A Home to Call Your Own: A look at the real estate bubbles in Hong Kong and China

Above photograph taken by the author in Science Park, Sha Tin, Hong Kong


A Home to Call Your Own: A look at the real estate bubbles in Hong Kong and China

For this week, I would like to depart from the readings, which I will return to next week, in order to discuss an issue which has cropped up throughout the previous weeks readings—the apparent real estate bubbles in Mainland China and in Hong Kong. At least in part, both of these bubbles developed as externalities from government policies and institutional responses. However, how policy origins are similar and differ provides an insight into the inner-workings of the two systems housed under the Chinese banner.

Skyrocketing real estate prices in mainland China causes much paranoia and fear in many investors and developers. The inflation patterns are most evident in China's booming economic hubs. For example Shanghai saw real estate prices rise by 150% between 2003 and 2010. Whole new towns of residential houses were built all around China, especially in the Pearl River Delta, with the expectation that the new Chinese middle class would clamber in order to own their own house or urban condominium. Now, in 2012, many of these developments are ghost towns, and atmospheric rental prices in Shanghai, Beijing, and other economic centers have left the middle class and lower class laborers out in the cold.

Economists look at statistics such as the price to rent ratio to determine whether real estate prices are in a bubble or just following a higher demand or supply pattern.  Rents, which are very responsive to market forces and also change more often, act as a baseline by which relative prices can be judged.  China's nationwide price to rent ratio in 2012 was 400:1, which is higher than the international standard of around 200:1.  Also, this figure doesn't focus on urban areas, where the discrepancies are the most severe.

Early on, the prices and spectacular construction rates heralded a more modern, cosmopolitan China. Wages in the largest cities were booming, so likewise real estate became more in demand, attracting investors, speculators, and developers from all over the world. Developers couldn't construct houses fast enough to meet rising demand, with many prime apartments sold before the first bricks of the foundation were laid. Waiting lists were common for prime locations in the big cities, and many speculators and real estate investors made huge fortunes.

The boom ascended to new levels in 2005 with the expiration of the Multi-fibre Agreement, which had formerly limited textile exports from developing to developed nations, and subsequently allowed FDI and new investment to flood the Chinese market with liquidity. Bolstered by an optimistic banking system, much of this liquidity ended up being invested into real estate.1

In a 2010 New York Times article, David Barboza documents some of the more superlative aspects of the boom:

Signs of exuberance are everywhere. An investor in Shanghai recently bought 54 apartments in a single day; a villa sold for $30 million last year; and in December a consortium of developers paid more than $3.5 billion for a huge tract of land in Guangzhou, one of the highest prices paid for any property, anywhere. In the city of Tianjin, in north China, developers have created a $3 billion “floating city,” a series of islands built on a natural reservoir, featuring villas, shopping malls, a water amusement park and what they say will be the world’s largest indoor ski resort.


Indeed, for the price of a Tomson apartment in Shanghai, a buyer could easily purchase a 6,000-square-foot home in Los Angeles built by Frank Lloyd Wright and now for sale ($10.5 million), or a 52-acre site with a 22-room residence in New Canaan, Conn. ($24 million).

Barboza interviews many of the casual investors in the market—rich Chinese who made their money in other sectors but still have large holdings of real estate as a “safe” investment.

Motivating the once-seemingly insatiable demand for property, higher investment in real estate is due to negative real interest rates on household savings. The low interest rate is partly due to all the liquidity entering China from foreign investors. Spurring this effect is the pegged exchange rate of the RMB being kept low in order to encourage exports and discourage foreign imports. However, this undervalued exchange rate encourages outside investors using advantageous exchange rates to buy up relatively cheap, low-maintenance domestic assets—real estate2.

Due to the high levels of liquidity from FDI and government spending, China is also experiencing high inflation which once again leads to the negative real interest rates on savings, making holding currency and government bonds undesirable. When families facing inflated prices have a choice between investing in government bonds, holding cash, or a booming real asset such as land, the choice seems obvious.

However, at least part of underlying cause for high real estate prices lies not in private investors, but in local governments starved by the central Communist Party. In 1994, Vice Premier Zhu introduced the Tax Sharing System as a method for cracking down on greedy, coercive local governments. The law established a tax system whereby all money first had to be filtered through the central government and then allocated regionally. Local governments,such as cities and provinces, were unable to raise their own revenue by releasing bonds, inter-province borrowing, or other methods allowing them to run a deficit. This left local governments desperate to find alternative sources of revenue.

One of the alternative sources is the infamous SOEs. Although prevalent before 1994, the SOEs took over a new function after the Tax Sharing System. Their new purpose was to become Local Financing Platforms. Government officials used the LFPs to take out loans from the bank and essentially launder the money back into government honey pots. This wasn't done directly, but rather by governments buying equity in SOE funded projects and other tricky financial go-arounds.

Another revenue raising scheme was utilization of the main resource local governments did control—real estate. The RMB was believed to be overvalued in 1994, so people were fearful of holding on to cash, which spurring demand for property. This demand lead the government to make big money by leasing land rights to developers and investors. The land auctions brought a large new revenue stream to governments, however local governments were incentivized to keep prices high. They also used real estate as collateral for risky investments, such as those undertaken by the LFPs. This cyclical monopoly ownership over land lead to inflated prices, as well as giving the impression that land was one of the few reliable investments—if it was good enough for governments it had to be good enough for individual and corporate investors.

In the aftermath of the Global Financial Crisis in 2008, China began instituting strict regulations to try and curb the housing bubble's growth, especially in light of the injection of the massive 4 trillion RMB stimulus package. Regulations included heavy penalties for speculators turning over properties within a year of purchase, limits on the hoarding of properties, and increasing the mortgage interest rates just for investors and developers. In 2012, the bubble shows signs of deflating. This is welcome news to some, but for those governments still relying on land auctions to raise revenue, the desperation for alternative, shadier access to credit is once again apparent.


In Hong Kong, there is a related real estate bubble, with prices jumping over 50% since 2010. Part of it actually relys on a similar mechanism to the Local Finance Platforms. One can view the example of the MTR Corporation, which owns and operates the public subway system in Hong Kong. The MTR Corporation was established in 1975 as a government owned transit company, similar to Amtrak in the United States. The corporation then transformed into an LLC, and offered an IPO on the Hong Kong Stock Exchange in 2000. This transition all happened under the guise of privatization, however the Hong Kong government is still the majority 76% shareholder in the public corporation.

This was all performed through government injected real estate, which is already a scarce commodity on the small island city. Not only was the MTR then able to construct and profit from the public transportation infrastructure, but the MTR corporation is also one of the largest “private” landowners in Hong Kong, with a mall over nearly every station and many other properties throughout the city. By gaining monopolistic power through government land grants, the MTR corporation is part of the reason why real estate is so high in Hong Kong.

Another major contributor to inflated prices is slightly more complex. Hong Kong, as one of the centers of fast growth and foreign investment, is reliant on its large pool of inexpensive labor. However, partially due to the monopolistic landlords and partially to limited space in the small Semi-Autonomous Region, rental prices are prohibitively high to most low skill workers. Companies would have to offer higher wages in order to allow these laborers merely to live in the city. This would scare off Multi-Nationals and they would invest instead in cities such as Singapore, Seoul, or Taiwan.

In response to this problem, the Hong Kong government builds large amounts of public housing projects in order to keep cost of living and wages low. Nearly half of Hong Kong's 7 million people live in public housing. Many of these buildings even have their own inexpensive restaurants in the ground floor, as the apartments are too small for kitchens. The Hong Kong government, therefore, essentially subsidizes the industry of Hong Kong through a cheap labor force.

Demand for this public housing has so far outstripped supply, as more immigrants come to Hong Kong attracted by high wages and cheap housing. The government, intent on following through with its public housing policy, continues to build these large developments throughout the outskirts of Hong Kong. As an interesting side note, this also further necessitates the need for efficient public transportation to move this large labor force to the jobs in the city, as provided by the MTR corporation. By monopolizing much of the land outside of the city, it further raises the price of the properties in the center of the city, which can then be sold as high-cost office space or luxury apartments.

Hong Kong's most recent attempt to curb this bubble is a steep 15% tax instituted in October of 2012 on foreign individuals buying homes. Hong Kong claims this is a defense primarily against American speculators, spurred to put their money in real estate in response to the US's low interest rates due to QE3.


Both China and Hong Kong are grasping for ways to slowly deflate their relative bubbles. For China, this task is made even more challenging as the inflated price also provides sustenance for much of their local government infrastructure. Many land auctions in the past few months have already shown signs of diminished demand.  Although Hong Kong's bubble is not yet as severe and prices are due primarily to high demand and low supply, Hong Kong also has to walk a fine balance between curbing rising prices and demand without scaring away foreign investors. Both of these countries have jumped into action to deflate and prevent the bubble from popping, lest they end up like the United States in 2008.


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1Though the banks were more prone to extend mortgage credit during this period relative to other periods in China, relative to the United States mortgage loans are still much less of a factor in the Chinese bubble. However, China is still seeking to curb real estate loans in the aftermath of the 2008 Economic Crisis.

2It should be noted that China strictly limits the amount of property that can be owned by foreigners in China. However, there are many examples of joint ventures or Chinese real estate companies that are funded by major foreign investors.