a US-style subprime credit crisis less likely in China.
Second, while the rapid housing price appreciation has often been highlighted as a concern for the Chinese housing market, the price appreciation was accompanied by equally spectacular growth in households’ disposable income – an average annual real growth rate of about 9% throughout the country during the decade. This joint presence of enormous housing price appreciation and income growth contrasts the experiences during the US and Japanese housing bubbles. The enormous income growth rate across Chinese cities thus provides some reassurance about the housing boom and, together with the aforementioned high mortgage down payment ratios, renders the housing market an unlikely trigger for an imminent financial crisis in China.
Did the soaring prices put housing out of the reach of typical households?
Despite the enormous housing price appreciation over the decade, the participation of low-income households in the housing market remained stable. We analyse the financial status of mortgage borrowers with incomes in the bottom 10% of all mortgage borrowers in each city for each year. By mapping the incomes of these marginal home buyers into the income distribution of the urban population in the city, we find that they came from the low-income fraction of the population, roughly around the 25th percentile of the distribution in first-tier cities and around the 30th percentile in second-tier cities throughout the decade.
Figure 3. Price-to-income ratio in full sample
How much financial burden did households face in buying homes?
While these low-income home buyers were not excluded from the housing market, they did endure enormous financial burdens in buying homes at price-to-income ratios of around eight in second- and third-tier cities and, in some years, even over ten in first-tier cities. In concrete terms, this means that a household paid eight times its annual disposable income to buy a home. In order to obtain a mortgage loan, it had to make a down payment of at least 30%, and more typically 40% of the home price, which was equivalent to 2.4 to 3.2 times the household’s annual income. Suppose that the household made a down payment of 40% and took a mortgage loan for the other 60% of the home price, which would be 4.8 times its annual income. A modest mortgage rate of 6% would require the household to use nearly 30% of its annual income to pay for the interest on the mortgage loan. Furthermore, paying the mortgage would consume another 16% of its annual income using a linear amortization even if the mortgage had a maximum maturity of 30 years.
To understand the willingness of households to endure such severe financial burdens for a home, it is important to take into account the households’ expectations. To the extent that urban household income in China has been rising steadily during the studied period, as well as in the previous two decades, many households may expect their income to continue growing at this rate. At a 10% nominal income growth rate, a household’s income in five years would grow to 1.6 times of its initial income and the ratio of current housing price to its future income in five years would drop to five. Thus, a high expected income growth rate renders the aforementioned financial burdens temporary.
Second, frictions in the Chinese financial system might also have contributed to the high housing prices. The spectacular economic growth in China since the 1980s has been accompanied by a high savings rate, (e.g., see Yang, Zhang and Zhou 2013), but due to stringent capital controls, savers cannot invest their savings in international capital markets and, instead, have only a few domestic investment vehicles. Bank deposit accounts have remained the predominant investment vehicle, with assets totalling near 100 trillion RMB in 2013, despite the fact that the real one-year deposit rate averaged only 0.01% in 2003-2013. While the Chinese stock market experienced dramatic growth during this decade, it was still relatively small, with a capitalization of slightly less than 20 trillion RMB in 2013. The size of bond markets was even smaller. Facing this largely constrained investment set, it has been common for households to treat housing as an alternative investment vehicle, which also helps explain their willingness to pay dearly for housing.
What’s ahead for the Chinese housing market?
By thoroughly analysing characteristics of mortgage borrowers, our analysis leads us to take a more nuanced view of what to expect for the Chinese housing market. On the one hand, the rapid income growth which accompanied the enormous housing price appreciation helped support the steady participation by low-income households in the housing market. The housing price growth in the last decade is much more in line with the income growth, especially in the second- and third-tier cities. However, the high expectation of future income growth, which might have been a key driver of the observed price-to-income ratios, may not be sustainable. When China’s growth rate eventually regresses to the mean, as argued by Pritchett and Summers (2014), and especially when China experiences a sudden stop, households’ expectations may crash. In such a case, the large price-to-income ratios have substantial room to contract, which in turn could act as an amplifier of the initial shock that triggers the economic slowdown.
Another risk factor is the possibility of over-supply, but this seems to be restricted mainly in second- and third-tier cities. We argue that the current fiscal arrangement between the central and local governments led to an increasing reliance of local governments on land sales revenues in their budget. This could be responsible for the over-supply of land in second- and third-tier cities; it could also provide an anchor for the home-buyers’ belief that the housing market is ‘too important to fall’, leading to possible speculative home purchases. Therefore, a new fiscal reform could impact the housing market.
Case, K and R Shiller (1987) “Prices of single family homes since 1970: New indexes for four cities”, New England Economic Review, 1: 45-56.
Deng, Y, J Gyourko and J Wu (2014) “Evaluating the risk of Chinese housing markets: what we know and what we need to know”, Working Paper, National University of Singapore.
Fang, H, Q Gu, W Xiong and L Zhou (2015) “Demystifying the Chinese Housing Boom”, NBER Macro Annual, Volume 30, forthcoming.
Pritchett, L and L Summers (2014) “Asiaphoria meets regression to the mean”, NBER Working paper #20573.
Yang, D, J Zhang and S Zhou (2013) “Why are saving rates so high in China?” in Capitalizing China, edited by J Fan and R Morck, University of Chicago Press, 249-278.