Asia

The most important asset class in the world (Part II of II)

Part I looked at how Chinese stocks are trading at depressed levels, largely due to the low prices of the “big four” Chinese banks. One of the big fears is that Chinese real estate is in a bubble. If such a bubble exists then it’s popping could have a severe impact on the banks, but also on the wider Chinese economy. In turn, that would have major implications for global commodity markets and the world economy. But is there really a bubble in Chinese property?

Let’s look at how Chinese real estate prices have moved in recent years. Here’s a chart from the Economist showing Chinese prices (orange line), adjusted for inflation, going back to early 2001. For comparison it also shows the USA (dark blue), Canada (lilac), France (brown) and Hong Kong (green).

Prices adjusted to inflation

The first thing that jumps out is that Hong Kong is experiencing a major bubble (see here, here and here for more). I have no doubt about that.

…the current boom is even greater than in 1997. That was followed by a massive bust.

In fact this chart of real (inflation-adjusted) prices for Hong Kong alone, where data goes back further, shows that the current boom is even greater than in 1997. That was followed by a massive bust.

inflation-adjusted) prices for Hong Kong

Hong Kong is, after all, a small part of China. But it has a different currency, different financial system, different political governance and different taxes. So it’s not representative of the country as a whole. When I talk about “China” I’m referring to the mainland of the Peoples’ Republic.

Going back to the first chart, mainland Chinese prices are up 37% since early 2001, in real (inflation adjusted) terms. That’s a big move, since real estate tends to track price inflation in the long run.

But it’s already down slightly from the peak of 50% in early 2009, four years ago. In other words the government seems to have been doing a good job of gently deflating prices. Certainly prices have been falling much more gently than the similarly sized US bubble that peaked in early 2006.

Also Chinese prices have risen much less steeply than either France or Canada – just two of many countries that have been going through genuine bubbles (such as Britain and Australia today, and Spain and Ireland before that).

There are other ways to look at real estate prices though. What about prices in relation to incomes? After all Chinese wages and salaries have been rising fast over the past couple of decades.

Affordability of housing in relation to earnings is maybe a better way to look at the market, especially in a fast growing country. The next chart looks at this relationship (there is no data for Hong Kong).

chinese real estate

This picture tells us a completely different story. By this measure Chinese real estate is actually twice as affordable today as it was in early 2001. (US real estate also looks cheap on this measure.)

Chinese property prices are above the inflationary trend. But on the other hand they have been fallen hard in relation to incomes…

So this is giving us two completely different stories. On the one hand Chinese property prices are above the inflationary trend. But on the other hand they have been fallen hard in relation to incomes, and now look cheap by that measure.

Here’s yet another way to look at it, comparing prices against rents. This is equivalent to looking at P/E ratios for stocks. We’re comparing prices with the current incomes that can be earned from the assets.

You could buy a house and rent it out. This ratio compares what you would pay with the annual rental income. When the figure is low then the market is cheap, and when the figure is high the market is expensive. annual rental income.

Once more Canada (lilac), Hong Kong (green) and France (brown) look to be in bubble territory. The USA (dark blue) looks cheap on this measure.

As for China (orange line), it’s just above average, but not by much. Prices have stabilised and fallen slightly since 2009, bringing it close to the average line. Prices are a little rich maybe, but they certainly don’t look to be in bubble territory.

Of course there may be localised property bubbles in big cities such as Shanghai, Beijing or Guangzhou – just as there are in London, England and Paris, France and Manhattan in New York. If bubbles pop in large cities there could be ramifications for the local economies and for the lending banks.

But China is a big place. (For example, how many people outside China have heard of Chongqing, a city of 29 million people?) On this evidence at least, there is no widespread property bubble in China.

That’s not to say there aren’t other big issues in China, such as the large and fast expanding amount of corporate debt, much of it from non-traditional sources (“shadow banking”). This could create problems for the Chinese banks and the economy as a whole.

However I’m not overly concerned about there being a bubble in the Chinese real estate market. So we can have reasonable peace of mind that what I’ve called the “most important asset class in the world” isn’t about to implode.

Whatever problems there really are in China, they seem to be priced into the stock market (see part I). The time may be approaching when its time to invest in Chinese stocks again. I’ll certainly be keeping a close eye on the situation. So should you.

Stay tuned OfWealthers,

Rob Marstrand
robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.