Re-Thinking China’s Rise – Real Estate

For many years now proponents of China’s endless rise, and its ever expanding real estate sector, point to a stream of workers flowing into cities as the world’s largest rural-to-urban migration unfolds. Stephen Roach, former head of Morgan Stanley Asia and now at Yale makes the argument quite succinctly in an August 29th Project Syndicate article:

“Reports of ghost cities, bridges to nowhere, and empty new airports are fueling concern among Western analysts that an unbalanced Chinese economy cannot rebound as it did in the second half of 2009. . . But the pessimists’ hype overlooks one of the most important drivers of China’s modernization: the greatest urbanization story the world has ever seen.”

He goes on to mention a series of statistics highlighting the increasing flow. As of 2011 over half of China’s population now lives in cities. Both the OECD and consulting firm McKinsey predict the trend to continue well into 2025 – 2030. And because tens of millions continue seeking their fortunes in cities they’ll all need somewhere to live.

“Shanghai Pudong is the classic example of how an “empty” urban construction project in the late 1990’s quickly became a fully occupied urban center, with a population today of roughly 5.5 million. . . China cannot afford to wait to build its new cities. Instead, investment and construction must be aligned with the future influx of urban dwellers. The “ghost city” critique misses this point entirely.”

Concerns however can’t be dismissed so easily.

First and foremost, rural-to-urban migration continuing at the same rate while China was growing at double-digits is highly unlikely. China’s economy has been slowing far faster than most expect and may be hovering closer to 7% rather than 9% for 2012.  Peking University’s Michael Pettis predicts slow growth and difficulties in re-balancing over the longer term.

The Pudong example is a bit of a red herring as well. Lying just across the river from Shanghai, one of China’s largest cities and busiest ports, and heavily supported by Beijing’s leaders, Pudong was destined to become heavily populated. Rental rates in Queens, Brooklyn and Jersey City, just across the river from Manhattan were also barely affected by the real estate collapse in the U.S. The exception doesn’t prove the rule.

Does Ordos, or any number of other third and fourth tier urban infrastructure projects hold as much appeal? Probably not. And all of those airports have actual costs associated with their under-use. Banks may be sitting on more debt than they now recognize without landing fees paying back the construction loans taken out by local governments. A heavily state-influenced finance sector may cushion the blow by rolling over or extending those obligations, but these aren’t risk free investments.

Another key assumption: the real estate being built matches the demands of urbanization and not merely investment for choice-deprived wealthy Chinese.

True enough migrants flooding into Chinese cities looking for work need some place to live but the construction and factory workers stay mostly in temporary dorms on site and do not have residency permits to stay in these cities. Others, including newly minted college grads pack into tiny apartments often with 4-6 people per room. They earn barely a living wage and can only dream of someday owning their own place. Far too few affordable housing units were being built prompting the central government to demand an additional 36 million units by 2015.

That goal is proving far harder to implement than decree.

Lucy Hornsby of Reuters reported: “a good portion of what’s being built is already-planned construction re-labeled as affordable housing.” The Peterson Institute’s Nicholas Borst ran a sensitivity analysis estimating how much government funding would be needed to offset a drop in commercial lending. He found that 2011 levels accounted for only 10% of what was needed. The rest was meant to be provided by already cash-strapped local governments.

Local governments apparently aren’t filling the gap.

The China Development Research Foundation (reporting to the State Council, one of China’s highest central government organizations) stated “local governments…neglect the construction of public housing even as they are pushed by the central government to implement public-housing policies,” according to a story by the Wall Street Journal’s Esther Fung.

Corruption degrades officially designated government funding even more. Reuters highlighted China’s National Audit Office report on the misuse of $471 million in 2011 affordable housing funds. And that’s the part they caught.

So who has been buying the new and mostly high-priced apartments that drove the initial real estate boom – those with limited investment choices. And for years real estate had the best returns, which fueled even more development projects and higher prices. The Chinese government then stepped in to cool the market with rules limiting second or third residence ownership and increased minimum down payments.

None of this economic activity was driven by the rural-to-urban migration of mostly poor workers.

The most bullish analyses on China often have more to sell than to explain. As China’s slowdown continues, and hairline fissures begin to widen, expect more uncertainty not less about the perpetual economic growth story.


Photo: Map of China’s plan for nation-wide high-speed rail, Shanghai New Railway Station, 2010.