What’s behind China’s skyrocketing residential property market? Subsidies … subsidies … subsidies

By Rosealea Yao and Tom Miller

Rosealea Yao is Dragonomics’ research manager and a guest contributor to Dragonbeat blog this week

Just how expensive are Chinese homes?

The standard measure of housing affordability compares average house prices with average household incomes. In developed country markets, prices are generally considered expensive if they exceed four times average annual household income.

The house-price-to-income ratio in most Chinese cities has been well above eight for years, and reaches an eye-watering 14 in the priciest cities. The cost of housing in China looks scarily high.

Yet China’s housing market continues to roar upwards. Despite the government’s best efforts to cool the property fever in 2007, the market adjustment that followed in 2008 now appears but a blip: house sales in the first half of 2009 matched the frenzied buying of 2007, and prices look set to follow.

There are two basic reasons why Chinese house prices can continue to defy the laws of property market gravity that apply everywhere else. First, the complex transition from a socialist allocated system to a market system created numerous hidden subsidies for home buyers.

Second, shifts in income distribution in the last decade mean that a significant minority of home buyers can continue to push prices up, even as low-end buyers find it increasingly difficult to finance a house purchase without government help.

Roughly 80 per cent of China’s urban residents own their homes – an astonishing number for a country that only began to privatise its housing stock in 1998. In most Western countries, by comparison, average home-ownership rates are around 60 per cent.

The biggest driver of home ownership has been implicit government subsidies. One-third of home owners purchased their homes at subsidised rates from their work units during the initial housing reform programme.

Including households that purchased “economic housing” (supposedly affordable housing subsidised by the government for lower-income families) and those living in low-rent subsidised housing, well over half of all urban households enjoy some form of subsidised housing.

In short, a high proportion of households live in apartments purchased at below-market prices or have upgraded to apartments financed by the sale of a property bought at a subsidised price. This means that the vast majority of households do not spend a large proportion of their income on housing.

This conclusion is supported by household survey and mortgage data, which show that housing expenditure accounted for just 10 per cent of total consumption expenditure in 2002-2008, and that aggregate mortgage servicing costs amounted to 2 per cent of national disposable income in 2008.

The high proportion of home owners also means that a large slice of the housing market, especially in city centres, serves upgrading demand rather than new demand – a situation exacerbated by growing income inequality, which has helped skew the housing market away from affordable housing.

Between 2002 and 2006, the income share of the richest 25 per cent urban households rose substantially while the income share of the bottom 75 per cent fell. The top 25 per cent of households enjoy a house-price-to-income ratio of 6.5, a third lower than the national average.

Since China has about 200m urban households, that leaves 50m families with sufficient financial leverage to support national house prices almost on their own, as the potential demand from these 50m upper-income households is eight times the annual housing supply of 600m sq meters.

Although Beijing is committed to providing a limited supply of subsidised public housing for the poorest 5 per cent of urban households, it looks set to rely on the private market to meet the demand from existing home owners for greater comfort.

The population of China’s towns and cities is expected to swell to 1bn by 2020, by which time urban residents will make up 70 per cent of the total population. That means finding housing for 400m new city dwellers.

But China’s increasingly skewed wealth structure means that the market in major urban centres will remain dominated by demand for upgrading to higher-end housing.

China’s cities can probably sustain very vibrant housing markets based on a relatively small and affluent segment of its total urban population, even if the majority of urban residents find it hard to afford new housing.

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