Can China’s Real Estate Market Avoid a Japan-Style Drop?

Pandemic Drags on China’s Economy

China’s economy grew 5.2% in 2023, surpassing the government target of around 5%. Over the past two years, though, growth averaged an annual 4.1%, given the increase of just 3% in 2022, when cities were locked down. Over a span of three to four years since the prepandemic days of 2019, this represents a decline of about 2 percentage points from the growth in the 6% range that was the norm then. The pandemic’s impact on the Chinese economy was huge.

With cities being locked down, the pandemic forced many small businesses and sole proprietorships to suspend or shut down their operations for good. Such harm was seen in other nations to a greater or lesser degree. In China’s case, however, individuals and sole proprietors did not receive cash disbursements, and the socially disadvantaged were more readily affected by the pandemic. A survey of household income and expenditure reveals that the nominal disposable income of individuals, which increased 8.9% in 2019 before COVID-19, fell to growth of 6.3% in 2023.

The pandemic also fostered conflict between China and the United States and heightened friction between China and the West. Mutual distrust strengthened at the governmental, corporate, and individual levels through the suspension of face-to-face exchanges. A derisking trend spread widely from the perspective of economic security, and Western businesses became hesitant about investing in China.

The Twin Blows of a Real Estate Slump

COVID-19 also became an indirect factor of an unprecedented real estate slump. Monetary easing to stimulate an economy that had slowed from the pandemic triggered a real estate boom. However, declaring that real estate is for living in and not for investment, the Chinese government implemented regulations at the same time to curb the fund raising of property developers and to curtail bank loans to the real estate sector. These developments led to the rapid cooling of the market. Major developers are struggling to maintain cash positions, and housing prices are continuing to fall.

Nearly three years later, there are no signs of a recovery from the real estate recession. I believe that this slump is largely behind the slowdown of the Chinese economy. Residential floor space sold in 2023 totaled 950 million square meters, a 40% decline from the 1,570 million square meters sold in 2021. Property development investments contracted 25% over the same period. While the price of new residential housing (70-city average) fell 4% from its peak, given the limits of sampling methodology, the actual figure is thought to be a decline of 10% to 20%.

The decrease of real estate prices is also contributing to the weakness of consumption. Housing assets account for about 70% of the assets held by households. The falling value of housing assets is deterring consumption expenditures. According to Harvard University Professor Kenneth Rogoff and others, China’s real estate sector directly and indirectly accounted for 25% of its GDP in 2021. The contraction of this sector is having a substantial impact.

Moreover, in view of China’s demographic structure, it is highly likely that the demand for residential housing will gradually diminish going forward. The average age of first-time buyers of residential housing is 27, with those aged 25 to 34 being the main purchasers of homes. This age group will decrease from 230 million in 2017 to 160 million in the first half of the 2030s. I anticipate that, influenced by this demographic change, the demand for housing purchases will trend downward.

Still Room to Grow

Given the above discussion, will China be unable to escape from its economic predicament? Japan experienced the collapse of a real estate bubble in the 1990s, causing its potential growth rate to drop from a growth rate of 4% to 5% to about 1%, a level where the economy has remained stuck. Is China about to follow the footsteps of Japan?

Burdened by such structural factors as a shrinking population, China’s economy will be unable to avoid slowing further. However, I believe that if the government responds with appropriate policies, China will be able to avoid a sudden shift to a low growth rate as befell Japan in the 1990s.

As of the end of 2023, 66% of China’s population lived in cities, which is a similar level to Japan in 1963. China’s per capita nominal GDP (stated in US dollars) was one-sixth of that of the United States in 2022. Japan’s per capita nominal GDP was at a similar level in 1960. These comparisons suggest that China’s economy still has plenty of room to grow. While recognizing that China’s total population has begun to shrink and such changes as a falling birthrate and an aging population, China’s economy is still younger in its developmental stage than Japan in the 1990s.

Fear of Deflation

What are the policy responses that would enable China’s economy to achieve a soft landing? I believe that three policies need to be implemented at the same time. They are (1) the sufficient expansion of macroeconomic policies, (2) far-reaching responses to the real estate slump, and (3) economic reforms that expand the sphere of activity of private enterprises.

The first response to consider are macroeconomic policies, such as fiscal and monetary measures. Deflation has become a matter of concern in China. The consumer price index decreased 0.8% year on year in January. The producer price index similarly fell 2.5% in January. The downward trend of prices is in part related to such supply factors as declining food and energy prices. The most important factor, however, is the weakness of final demand. Personal consumption and the investment sentiment of companies are soft, which are becoming manifest as the weakness of final demand. In view of such conditions, the government should expand fiscal and monetary policies to stimulate final demand.

At the Central Economic Work Conference held in December 2023, the Chinese government recognized that a demand shortfall existed and stated that countercyclical adjustments would be strengthened. China is therefore likely to expand its fiscal and monetary policies. Economic policies pursued to date may be insufficient to buoy the economy, meaning that more ambitious macroeconomic policies will likely be required going forward.

Government Purchases of Unfinished Properties

Furthermore, there is a need for impactful responses to the real estate slump. The government has implemented measures to stimulate demand in stages, such as reducing the interest of housing loans, easing the minimum down payment ratio, and eliminating the restriction on buying second homes that was meant to prevent speculative real estate purchases. These measures, however, have had little effect.

The main reason for the deepening real estate recession is the mistrust people feel toward property developers. Most housing sales are made in advance in China, with delivery occurring two or more years later. The International Monetary Fund estimates in its Global Financial Stability Report of October 2023 that nearly a third of China’s property developers are effectively insolvent. When people are worried about the solvency of property developers, they will be too fearful to buy homes. Indeed, there are currently a considerable number of property developers whose cash flow problems are preventing them from delivering homes as scheduled.

What will be important in stabilizing the real estate market is completing and delivering unfinished homes to their purchasers. Although some measures have already been taken, drastic measures will be needed since developers in financial difficulty will be unable to complete unfinished properties on their own. For example, the government could establish a property-buying facility that would buy and responsibly complete unfinished housing.

Another important measure is restoring the health of the real estate sector through mergers and restructurings. The state-owned sector should be used to temporarily inject public funds, even if indirectly. The government, however, is hesitant to take such measures out of a reluctance toward rescuing the private property developers causing the real estate bubble and from concerns about the potential for moral hazard.

Looking for Answers at the Third Plenum of China’s Central Committee

Finally, economic reforms that expand the sphere of activity of private enterprises are needed. The fixed asset investments of private enterprises decreased 0.4% year on year in 2023. One factor for the weakness of these investments is the way the government’s strengthening of regulations is reducing private enterprises’ interest in investing.

Naturally, interest in investing has not diminished across all industries. While investments fell 6% year on year for tertiary industries such as real estate, platform providers, education, and many more whose regulation was strengthened, the investments of manufacturing industries were relatively firm, rising 9% year on year. Investments have continued to grow by double digits for the automobile industry, with booming EV sales, and in the electrical machinery industry as China aims for greater self-reliance in semiconductors and other advanced technology. Even so, the cautious stance of private enterprises as a whole cannot be denied.

To increase investment interest, it will be necessary to promote economic reforms that make use of the market mechanism and to expand the sphere of activity of private enterprises. In this process, it will be important to allow such enterprises to enter industries that have heretofore been monopolized by state-owned enterprises.

Important policies for economic reforms have tended to be decided at the Third Plenum of the Central Committee of the Chinese Communist Party, a meeting usually held in the autumn of the year following the CCP National Congress. Since the twentieth National Congress took place in October 2022, the Third Plenum was expected to occur one year later, in the autumn of 2023. However, as of the present moment, this Third Plenum has yet to take place.

As things stand now, the policies that I believe are necessary have either not been implemented or remain inadequate. Whether the Chinese economy can achieve a soft landing will depend on the Chinese Communist Party and government shifting with appropriate timing to more decisive policies.

(Originally published in Japanese. Banner photo: Condominiums whose construction has stopped in Zunyi, Guizhou Province, China. © Jiji.)