The Strange World of Chinese Real Estate Liquidity

We are frequently so entranced with the meteoric price increases of Chinese real estate that seem to dwarf anything we’ve seen before that we frequently lose sight of details that really matter.  These details beyond price headlines really matter because many of these are the market dynamics that impact future changes.

One recently caught my eye and I will be honest in saying that I’m still trying to process the impact of what this data means.  The Chinese real estate market has extremely low levels of relative liquidity.

What I mean by that is that relative to the number of housing units in specific metro areas, there are actually a relatively small number of housing transactions.  Many times transactions will be reported for major metro areas in China, but there is frequently little context given that obscures the relative measure of liquidity.

To give you, some idea of what I mean the average home in the United States is sold roughly every 20 years.  This excludes housing units that are apartments, but gives us some idea.  Furthermore, this number does not fluctuate as much as you might think except in extreme periods like during and after the 2008 subprime crisis.

However, in China these numbers are astoundingly different.  As an example, in 2015 Shenzhen housing transactions relative to the number of housing units was under 1.9%. If each unit could only be sold once before being sold again, it would take Shenzhen 54 years before being resold.  What is amazing is that projected 2016 housing transactions in Shenzhen have gone down from 2015.  If current rates hold, unit turnover will fall to about 1.2% or approximately an 86 year turnover cycle.

In other cities, we see similar levels of low relatively real estate market liquidity.  2016 projections, estimate Shanghai unit turnover at under 2.7%, Tianjin at 3.4%, and Xiamen at 2%.  This would equal cyclical turn over rates of 37.6, 29.6, and 50.3 years.  To put these numbers in perspective, China only opened in 1979 so according to these numbers, each unit has yet to even sell a second time with many years to run.

Other cities show similarly low levels of relative unit turnover.  I’ll be honest in saying that giving some the peculiarities of the Chinese real estate market, I’m still trying to think through all the potential implications.  I have a couple of theories.

First, it is quite likely that Chinese real estate hit a tipping point a few years ago where real estate had been transferred on a preferential basis to existing urban residents under various schemes, the large majority of savings had been consumed to purchase housing units, and the only driver of the Chinese real estate market became channeled credit via state owned banks.  As I noted in a previous post, 2015 was the first year where the marginal new housing unit would have equaled a mortgage of greater than 50% LTV.  2016 is likely to be a significant increase from 2015 implying that the real estate driver has changed from a couple of years ago.  It is not longer unit transfer and savings consumption and credit growth of households.

Second, this seems to place a lot of pressure on Beijing to keep real estate prices elevated.  Many in China view this as a form of savings given the lack of other options and household income levels that are both under pressure and slower growing than real estate prices.  While households are little invested in the stock market, they are heavily invested in real estate implying much higher wealth dependence effect on real estate.

Third, it seems to imply much greater fragility in supporting the real estate market than is generally assumed.  Typically when prices go up, we see rapid growth in turnover volume but not only have we not seen this, in some cases we have see a decline in turnover.  The only apparent support of the real estate market is higher credit growth which means to support this, PBOC will need to pump even higher levels of credit to support price increases or stability.  This implies a lot more fragility in the real estate market given the relative lack of volume.

I think there are other implications but I’m still thinking through many of these implications.  However, I think it is pretty clear, there is a lot more going on here that requires thinking about the market microstructure of what is driving these dynamics.

Is Chinese Mortgage Data Waaaay To Low? (No, seriously)

So recently a lot of ink has been spilled on the rapid growth in Chinese mortgages.  On the face of it the increase is certainly worrying.  New mortgage lending in 2016 is up 111% and the total stock of mortgages is up 31%.  Even if we take a broader measure of household lending that likely captures a not insignificant amount of real estate related debt, medium and long term loans to households is up 31%.  The numbers on their face appear large with medium and long term loans to household registering 22 trillion RMB and personal mortgages clocking in at 16.5 trillion RMB.

These sound like big number and in some ways they are, but in reality these numbers are if anything suspiciously too low.  Most get caught up on the size of the numbers but never place these total numbers in any type of context.  In fact, if you place these numbers in context, these numbers are absurdly low.  Let me explain.

For conservatism, data, and simplicity sake, I am going to limit the analysis to urban housing units.  In other words, let us assume that all mortgage and medium to long term household debt is owed only by urban households.  This does not change the outcome in anyway and if anything make it much more conservative than it would be otherwise.

The primary thing we want to do is adjust for the number of households in urban China.  Without going into all the underlying calculations, which come from all official data, there are approximately 272 million urban households in China and according to official data, only a very small number of households do not own their housing.  Again, this is all relying and strictly using official data.

If we then estimate urban residential real estate wealth using the 100 City Index price per square meter as our high value and the Third Tier City Price per square meter as our low value, we have both a high and low value for our estimate of urban residential real estate wealth.  This gives us an estimated upper bound of 330 trillion RMB and a lower range of 189 trillion RMB.

Here is where it gets interesting.  If we translate this into a broad loan to value number, this means that urban China has an estimate loan to value ratio on its real estate holdings of 5-9%.  In other words, almost all of urban Chinese real estate is owned almost entirely free and clear according to official statistics.

If we apply this analysis backwards, the numbers are even more nonsensical.  In 2011, the urban loan to value ratio ranged from 3.3-4.5%.  If we use absolute numbers, the appear even more absurd.  When the average housing unit in 2011 cost 665,000 RMB using the third tier city price and 910,067 using the the 100 City National Index, mortgage debt totaled only 29,675 RMB per urban housing unit.

If we focus just on the new mortgages and new urban units, the numbers look decidedly problematic.  For instance, if we use the 100 City Index housing price, this would give us an implied equity share for new housing units from new mortgages of 71%.  In other words, if we assume that only newly constructed units are purchased with new mortgage debt, owners would be providing a down payment equal to about 71%.

Now while I use the slightly more restrictive mortgage debt, even if we include the broader label of medium and long term this would barely dent the number.  If we use the medium and long term household debt number instead which is only about 4-5 trillion RMB more, again using only urban households, this would still barely move the per unit or value debt number.   To bring Chinese urban housing wealth up to a 20% LTV, would require about a 41 trillion RMB increase in mortgage debt.  Put another way, outstanding mortgage debt would need to go from about 16.5 trillion RMB to 58 trillion RMB. Including the obvious candidates that some have nominated simply does not come close to making these numbers plausible.

We are left with a conundrum: either believe the data at these levels or find a better candidate when no good obvious source of debt under counting exists.  I’ll be honest in saying I’m not sure whether to accept them as vaguely reasonable representation or believe that they are not even close.

If we consider the possibility that these debt numbers are relatively accurate, while there are positives, there are also very real risks.  First, it raises the scope that Beijing could further increase urbanization and home ownership rates by loosening credit.  However, there is evidence that rural households migrating to urban areas are already debt budget constrained and that Beijing is uncomfortable with the level of debt even at these levels.  Additionally, this raises the possibility that real estate prices have a long way further to appreciate which seems implausible given already elevated price to income levels.

Second, this would imply that households have put very high level of savings into their homes and may have less liquidity available than understood.  By some recent estimates, Chinese households had 70% of their wealth in real estate.  Liquidity constraints may exacerbate any real estate or broader economic down turn placing additional pressure on prices.

Third, this would seem to place enormous pressure on public officials to maintain housing prices at elevated levels.  If Chinese households have placed the vast majority of their wealth into their home, though lack of leverage will not magnify the financial returns, it will place enormous pressure on the government to prevent price declines.

There is one possible scenario, though we do not have the data to say for sure this happening that would explain the discrepancies we see.  Given the mismatch of the mortgage data and required down payment this raises the possibility of the leverage upon leverage scenario.  For instance, a home is owned with no mortgage debt.  The owner then pledges the real estate as collateral to borrow money for the equity share and borrows money in the form of a mortgage to purchase additional real estate.  In this instance, only one mortgage appears outstanding where, if we assume the second property is financed with a 50/50 debt/equity split at the same value of the first property, then we have a mortgage per unit value of 25%.  However, in reality the risk level is much higher as both properties have debt against them and depend on stretched cash flow valuations or capital appreciation.

There are many possibilities but the only thing we can say for sure at the moment, once we break down mortgage data into per housing unit basis, the numbers seem implausibly low.


Is Singapore Headed to an Iceland Style Meltdown: Part I

The piece by Jesse Colombo asking whether Singapore is headed to an Icelandic style meltdown received a lot of attention but not a lot of analysis.  I think it is important to examine not only the factual basis for the arguments put forth but also the bigger picture philosophical framework for predicting financial crises.  Today in the first part, I will place the arguments in a type of philosophical framework and the biases we have with regards to economic and financial analysis.

Event convergence.  Plane crashes are fascinating events.  They are rare and unpredictable events that are normally a confluence of divergent factors that uniquely converge at one point.  Many of the factors that are present in plane crash are common in many flights that never crash.  An accumulation of risk factors does not guarantee a catastrophic event but only increases the probability necessitating a catalyst event to cause a crisis.

Many of the financial and economic risks that Mr. Colombo cites are valid concerns, though I do not share his belief about the severity of those imbalances and their probability in causing a financial crises.  Real estate prices, excessive debt levels, and monetary stimulus are all elevating risk factors many of which have been acknowledged by the Singaporean government.  However, I do not currently believe that these factors are so unbalanced as to cause a financial crisis.

All the world is a nail if you only have a hammer.  There is a joke about the stock market that says it has successfully predicted 10 of the last 3 recessions.  Since the 2008 global financial crisis, many people carrying forward those lessons have dedicated themselves to forecasting bubbles   Unfortunately, irrational exuberance has given way to irrational bubble obsession.  A range of analysts, not just Mr. Colombo, have taken to calling just about everything the next bubble.  Given the number of bubbles that Mr. Colombo is predicting it is not unreasonable to think that one of them may come to pass though given the number of bubble forecast, that does not validate his wisdom but prove only that he makes lot of predictions.

Mr. Colombo is predicting bubbles across a wide range of economies and individual markets.  From Canada to Asia and higher education, social media, health care and housing, the prediction of bubbles everywhere we look is swamping reality.  I believe the reality is much more complex and driven by different factors.  To give one simple example, most commodity prices have grown relatively slowly post 2008 and enjoy significant new demand from emerging markets like China and rapid supply growth due increased oil and gas output in the United States.  If everything you see is a bubble, you miss much of the complexity of the global economic system and the underlying dynamics.

When is a bubble a bubble? Prior to the 2008 financial crisis, there was a debate in central banking circles about whether or not monetary policy should be concerned with asset values like home prices.  Alan Greenspan made a cogent argument that bubbles could not be identified before they “popped”.  He was not saying the bubble did not exist but only that predicting bubbles was akin to astrology.  In fact in his career, Alan Greenspan correctly understood the rapid increase productivity in the late 90’s due to improved information technology but failed to understand the importance of low interest rates in fueling the disastrous housing bubble in the United States.

The Icelandic meltdown was a catastrophic event that was accompanied by large defaults, collapses in real economic GDP, and a fall in the exchange rate.  In fact, may countries have had similar economic and financial imbalances without suffering a catastrophic financial bubble crisis.  However, Mr. Colombo has predicted a catastrophic event like the Icelandic meltdown and not a slowdown in asset price increases, recession, or other such mitigating process.  History tells us instead that financial crises are relatively rare events while it is much more common to have a “balance sheet” recession or reduction in credit due to higher default levels.  In other instances, asset prices may fall or slow for extended periods of time without having a full crisis.

Cities are different.  There is not a clear answer but major cities, and especially financial centers such as Singapore, operate under slightly different rules than most places.  Cities like New York City, London, Abu Dhabi, and Hong Kong suffer from many of the risk factors such as high real estate prices and rapid expansion of credit and yet they continue to flourish and expand.  During the financial crises and even in other periods of economic stress, these cities have suffered less even though real estate and other financial factors indicated stress.

Iceland however, never had a financial center but only borrowed in other currencies to reinvest else where for its firms global investment.  That makes it significantly more risky than a financial hub like Singapore.

Many cite the old adage that if we do not learn from history we are doomed to repeat it.  I prefer a variant of this saying which says, history repeats itself but just differently enough to fool us into thinking we know what we are doing.  While I agree with many of the general risks cited with regards to the Singaporean economy, I think it suffers from a variety of defects not least of which are some philosophical or theoretical short comings.  Though I am no defender of the economic and financial policies of the current Singaporean government, as anyone knows, I think the risks of a catastrophic financial crisis are extremely over stated.

Note: The second part of this series will deal with the analysis of risks cited and what the risk for a catastrophic financial and economic crisis in Singapore is.

The Ongoing Data Discrepancy in Chinese Inflation and GDP

A question I have answered frequently in recent history is why I decided to write my working paper How Badly Flawed is Chinese Economic Data? and the answer is simple.  I was astounded that smart people would so readily believe the economic propaganda being announced by Beijing.  Apparently, other people have been just as skeptical and and heartfelt thank you to CNBC for broadcasting this:

Now whether you agree with everything that I have said, how I calculated it, or the final conclusions I reached let me give you some new information.  According to new official data (as I stress about Chinese data: do not actually believe it) in 70 major cities the price of new homes rose 7.5%.  Nor was this increase limited to new homes as existing home prices jumped also.  According to Bloomberg: “Existing home prices rose 15 percent in Beijing last month from a year earlier and increased 11 percent in Shanghai and Guangzhou each, according to the data”

Now to put these numbers in perspective you must bear in mind that according to the same people that released these statistics, from 2000-2011 urban areas saw housing price inflation of 8% total.  It must be emphasized that the real estate asset price and the consumer price change are two very different things but they are also very related.  The real estate component of CPI is not going to increase in perfect correlation with the change in real estate prices, especially when there is a bubble.  However, nor are the housing CPI and real estate asset price independent and unrelated.  To think that real estate asset prices go up by 7.5% annually but the housing CPI goes up by only 8% in 12 years in ludicrous.

The reason this matters is that banks are enormously stressed and continuing to lend to developers to buy land, consumers to buy apartments, and related industries to stay in business.  Think the banks aren’t stressed?  Chinese interbank rates are already spiking in anticipation of the end of the month capital adequacy ratio tests and the market is pushing for additional PBOC liquidity.

There are a couple of problems here.  First, it should serve as a warning sign that every time there is a capital adequacy test, Chinese banks go into panic mode.  That is not a good sign.  Second, banks should not be this dependent on on the central for bank for ongoing liquidity.  This smacks of an ongoing quiet bailout.  In normal times, banks should be able to lend to each other with minimal central bank intervention to ensure smooth financial market operation.

Given the line of rights issues that have already started are continuing by banks, this sounds a lot like a government engineered bailout except under quasi-Communist Authoritarianism, you get try to dupe the private investors into putting up the capital.  (Am I the only one that finds it odd that the quasi-capitalist US does a public bailout while the quasi-Communists conduct a private bailout?).  Point being, the PBOC and string of new rights issues are telling you just how stressed Chinese banks are.

You definitely can’t believe the macroeconomic data any more than you can believe a set of public Chinese books.

My New Working Paper on Bogus Chinese Economic Data

So after getting a bunch of questions about a blog post I did about bogus Chinese economic data, some challenging what I wrote and some just wanting to know more, I decided to give it a bit more formal treatment.  I put together a working paper entitled How Badly Flawed is Chinese Economic Data? The Opening Bid is $1 Trillion available here.

I plan on covering some of the major findings periodically over the next couple of weeks but Chinese is so fraudulently manipulated as to be Alice in Wonderland absurd.  Let me give you one simple example below in this table.

According to the official National Bureau of Statistics China (NBSC), the price of private housing in urban areas between 2000 and 2011 rose by a grand total of 6% with rural area prices grew slightly faster registering a 20% increase.  It needs to be emphasized that these are not annual numbers but rather the total increase in China in 12 years.  To anyone who is alive and has heard of China, these numbers are not simply questionable but downright comical and fraudulent.

It is also worth noting that according to the NBSC, approximately 70% of Chinese households are considered “private housing” occupants.  This means that the NBSC is saying about 70% of Chinese households have faced housing price inflation of between 6-20%.  More about this break down in a future post which is very interesting in itself.

The primary point of the paper is not simply to reveal more discrepancies in the Chinese economic data, which it does, but also to measure the impact of these fraudulent statistics on real economic activity.

If you don’t want to read the paper or hit the highlights, don’t worry I will be posting the greatest hits here over the next couple of weeks.

Enjoy and cross your fingers.

Chinese Finances and Milk Formula

Chinese mothers and politicians are actually pretty similar.  Safety conscious Chinese parents causing baby formula shortages “from the Netherlands to New Zealand” worry that what they are buying isn’t what it is supposed to be.  Chinese politicians are worried about the same thing.  Beijing is terrified that the Chinese finances are a house of cards and unfortunately the evidence of this keeps mounting.

As credit crunched in the last week of June because the Peoples Bank of China declined to provide overnight lending knowing the perilous state of state bank finances, the banks scrambled to meet capital adequacy ratios.  Since the end of the second quarter, Chinese banks have seen a trillion reminbi of deposits leave while seeing an explosion of credit.  In the first of week of July alone, 700 billion reminbi of deposits left and loans grew by 170 billion.  As Forbes notes, this comes from moving off balance sheet items back on the balance sheets and more worryingly not recording loans as deposits.

Even the Chinese government and press is waking up to the idea that the numbers they are being given are less than realistic.  The Chinese deputy finance minister of China actually admitted “the total amount of borrowing by local governments was unknown but he also asserted it should be manageable.”  I am unsure how you don’t know how much debt you have but know that the risk is manageable, but I am sure those Chinese statisticians will come up with something.  It is too bad that it took Detroit going bankrupt to bring the risks home.  I would have thought the 2008 financial crisis would have brought the issue of excess leverage home, but what do I know.

In an amazing show of independence, Chinese papers are even questioning land sales data.  Different ministries and government agencies that provide land sales data have been caught publishing such widely divergent numbers as to warrant skepticism by the Communist Party mouthpiece.  The reason this matters is because to reduce debt and pump GDP, local governments are selling land, and a lot of it.  According to one report, the first tier cities in China have already sold more land in 2013 than all of 2012 with another report saying land sales were up more than 40%.  Furthermore, the land is being sold for record amounts with final sales prices to consumer in many cases expected to top more than $1,000 a square foot or twice the average price in San Francisco.  Not sure how a farmer moving to the big city can afford that type of apartment so even mass urbanization won’t solve that problem.

The reason land sales and debt statistics matter is because they are intricately linked.  By one estimate, local Chinese governments received 40% of their revenue from land sales.  An acceleration of land sales by such an enormous amount should be an enormous warning signal that local governments are under enormous financial strain.  Local governments are selling assets to meet debt obligations.  Politically motivated loans are being made to developers so they can buy land and build enormous apartment blocks at $1,000 a square foot even if existing occupancy rates hover around 50% in most big cities.  The government is telling you how bad their debt burden is.  I have heard anecdotes of local government projects with total revenues not approaching debt service costs.

I mean building over priced homes with nobody living in them could never come back and cause problems right?