China Trends: Giving Up The Bubble Ghost

Last night, CBS’s 60 Minutes did a great two-part report on the real estate industry in China and the growing sense that there is a huge bubble that is about to burst here. Part 2 is an especially good eye-opener to anyone who hasn’t heard of the “Ghost Cities” being built all around the country:

(Part 1 was a fabulous profile of one of China’s most famous real estate moguls, Zhang Xin. You can see it here.)

Given the time difference, the report aired at what amounts to the start of the business day on Monday in China and the reaction here has been swift. The chattering class lit up social media and blogs (including this one) are posting like crazy, making China’s property bubble the topic du jour.

In what may have been a coincidence, just after 60 Minutes aired their report, share prices of Chinese property builders started tanking everywhere, causing CNBC’s Deirdre Wang Morris to nearly jump out of her Twitter feed in shock:

Then the obvious cause-and-effect speculation started.

Developers ended up having their worst day since June 2008. But as good as the report was, and its possible effect on Chinese stock markets notwithstanding, it was really kind of old news. Questions about the viability of China’s real estate sector have been around for years. Way back in 2009 Al Jazeera’s Melissa Chan did what was then a groundbreaking report on the “Ghost Cities” that were starting to pop up everywhere.

But the fears are understandable. Real estate is the lynchpin of any modern economy. Eleven years ago The Economist ran a cover story about how the housing markets in the west were pretty much propping up what should have been down economies all around the world, which were either in a post-9/11 slump, or still recovering from the Asian Financial Crisis. They called it, “The Houses That Saved the World.”

Looking back, it seems a little foolish. America’s – and Europe’s – housing market was at the start of an historic rise that would dwarf any in history… and that would eventually crash spectacularly, dragging down almost the entire world with it.

Real Estate giveth, and real estate taketh away.

So it’s no wonder that today people have the same fears about what’s happening in China. Is there a housing bubble here? Yup. But the fundamentals of the market here are much more sound than they were the in US. People don’t go into debt here; they buy their homes in cash, as it’s almost impossible for consumers and small businesses to get loans from the state-owned banks. 50%-60% down payments are the norm. Also, the nature of home buying is radically different than the US. It’s not fair to make comparisons between the pre-2008 market in the US and what’s going on in China today. People here aren’t buying investments that they’re looking to flip in short order. They’re buying homes to live in and to fund their retirements with.

Furthermore, there are actually people who could fill all of the apartments being built. The problem isn’t a lack of demand; it’s that the prices for these apartments are too high, making them inaccessible to the hundreds of millions of rural people who are flooding into cities.

There are even some who don’t see Ghost Cities as a completely negative phenomenon. Jonathan Anderson of Emerging Advisors Group had this to say to the Wall Street Journal just last week:

They’ve certainly been a black hole, he says, but a hole that has emptied largely into the equally dark vaults of China’s state-owned banks, where bad debts can remain buried for a long time.

The fundamental issue in China that is fueling this dangerous growth is that there is no other way for Chinese people to invest. Banks offer measly interest rates, and given the pace of inflation here, anybody who parks their cash into a bank ends up seeing the value of their savings decline over time.

There are no mutual funds. Money can’t be moved overseas. The stock market is inaccessible (and even if it was its so rigged as to be laughable). The only thing that people have left to invest in are homes. They have become, in effect, China’s 401K program.

Since everybody’s home is basically a piggy bank, when values go down, it’s like your retirement fund deflating. A collapse here wouldn’t mean that people will be foreclosed upon and put out into the streets. Most who own aren’t carrying much in the way of debt. The banks will not go under because of bad consumer loans. The problem, which they allude to in the 60 Minutes piece, is the social stability angle of people losing the value of their life’s savings and potentially rioting in the streets. We’ve seen shades of this already in Shanghai.

The Chinese real estate market is showing signs of real strain right now and local governments are having funding problems because their main source of income (land sales) is starting to dry up. But there’s no way that the new government coming into power this week is going to let the engine that has been driving China’s growth sputter to a halt. What you’ll probably see over the next year are their attempts to engineer a soft landing and give the Chinese people new ways to effectively save for their future.

Right now is probably a GREAT time to be in the business of creating legal investment alternatives for middle class Chinese who need a place to put their cash.