Bubble, Bubble, China’s in Trouble

The Chinese dream, like the American dream, has taken shape around the promise that each new generation will live better than the one before it. In recent years, that has meant more job options, more material comforts, and increasingly, home ownership. Last fall 80 percent of respondents to a China Youth Daily online poll said that home ownership was a prerequisite for happiness.

Today’s frenzied housing market in China’s top-tier cities is rattling that aspiration, threatening to create a generation of agitated young people who work hard, play by the rules, but feel angry at the system and priced out of their chance at the Chinese dream. With residential prices and commercial prices in top-tier cities jumping 11.7 percent over the last year — and jumping more than 50 percent in some particularly hot eastern cities — the government in Beijing is worried.

Chen "Aggie" is a 20-something marketing professional in Beijing. The daughter of shopkeepers, she hails from a small village in the western province of Guizhou. She came to Beijing for college, and has since made the great leap forward that so many families in China hope for their children: moving from blue-collar to a white-collar job. Stories like hers are regular fodder for state-run media. But real estate is where the vision of upward mobility smashes against unhappy reality. Ten years ago, even five, her salary would have made buying an apartment feasible, but not now. "I was born too late," she says. "I missed the train."

According to the investment bank Goldman Sachs, in recent years housing prices in Beijing have risen 80 percent faster than wages. Chen’s friends from well-to-do families — "second-generation wealthy," as they’re called — have been able to borrow money for hefty down payments; her friends from humbler backgrounds cannot. When I met her at a Beijing Starbucks, she was dejected and making plans to leave the city. In some senses, her struggles mean the Chinese capital is just like any other world-class city — London, Paris, New York — where only the wealthiest and most established can own homes. But this realization is crashing hard on a generation of little emperors and empresses that have been told they could have everything.

The agitation of China’s young professionals is a politically sensitive subject. Recently the government banned one of the most popular shows on television, Wo Ju (Narrow Dwelling), a sort of Chinese Friends set in a city much like Shanghai. The show chronicles the exploits of a young couple with good jobs and degrees from China’s finest universities who still can’t afford a home, until a young woman has an affair with a well-connected government official. Wo Ju drew millions of viewers and sparked controversy; prominent Chinese writer Xiao Fuxing has denounced the show’s equation of home ownership with happiness as a "thorn" in Chinese society. (In big cities such as Beijing and Shanghai, it’s a truism that a man who can’t afford a home isn’t worth marrying.) The fact that Wo Ju was deemed so dangerous by the censors only reveals how deeply it struck a chord with China’s aspiring classes.

Last month, a representative of the Communist Youth League told a gathering of Chinese reporters that the government was launching a propaganda campaign to convince young people to lower their expectations for success. The message: Let them rent. "Everyone worries about the 1980s generation — the young generation," says Yang Xiao, a reporter with Beijing Youth Daily newspaper. "What if they become cynical or have no dream?"

Meanwhile, it’s not only the young and restless in China for whom real estate represents a source of frustrated ambitions. Economists say one significant driver of China’s soaring real estate prices has been wealthy investors in China snatching up property, because they have few other investment options. Current laws — based on longstanding Chinese economic doctrine that regards capital inflow as good, outflow as bad — forbid Chinese citizens from making most kinds of overseas investments. Meanwhile, stock markets in China are unstable and immature, and there are few tax incentives for philanthropy. As a result, the wealthiest in China are faced with a problem unimaginable a generation ago: what to do with their money.

The answer, for many, has been to invest in one of the few options available to them — an asset whose value, within their lifetime, has only gone up and up: real estate. "Property is being held by many as a store of value, like gold," explains Patrick Chovanec, a professor at Tsinghua University’s School of Economics and Management. "This bids up prices and also skews development toward high-end properties, as opposed to affordable housing."

Ms. Wang, the wife of a successful Beijing businessman who gave only her surname, has purchased four homes in recent years. There’s the apartment she and her husband live in, and three others they hold as investments. All three are vacant; she’s making no attempt to rent them out. No property taxes are assessed in China, and so there’s no financial penalty for simply buying and holding. The rental market in Beijing, in comparison to the red-hot real estate market, is fairly weak, and besides, renting out those apartments — putting them to use and risking some wear and tear — could diminish their value. So they remain pristine and empty.

Ms. Wang’s thinking is not unique. Many of China’s wealthiest see empty apartments as their best investment option. China’s nouveau-riche, which have benefited from the country’s rising tide, are now bumping up against its limits. The economy hasn’t diversified enough to afford them many options for building their wealth. Privately, some are beginning to grumble; as one corporate tax analyst in Beijing told me: "The government is to blame."

Massive immigration into China’s fast-growing cities, as well as emerging investment pressures and lingering housing-welfare programs favoring government employees, all combine to drive up both residential prices. In the case of commercial properties, additional forces are at work; with an underdeveloped credit and risk-assessment system in China, business loans are issued not on the basis of expected earnings, but on collateral — usually property. Companies have multiple incentives to acquire property, and commercial realtors have an incentive to keep the asking price for office space high, even if offices remain vacant, because lowering prices (and thus the value assigned to a property) could bring unwanted scrutiny of outstanding loans. Across from the vaunted Olympic Aquacube in northern Beijing sits an impressive five-tower commercial property; it was built three years ago, but many of the offices remain empty. Still, several new commercial properties are under construction not far away.

Beijing is worried about both the economics and the political implications of the real estate frenzy, and has lately announced several measures to cool off the market. The government is walking a tightrope — on the one hand wanting to prevent a total meltdown ("The government has to move before  the bubble bursts and destroys the overall economy," said private-sector economist Zuo Xiaolei in unusually frank comments to state-run China Daily newspaper), and on the other hand not quite wanting to slow down an economy so heavily dependent on construction, property-rights sales, building materials, and other construction-related jobs.

There are holes in the new regulations. Efforts to limit the purchase of multiple homes are easily circumvented: Ms. Wang, for instance, purchased one of her homes in her daughter’s name (using easily obtained false documents about her daughter’s place of employment). Higher down-payment requirements won’t ward off wealthy investors who pay in cash up front.

True reform won’t be easy because it involves a painful re-examination of core aspects of the Chinese economic system, Chovanec argues: "The government is dealing in terms of edict, not root causes — but it’s not easy to just order water to stop flowing downhill."

Over time, some regulatory holes will likely be closed, but reining in local governments and corruption pose additional challenges. With many city governments deriving between one-quarter and one-third of their annual revenues from the sale of land-use rights for development, it will be hard to wean localities across China from such a giant cash cow. The incentives for graft are high.

Zhang Xin is co-president of SOHO China, Beijing’s largest property developer, and has made her fortune on the property boom. Yet the former Goldman Sachs investment banker, who last year made Forbes magazine’s "Top Ten "Billionaire Women We Admire" list, admits she is worried about the engine of her wealth. As she told China International Business magazine in January: "We do have a view that this is a bubble. Real estate is very much driven by government policy … I am sure the government is worried about it, but what do you do? They want the stimulus and if you want to create jobs then this is a by-product." She finds the empty apartment syndrome troubling: "These buildings are not fully occupied and people should be worried about it … Because of where China is with asset bubbles, people want to buy the assets regardless of whether they can be leased out or not. People just want to hold [property], even if it is empty."

Of course, if China’s real estate is a bubble scenario, it won’t necessarily pop in the same way as the U.S. housing market, or as immediately — residential borrowers aren’t as highly leveraged (down-payment requirements are relatively higher), and state-run banks won’t call in bad loans as quickly. Some observers, such as hedge-fund guru Jim Chanos, see an immediate danger ("What we’re talking about is a world-class — if not the world-class — property bubble," he recently told PBS host Charlie Rose, adding that he expects a dramatic slowdown in China within a year). Some argue the danger is overstated; others think the day of reckoning may be 5 or 10 years off.

But one thing is clear now: The political frictions are already evident — and both China’s haves and its have-nots are fuming.