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The Inexorable Decline Of China’s Housing Market

FYI | Nov 03 2014

By Arthur Kroeber of GavekalDragonomics

Since the turn of the century, China’s booming housing market has been one of the most important drivers of the global economy. Between 2000 and 2013, annual housing completions tripled. Largely because of the demand from housing and related infrastructure, Chinese steel use quadrupled. Prices of iron ore and many other commodities soared.

In the coming decade, China’s housing sector will again be a crucial factor in the global economy, but in the opposite direction. Annual construction volumes will fall by -15% to -20% by 2025, or by about -2% a year. This decline is bad for China’s GDP, of which nearly a third depends directly or indirectly on property and construction. And it suggests that commodity producers, who have lived high off the Chinese hog for years, should prepare for leaner times as prices grind inexorably downward.

This outlook is the result of a new model we have developed for China’s housing sector, the details of which our China Service will publish tomorrow. In brief, we conclude that China’s housing market is in no danger of collapse, as some of the more breathless commentators claim—but it has matured. Total demand for housing peaked around 2011 and is likely to stay roughly stable at current levels through next year, before entering a steady decline.

The main reason for this decline lies in the evolution of upgrading demand—when existing urban residents moving from old, poor quality flats into bigger modern ones. Upgrading, not the migration of farmers into the cities, was the biggest driver of the housing boom, accounting for 44% of floor space completed over 2000-2013. Upgrading demand peaked in 2011 and will shrink by two-thirds by 2025. Demand created by urban population growth (including migration) has also peaked, but will remain stable for the next few years and then decline modestly as the pace of migration gradually slows.

These projections are grimmer than our old view, but we are far from joining the Armageddon school of Chinese property analysts. First, even after the decline, housing completions will be a very robust 1.5bn square meters in 2025, the same as in 2006. Second, Beijing has some ability to influence the trajectory of construction through subsidized housing and urban redevelopment, both of which were expanded this year.

But the best the government can do is smooth the downturn. It cannot cause construction to re-accelerate, and attempts to keep housing sales at an artificially high level would be disastrous. We believe the authorities are alive to this risk. Their efforts to support a flagging property market this year were fairly modest, suggesting that they are willing to let sales and prices drift down so long as the moves are not too abrupt.

It is clear, however, that housing’s shift from a growth driver to a zero or negative growth contributor means that the government’s aim to maintain GDP growth at 7% through 2020 is unrealistic, and will have to be revised down—perhaps as early as next year. This outlook also underscores the urgency of deregulatory reforms, especially in services, that can help build a new economic growth driver to replace the sputtering real estate engine.

Commodity prices have already suffered from China’s construction slowdown of the last two years. It is likely they will fall further. In the past, Chinese steel consumption tracked housing construction quite closely, and the industry’s current forecast of 1% growth in total Chinese steel use over 2014-15 reflects a recognition of the housing peak.

Optimistic voices suggest that steel demand can continue to grow at low rates (1-3% a year) through the end of the decade, thanks to more steel-intensive construction techniques (more high-rises) and stronger demand from other sectors such as autos and shipbuilding. This might be possible, but commodity producers should be skeptical. China’s long housing party is over, and it’s time for the revelers to sober up.

Reprinted with permission of the publisher. Content included in this article is not by association the view of FNArena (see our disclaimer).

The information contained herein is provided for informational purposes only and should not be regarded as an offer to sell or a solicitation of an offer to buy the securities or products mentioned. This document is a private publication intended for private distribution. The value of all investments and any income generated can decrease as well as increase. Performance numbers shown are records of past performance and as such do not guarantee future performance. No representation is made that any one investor achieved any of the results shown herein. This information is subject to change without notice. The securities and products mentioned may not be eligible for sale in some states or countries, nor suitable for all types of investors. Gavekal Research Limited does not warrant the accuracy, completeness, reliability, fitness for a particular purpose or merchantability of this information, and expressly disclaim liability for errors or omissions in this information and data. Gavekal Research Limited shall have no liability for the use, misuse, or distribution of this information to unauthorized recipients.

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