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China’s Bursting Housing Bubble Will Rock the Economy for Years

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(Bloomberg) — The wave of stimulus aimed at reviving China’s housing market — billions in bank loans, interest rate cuts and support for developers — has done little to help Echo sell her home near Shanghai.

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The media worker has received only four nibbles from potential buyers in six months, and is considering a 10% cut to her asking price of 3.3 million yuan ($460,000). She thinks this stagnant housing market, the worst in China’s modern history, will drag on for years.

“Everyone is waiting for a steeper drop in home prices before they make up their mind to buy,” said Echo, who asked to be identified only by her first name for fear of retribution given her negative outlook. “There’s going to be a vicious cycle.”

While many economists say China’s crippling housing downturn won’t get much worse and that the stimulus will kick in this year or next, the reality on the ground for sellers like Echo is much bleaker.

Home sales and prices remain sluggish amid an economic slowdown and Covid Zero restraints. Consumer confidence is near a record low, and a recent central bank survey showed 73% of households expect property prices to stay unchanged or drop in the near term. Not even the Golden Week holiday, normally a good time for real estate, could provide a spark, with sales off 38%.

As President Xi Jinping and other Communist Party leaders gather Sunday for their twice-a-decade congress, few issues matter more than a housing market that’s been hobbled by Beijing’s own policies aimed at reducing credit risk while making homes more affordable in the name of “common prosperity.”

With estimates ranging from $2.4 trillion for the new-home market to $52 trillion for existing inventory, the sheer expanse of China’s residential housing sector means there’s plenty at stake.

Real estate accounts for about a quarter of domestic output and almost 40% of household assets. Bursting a bubble of this size without triggering a financial crisis is difficult for any government, and previous attempts in Japan from 1989, and the US in 2007-08 proved to be disastrous.

Policymakers are showing increased urgency to deal with the fallout. Among the most recent moves, the central government is allowing nearly two dozen cities to lower mortgage rates. Financial regulators have told the biggest state-owned banks to extend at least 600 billion yuan of financing to the industry. Beijing even offered a rare tax break for people who buy a new home within a year of selling.

So far, none of the moves has done much to restore confidence in a sector that’s endured endless pain in the last 18 months. The government crackdown on borrowing has hammered developers like China Evergrande Group, sparking a wave of more than $50 billion in dollar bond defaults.

An analysis by the International Monetary Fund this week showed that 45% of developers might not be able to cover their debt obligations with earnings, and 20% of them could become insolvent if their inventory value is marked to current property prices.

A gauge of high-yield debt remains near the lowest in more than a decade, while the main property stock index has tumbled 39% this year. Property stocks and bonds are unlikely to rally until home sales pick up.

Consumers are feeling the pinch too. The turmoil has sparked unprecedented protests after the developer cash crunch led to construction delays across China, prompting hundreds of thousands of homeowners to boycott their mortgage payments until their homes get built.

The potential spillover effects on the economy are massive. Millions of households are seeing their nest egg quickly lose value while Covid lockdowns have dragged down consumer confidence. That’s translating into a record increase in savings and the weakest demand for loans since before the global financial crisis. In the year through September, banks extended the least amount of mortgages in any year since 2015.

The current downturn, now in its second year, is already breaking records, making it the steepest and longest slump since private home ownership began in the 1990s. While sales in big cities like Beijing, Shanghai, and Shenzhen saw a slight uptick in the first weeks of September, the overall market by dollar value at the 100 biggest developers was still down 25% last month from a year earlier.

Lengmu, a real estate agent in Shanghai, has only done two deals since the city lifted its lockdown in June. He says the average number of second-hand homes sold in one block has dropped to below 10 over the past six months, compared with around 30 to 50 in a good year. Clients have either left the city or are waiting for prices to stop falling.

“It’s really tough to broker a deal these days,” said Lengmu, who only wanted his first name used and has worked in real estate for four years. He hopes the market will improve after the rate cuts. “If you can’t secure any deal, you don’t get paid anything more than your basic salary. I feel pressured.”

Market Floor

Some economists say the policy moves, along with a gradual easing of Covid restrictions, may help the market find a floor this year and plateau into 2023. Few are calling for a sharp rebound.

“The government’s measures are aimed at preventing the difficulties in the property market from spilling over into the broader economy rather than stimulating the housing market,” Morgan Stanley analysts including Stephen Cheung and Chloe Liu wrote in an Oct. 9 note. They don’t see a recovery until the second quarter of next year. Deutsche Bank AG says the market may have bottomed in August.

Optimists point to China’s burgeoning middle class that will fuel new levels of spending. China surpassed Japan as the world’s second-largest economy in 2010, helped by the largest urbanization in history.

Still, Bloomberg Economics says this trend is slowing, with some 65% of China’s population now living in cities. Housing supply needs to drop by about 25% to align with projected fundamental demand in 2031, according to Chang Shu, chief Asia economist at Bloomberg Economics. Fundamental demand strips out speculative buyers.

There’s plenty of supply already after developers like Evergrande went on a borrowing frenzy in the last decade to build more apartments. Bloomberg Economics estimates about 2.8 billion square meters of real estate is currently sitting empty — an area 47 times the size of Manhattan.

Even as Beijing takes steps to bolster the market, the government has stuck to its mantra that “houses are for living in, not for speculation” — suggesting there’s no interest in going back to the go-go era of the last decade. Finishing uncompleted homes is more about curtailing social unrest and safeguarding financial stability.

“Central authorities will likely have to make some sort of public and credible commitment to ensure that housing construction will be seen through to completion,” said Adam Wolfe, emerging markets economist at Absolute Strategy Research Ltd. in London. “A few words from Xi Jinping that this is a political priority just might do the trick.”

That equanimity is fueling bets Xi will do more during his third term to ensure China pulls through the crisis. None of the economists surveyed by Bloomberg is calling for a recession any time soon: the median estimate is for gross domestic product to expand 5.1% in 2023, up from 3.4% this year.

“China as a country will get through the property downturn — it always does,” said Anne Stevenson-Yang, co-founder of research firm J. Capital Research Ltd., which is bearish on Chinese real estate. “But people will take losses and banks are going to be asked to take a haircut.”

Morgan Stanley’s economists recently took a stab at predicting what happens if Beijing drags its feet, modeling a stress test that would result in growth of just 1% in the first half of next year and 11 million job losses. The IMF painted its own bleak picture of how the housing slump may morph into a banking crisis. In one scenario, 15% of small banks may go under.

“All you can do is look at history and make an educated guess,” said Larry Hu, an economist at Macquarie Group Ltd., who last year predicted Beijing’s tightening policies would last into 2022. “What if authorities can tolerate another 12 months of a downcycle? That’s your new nightmare scenario.”

(Updates with IMF report in 11th paragraph)

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