Deutsche Bank: China property certainly in a bubble

Another day, another warning about Chinese property bubble. After I reported earlier in the week on a research note from UBS, which warned the Chinese property prices had started to boil over once again, Deutsche Bank has now issued the same warning.

• London property is the most at risk of a bubble but watch China, Says UBS
• China property price bubble and the end of Chinese deflation

In a special report on the Chinese property bubble published yesterday, Deutsche’s chief economist Zhiwei Zhang, Ph.D. and team write that they believe a property bubble is rising in some Chinese cities and there are clear signs of a bubble in the land auction market.

Chinese property bubble is clear

According to Deutsche’s report, there are clear signs of a property bubble in some Chinese cities. In a group of 19 large- and medium-sized cities, property price rose almost 20% on average in the past 12 months. This is more than double their average nominal GDP growth in 2015, which was only 7.3%. As I pointed out yesterday, 20% year-on-year growth is only the headline figure. In some key cities, property prices are up 30% year-to-date in some districts property prices are up over 50%. Price-affordability ratios in a few big cities have risen to record levels of nearly 20 years of annual income.

The clearest sign that a bubble is brewing in China’s property market comes from the mortgage market according to Deutsche. There has been a surge in mortgage loans during the summer months. During July and August, outstanding mortgage loans increased by RMB1 trillion, which is equivalent to over 70% of total new RMB loans in the past two months. Throughout the first half of the year mortgage loans made up around 34.8% of total loans, which was already much higher than the average of around 25% seen in previous years.

And while it’s clear a bubble is brewing in the property market, Deutsche makes the point that a Chinese property bubble has already arrived in China’s land market. Here the figures really tell the whole story. Last year China’s average nominal GDP growth was 7.3%. The average property price change in tier 1 and tier 2 cities between August 2015 and August 2016 was 18.9%. The average unit land price change in tier 1 and tier 2 cities year-to-date versus January 2015 to August 2015 is a staggering 138% across the 19 cities covered.

 

Chinese property bubble

In fact, land prices have now got so out of control that in some cases unit land prices in auctions are even higher than the finished apartments nearby according to Deutsche’s analysis of auction figures. The bank gives the case of Suzhou as an example:

“We start with Suzhou as an example. On April 7, 2016, a piece of residential land was sold at RMB26032 per square meter. For the developer to break even in this transaction, the selling price of the finished apartments needs to be at least RMB36284 per square meter, assuming a construction cost of RMB1544 per square meter and 24 percent other costs such as taxes and fees.3

For comparison, we found 24 apartment buildings within 3 kilometers of this piece of land, all finished between 2008 and 2016. The current average listing price of these nearby apartments is RMB23722 per square meter, which is 8.9 percent below the price of the auctioned land and almost 35 percent below of the implied breakeven price of the apartments to be built on this land.

Developers in China often enjoyed a profit margin of over 20 percent in the past. If this developer expected a similar profit margin for this particular project, the implied selling price would be at least RMB49243 per square meter, over 100% higher than the current listing price of nearby apartments. To us this seems highly unlikely to materialize in the next few years, considering property prices in Suzhou already appreciated some 25 percent in the past year, especially against the backdrop that wage and overall economic growth in China are both slowing down.”