Demystifying the Chinese Housing Boom

NBER WORKING PAPER SERIES DEMYSTIFYING THE CHINESE HOUSING BOOM Hanming Fang Quanlin Gu Wei Xiong Li-An Zhou Working Paper 21112 http://www.nber.org/papers/w21112 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 April 2015 This paper is prepared for NBER Macro Annual (Volume 30). We are grateful to the editors, Marty Eichenbaum and Jonathan Parker, our discussants, Erik Hurst and Martin Schneider, as well as seminar participants at Bank of America Merrill Lynch, Harvard University and Princeton University for helpful discussions and constructive comments. We also thank Sean Dong, Qing Gong, Min Wu, and Yu Zhang for excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer- reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2015 by Hanming Fang, Quanlin Gu, Wei Xiong, and Li-An Zhou. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Demystifying the Chinese Housing Boom Hanming Fang, Quanlin Gu, Wei Xiong, and Li-An Zhou NBER Working Paper No. 21112 April 2015 JEL No. R3 ABSTRACT We construct housing price indices for 120 major cities in China in 2003-2013 based on sequential sales of new homes within the same housing developments. By using these indices and detailed information on mortgage borrowers across these cities, we find enormous housing price appreciation during the decade, which was accompanied by equally impressive growth in household income, except in a few first-tier cities. While bottom-income mortgage borrowers endured severe financial burdens by using price-to-income ratios over eight to buy homes, their participation in the housing market remained steady and their mortgage loans were protected by down payments commonly in excess of 35 percent. As such, the housing market is unlikely to trigger an imminent financial crisis in China, even though it may crash with a sudden stop in the Chinese economy and act as an amplifier of the initial shock. Hanming Fang Wei Xiong Department of Economics Princeton University University of Pennsylvania Department of Economics 3718 Locust Walk Bendheim Center for Finance Philadelphia, PA 19104 Princeton, NJ 08450 and NBER and NBER [email protected] [email protected] Quanlin Gu Li-An Zhou Guanghua School of Management Guanghua School of Management Peking University Peking University Beijing 100871 Beijing 100871 CHINA CHINA [email protected] [email protected] There have been growing concerns across the global economic and policy communities regarding the decade-long housing market boom in China, which has the second largest economy in the world and has been the major engine for global economic growth during the past decade. News in recent months seems to suggest that the housing boom might be slowing down. A main concern is that a housing market meltdown might severely damage the Chinese economy, which in turn might generate contagious effects across the world and slow down the fragile global economy that has just emerged from a series of crises that originated in the U.S. and Europe. In particular, critics are concerned that soaring housing prices and the enormous construction boom throughout the country might cause China to follow in the footsteps of Japan, which had an economic lost decade after its housing bubble burst in the early 1990s. How much have housing prices in China appreciated during the last decade? How did the price appreciation vary across different Chinese cities? Did the soaring prices exclude low- income households from participating in the housing markets? How much financial burden did households face in buying homes? Addressing these questions is crucial for systematically assessing the risk to the Chinese economy presented by its housing market. We address these questions by taking advantage of a comprehensive data set of mortgage loans issued by a major Chinese commercial bank from 2003-2013. Specifically, we construct a set of housing price indices for 120 major cities in China, which allows us to evaluate housing price fluctuations across these cities, in conjunction with the growth of households’ purchasing power and stock price fluctuations. The detailed mortgage data also allow us to analyze the participation of low- income households in housing markets and the financial burdens faced by low-income home buyers. Due to the nascent nature of the Chinese housing market, there are relatively few repeat home sales available for building Case-Shiller type repeated sales housing indices. Instead, we take advantage of the large number of new housing developments in each city and build a housing price index for the city based on sales over time of new homes within the same developments, which share similar characteristics and amenities. Consistent with casual observations made by many commentators, our price indices confirm enormous housing price 1 appreciation across China in 2003-2013. In first-tier cities, which include the four most populated and most economically important metropolitan areas in China-- Beijing, Shanghai, Guangzhou, and Shenzhen-- housing prices had an average annual real growth rate of 13.1 percent during this decade. Our sample also covers 31 second-tier cities, which are autonomous municipalities, provincial capitals, or vital industrial/commercial centers, and 85 other third-tier cities, which are important cities in their respective regions. Housing prices in second-tier cities had an average annual real growth rate of 10.5 percent; third-tier cities had an average annual real growth rate of 7.9 percent. These growth rates easily surpass the housing price appreciation during the U.S. housing bubble in the 2000s and are comparable to that during the Japanese housing bubble in the 1980s. Despite the enormous price appreciation, the Chinese housing boom is different in nature from the housing bubbles in the U.S. and Japan. Our analysis offers several important observations that are useful for understanding the Chinese housing boom. First, as banks in China imposed down payments of over 30 percent on all mortgage loans, banks are protected from mortgage borrowers’ default risk even in the event of a sizable housing market meltdown of 30 percent. This makes a U.S. style subprime credit crisis less likely in China. Second, while the rapid housing price appreciation has been often highlighted as a concern for the Chinese housing market, the price appreciation was accompanied by equally spectacular growth in households’ disposable income---an average annual real growth rate of about 9.0 percent throughout the country during the decade, with the exception of a lower average growth rate of 6.6 percent in the first-tier cities. This joint presence of enormous housing price appreciation and income growth contrasts the experiences during the U.S. and Japanese housing bubble. Even during the Japanese housing bubble in late 1980s, the Japanese economy was growing at a more modest rate than that of China. The enormous income growth rate across Chinese cities thus provides some assurance to the housing boom and, together with the aforementioned high mortgage down payment ratios, renders the housing market an unlikely trigger for an imminent financial crisis in China. 2 Third, despite the enormous housing price appreciation over the decade, the participation of low-income households in the housing market remained stable. Specifically, we analyze the financial status of mortgage borrowers with incomes in the bottom 10 percent of all mortgage borrowers in each city for each year. By mapping the incomes of these marginal home buyers into the income distribution of the urban population in the city, we find that they came from the low-income fraction of the population, roughly around the 25th percentile of the distribution in the first-tier cities and around the 30th percentile in the second-tier cities. Fourth, while these low-income home buyers were not excluded from the housing market, they did endure enormous financial burdens in buying homes at price-to-income ratios of around eight in second- and third-tier cities and, in some years, even over ten in first-tier cities. In concrete terms, this means that a household paid eight times its annual disposable income to buy a home. In order to obtain a mortgage loan, it had to make a down payment of at least 30 percent, and more typically 40 percent, of the home price, which was equivalent to 2.4 times to 3.2 times the household’s annual income. Suppose that the household made a down payment of 40 percent and took a mortgage loan for the other 60 percent of the home price, which would be 4.8 times its annual income. A modest mortgage rate of 6 percent, which is low relative to the actual rate observed during the decade, would require the household to use nearly 30 percent of its annual income to pay for the interest on the mortgage loan. Furthermore, paying the mortgage would consume another 16 percent of its annual income used a linear amortization even if the mortgage had a maximum maturity of 30 years. Together, buying the home entailed saving 3.2 times the annual household income to make the down payment and another 45 percent of its annual income to service the mortgage loan. To explain the willingness of households to endure such severe financial burdens for a home, it is important to take into account the households’ expectations. To the extent that urban household income in China has been rising steadily during the studied period, as well as in the previous two decades, many households may expect their income to continue growing at this rate.

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