It is one of the hottest topics of conversation in Shanghai:  Has the property market （不动产市场）peaked? 

The writer has been studying this question recently, and thus was pleased to take the opportunity to visit the 2004 Shanghai Property Trade Fair “2004 中国上海房交会” which was held in the 上海展览中心 on 延安西路 on June 17-21.

No Doubt that Shanghai Real Estate is a Bubble

Even before visiting the Trade Fair, the writer had no doubt that Shanghai’s property market had become a “bubble” that will soon burst.  And the visit did nothing to change my mind. 

The fact is that Shanghai’s property market has become massively over-developed and is becoming increasingly over-supplied with both residential and commercial properties.

At the “2004 中国上海房交会” property developers (sellers) were clearly worried.  Very few were willing to put a price on new developments that will be offered for sale in the next few months.  What is now apparent is that, after five years of good times, Shanghai is enter a multi-year “buyer’s market” (买手市场).

“Middle-Upper and Upper Scale” (中上高等住宅) Residential Flats Will Crash

In the residential sector, the amount of over-supply in the “middle-upper and upper scale” segment is especially severe.  More ominously, a very large part of “demand” in this segment over the last two years has come from small and large property speculators, not real owners.  As a result, when prices begin to fall—as they are beginning to do—we can expect to see panic selling and a long decline in prices.  My guess is that prices of “middle-upper and upper scale” flats in all locations except the most desirable (along the Huangpu River in Lujiazui and in Jingan and Luwan and close-in Xujiahui Districts) will drop 30-50% over the next 2-3 years. 

商务楼市场Commercial  Market also Overbuilt

Because of massive over development and over-supply, and intervention by the government over several years to boost demand (and help developers), in 2004 the Shanghai property market entered the classic end-stage of a real estate bubble: 

Over-building and Lack of Planning (过剩建筑，规划不再)

Over-building in Shanghai has become obvious in recent years.  Of course, Shanghai has needed new development, so new building was necessary.  “Over-building” has occurred because local government officials have either not properly planned or have ignored or violated sensible development plans.  The result is too high density of high rise apartment buildings and lack of attention to and investment in environmental and social infrastructure:  green spaces, parks, roads, sidewalks

This report from 房地产时报 of  2003年09月29日 tells the story of over-development and violations of regulations.

本报讯　上海城市建设正在执行一个“双�搗o减”的方针，即�揄ﾁ公共绿地、公共活动空间，减少建筑容量、控制高层建筑，以此遏制高层建筑的无序开发。上海将严格执行住宅楼容积率控制在2.5以内，商办楼容积率控制在4.0以内的标准。目前这些规定已写入《上海市城市规划条例修正案（草案）》，该草案即将提请市人大常委会会议审议。

据市房地局统计：到2002 年底，上海全层8层以上、已办产权证的高层建筑达4916 幢，其中，16至19层有1101 幢，20至29层有1518 幢，30层以上有338幢。来自市规划局的统计：从1996 至2003 年6月，上海全市8层以上的高层，包括经审批的已建、在建、未建的合计有6783 幢，其中，18层以上为2655 幢，30层以上的为587幢。经有关部门调查，这些楼盘中，容积率超标的不在少数。

Reasons for the Bubble

Between 1999 and 2004 prices for resident flats in Shanghai increased by some 20-30% a year, while supply exploded. 

There are four reasons why a bubble developed in Shanghai residential market. 

1.  Government policies

From 1999 to 2003 Shanghai’s government allowed individual buyers of residential properties to apply 100% of the cost of buying residential property to “off-set” their individual income tax liabilities.  This was a tremendous incentive for white-collar salary men and others to purchase flats.  It helped to create a steady rise in property prices beginning in 1999 (which is why the policy should have been stopped sooner).  The effect of the policy was to encourage buying property not just for personal living, but for speculation.  Most middle and upper income families bought not just one flat, but two, three or four flats. 

The main effect of the policy was to create a huge (but “artificial”) demand for the products being produced by real estate developers.  From a fiscal policy standpoint, it was essentially a transfer of city government tax revenues to property developers.

2.  Bank lending

Shanghai banks began lending for property purchases in the late 1990s.  They soon became excessively aggressive in pushing these loans.  At end 1Q 2004, individual mortgage loans outstanding in Shanghai banks reached RMB 229 billion, up 48% YoY.  At 3Q 2001 the amount was RMB 80 billion.  New individual mortgage lending in 1Q 2004 was RMB 30 billion.

3.  Local government relationships with developers

Local government officials have been willing supporters of developers’ new projects.  Almost no constraints have been put on developers with the right “connections.”

Since 1999 real estate development has contributed a significant (and increasing) part of Shanghai’s GDP growth.  Local officials are particularly keen to “manage the numbers” and to keep development growing.

4.  Media behavior

A fourth reason for the bubble was the “hype” provided for real estate investment and speculation by Chinese media, especially newspapers and magazines.  For more than four years newspapers and magazines have celebrated new real estate development and carried stories of ever rising prices.  This “cheer leader” effect was consistent with government policy (influenced by developers) that has always sought to encourage buying.

Also, virtually all media reporting about real estate, and especially about particular projects, in magazines like 上海楼市，has been “payola”: i.e., writers have been paid by developers to say positive things about their developments.  Every development is described as a “great investment.”

The Crash has Started in the Secondary Market

It is typical in the final stages of a “bubble” that the rise in prices begins to slow, while transaction volume begins a precipitous decline because there are few if any buyers left.    A few recent news stories show that this is what is happening, beginning in the secondary market.

一周数字         http://www.jfdaily.com 2004-6-16 9:43:59          稿件来源：新闻晚报《房产周刊》   　　

今年1—4月，上海商品住房价格每月环比��长分别为1.9%、0.9%、1.0%、0.9%，比上年末累计��长4.7%。

今年1—4月商品住房预售面积中，每平方米3500元以下的占15%，3500—6000元的占38%，6000—9000元的占36%，9000元以上的占11%。   

From 青年报2004年6月17日 (chart below by S.M. Harner and Company)

•Volume of transfers (sales) of second hand flats in May dropped 20% from April.  The largest drop was in mid-priced flats selling for RMB 500,000 to 1,000,000.

•In May the volume of second hand flats sold was about 11,300 units, a significant drop from April’s 14,897 units.  Compared with volume of 25,438 in March, the decline is over 50%.

Supply will Keep Coming through 2004 and 2005

From 青年报2004年6月14日:

•         During the month of May, 41 “expected ‘hot‘ properties” （预热盘） hit the market, double the number in April.  

•         39 of the properties are “Phase One” developments, which will be followed by more supply this year and next.

•         In the first 5 months of 2004, 106 “hot” properties have come on the market, an increase in total supply of 77% compared with 2003.

•         A feature of the new supply is that “high end” flats (over RMB 10,000/ sq. meter) occupies a high 37%.

•         The projects are concentrated in Pudong and Minhang districts, which together had a 27% share.

A Threat to the Entire Chinese Economy?

Many cities in China have real estate bubbles similar to the one in Shanghai.  Most or all of them will experience a major correction that will cause a decline in GDP growth and increase in unemployment. 

Of course, real estate development has been directly tied to and dependent upon bank lending. 

At end 2003 total China-wide property development loans and individual mortgage loans totaled RMB 2,466 billion and RMB 1,178 billion, respectively.  Up 37% and 43% respectively from 2002. 

•         The property loans accounted for 21.4% of all loans from financial institutions; compared with 17% in Japan during the bubble period.

•         Year 2003 characterized by speculative, illegal “insider” acquisition and transfer of land.

•         Purchase of residential property for “investment” by about 25% of buyers in Nanjing and Hangzhou

Source:  Southern Securities in Xin Caijing 2004.6

Will the coming crash in the real estate sector create a major shock to the Chinese financial system.  I think the answer is a definite Yes.   Property development in most countries creates traps and moral hazard that tend to lead to periodic systematic crises.  Those countries with relatively sound financial, political, and legal systems, and a free press, usually succeed in avoiding or mitigating the most severe types of crises.  China, lacking these elements, will have a harder time.