China Watch – Land turnover ‘plunge’ a predictor of recessionary forces
Concerns continue to grow in China where the value of land sales are down 38% y.o.y and VOLUME down 45% according to Market Watch:
Total land sales fell to 1,767 transactions in May in 300 Chinese cities, down 45% from a year ago and 19% lower than in the previous month, according to a survey published Friday on China’s leading real estate website Soufun.com.
In the same month, the total transaction value for land sales dropped 38% year-on-year, marking a 30% drop from April, to 13.75 billion yuan ($2.2 billion).
Global Property Guide tweeted this as ‘a plunge’.
The volume factor should immediately prick the ears and eyes of regular readers here. Why? The Land Values Research Group released a probing piece on the predictive nature of falling land volumes as a precursor to recession in From the Sub-prime to the Terriginous. A 45% fall in volumes and 38% fall in Chinese land sold over the last year is significant, but the resulting 5% fall in prices is minimal, suggesting more significant price falls to follow. In fact it could go further according to author of the LVRG report, Dr Gavin Putland:
A downturn in the property market, especially in turnover (sales) of properties, is a leading indicator of recession, with a lead time of up to 9 quarters for turnover, or up to 8 quarters for values. Of all the countries in which a conspicuous fall in turnover was documented, there was no case in which the onset of recession preceded the fall in turnover.
Putland systemically analysed 36 nations and the trigger points for recession to develop his hypothesis. He continues:
In the property market, a fall in turnover is a leading indicator of a fall in prices, and the lead time is usually one to two quarters. In no case is there persuasive evidence of the fall in prices coming first.
If prices have fallen just 5% and volumes are accelerating in their downturn, we can expect further price falls – dramatic ones if the central government remains on the sidelines. The accelerating fall in Chinese land volumes, with 19 of the 45% plunge occurring in the last month, suggests the next few months are crucial.
Expect exposures to iron ore, particularly low grade iron ore (Atlas, Fortescue) to be minimised by savvy investors. Other effects include the obvious halt in housing construction. That’s why Goldman Sachs is bearish on global copper.
The potential for a dramatic cut in housing construction has been accelerated by the finding that 53 million vacant homes exist in China. These are nothing more than speculative vacancies. House prices are already falling, more dramatically in the First Tier cities. With construction related employment to dry up (or go backwards), economic pressures will escalate.
The country’s property sector is an important driver of growth, with economists estimating that real estate and related industries, such as steel and cement, account for 16% to 25% of GDP.
Dangers of Falling Prices
(Global) House prices are inching up. But is this a cause for much cheer? Or are we watching the same movie again? Recall how after a decade-long boom, house prices started to fall in 2006, first in the United States and then elsewhere, contributing to the 2008-9 global financial crisis. In fact, our research indicates that boom-bust patterns in house prices preceded more than two-thirds of the recent 50 systemic banking crises.
Zhu warns of the primitive state of the monetary policy toolbox to deal with asset bubbles. More attention must be given to the fiscal toolbox of tax reform.
However, Zhu’s findings are similar to Putland’s in that land (housing) bubbles are a key predictor of recession. As we have shown above, shifts in volume are a further outlier predictor.
Commentators around the world will be wondering if the Chinese Government will sit out the possible correction or act to bail this one out? The size of any real estate sector is too big to alter, especially when the bubble is this big.
Such large drops in land sale volumes would normally see more widespread bankruptcy in the development industry. Why not in China?
In the west (especially here in Australia), banks will ‘call in’ outstanding debts that are heading underwater due to lower land prices. This accentuates the risk developers take on. For that reason Australian property developers do anything to avoid falling land prices, offering free cars, holidays or carpet. The banking industry thus plays a key role in deterring pricing corrections back to earning capacities.
From the Australian banking perspective, they have witnessed the danger of falling US land prices (starting in the June quarter of 2006).
Falling land prices filtered through the US financial industry as a self-feeding juggernaut, enforcing the financial sector to write down the value of loans on their books. Derivative values, based on housing (read land), fell in turn. Less credit could be created. The riskiest loans, the sub-prime loans were the first to be called in.
Unfortunately these effects made it into mainstream analysis, not the catalyst. Perhaps we can call this LIFO theory – the last in, first out level of analysis.
Finally the US ramifications of falling land prices hit fever pitch with the bankruptcy of Lehman Bros two years following the initial fall in land prices (Sept 15, 2008).
The face saving nature of Chinese culture to postpone the economic correction?
Global Property Guide paraphrased the Market Watch article:
The so-called “hot season” for property in China, which usually lasts from the last week of April through May, did not happen this year, observed an analyst at Soufun, China’s leading real estate website.
Chinese cities including the affluent Hangzhuo in Zhejiang province have listed no land sales since March, while the city of Jinan in the province of Shandong recorded no sales in May, said a report from Life Daily, a government-run paper.
Defaults and bankruptcies weaken a city’s investment appeal, analysts say.
But bankruptcies among highly leveraged developers are normal in markets and a natural progression as weaker players are weeded out.
Much of that fear is from local officials, who fear bankruptcies are an investment deterrent. But who wants to invest under the burden of high land debts?
Comparing Australia, American and China’s land markets
Australia has a highly controlled land market by the 8 major developers who have an average 19.3 years of land banks on their books. This control is reinforced by a proactive banking sector willing to call in credit lent on falling land prices. Both angles reduce the ability of price to reflect market sentiment. Compounding affordability pressures were volume manipulations, further curtailing pricing corrections.
America, surprisingly it seems, had more extensive competition in its land market. This lack of control over land supply led to big land price falls – the domino that sideswiped the global economy.
As Zhu warns of rising land prices so soon after the crash, we remind of the need for taxation of economic rents via LVT. This would deter the influence of Blackstone Capital and other major investors, who seem set upon crowding out mum n dad investors in the rental market with the help of services like this.
Lastly, China has the least mature market and probably the most widespread competition. But a fearful local government who rely heavily on land sales for revenue is acting to deter bankruptcy. With less concern from higher up the chain of command and local governments already heavily in debt, the hopes of local Communist Party leadership ambitions may be dashed by the inability of wage earners to meet the rising land price burden. For ‘three generation’ mortgages already to be commonplace defines a failure of Chinese housing policy and an unwillingness to learn from the long history of land bubbles (as Sun Yat-Sen wisely pointed out decades ago). Concern over ghost villages reiterates the unsustainable position the Chinese housing market is in.
Additional factors include:
- the pressures on multinational companies to stay in China as wages etch ever upwards to meet the demands of rising land prices.
- the new era of robotics.
- the relative inexperience of market participants who have only enjoyed rising property prices.
If Putland’s theory plays out, some choppy times are ahead indeed.