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Why China's Property Market Should Not Be A Concern

Question: Why would no Australian political party of any stripe ever propose a tax on the sale of the family home? Answer: Because it would be electoral suicide. Indeed, governments and oppositions in this country have over the past decades been forced to address the issue of housing unaffordability and potentially bubbling prices with the dilemma of not wishing to upset the mass of middle class citizens pursuing the Great Australian Dream. The current government is doing little more than building new public housing for the poor. Were it to release vast tracts of land for private middle-income housing as is often suggested, prices of existing homes would fall and voters would be very upset over lost property value. Chinese authorities have also been addressing the country's property bubble for many years now, and have particularly stepped up efforts this last year. Beijing does not want to disenfranchise its new middle class from the get-go, but it does want to smash rampant property speculation. Fears that Beijing will cause China's robust and world-saving economic growth to subside at a critical time – a time of European debt crises and a struggling US economy – have been very much part of the reason stock markets corrected by 15%. Aside from slowing the flow from the fiscal stimulus tap to banks lending money for property speculation, Beijing has also tried three other policies. One is ask local governments to increase the supply of property for private housing, another is to ask property developers to stop hanging on to housing inventory and hoping to sell at higher prices, and the other is dramatically increase the supply of low-end housing. The problem is, property speculators and developers include a large number of local government officials. Unsurprisingly, they are not keen to comply with any policy that would see the value of their investments fall. Thus of the three policies, only the flood of subsidised new housing for China's vast number of low income earners is meeting with any success. There is nevertheless one problem here, too, and that's finding builders who will agree to build the subsidised housing when the profit margin is contained. Building middle class houses is much more profitable in a rising property market. But Beijing seems to have found a way around that problem as well. Hence the world perceives a risk that the flood of cheap housing will accommodate the ongoing flow of Chinese from rural areas to the cities, the property bubble will burst, Chinese demand for raw materials will plummet, and the world will be plunged back into recession without its premier demand driver. However GaveKal analyst Cathy Holcombe, based in Hong Kong, suggests that by increasing low-end housing, Beijing just might serve to underpin property prices, not destroy them. Holcombe points to her own home city and its history in drawing her conclusion. It can be argued Hong Kong has been in a property bubble since the Second World War, discounting a few ups and downs along the way. Hong Kong property prices have remained among the most expensive on the planet, yet the colony has a long history of subsidised government housing. When Mao Zedong went for a long walk in the late 1940s, hoards of Chinese fled to the British colony to escape communism. Suddenly the British were forced to release limited land for cheap housing to replace the shanty towns which had grown up and had led to a huge fire sweeping the city in 1953. Later impetus was provided by anti-British rioting in 1973. But land in Hong Kong was only leasehold, and so the colonial government was able to keep a tight rein on supply. The other problem was that Hong Kong consisted then of little more than a port and a lot of willing labourers. Property thus became an important source of taxation to supplement little opportunity elsewhere. This has meant that Hong Kong as it is today has been built on a system of high property taxation affording low corporate and income tax policies in return. Hong Kong has become a thriving financial centre in the meantime, where it is simply accepted that property prices are among the highest in the world. The offset to high property prices and taxes is an otherwise low tax environment. Holcombe sees a parallel between the numbers of Chinese fleeing the mainland for Hong Kong in the fifties and the current great rush of Chinese from rural areas to the cities. Initially, Beijing hoped a capitalist model would suffice to ensure such immigrants would be sufficiently housed. The private sector would build the houses and the government would make sure the banks were well funded to supply finance. Unlike Hong Kong, mainland China is well supplied with land. But inevitably, a class divide began to appear. The new middle class could afford to buy houses built by developers, but the formerly peasant class could not. Government officials and canny investors became wealthy from property speculation. House prices rose exponentially, only exacerbating the problem. So now Beijing is in a mad rush to return to a more socialist model of providing subsidised government housing. But as is the case in Australia, the fear is cheap housing at the low end could spark a tumble all the way up the property ladder. The new middle class would be shattered at a time Beijing is trying to grow its domestic economy. Yet at first, Beijing simply tried to auction off as much land to developers to build subsidised housing as it could. Its problem was that there were few takers. As noted earlier, who wants to build cheap housing for a fixed margin when you can build middle class housing for a rising margin? So more recently, Beijing has adopted more of a Hong Kong model. It seems like reverse logic, but Beijing has tightened the rules on the land it is trying to sell. Bidders must now put up a sizable fee just to participate in an auction of any land, whether for public or private housing, and must pay 50% of the cost within a month. This has naturally now excluded smaller players from the market, which seems a funny way of trying to encourage sales. The Hong Kong model, however, shows that the required subsidised housing will be built by the larger players if the larger players have the upper hand in all land auctions. The big developers will attempt to keep the authorities happy by going along with their wishes and will thus gain advantage in more profitable ventures. Under this model, Beijing, in return, will be able to control the developers more closely, and will take big fees. Like Hong Kong, the government will collect significant taxes from the property market. All of which adds up to a sustainable and underpinned property bubble in which speculators are curbed through increased supply, but the middle class is not busted through collapsing prices. And to this we add some other, oft noted points. The proportion of Chinese homeowners with a mortgage is very low by Western standards. There is no such thing as a subprime mortgage in China. Default rates are very low. Equity loans are non-existent. This means that were Chinese property prices to collapse anyway, only the speculators would be burnt. The average middle class homeowner would not actually lose any money other than on paper, would not be forced to sell, and those now relying on subsidised housing would have a greater opportunity to afford their own home. So once Beijing gets all its policy tweaking right, the conclusion is that either China will suffer a property price collapse of little consequence or will maintain a sustainable and manageable bubble which will not actually threaten to burst. Grave fears are unfounded.