Property Market Turning Sour in China

Bloomberg posted an article today about Chinese apartment/home buyers who are demonstrating against their landlords/developers as prices are falling:

On Nov. 19, Deng faced off a ring of security guards three rows deep wearing camouflage and carrying shields as he joined more than 100 homeowners rallying in front of the development’s sales office. His transformation from newlywed to street protester came after China Vanke Co. slashed prices for future buyers at the Qinglinjing complex, erasing about 20 percent of the value of his three-bedroom unit overnight.

The story goes on to explain how Deng's parents contributed their savings and Deng's boss provided a loan so that he could meet the 30% minimum down payment on the apartment.  He was only able to contribute 4% of the down payment himself.

The article also tells the story of Zuo Hangxai,who "became a home owner after losing patience waiting for years for prices to come down. She recalled the frenzied scene when she picked her apartment in the same development as agents crowded around urging her to buy and then clapped and congratulated when she nodded agreement."

Evil Developers and Buyers Remorse
While I will contend that even in Zuo Hangxai's case, the people now protesting were willing buyers, the Chinese market has experienced a super-bubble which was aided by the developers.  Developers near major cities had worked with the government to remove people from their current homes in order to demolish them and build massive complexes.  There were many stories and videos about these cases a few years ago.  Unlike here in the US, where there's a more rigid legal process for trying to evict someone, many of the Chinese who fought back would leave their homes for work and return to a pile of rubble.

Without a home, these people become buyers, and perhaps end up buying from the companies who destroyed their homes.

On the other side, China's super bubble was largely driven by rising demand and rising home prices, which led to price appreciation and speculation to an extreme degree.  Many middle class families were priced out of even modest new homes and apartments because of the rampant speculation.  Developers were happy to build more units knowing they could get a great price, and incremental buyers were happy to pay because they expected to flip the unit at a substantial profit.

As we experienced here in the US, eventually the music stops and some are left without a chair.

For the US, housing prices topped out sometime in mid-2006.  More than five years later, our housing market still hasn't recovered.  Anyone who bought near the top probably felt like demonstrating back in '07 and '08.  I would suppose the reality of the situation has sunk in at this point - those who bought at the top, for whatever reason, may never recoup their "investment".

For Deng and Zuo, I think the worst is yet to come.  The same Bloomberg article says that the home ownership rate in China is 87.8% compared to 66.3% in the US.  That is a staggering difference and is very bad news for current home owners.

In the US, that means as prices fall, 33.7% of the population could conceivably enter the market and buy a home.  In China, that number is 12.2%.  Roughly one in ten people are not homeowners!  Who do the other nine of ten sell their home to?

I don't know all of the socio-economic reasons behind such a high rate of homeownership, but the article does give a few hints:

Deng had moved to Shanghai three years earlier from a small city in the north to be closer to a girl he met in college. When talk turned to marriage, his girlfriend insisted they buy an apartment first, he said. “At my age, I should get married and I should have my own home whether or not I can afford it so that I can be the same as my classmates,” Deng said.

#1 - China's One Child Policy which led to infrantricide towards female newborns, has led to a massive imbalance in the sexes.  If you are a young adult male in China, looking for a wife, you've got some darn stiff competition and need to prove your worth (buy a home).  See also - China: Too Many Men.
#2 - China's burgeoning middle class also comes with "Keeping up with the Joneses" syndrome we know well in the US.  Deng feels like he should own a home whether or not he can afford it so that he can fit in and also get a wife.

Financial Crisis Looming
China's centrally managed economy may be able to weather the oncoming property bust better than we could here in the US.  Bear Stearns, Lehman, and other major financial firms collapsed or nearly did because of their exposure to the US housing market and because there were at least some rules they couldn't avoid (such as marking down investments to current market prices).  The US government then took steps that were clearly anti-capitalism and maybe illegal to prevent the situation from getting worse.

In China, I would suspect the government will be much quicker to support firms and the economy and can more easily re-write the rules.  If the Industrial and Commercial Bank of China found one day it was insolvent, the government could more easily make direct loans, rework the bank's lines of credit, or restrict withdrawals.

Given what seems to be massive over-development in China, I can't imagine this ending well.

Buyer's Market; Best Deals in a Generation?

Bloomberg has an interesting article today arguing that the current property market may be the best opportunity in a generation:

People like the Matthewses who are able to survive the scrutiny of mortgage lenders are getting the best deals of the five-year U.S. housing bust, and perhaps the best deals of a generation, after a 31 percent decline in home prices since 2006. It’s the bright side of an otherwise bleak real estate market: Good houses at cheap prices are plentiful, while loan rates are hovering at record lows.

How about this bold prediction:

“It’s hard to see the possibility of losing on a home purchase right now, with these mortgage rates,” said Dean Baker, an economist who in 2005 predicted a decline in the government’s home-price index that now is within two percentage points of his forecast. “Prices may go lower, but not by much. Even if they do, you’re still getting a good deal.”

Great time to buy - sure, but a no-lose situation?

There certainly are a lot of reasons why buying might be a sound decision right now, including rates and depressed prices.  But let's not get going down the path of five years ago where everyday people were buying several homes with the expectation that they would flip them in a few years.

The economy is in the tank, and I predict it will get worse before it gets better.  If your employer has been laying off workers, is it a good time for you to take on hundreds of thousands of dollars in debt?  

The weak economy and layoffs also reinforce the foreclosure cycle.  Layoffs lead to missed mortgage payments which lead to a foreclosure.  That foreclosure can lower the value of other homes in the neighborhood and multiple foreclosures in the neighborhood can cause real problems.  Mortgage holders who are current start to ask themselves if it is worth it to continue to pay a $500,000 mortgage when their house is only worth $350,000.  This can lead to "strategic defaults" wherein a homeowner can afford to pay his/her mortgage, but chooses not to.

Where are we in the cycle?

Mike Shedlock at Global Economic Analysis updated the pictorial below in late August.  The graph compares the US housing market's bubble and bust cycle to the cycle Japan experienced a decade ago.  His most recent commentary was in response to a reader's question on when to buy and how far are we from the bottom:

As you can see, the housing bubble in the US (red text) follows a similar trend to the bubble experienced in Japan (blue text matching the prices on the left and dates at the bottom).

In his opinion, there are still many sellers who are at the edge.  A slight push and they'll "Sell Before It's Too Late" which will compound the housing bust.  I don't completely agree with this, although I am fearful that if we do enter a full-fledged recession soon, we may see this.  My current expectation is for government support to keep the economy and housing market from collapsing, although I would not be surprised if we do technically re-enter a recession.  My caveat is that if the Super Committee gets bogged down by political ideologies, the markets will tumble and uncertainty will abound.  This will quickly reach the economy and the housing market.

Please note that in the above pictorial, the blue text highlights the psychology of home buyers and sellers.  When the market is at its worst, participants believe "It's Better to Rent", while on the upswing, they believe buying is the best option.  As I discussed previously, excluding potential appreciation of a home's value, I think the renting versus buying markets are priced quite similarly.

New Home Sales at Six Month Low

August government data showed new home sales at a six month low, led by buyer focus on distressed properties and increasing foreclosures which keep housing prices low.  According to a Bloomberg report:

Purchases of new houses in the U.S. declined in August to a six-month low as the biggest drop in prices in two years failed to lure buyers away from even less expensive distressed properties.

Sales, tabulated when contracts are signed, dropped 2.3 percent to a 295,000 annual pace, figures from the Commerce Department showed today in Washington. The median estimate of 73 economists in a Bloomberg News survey called for a decline to 293,000. The median price slumped 7.7 percent from August 2010, the steepest 12-month drop since July 2009.

Foreclosure-driven price decreases for previously owned homes may keep attracting investors away from new properties, hurting builders like Lennar Corp. Limited access to credit, rising unemployment and waning consumer confidence also signal the industry that helped precipitate the recession will take time to find its footing.

Looking forward, September and October data could show improvement with mortgage rates moving much lower as compared to August.

Low Mortgage Rates, but Weak Housing Market

The mortgage and housing markets are back in the news at levels that seem reminiscent of 2009.

Bloomberg discusses low rates but a poor housing market:

U.S. mortgage rates are the lowest in at least four decades, with a 30-year fixed loan available at 4.09 percent. That didn’t help Alexis Wolf buy a townhome in Beaverton, Oregon.

“Unless you have family help, you’re stuck renting,” said Wolf, 26, a real estate broker who turned to relatives for a loan because she didn’t have the credit and employment history needed to qualify for a mortgage.

Wolf’s experience illustrates the predicament for Federal Reserve policy makers as they end a two-day meeting today to consider ways to boost economic growth. Low interest rates, the traditional medicine for a flagging economy, aren’t helping housing, which since 1982 has aided every recovery except the current one.

Sales of existing homes rose more than forecast in August to a 5.03 million annual pace as investors used cash to buy distressed properties, a report today from the National Association of Realtors showed. The sales pace has fallen from a peak of 7.08 million in 2005, before the housing boom turned into a subprime-mortgage bust that helped drag the U.S. into an 18-month recession.

Rising foreclosures, tighter lending standards and unemployment stuck near 9 percent for more than two years are all weighing on the market. Lower borrowing costs aren’t likely to make a difference, said housing economist Brad Hunter.

Unfortunately, mortgage defaults are picking up again:

Default notices sent to delinquent U.S. homeowners surged 33 percent in August from the previous month, a sign that lenders are speeding up the foreclosure process after almost a year of delays, RealtyTrac Inc. said.

First-time default notices were filed on 78,880 properties, the most in nine months, the Irvine, California-based data seller said today in a report. Total foreclosure filings, which also include auction and home-seizure notices, increased 7 percent from a four-year low in July to 228,098. One in 570 homes received a notice during August.