ZHU NING Keep­ing the lid on our hous­ing prices

China Daily (Canada) - - BUSINESSVIEWS -

No­bel lau­re­ate and Yale Univer­sity pro­fes­sor Robert Shiller was one of the first global econ­o­mists to talk about the run­away risks in China’s spi­ral­ing prop­erty prices, a sub­ject that has been of con­sid­er­able in­ter­est in China re­cently.

Shiller, well-known for his in­sights on global as­set prices and ex­tended re­search work on be­hav­ioral fi­nance, macro­eco­nomics and real es­tate, had dur­ing a visit to China men­tioned that prop­erty prices were mov­ing at a “dan­ger­ously high” pace.

That com­ment, highly con­tro­ver­sial back then, seems even more con­tro­ver­sial now, given that real es­tate prices across most of China have in­creased by more than 50 per­cent and by more than 100 per­cent in a few high pro­file mar­kets.

It is also worth not­ing that Shiller has not al­ways been spot on with his pre­dic­tions, es­pe­cially those on the US real es­tate mar­ket.

In 2005, Shiller faced con­sid­er­able skep­ti­cism when he pre­dicted that the real es­tate bub­ble would burst in the United States. The US real es­tate mar­ket started show­ing bub­ble signs two years later. This was fol­lowed by five years of con­tin­u­ous price de­cline. How­ever, the prob­lem with the Chi­nese real es­tate mar­ket is far more com­plex.

In the last three decades, China has emerged as one of the great­est economies in the whole world and its cit­i­zens are en­joy­ing a life­style com­pa­ra­ble with those in coun­tries with far higher in­comes. At the same time, the de­sire to lead com­fort­able lives has prompted Chi­nese peo­ple to also highly value the qual­ity of their res­i­dence.

Fur­ther­more, be­cause ur­ban­iza­tion is an im­por­tant driver for the next stage of eco­nomic growth, it is nat­u­ral that more peo­ple may mi­grate to the big­ger cities, which fur­ther boosts in­vestors’ con­fi­dence in real es­tate as an as­set class.

On the other hand, Shiller’s re­search on real es­tate can of­fer at least the fol­low­ing per­spec­tives on the Chi­nese real es­tate mar­ket.

Based on Shiller’s re­search and some other re­search car­ried out in the Nether­lands, there is lit­tle ev­i­dence that real es­tate as an as­set class can out­per­form a coun­try’s long term in­fla­tion. In this sense, real es­tate may not be as at­trac­tive as eq­ui­ties in terms of in­vest­ment re­turns.

At the same time, the re­search also shows that the cur­rent method­ol­ogy used by China to cal­cu­late the ap­pre­ci­a­tion level of the real es­tate mar­ket is flawed, be­cause it does not ac­count for the fact that the sam­ple size for real es­tate trans­ac­tions has changed over time. This is a par­tic­u­larly se­ri­ous prob­lem for the Chi­nese real es­tate mar­ket be­cause of the has­tened pace of real es­tate de­vel­op­ment in ur­ban ex­pan­sion. Based on some of the au­thor’s cal­cu­la­tions, such a bias may re­sult in an un­der­state­ment of hous­ing mar­ket ap­pre­ci­a­tion by more than 100 per­cent!

Fur­ther, like many other as­set classes, such as eq­ui­ties and fixed in­come se­cu­ri­ties, the value of real es­tate is pri­mar­ily de­ter­mined by its fun­da­men­tal value, in this sense, the rent gen­er­ated from leas­ing it. Based on such cri­te­ria, the rental yields from Chi­nese real es­tate is ap­pallingly low, when com­pared with in­ter­na­tional av­er­age — and also mea­ger com­pared with Chi­nese data from five years ago.

Put dif­fer­ently, al­though hous­ing prices have in­creased sub­stan­tially over the past five years, rents or the div­i­dends from own­ing real es­tate as in­vest­ment as­sets have not in­creased in tan­dem.

One of Shiller’s ma­jor re­search con­tri­bu­tions is that based on his re­search on the real es­tate and eq­ui­ties mar­ket in the US, he shows con­vinc­ingly that there can­not be too much de­vi­a­tion in as­set prices and the fun­da­men­tal value. If it does hap­pen, then there are chances that bub­bles will form, Shiller had said.

Shiller, how­ever, ad­mits that bub­bles do not nec­es­sar­ily pop im­me­di­ately af­ter they are sighted and it is dif­fi­cult to pre­dict when they might do so. As a mat­ter of fact, the for­ma­tion and es­ca­la­tion of bub­bles may in­deed re­in­force peo­ple’s be­lief in as­sets that are al­ready in the bub­ble price range. The au­thor is a fac­ulty fel­low at the In­ter­na­tional Center for Fi­nance, Yale Univer­sity, and deputy di­rec­tor of the Shang­hai Ad­vanced In­sti­tute of Fi­nance, Shang­hai Jiao­tong Univer­sity. The views do not nec­es­sar­ily re­flect those of China Daily.


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