China: The Show Goes On
[I see every reason now for China to have a serious hard landing
I doubt it will be good for commodity prices in general – mish]
Andy Xie (Hong Kong)
“I lost 20% because of you,” a schoolmate in Shanghai screamed at me. “I had to hire several guys to line up for seven days and seven nights to buy three flats last month.”
Last October, he read in the paper that I had said Shanghai property was a bubble. He was scared and held off his purchases. Then the prices kept rising. By January he couldn’t take it any more and jumped in.
I felt terrible. I didn’t say that the bubble was popping. I said that the bubble could last for months but not years. The basic assumption was that the dollar would bottom in 2005. I thought that the Fed would raise interest rates above 3% and that US consumption would weaken substantially in 2005, which would cut off the hot money flow to Shanghai. It would be hard, I felt, for the Shanghai bubble to survive 2005.
A bubble keeps expanding until it pops. It is always hard to predict when a bubble will burst. The Internet bubble crashed when the supply of broadband capacity overwhelmed demand and bandwidth prices collapsed, which scared the NASDAQ investors into running for the exits.
The Bangkok property market began to crack when the dollar bottomed in 1995. The falling property prices spooked foreign speculators and the hot money began to leave. In my view, Shanghai now resembles Bangkok 10 years ago and, I think, is likely to follow the same path.
The Shanghai property market does seem to have nine lives. While the hot money is powerful, Shanghai’s supply is also massive. No city in the world has sold so many flats year after year. Shanghai has managed to find new people to come to buy again and again. The dollar weakness towards the end of 2004 has triggered another wave of buying.
“Are there a lot of Dutch people?” one friend in Shanghai asked me. “They are buying now.”
I didn’t have the heart to tell him that the Dutch were quite a small group. Fortunately, Americans are buying and there are many more Americans. I am not talking about Chinese Americans or the returnees. Regular folk from America are buying.
One property-owning friend in Shanghai received a letter from an American lawyer. The letter was an unsolicited offer to buy my friend’s property. It ended on an altruistic note. “You can sell to me and use the money to buy several more by leveraging up. It is a more efficient use of your capital.”
I don’t know why this lawyer was in Shanghai. It seems that his lawyerly skills were put to good use in stir-frying Shanghai properties. I wish him good luck.
While I am in Shanghai, the important players in Shanghai market are actually not in Shanghai. They are in Taiwan, Hong Kong, Southeast Asia and, increasingly, Japan and the US. When Shanghai’s bubble pops depends on when outsiders change their view towards Shanghai, which would be a combination of money becoming more expensive and Shanghai hype fading.
There are two types of local buyers.
First, many people in Shanghai have relatives abroad and receive money from them to buy properties. People who left Shanghai before 1949 or after 1980 are very successful in the world (not necessarily yours truly). The people who left Shanghai before 1949 are rumoured to own one-third of the wealth in Taiwan and half in Hong Kong.
Even the people who left after 1980 may have income equal to the total income of Shanghai people today (my guesstimate). The Shanghai Diasporas give money to their relatives who buy properties in Shanghai. Sunshine or rain, Shanghai can count on this constant flow of money.
Since 2002, the money inflow has gone beyond the Shanghai Diasporas. Average guys from Taiwan and Hong Kong with no historical linkages to Shanghai have been buying. Then, Japanese and Americans came.
Second are the resettled residents who use the resettlement compensation as a mortgage downpayment to purchase a property, usually quite further out from downtown but of bigger and better quality. They are the most important source of demand in the outlying areas of the city. However, their money comes from those who pay for properties built over their old place. This is derived demand from those, mostly from abroad, who pay high prices for downtown properties.
Local residents in Shanghai, as far as I can observe, are increasingly marginalized in Shanghai’s property market. When three months of average wages could buy only one square meter of low-grade property, even the most ardent bulls blush when they talk about local demand. Shanghai’s property market is an outsiders’ game.
While new demand is vital for keeping up the market, what the existing owners do could tip the balance. It is no secret that a large proportion of the flats in Shanghai are unoccupied. Their owners live somewhere else. Their financial condition will determine if they will run for the exits or hold on when the downturn comes.
I met a table-full of such owners last week at a dinner. They were there to debate me on Shanghai property. We discussed most of the arguments that were floating in the market. I summarize the arguments and counterarguments below.
1) Hong Kong, London, New York, and Shanghai?
That Shanghai’s property prices should converge to those in Hong Kong, London, or New York is the most common argument for the bulls.
“The flat that costs $400,000 could be worth $2 million in London,” one guy from Kansas City shouted at me over the phone a couple of weeks ago.
Why didn’t he compare Shanghai to Kansas City? A mansion costs $100,000 there. The bulls would call that blasphemy. They cannot imagine comparing Shanghai with any city other than London or New York.
The way that people are thinking about Shanghai reflects more the triumph of propaganda than reality. Property prices in a city reflect the productivity of the people living there. Unlike a machine, property does not have its own inherent productivity.
The productivity in a city shows up in its average disposable income per capita. This is why property analysts use the ratio of household disposable income to property price as an affordability index. On that measurement, Shanghai is about three times as expensive as either London or New York.
Further, the recent rise in Shanghai’s income reflects its property boom rather than productivity increases in productive industries. When the property bubble bursts, Shanghai’s income level could come under serious pressure.
What about growth? If a city grows faster, its property market should enjoy a premium. However, it is too early to tell how fast Shanghai can grow. The property sector has been pumping its growth. It is not easy to find competitive industries in Shanghai. Unless new competitive industries emerge in Shanghai, its high growth rate may not be sustainable beyond the property bubble.
2) Rich people move to Shanghai
“All the rich people are moving to Shanghai. Is it true?” one Shanghai friend asked me over the weekend.
This is a new spin on the old argument for the bulls: Shanghai’s income should include that of those who work elsewhere and will probably move to the city. But people do not ask why these people want to move to Shanghai.
Shanghai people who left have become very successful. But the people who stayed behind are still relatively poor. Further, their income depends on the ones who left and are buying properties in Shanghai. Does it tell you something about Shanghai as a place for creating wealth?
“Would you move back to Shanghai?” I asked the people at my dinner debate last week. “If you do, what could you do there?”
Nobody had an answer.
Shanghai today is not the same as it was in 1930s or 40s. Then, Shanghai was a free city. From movie making to banking, Shanghai was the most successful city in Asia. Today, it is mostly a good property show. Where could one find competitive industries in the city?
China’s financial sector is, in my view, value-destroying. Forget about a meaningful financial center. The media sector is controlled and is in my view unlikely to become a significant value-adding industry for Shanghai or any other city. The successful foreign companies in Shanghai are in manufacturing. They do not create high paying jobs like finance or media to support an expensive property market.
Many things are out of Shanghai’s control in its development. Finance and media that are vital to a global city are tied down by the political system. Until China loosens up further, Shanghai’s development is quite constrained.
3) High cost justifies high prices
As land prices surge in auctions, many are arguing that property prices could not come down because the land costs have become so high. I heard the same argument in Hong Kong in 1997 and Tokyo in 1989. Price is determined by the balance between demand and supply. This argument only looks at the supply side.
The rapidly rising land price reflects speculation that exaggerates demand and, hence, the profit expectation of property developers. As they extrapolate the rising trend of property prices, they are willing to buy land at higher prices.
4) There is no land left
Land shortage is a common argument justifying high property prices. Hong Kong is a typical example. Some are trying to create the same perception for Shanghai. It is not true in either. Hong Kong has plenty of land but the supply is under government control. In Shanghai, one can see the land supply on the way to the new airport. What about the downtown land supply? Many investors attribute the high prices to the relative scarcity in the central area. I don’t believe that the land supply in the central area is totally drying up. Hong Kong is still finding land in its central area to build on. Shanghai is much younger than Hong Kong and still has many areas in the central area that could be redeveloped.
Further, when the downtown area is really filled up, Shanghai could always create another downtown. The World Expo site, for example, is a concept to create a new central area. The financial district in Pudong is another such concept. The supply of concepts is unlimited.
Further, land shortage per se does not justify high property prices. The purchasing power of the people is a more powerful factor. It is like the supply of shares from a company. A share price can be ramped up by keeping supply down. Many tech companies have only 20-30% of the shares floating, which creates some scarcity value. However, over time, the company has to deliver profits for the share price to stay up. Manipulating supply can be effective in the short term but its impact won’t last.
My schoolmate called me again and wanted me to meet up with someone who could explain to me how Shanghai’s property market worked. I went to a bar in an expatriate area. It was the sort of place that charges for a drink as much as a waiter earns in a day.
When my schoolmate saw me, he called me over and whispered something into his pal’s ear. He took a hard look at me and then burst into laughter. “You scared me,” he said, pointing a finger at me. “I bought 20 flats last October. You then said it was a bubble. Now, Hong Kong property agents call me every day and offer 20% more.”
“Yeah, I listened to him and missed 20%,” said my schoolmate. “I should call him Mr. -20%.” He was not happy.
“Mr. -20%.” The chap was laughing uncontrollably and nearly fell off the chair. “You will soon be Mr. -50%. Come, come, and have a drink. It is on me.”
I was thick-skinned and poured down the drink. I needed it.
“They will keep it up. You know,” he said, pointing a finger skywards, “before the Olympics, before the World Expo, it is safe.” |
