Is the Chinese Property Market in a Bubble?

Investors may be shifting capital from stocks to houses.

Fei Yang / Getty Images

The Chinese stock market rout in 2015 and 2016 shook investor confidence and led many investors to shift capital into the real estate industry. Direct loans to the real estate sector soared to $3.6 trillion by June 2016, according to Capital Economics, even as the country’s economy has cooled off. This capital has moved into large coastal cities like Shanghai, while thousands of smaller cities have large numbers of empty properties.

Fear of an Asset Bubble

These rising valuations that are concentrated in large coastal cities have sparked fears of an asset bubble as investors shift capital from stocks to houses. In fact, the real estate appreciation in parts of the country has exceeded the rates seen during the height of the U.S. real estate bubble prior to the 2008 financial crisis. International investors may want to take note of these dynamics and reduce their exposure to certain parts of the Chinese market.

In this article, we will take a look at how the stock market’s volatility may have created a bubble in the country’s real estate market.

Stock Market Turmoil

The Shanghai Stock Exchange lost nearly a third of its value between June and July of 2015 when over 1,400 companies halted trading to prevent further losses. While these losses were recouped in the following months, volatility returned in January of 2016 after the market fell 7% within 30 minutes of the market opening.

These developments led to a global economic rut throughout the early part of 2016 affecting most of the world’s markets.

Chinese investors were perhaps most concerned by the government’s inability to stem the losses during these times. These investors had assumed the government step in to ensure stocks kept rising in price.

Regulators did take extreme measures in the face of crisis, including limiting short selling under the threat of arrest, providing cash to brokers to buy shares, and utilizing state-run media to persuade citizens to buy more shares, but they failed.

There was no clear cause for the stock market crashes other than perhaps a shaky global economy, a slowdown in Chinese industrial production, and potentially lofty equity valuations. But, it’s worth noting that the Chinese stock markets are dominated by retail investors rather than institutional investors, which tends to result in greater short-term trading and volatility. The combination of a slowing economy and market psychology precipitated the decline.

The Rise of Real Estate

Real estate prices in China’s top 10 cities have risen by 23% from 2015 to 2016 as investors moved from stocks to houses – more than the 20.5% increase seen during the U.S. real estate bubble. Regulators responded with stricter lending requirements, restrictions on nonresidents, and other measures, but they have been largely unsuccessful. Chinese real estate billionaire Wang Jianlin recently called it the “biggest bubble in history” in a CNN interview.

Bank of America Merrill Lynch analysts appear more confident that moves to curb real estate prices by regulators could lead to a slowdown in the market.

But, if real estate prices do begin to fall, there’s a worry that the high amount of debt could create a new problem, as defaults could begin to creep higher. The risk of a hard landing remains low in the eyes of most analysts, but many believe that the economy has yet to reach a bottom.

International investors may want to prepare for real estate prices to potentially move lower by avoiding Chinese real estate holdings and focusing on growth areas of the economy. In addition, investors may also want to reduce exposure to Chinese equities as a whole in case the debt markets were to become a problem. Rising defaults in real estate could prompt investors to withdraw capital from stocks to improve their balance sheets.

The Bottom Line

China’s stock market turbulence throughout 2015 and 2016 has led many investors to shift capital into the real estate market.

Unfortunately, the capital has concentrated in large coastal cities like Shanghai rather than the wider market, which has created bubble-like conditions. International investors may want to adjust their portfolios to reduce any potential risks stemming from the fallout from a bursting real estate bubble.