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Government intervention has so far averted a crisis in China’s booming property market. But local and central efforts to prevent bubbles from building up have created new risks for the economy.

Real estate construction project in Shenzhen

China’s real estate market is heating up. Despite the recent slowdown in economic growth, house prices in China’s cities are rapidly increasing. In Shenzhen, a hub for innovation, prices grew by up to 40 per cent this year alone. The situation is similar in many coastal cities, causing concern among Chinese officials and economists. Yet, at least until now, there are no signs for an acute overheating. Warnings of “bubbles” in China’s markets go back to the 1990s, especially in the real estate sector. Yet these presumably fragile markets, supported by state intervention, have continued to grow.

Has Chinese policy been especially effective in stabilizing markets? Or has it only delayed a massive real estate and financial crisis? One Chinese characteristic is the public ownership of land. In line with socialist tradition, urban land is under the control of the municipal governments, whereas rural land is in the collective ownership of villages.

Status symbol and investment alternative

Private investors have only been allowed to purchase real estate since the late 1990s. They acquire the right to use the land for up to several decades, similar to a lease. Chinese households and private companies became enthusiastic real estate investors within a short period of time. Owning an inner-city apartment became a status symbol. Men looking for a wife have low chances to succeed if they cannot provide an apartment. Real estate is also seen as one of the few promising investments in China, where volatile stock markets and low interest rates leave few alternatives.

Municipal governments, construction companies and real estate developers have benefited from the pent-up demand and from the urbanization wave throughout the past two decades. Ambitious mayors and urban planners design cities for the 21st century to ease the migration pressure in metropolitan areas and to create new hubs for future growth. Excessive real estate investment in cities outside the boom regions has led to high levels of vacancies and even to the existence of ghost cities. Yet in the current market environment, even vacant apartments are considered good investments.

Speculation has triggered intervention

The speculation-driven growth in the real estate market has triggered repeated interventions by the Chinese government, which fears for the stability of the overall economy in case of an abrupt market correction. Authorities have a variety of instruments at their disposal to calm markets. China’s state-centered ownership, regulatory and market structures allow for administrative ad hoc measures that would not be available in privately organized real estate markets.

Local administrations can set and change the conditions for real estate acquisition. They can enforce local residency requirements to deter outside speculative investors. As the owners of local land, they can reduce or expand the supply depending on economic conditions and risk assessments. Local administrations generate the biggest share of their tax revenue through the sale of land use rights and real estate transactions. This makes them highly susceptible to corruption, which in turn triggers repeated interventions by the central government in Beijing, from investigations to tax reforms. At least so far, this “regulatory spiral," set in motion by local authorities obsessed with generating revenue, risk-loving investors and a stability-oriented central government, has not spun out of control and derailed the market.

Debt financing could lead to vicious cycle

Fulong Wu, professor for urban planning at University College London, as well as the Singaporean economists Qu Feng and Laura Wu have investigated China’s real estate market in international comparison. They explain the drastic price increases through the ongoing relatively high economic growth rates, rising wages and the speed of urbanization in China. But the situation has become more fragile, especially since financing conditions have fundamentally changed after the stimulus program in the wake of the 2008 global financial crisis. Whereas entire families combined their savings to purchase property in the past, current purchases are increasingly debt financed. The researchers warn of a vicious cycle once wage growth eases further and highly indebted property owners are no longer able to afford their mortgage payments. Such a scenario could cause a nationwide financial crisis.

The development has created a dilemma for China’s economic policymakers. The wealth of a big portion of the population now depends on real estate. At the same time, the cyclical government interventions – such as administrative limitations of new loans or local purchasing bans for certain groups of buyers – have triggered vocal popular resistance. Especially younger potential buyers feel disadvantaged compared to older property owners.

Members of China’s middle class may be apolitical in many other areas, but they reject being patronized when it comes to the dream of homeownership and the search for lucrative investment opportunities. Government intervention may have succeeded in temporarily cooling down the domestic real estate market. But many affluent Chinese are already investing in real estate abroad, and the limitations of domestic opportunities have sped up the outflow of capital – another potentially destabilizing development, which is likely to cause yet another turn in the “regulatory spiral.”

A German version of this article was first published in Frankfurter Allgemeine Sonntagszeitung on November 20, 2016.