The IMF just published a working paper examining real estate in China.
After a temporary slowdown in 2014-2015 China’s real estate market rebounded sharply in 2016. As signs of overheating emerged, the government turned to tighten real estate markets through a range of macroprudential and administrative measures. Many empirical studies point out that the house price surge is driven by fundamentals, while others consider the pickup of real estate activity is unsustainable. This paper uses city-level real estate data to estimate the range of overvaluation of real estate markets across city-tiers, and assesses the main risks of a real estate slowdown and its impact on economic growth and financial stability.
Real estate has been a key engine of China’s rapid growth in the past decades. Real estate investment grew rapidly from about 4 percent of GDP in 1997 to the peak of 15 percent of GDP in 2014, with residential investment accounting for over two thirds of the total real estate investment.
Bank lending to the sector makes up 25 percent of total bank loans, about half of all new loans in 2016, and banks’ increasing exposures to real estate, including through property developers and household mortgages, may pose financial stability concerns. Real estate also has strong linkages to upstream and downstream industries (about a quarter of GDP is real-estate related).2 In addition, land sales are a key source of local public finance, accounting for about 30 percent of local government revenue in 2016, while general government net spending financed by land sales is about 9 percent of the headline revenue in 2016. There has been a rapid expansion of government subsidies on social housing, consisting of nearly 6 million apartment units in 2015-2017.
Real estate markets vary significantly in China because of its large economic size, economic and social diversity, and fragmented local government policies. The real estate cycles tend to be more pronounced in top-tier cities in terms of price volatility, but they account for a small fraction of real estate inventory and investment. Smaller cities constitute over half of residential real estate investment, but the price increase on average was much lower during 2013-16.
Distortions render China’s property market susceptible to both price misalignment and overbuilding. On the supply side, the market is distorted by local governments’ control over land supply and their reliance on land sales to finance spending. On the demand side, the market is prone to overvaluation—housing is attractive as an investment instrument given a history of robust capital gains, high savings, low real deposit interest rates, a lack of alternative financial assets, as well as capital account restrictions.
The government has closely monitored real estate activity given its importance in the economy. Policies are highly decentralized, with local governments (often with local branches of the financial regulators) deciding land sale and infrastructure development, granting construction and sales permits to developers, and setting purchases restrictions. The central government and financial regulators can also affect the housing market through financing conditions and macro-prudential tools for mortgage lending.
If house prices rise further beyond “fundamental” levels and the bubble expands to smaller cities, it would increase the likelihood and costs of a sharp correction, which would weaken growth, undermine financial stability, reduce local government spending room, and spur capital outflows. Empirical analysis suggests that the increasing intensity of macroprudential policies tailored to local conditions is appropriate. The government should expand its toolkit to include additional macroprudential measures and push forward reforms to address the fundamental imbalances in the residential housing market.
Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
