Can China achieve a soft landing for its housing market?

Qin Yu notes that the property market will cool somewhat, if people’s housing price expectations go down. But this might at the same time bring down property prices too much. How can the right balance be struck?
This file photo taken on 17 September 2021 shows a man walking past a housing complex by Chinese property developer Evergrande in Guangzhou, China's southern Guangdong province. (Noel Celis/AFP)
This file photo taken on 17 September 2021 shows a man walking past a housing complex by Chinese property developer Evergrande in Guangzhou, China's southern Guangdong province. (Noel Celis/AFP)

The Chinese seem passionate about buying houses. China’s major cities have experienced a persistent housing boom in the past two decades. Riding on the wave of spectacular economic growth, Chinese home buyers snapped up units across cities and even overseas.

Undoubtedly, housing prices are high. This is seen particularly in a few major cities such as Beijing, Shanghai, Shenzhen and Xiamen. First, the housing supply is tight, while the demand is high in these cities. Second, the price-to-rent ratio does not seem right in these cities. It is too high. If buyers were to purchase based on the true worth of the units, the price-to-rent ratio would not be that high.

A housing bubble could be brewing, mainly because citizens expect housing prices to rise in the future.

MIT economics professor James Porteba explains this well. Buying a house is costly: you have to pay the mortgage, property taxes, maintenance costs, as well as forgo other investment opportunities. However, if the housing price goes up in the future, the capital appreciation may offset some of the costs, if not all. If the net costs of home ownership are less than renting, one will choose to buy a house instead of renting and vice versa.

Real estate has been an important pillar contributing to GDP growth. Therefore, Chinese home buyers believe that policymakers would never let the market fall.

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A general view shows residential buildings in Shanghai on 22 September 2021. (Hector Retamal/AFP)

Investment hopes prop up property bubble

But nobody can precisely predict how high housing prices will be at the future point in time that the house is sold. People have to make a guess based on their expectations of the housing price growth rate. Therefore, if people expect housing prices to go up, home ownership becomes less costly (because the buyer would enjoy higher capital appreciation), which increases housing demand. In other words, more optimism about the housing market will feed the housing demand.

In my opinion, housing expectations play an important role in explaining China’s housing frenzy.

In the past two decades, people had the belief that the housing market in China would never collapse. Real estate has been an important pillar contributing to GDP growth. Therefore, Chinese home buyers believe that policymakers would never let the market fall.

This is precisely a “guaranteed bubble” waiting to happen, according to Chinese academic Professor Zhu Ning in his 2016 book China's Guaranteed Bubble.

The same year, another group of academics from Chinese and American universities published a paper that backed up buyers’ expectations of the housing price growth rate. The buyers had expected housing prices in China’s first- and second-tier cities to grow by a range of 4.5% to 7.3% annually. While these expected growth rates might seem high, in reality, the actual growth rates were even higher.

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This photo taken on 9 November 2021 shows a residential and commercial complex under construction in Nanning in China's southern Guangxi region. (AFP)

The Chinese government has paid attention to the growth rates. In 2016, President Xi Jinping commented at the 19th Party Congress that “houses are for living in, not for speculation”. This statement signalled people to lower their expectations of speculative returns from housing investments. This point has also been frequently emphasised by the authorities in the past five years.

The recent Evergrande crisis and pilot property tax reforms may further lower people’s expectations of the growth in housing prices. According to the latest Urban Depositor Survey by the People’s Bank of China for the third quarter of 2021, only 19.9% of respondents expect housing prices to grow in the next quarter, compared to 25.1% in the third quarter of 2020, and 29.3% in the third quarter of 2019.

The Chinese government would not wish to see a significant drop in housing prices. It wants people’s expectations of housing prices to have a “soft landing”, instead of a hard crash.

Possible cooling of the market in the short term

What are the implications of lower expectations? The costs of home ownership will increase, because the expected capital appreciation becomes less. Therefore, more people may switch from buying to renting a unit. This will cause a reduction in housing prices and a rise in rents (and a reduction of price-to-rent ratio).

Meanwhile, transaction volume may decline in the housing market, since sellers may be reluctant to sell at lower prices. The housing market may become less active in the short run.

The Chinese government would not wish to see a significant drop in housing prices. It wants people’s expectations of housing prices to have a “soft landing”, instead of a hard crash.

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A man rides a bicycle next to a construction site near residential buildings in Beijing, China, 13 January 2021. (Tingshu Wang/Reuters)

To achieve this, we need to understand that people form their expectations based on their beliefs, and update their beliefs through information acquisition. There is a growing interest in academia on how people form their expectations of housing prices through information acquisition.

Information regulation and a soft landing

For example, people may be influenced by their social networks — researchers from Harvard University, New York University and Facebook find that individuals whose geographically distant friends on Facebook experienced larger recent house price increases are more likely to transition from renting to owning. They also buy larger houses and pay more for a given house which may not be rational.

...how to gently lower this expectation requires more nuanced management on information provision.

Another paper on housing expectations by the University of Michigan suggests that policymakers may not want to make more information widely available and easily accessible, because individuals may not know which information they should focus on. Instead, the policymakers should provide home buyers with limited but relevant information, or guide them to weigh and interpret the various pieces of information.

In August this year, China started to take steps to regulate WeChat public accounts on financial and economic news, because the quality of such information could not be guaranteed. Misinformation could spread widely on social media, wrongly influencing the readers’ expectations.

Overall, property speculation in China will come to an end with the principle that “houses are for living in, not for speculation”. The recent Evergrande crisis and the pilot property tax reforms may serve as a propeller to further lower buyers’ expectations of China’s housing price growth. But how to gently lower this expectation requires more nuanced management on information provision.

Related: How China’s housing market landed in the deep freeze | Why China is regulating the property market | Property conundrum: Chinese society disagrees over how much property prices should fall | Will clampdowns on China’s property sector lead to economic turmoil? | Will the Chinese government save Evergrande? | Is China’s economy collapsing?