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Inside the Bubble: A Glimpse at China’s Real Estate Industry

The Richest Industry and an Industry for the Rich

Starting in the late 1990s, China started to switch from a welfare-oriented public housing distribution system to commercialized housing. As homeownership rates have skyrocketed, real estate prices have been rising from several hundred yuan per square meter to 2,800 yuan (US$337) per square meter. According to the Shanghai Statistics Bureau, the price of Shanghai commodity housing in 2004 was 6,385 yuan (US$769) per square meter, 14.6% higher than that of 2003, while marketing companies estimated it to be 7,472 yuan (US$900) per square meter.

As urbanization has sped up in more recent years, people in rural areas have migrated into urban areas by the tens of millions. The influx of population gave rise to higher demand for housing. At the same time, large amounts of international speculative capital have poured into the housing market. At the end of 2004, it was estimated that 40% of the purchased housing in Shanghai was for investment purposes.

Steadily rising housing prices have gotten well beyond the reach of middle-class families. Meanwhile, vacant apartments have been purchased repeatedly for speculation. In Shanghai, the housing vacancy rate is as high as 12.8%, exceeding the international warning level of 10%. A report from Citibank stated that real estate bubbles have appeared in Shanghai, Tianjin, Shenyang and Ningbo.

China’s real estate industry has been leading the Top 10 Most Profitable Industries for the last three years. With a 15% profit margin, well above the world average of 5%, it has attracted and produced dozens of billionaires. Among the Forbes 2004 List of 100 Richest People in China, more than 40 were in the real estate business, compared to 37 out of the Forbes 2004 List of World’s 500 Richest People in the industry.

At the National People’s Congress held in March of this year, Premier Wen Jiabao’s government working report mentioned “emphasizing controlling the excessive increase in prices of production materials and housing.”

The Iron Triangle

In China, the land is owned by the public in name, but by the government in reality. Local government officials exercise full control over which lands are sold, granted or transferred. After the reform of the rural land system, farmers regained the right to use the land, but not to own it. As a result, officials at the county, township and village levels became the real owners of the rural land. Based on statistics from the Ministry of Land and Resources, from 1987 to 2001, more than 50 million farmers lost their land through government confiscation. For local government in urban areas, selling land has become a huge source of income and led to rampant corruption.

Observers describe the process of how excessive profits can be made through trading real estate:

– Come up with a plan for purchasing a piece of land

– Bribe the local government officials in charge of land so as to get a favorable price

– Make an initial payment at that price

– Fake necessary documents for bank loan applications for construction projects

– Fake mortgage certificates before the apartment buildings are built

– Bribe the bank officials in charge of approving mortgage loans

– Pay back the construction loans with part of the mortgage loans

– Buy more land, starting from the beginning of the process

The real estate developers, local government officials, and bank officials make up what is referred to as the “iron triangle.”

Since 2000, urbanization has been at the top of the local governments’ agendas. The real estate developers have relied on local officials for cheap land and provided luxurious housing in return. In the process, both parties have accumulated great wealth through illegal land trading. According to incomplete statistics from the Ministry of Land and Resources, in 2003, 168,000 illegal land trading cases were investigated, with less than 1,000 officials or developers given punishment. Such a low rate of paying a price for corruption has only encouraged the widespread, illegal trading of land.

With approval from local officials, real estate developers are able to use it to secure construction loans from the bank. When the construction finishes, or even before the apartments are sold, developers fake sales contracts to get mortgage loans from the bank. Although they are quite familiar with tricks played by the developers, bank officials often turn a blind eye or even instruct developers on how to fake documents, as long as they personally benefit from the deal. Consequently, the state banks undertake all of the risk associated with construction costs and apartment sales.

One such real estate developer in Guangdong Province wanted to get a bank loan. Since he had no assets to use as collateral, the manager of the local bank rejected the loan application. Then the developer asked his friends to call themselves apartment owners, who promised to use “their” apartments as collateral. Amazingly, the bank approved the loan without checking the veracity of their stories. There is a saying: “Sometimes the bank regulations are rigid, but there are always ways to get by under different pretenses.”

Victims of the Industry

According to the Ministry of Land and Resources, the total area of China’s cultivated land in 2003 is 123 million hectares, or 2.1% lower than the 2002 level. The cultivated land per capita is only about one third of the world’s average. The main causes for the ever diminishing cultivated land include ecological deterioration and human occupation.

The land deals between local government officials and real estate developers triggered the so-called new “Land Enclosure Movement.” In an all too common example, in 1988, Baonan village in Libao Town of Haian County in Jiangsu Province had more than 180 Mu of cultivated land [1]. By 2003, 164.6 Mu of land had been taken over for various “development projects.”

The township government sold the land that farmers relied on for making a living, forcibly occupied the land by hiring thugs to do the dirty work, and embezzled the majority of the compensation for the land requisition. Deprived and exploited, local villagers reported the corrupt practices to higher authorities 31 times to no avail. The central government has a policy for selling cultivated land. The Land Administration Law stipulates that requisition of farmland requires approval from the State Council, but such laws are rarely enforced at local levels.

In urban areas, the real estate developers have as many as ten ways to obtain land, one of which is “remodeling dangerous buildings.” In order to lower the cost, the developers often collude with city officials to either cut or embezzle the relocation fees. Urban relocated families would then have to pay the exorbitant housing costs, to the very people who made them homeless, to find a place to live in the city. The Ministry of Construction handled 4,820 letters of petition from January to August of 2002, 28% of which were about urban relocated families. Of the 1,730 individual or collective petitions, 70% were regarding the issue of urban relocation. The ratio increased to 83.7% for collective petitions.

Cases of social unrest have arisen from the government’s negligence on this issue. There have been many documented cases of violent conflicts between the forcibly relocated families and real estate developers. In 2003, more than 10 self-immolation incidents took place on Tiananmen Square, several of those immolators being victims of forced urban relocation.

“Land for education” is another way to get land on the cheap. A mainland development project for students, once commended by former president Jiang Zemin, was exposed by government investigators as a racket involving luxury villas, apartments and a golf course. The investigators discovered that land acquired cheaply by the privately owned Oriental University City, 40 kilometers south of Beijing and intended for 150,000 students, has gone up in value by almost 400%, while the company owes 2.2 billion yuan (US$265 million) to banks, building contractors, and local authorities.

After 2002, more than 50 University City projects have been planned or developed. Insiders have pointed out that under the pretense of education, real estate developers can obtain land at significantly lower prices.

A Dilemma

Where is the money for real estate investment coming from? The answer is: state banks.

The real estate business has been one of the biggest recipients of state bank loans. According to a report from the Shanghai Branch of the Central Bank, Shanghai’s newly added real estate loans in 2004 amount to 100 billion yuan (US$12 billion), more than 75% of the total newly added loans of all Shanghai domestic-based financial institutions. A professor from the Beijing Economics and Trade University believed that the total amount of real estate or housing loans add up to 2.6 trillion yuan (US$313 billion), or 14.7% of total domestic currency loans.

On the other hand, the ailing financial system cannot recover without a healthy housing industry. In February of 2003, the Central Bank published the 2002 Monetary Policy Executive Report, which announced the results of an investigation on real estate loans issued by some commercial banks between July 2001 and September 2002illegal loans amounted to 24.9% of the total amount investigated. If this result represents the situation of non-performing loans in the financial industry, we may infer that about 25% of the real estate loans end up unpaid.

Premier Wen Jiabao’s recent decision to crack down on housing prices is responding to an unresolved dilemma. The cooling down of the housing industry is certainly not in the interests of the “Iron Triangle” of real estate developers, local government officials, and bank officials. If the high-priced housing cannot be sold, many of the bank loans will become non-performing loans, adding to the problem of an already shaky banking system. However, if the housing prices maintain a very high level, it is virtually impossible for middle class families to afford such expensive housing, resulting in worse social unrest. Meanwhile, the high prices will attract more real estate construction projects and speculation, making the bubble even bigger.

Li Ding is an economist based in Washington, D.C.

[1] 1 Mu=666.7 square meters=798.7 square yards