Department of Real Estate and
Construction Management
Division of Building and Real Estate
Economic.
Royal Institute of Technology
Master of Science Thesis 397
An Analysis of the Bubble in the Shanghai Housing Market
Author:
Supervisor:
Lou Kai
Professor Hans Lind
Stockholm 2007
The analyze of bubble in Shanghai housing market
Master of Science thesis
Title:
Author
Department
Master Thesis number
Supervisor
Keywords
An Analysis of the Bubble in the Shanghai Housing Market
Lou Kai
Department of Real Estate & Construction Management
Division of Building and Real Estate Economics
397
Professor Hans Lind
Bubble, Real Estate, Housing, Shanghai
Abstract
The Shanghai real estate sector has entered a prosperous stage since the start of the
21st century; the proportion of the added value of real estate sector in GDP has risen
from 5.5% in 2000 to 8.4% in 2004. As the underpinning industry of the Shanghai
economy, the real estate sector is vital. But since 2003, housing sales witnessed rapid
price growth for years. Especially in the first quarter of 2005, the growth of housing
price has reached the surprising rate of 19.1%. Much concern has arisen on the real
estate sector with more insiders and outsiders on the topic of bubble phenomena.
Although the phenomenon are caused by many rational factors such as the
urbanization, large number of population, policy and finance influence, undeveloped
capital market, market expectation and so on, there’s still quite a lot of doubt if the
bubble really exists in the real estate market, especially the housing market. Based on
the information from National Bureau of Statistics of China, Shanghai’s Bureau of
Statistics…etc, and an in-depth market investigation, this paper analyzed Shanghai’s
real estate market’s general development and investigates whether there is a real estate
bubble in housing market and concludes that there was a bubble in past few years,
especially in 2003.
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The analyze of bubble in Shanghai housing market
Acknowledgement
I would like to thank my supervisor Prof. Lind, for his patient guidance, ceaseless
support and encouragement during the period of my thesis project. The inspiring
advice and insightful criticism from Prof. Lind are extremely essential and valuable in
my research and my thesis. This dissertation could not be completed without his effort.
I wish to express my sincere gratitude to him. In addition, my special thanks must go
to my family who has given me the greatest support, understanding and
encouragement, so that I can keep concentrated on my study.
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The analyze of bubble in Shanghai housing market
Contents
Abstract
1
Acknowledgement
2
1 Introduction
5
1.1 Background--------------------------------------------------------------------------------5
1.2 Purpose-------------------------------------------------------------------------------------5
1.3 Method-------------------------------------------------------------------------------------5
1.4 Disposition--------------------------------------------------------------------------------6
2 The development of Shanghai real estate market
8
2.1 Introduction of Shanghai----------------------------------------------------------------8
2.2 The situation of Shanghai real estate market-----------------------------------------8
2.2.1 Investment--------------------------------------------------------------------------8
2.2.2 Construction-----------------------------------------------------------------------10
2.2.3 Second-hand housing market---------------------------------------------------13
2.2.4 EAV---------------------------------------------------------------------------------14
2.2.5 Living condition------------------------------------------------------------------16
3 Bubble theories
18
3.1 Definition of bubble--------------------------------------------------------------------18
3.2 Cause of real estate bubble------------------------------------------------------------19
3.2.1 Expectation------------------------------------------------------------------------19
3.2.2 Psychology------------------------------------------------------------------------20
3.2.3 Speculation------------------------------------------------------------------------20
3.3 Development of real estate bubble----------------------------------------------------21
3.4 The end of real estate bubble----------------------------------------------------------22
3.4.1 Absorption-------------------------------------------------------------------------22
3.4.2 Transformation--------------------------------------------------------------------23
3.5 How to identify real estate bubble----------------------------------------------------23
3.5.1 Traditional economical theory--------------------------------------------------23
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The analyze of bubble in Shanghai housing market
3.5.2 Indicators--------------------------------------------------------------------------24
3.6 US housing bubble in history----------------------------------------------------------27
4 Weather bubble exists or not in Shanghai real estate market
28
4.1 Rational factors--------------------------------------------------------------------------28
4.1.1 Demand in Shanghai real estate market---------------------------------------29
4.1.2 Supply in Shanghai real estate market-----------------------------------------34
4.2 The debate of bubble in Shanghai real estate market-------------------------------38
4.2.1 Positive viewpoint----------------------------------------------------------------39
4.2.2 Negative viewpoint---------------------------------------------------------------40
4.3 Discussion about the debate of bubble-----------------------------------------------42
4.3.1 Discussion about positive viewpoint-------------------------------------------42
4.3.2 Discussion about negative viewpoint------------------------------------------42
4.4 The proof of bubble in Shanghai housing market-----------------------------------42
4.4.1 Price-to-income ratio-------------------------------------------------------------43
4.4.2 Growth rate of housing price to GDP growth rate---------------------------49
4.5 Summary---------------------------------------------------------------------------------51
5 Why bubble exists in Shanghai housing market
53
5.1 Policy inertia-----------------------------------------------------------------------------53
5.2 Financial pitfalls-------------------------------------------------------------------------53
5.3 Undeveloped capital market-----------------------------------------------------------54
5.4 International influence------------------------------------------------------------------54
5.5 Market expectation----------------------------------------------------------------------55
6 Conclusion
57
Reference
58
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The analyze of bubble in Shanghai housing market
1. Introduction
1.1 Background
Over the last two decades, China has achieved rapid economic growth, accompanied
by rapid development of the real estate market. Although the Asian financial crisis
damaged the real estate markets in Southeast and East Asia, it had little impact on the
real estate markets in Shanghai. As a result of rapid economic growth and
urbanization, demand for urban land and new dwellings have increased accordingly,
leading to the sustained growth of real estate prices. The rapid increase of Shanghai
real estate price over the past several years has raised concerns about the existence of
a speculative bubble in this asset market. Indeed, real estate price have been rising
rampantly. Since 1995, real estate price has increased around 18% annually, roughly
double the increase of previous real estate price booms in the late 1970s and late
1980s. Moreover, real estate price continued to raise strongly during the 2001
recession, the sluggish recovery through mid-2003, and from the 2004 even more
rapid growth.
1.2 Purpose
As the underpinning industry of the Shanghai economy, the real estate sector is vital.
The possibility of a bubble is crucial because the economy will be harmed once
bubble bursts. Bubble bursts in the Japanese real estate market in late 1980s led to a
ten-year depression of its economy. Bubble brought by financial crisis in 1997 made
great negative impact on South-east Asia. Shanghai housing market is experiencing a
likely bubble; this thesis is made to ascertain if the growing price is caused by rational
fundamentals as well as measure if a bubble exists or not in the past few years.
1.3 Method
This thesis paper analyze with economical theories mainly on Shanghai housing
bubble instead of the entire Shanghai real estate bubble. The process of analysis is
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The analyze of bubble in Shanghai housing market
based on macro economy of Shanghai. There is neither comparison of housing in
different districts nor micro perspective such as analysis from enterprise, building or
consumer perspective.
The method is mainly with theoretical analysis, quantitative analysis, qualitative
analysis and indicator analysis. When discussing the situation of Shanghai real estate
market, quantitative comparison analysis will be used. Then the concept of bubble
will be brought out with theoretical analysis. While in the process of measuring
housing bubble, quantitative analysis and indicator analysis will be further used.
1.4 Disposition
By reading many related articles and referring some database, this thesis would start
discussion on the real estate bubble problem, discuss the shape, the development and
the bad effect of the real estate bubble and analyze the present real estate condition.
Some methods would be used in order to estimate the bubble in Shanghai real estate
sector. The topic is settled as below:
In the first place, with the help of database from Shanghai Statistic Bureau, I
state a background introduction of Shanghai’s real estate market in recent ten years.
Afterwards, the concept of bubble will be introduced, and the theoretical analysis
of real estate bubble would be processed and the present research method about real
estate bubble would be also summarized as well as the notable real estate bubble in
late 1980s in the US.
Further attention would be paid on the Shanghai real estate bubble mainly on the
topic of Shanghai residential housing market. The thesis would focus on the supply
and demand of real estate on the basis econometric theory to separate rational factors
and bubble factors. Then the debate on Shanghai real estate bubble would be brought
out. Several methods would be used to finally determine if a bubble really exists in
the market in the past few years.
Why the bubble exists in Shanghai housing market? From several aspects, such
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The analyze of bubble in Shanghai housing market
as policy inertia, financial pitfalls, undeveloped capital market, international influence
and market expectation, many reasons that cause Shanghai housing bubble will be
given.
In the end, as an analytic paper, I will give a brief conclusion about this thesis
paper and show the areas which could be further developed.
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The analyze of bubble in Shanghai housing market
2. The development of the Shanghai Real Estate market
2.1 Introduction of Shanghai
Shanghai is in the southeast of China, facing the east sea. It was opened up in 1843
and used to be the largest port of east and Southeast Asia decades ago. In China,
Shanghai is now the biggest city, largest port, the trade and financial centre and the
most important cultural, industrial and commercial city. Rising from a fishing village,
Shanghai is one of the four municipalities directly under the central government.
Aside from Pudong New District, Shanghai has jurisdiction over 13 districts and six
suburban counties. The entire administrative area of the city, including surrounding
suburbs, townships and farmland, covers a total area of 6,185 square km. The total
population is around 20 million, of which around ten million live in the city proper.
There is a huge floating population of itinerant workers, probably numbering 3
million. It is universally regarded as the bastion of China’s economy today – and
according to the industry respected “emerging trends in real estate Asia pacific 2007”
report from the Urban Land Institute and PricewaterhouseCoopers, it is one of the
most exciting cities in the entire region for both property investment and
development.
2.2 The situation of Shanghai real estate market
Thanks to the fast development of the economy in China, Shanghai’s real estate
market has made remarkable progress and witnessed great-leap-forward development
in all the regions of investment, construction, market transaction and economical
contribution.
2.2.1 Investment
The housing problem has been one of Shanghai’s most serious social problems due to
the huge population. The development of Shanghai’s real estate investment has
experienced several stages. During the preliminary stage from 1988 to 1993,
Shanghai’s real estate investors were paying a lot of interest to real estate investment,
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The analyze of bubble in Shanghai housing market
which caused the ratio of real estate investment to total capital assets investment to
rise. After the year 2000, for the first time the amount of investment in Shanghai’s real
estate market exceeded 100 billion Yuan, reaching 117.55 billion Yuan, which
occupied 38.1% of total capital assets investment.
1995 – 2006 Shanghai real estate investment (x in 100 million Yuan), Shanghai total
capital assets investment (y in 100 million Yuan) and the ratio of real estate to total
capital assets z (%) is shown in graph 2 –1 and 2 –2.
investment in real estate development
investment in fixed assets
4000
3500
3000
2500
2000
1500
1000
500
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Graph 2 –1 investment in real estate development and investment in fixed assets in
many years
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The analyze of bubble in Shanghai housing market
the ratio of investment in real estate development to investment in fixed assets
45
40
35
30
25
20
15
10
5
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Graph 2 –2 the ratio of investment in real estate development to investment in fixed
assets in many years
2.2.2 Construction
In 1991, the constructing and completed area of commodity housing in Shanghai were
3.2 million square meters and 1.1 million square meters respectively. These figures
reached the peak in 1996 in the 1990s, and were 19 times and 11 times as much as
those of 1991. There was a fall between the year 1997 and 1999 due to the
diminishing amount of investment. After the year 2000, Shanghai real estate market
once again got into a fast growing stage. The constructing area which maintained 10 –
20% growth rate kept going up all these years and reached 109 million square meters
in 2006. Meanwhile the completed area was also accelerating; it reached the peak in
2004 with 34 million square meters, the growth rate was 38.2% year on year. After a
small falling in 2005, it went up again in 2006 with a 6% growth rate. Hopefully it
could reach a new peak in 2007.
The soaring growth of sold area and price of residential building is evidence that
Shanghai real estate market is developing fast. The sold area of new completed
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The analyze of bubble in Shanghai housing market
commodity residential building in Shanghai had been going up year by year since
1995 to 2004, the average annual growth rate over 20%. In 1995, the sales area of
new completed commodity residential building was 5.7 million square meters, while
this figure increased by 6.1 times in ten years which reached 34.89 million square
meters in 2004. Sold price was also maintaining an upward trend besides small
downfall in 1997 and 1999; the average annual growth rate was beyond 10%. The
price of newly completed commodity residential building was 2.57 thousand Yuan per
square meters in 1995 and 7.04 thousand Yuan per square meters in 2006.
1997 – 2006 Constructing area of commodity housing (X in 10k m2), completed area
of commodity housing (Y in 10k m2), sold area of commodity housing (Z in10k m2) is
shown in graph 2-3 and 2-4
Constructing area of commodity housing
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
1997
1998
1999
2000
2001
completed area of commodity housing
2002
2003
2004
2005
2006
Graph 2-3 the constructing and completed area of commodity housing in many years
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The analyze of bubble in Shanghai housing market
completed area commodity housing
sold area of commodity housing
4000
3500
3000
2500
2000
1500
1000
500
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Graph 2-4 the completed and sold area of commodity housing in many years
2.2.3 Second-hand housing market
In 1996 there was only 0.82 million square meters of sold area in Shanghai
second-hand housing market, while in 2004 it reached 27.3 million square meters.
1996 – 2006 the sold area of second-hand houses is shown as follows. Traded area of
second-hand houses (X in 10000 m2), traded area of residential second-hand houses
(Y in 10000 m2) is shown in graph 2-5
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The analyze of bubble in Shanghai housing market
traded area of second-hand houses
traded area of residential second-hand houses
3000
2500
2000
1500
1000
500
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Graph 2–5 the traded area of total second-hand houses and residential second-hand
houses in many years
2.2.4 The economic added value (EAV) of real estate industry.
In the past decade, the added value of real estate industry has been accelerating
increasing because the fast real estate development and soaring housing prices in
Shanghai. When back in 1993, EAV was merely 2.638 billion Yuan and took 1.75% of
GDP. But in 2004, EAV was 62.259 billion Yuan and took 8.4% of GDP. These
figures show clearly that real estate is playing more and more important role in the
national economy. In recent two years, the EAV of real estate industry relatively
decreased and the ratio was also fallen down.
1995 – 2006 The EVA of real estate industry in Shanghai (X in 100 million Yuan), the
GDP of Shanghai (Y in 100 million Yuan), and the ratio of X to Y (Z) is shown in
graph 2-6 and 2-7
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The analyze of bubble in Shanghai housing market
EVA of real estate industry (100m)
GDP (100m)
12000
10000
8000
6000
4000
2000
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Graph 2–6 the contrast of real estate EVA and GDP in many years
ratio of real estate EAV to GDP
9
8
7
6
5
4
3
2
1
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Graph 2–7 the ratio of real estate EAV to GDP in many years
2.2.5 Living condition
People living in Shanghai could have a feeling that their housing conditions have been
improving a lot. In 1992, the per capita dwelling area was merely 6.9 m2, while this
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The analyze of bubble in Shanghai housing market
figure has changed into 16 m2 in 2006. Especially after 1995, the change was
marvelous with the annually growth rate of per capita dwelling area of 0.7 m2 or so.
The average dwelling area (X in square meters) in urban district of Shanghai in
different years is shown in graph 2-8
per capita dwelling area in urban district
18
16
14
12
10
8
6
4
2
0
1992
1994
1996
1998
2000
2002
2004
2006
Graph 2–8 per capita dwelling area in urban district of Shanghai in many years.
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The analyze of bubble in Shanghai housing market
3. Bubble theories
3.1 Definition of bubble
Before discussing the existence of a bubble in Shanghai’s housing market, we need to
define the term firstly. The term “bubble” is widely used but rarely clearly defined. In
its widespread use the term refers to a situation in which excessive public
expectations of future price increases which cause prices to be temporarily elevated.
Here we subscribe to the definition from Stiglitz (1990):
If the reason the price is high today is only because investors believe that the selling
price will be higher tomorrow---when “fundamental” factors do not seem to justify
such a price---then a bubble exists.
When the bubble occurs in equity markets, it is called a stock market bubble; when
the bubble occurs in real estate markets, it is called a real estate market bubble;
During a housing price bubble, homebuyers think that a house that they would
normally consider too expensive for them is now an acceptable purchase because they
will be compensated by significant further price increases. They will not need to save
as much as they otherwise might, because they expert the increased value of their
home to do the saving for them. First-time homebuyers may also worry during a
housing bubble that if they do not buy now, they will not be able to afford a home
later. Furthermore, the expectation of large price increases may have a strong impact
on demand if people think that home prices are very likely to fall, and certainly not
likely to fall for long, so that there is little perceived risk associated with an
investment in a home.
Accordingly, the key features of a bubble are that the level of prices has been bid up
beyond what is consistent with underlying fundamentals and that buyers of the asset
do so with the expectation of future price increases. On one hand, the increasing price
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The analyze of bubble in Shanghai housing market
causes irrational expectation of buyers who think they can’t afford the house in the
near future if they don’t purchase it while they can now, so that the demand for house
will consequently go up. On the other hand, the soaring demand results in soaring
price, which makes buyers more positive on the thinking that the price will keep
rising.
If expectations of rapid and steady future price increases are important motivating
factors for buyers, then house prices are inherently unstable. Prices can not go up
rapidly forever, and when people perceive that prices have stopped going up, this
support for their acceptance of high home prices could break down. Prices could then
fall as a result of diminished demand: the bubble bursts.
3.2 Cause of real estate bubble
Form the economical perspective, the bubble is a phenomenon that occur while the
economy is in an unbalanced condition. The cause of unbalanced economy could be
various; the speculative behavior triggered by unrealistic expectations is the direct
reason. Generally speaking, the causes of a real estate bubble are several, as follows:
3.2.1 Expectation
Traditional western economists believe that expectation has an impact on the demand
and supply of commercial goods and to the real estate market this rule is more
remarkable. First from the perspective of demand, consumers will postpone their
purchase when they have expectation that the prices of commercial real estate are
going down, which reduces the purchase in the market and then further reduces the
demand from expectation; On the contrary, consumers will accelerate purchasing
commercial real estate when they have expectation that the prices are going up, which
increases the purchase and then further increases the demand from expectation. That’s
so called in Chinese “buying up not down”. Second from the perspective of supply,
we can make analysis from the process of producing and organizing in real estate
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The analyze of bubble in Shanghai housing market
enterprises. While enterprises are operating projects of real estate, based on the
principle “maximize the profit” as well as the market situation and their capability,
they draw up operating plans for projects and then carry out till the products show in
the market, which makes the supply to the market. While in a real economical society,
enterprises driven by profits would like to slower the supply of real estate or even
consider postponing the development of real estate if they make sure that the real
estate prices are going up in the future, which causes relatively shortage of supply and
eventually makes real estate prices go up.
Obviously from the simple analysis about the influence of supply and demand
mentioned above, we could find out that when there is such expectations that the real
estate prices is going up, on one hand consumers will have higher demand for real
estate which stimulates the prices to go up, on the other hand with the interest of
higher profits the enterprises will tend to decrease the supply which also stimulates
the prices to go up. The combination of these two aspects eventually causes the real
estate prices increase. That’s so called “self-fulfilling” in economics. The prices will
keep going up because this kind of price increase has no self-restraint.
3.2.2 Crowd psychology
As a matter of fact, the analysis above has an important implication: crowd
psychology. Crowd psychology is a theory that people usually based on the
information from the others’ activities to make the similar decisions because of
information asymmetry or difference in information identification capability. The
more crowd psychology in the market, the more fiercely market prices will fluctuate,
which makes a higher portion of irrational behavior in a speculative bubble.
3.2.3 Speculation
Speculation is a universal behavior in the market. It refers to the behavior with
prediction adjustment of some asset prices, investors with their acquired market
information make adjustment on buying and selling to gain the price difference. It has
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The analyze of bubble in Shanghai housing market
an intrinsically difference with normal investment, shows as following aspects: (1)
these two have different purposes. Investment which is corresponding to actual
economical growth, aims to appreciate the capital by operating of assets. Speculation
which has no corresponding to actual economical growth, aims to gain the price
difference of assets. (2) These two have different market performances. The behavior
how long these two will hold the assets and the behavior after these two purchases the
assets are totally different. Investment is long term stable and consistent, while
speculation is short termed and uncertainty. (3) These two have different market risk
and features. In general, investment is only influenced by the management risk which
depends on manager’s situation and his judgment of the market, so that the risk is
relatively small. Speculation is another case; it mainly depends on speculator’s
subjective prediction. It has a relatively high risk which requires speculators have
higher capability of predicting. Higher risk results in higher benefit, so if speculation
succeeds, the benefits will way higher than investment. Different activity levels of
speculation have different impacts on the growth of the economy. Appropriate
speculation based on investment could have positive impact on real estate market
development and macro economics growth. Appropriate speculation could boost the
prosperous and activities, although it might also bring a bubble. This kind of bubble
could also boost the development of real estate market and macro economics, if it is a
rational bubble. While real estate speculation exceeds some level, appropriate
speculation transforms into excessiveness and brings new speculation to get involved
in this market, which eventually make the real estate prices soaring and later the real
estate bubble will burst along with the accumulative market risk.
3.3 Development of real estate bubble
In this part I will briefly discuss the principles about real estate bubble developing
into a bubble economy. Real estate bubbles can stimulate consumption and
investment as well as boost social demand. Complying with central bank’s measures
such as expanding money supply and reduces interest rate; real estate bubble could
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The analyze of bubble in Shanghai housing market
cause the total supply going up. Real estate bubble and finance have two connections;
one is that real estate prices soaring more rampantly because increasing real estate
benefits bring more capital into the real estate market. The other is that real estate
bubble may gradually change into a bubble economy. That will happen if investors
use expanding real estate as mortgage to apply for loan to reinvest into real estate
which makes more floating money in the market and eventually cause higher and
higher total supply.
Excessive economical bubbles could distort the allocation of resources which is
harmful of social departments’ development. Once bubble bursts, there can be
financial crisis because of a lot of bad assets afloat in the banks. In addition, the
failure of government’s policies is the subjective reason that real estate bubble turns
into a bubble economy. Along with globalization, international financial system could
make real estate bubble a new vicious circle. If the demand of one country is
relatively insufficient, excessive capital will stimulate investment abroad which gives
high pressure on currency appreciation. When the appreciation is over, along with a
lot of capital going abroad which will cause relatively diminishing inputs of national
constructing, the development of real estate market will further deteriorate.
3.4 The end of real estate bubble
When real estate bubbles burst, it has a devastating impact on people. In history, the
burst of bubble economy made Japan suffer over ten year’s depression. Lots of bad
assets, stagnating economy, soaring unemployment and unstable political situation,
which caused by bubble bursts make people scary of a bubble. But in reality, a bubble
is a quite usual phenomenon in economics and it is merely a small probability event
that a bubble bursts.
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The analyze of bubble in Shanghai housing market
3.4.1 Analysis on real estate bubble absorption.
Real estate bubble absorption is a situation that the level of real estate bubble steps
down because of the improvement of the macro economical environment, industrial
environment and market environment. It implies that not only the potential real estate
value increases because of the improvement of infrastructure, faster speed of industry
growth and accelerating urbanization, but also the real estate bubble could decrease
with more rational expectation. The soaring growth of economy as well as the
improvement of macro environment will make an adjustment to the level of real estate
bubble to make it go down which shows that the macro environment has an
absorption function to the real estate bubble. The rationalization of industry chain and
raising growth rate of industry would also have a bubble absorption function. In
addition, the raising ratio of individual residence purchases is also an index to the real
estate market environment improvement, because real estate bubble will decrease if
this ratio goes up which is favorable for bubble absorption.
3.4.2 Analysis on real estate bubble transformation.
The transform of a real estate bubble is caused by different efficiency of assets
utilization. Bubble of low yield assets will increase because of the bubble decrease of
high yield assets. For example, there can be some complex transformation in real
estate bubble and stock bubble. If the yield of real estate market is higher than that of
stock market, the level of real estate bubble will go down, and vice versa.
3.5 How to identify real estate bubble
In attempting to identify whether a bubble exists or not, there are mainly two
measures: one is traditional economical theory, by which could measure the level of
bubble through economical theory analysis; the other is indicator, which could be one
or massive indexes to reflect the situation of a real estate bubble.
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The analyze of bubble in Shanghai housing market
3.5.1 Traditional economical theory
The measure of traditional economical theory is to analyze and assess the inner value
(theoretical price) of real estate and compare the figure to the market price for
measuring the level of real estate bubble through some basic economical theory
analysis. The key to this measure is how to get the inner value accurately. Using fixed
real property to assess the real estate inner value is one of the methods.
One classic tool of using this method is by capitalization of income to assess the inner
value of real estate: if one purchases a real estate, from which people could get annual
benefits, the present value of income flow should equal with the price cost. This
method supported by classical economy theory has a very clear advantage. It could
relatively reflect the base price of real estate which is described by economical theory.
Tightly combined with capital investment decisions, it could also reflect the inner
value of real estate. But this method also has obvious pitfalls. On one hand, it’s quite
hard to predict income flow of future which could be easily influenced by subjective
factors. On the other hand, future’s income flow itself is a random event, not as fixed
or stable growing as we assumed it to be while calculating the value. In addition,
valuing interest rates is an even harder case which could influence the real estate price
a lot.
3.5.2 Indicators.
The second measure is indicators, which are indexes relevant with real estate bubble.
Many indicators can be used to evaluate whether houses in a given area are fairly
valued. By comparing current levels to previous levels that have proven unsustainable
in the past, we can make a guess whether a given real estate market is experiencing a
bubble. There are many indicators used to measure real estate bubble, such as real
estate price growth rate, land price growth rate, residence vacancy rate,
price-to-income ratio and real estate growth to nominal GDP growth. Some indicators
are relevant with the measure of real estate bubble, such as mortgage loan growth rate,
individual income growth rate, population, number of families and so on.
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The analyze of bubble in Shanghai housing market
Indicators describe two aspects of a housing bubble: a valuation component and a
debt component. The valuation component measures how expensive houses are
relative to what most people can afford, and the debt component measures how
indebted households become in buying them for home or profit.
(i) Housing affordability measures
The price to income ratio is the basic affordability measure for housing in a given area.
It is generally the ratio of medium house prices to medium class disposable incomes,
expressed as a percentage or as years of income. It is sometimes compiled separately
for first time buyers and termed attainability. This ratio, applied to individuals, is a
basic component of mortgage lending decisions.
The deposit to income ratio is the minimum requirement down payment for a typical
mortgage, expressed in months or years of income. It is especially important for
first-time buyers without existing house equity; if the down payment becomes too
high then those buyers may find themselves "priced out" of the market. For example,
as of 2004 this ratio was equal to one year of income in the UK. Another variant of
this ratio measures the ratio of median family income to the income necessary to
qualify for a typical mortgage or a typical house; this is what the National Association
of Realtors calls the "housing affordability index" in its publications. In either case,
the usefulness of this ratio in identifying a bubble is debatable; while down payments
normally increase with house valuations, bank lending becomes increasingly lax
during a bubble and mortgages are offered to borrowers who would not normally
qualify for them.
The Affordability Index measures the ratio of the actual monthly cost of the mortgage
to take-home income. It is used more in the United Kingdom where nearly all
mortgages are variable and pegged to bank lending rates. It offers a much more
realistic measure of the ability of households to afford housing than the crude price to
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The analyze of bubble in Shanghai housing market
income ratio. However it is more difficult to calculate, and hence the price to income
ratio is still more commonly used by pundits.
(ii) Housing debt measures
The housing debt to income ratio or debt-service ratio is the ratio of mortgage
payments to disposable income. When the ratio gets too high, households become
increasingly dependent on rising property values to service their debt. A variant of this
indicator measures total home ownership costs, including mortgage payments, utilities
and property taxes, as a percentage of a typical household's monthly pre-tax income.
The housing debt to equity ratio also called loan to value, is the ratio of the mortgage
debt to the value of the underlying property; it measures financial leverage. This ratio
increases when homeowners refinance and tap into their home equity through a
second mortgage or home equity loan. A ratio of 1 means 100% leverage; higher than
1 means negative equity.
(iii) Housing ownership and rent measures
The ownership ratio is the proportion of households who own their homes as opposed
to renting. It tends to rise steadily with incomes. Also, governments often enact
measures such as tax cuts or subsidized financing to encourage and facilitate home
ownership. If a rise in ownership is not supported by a rise in incomes, it can mean
either that the buyers are taking advantages of low interest rates (which must
eventually rise again as the economy heats up) or that home loans are awarded more
liberally, to borrowers with poor credit. Therefore a high ownership ratio combined
with an increased rate of sub-prime lending may signal higher debt levels associated
with bubbles. There are several formulas for the rent measures:
The price-to-earnings ratio is the common metric used to assess the relative valuation
of equities. To compute the P/E ratio for the case of a rented house, divide the price of
24
The analyze of bubble in Shanghai housing market
the house by its potential earnings or net income, which is the market rent of the
house minus expenses, which include maintenance and property taxes.
The price-rent ratio is the average price of an owned house divided by the received
rent income (if buying to let) or the estimated rent that would be paid if renting (if
buying to reside).
The gross rental yield, a measure used in the United Kingdom, is the total yearly gross
rent divided by the house price and expressed as a percentage.
The occupancy rate is the number of occupied units divided by the total number of
units in a given region (in commercial real estate, it is usually expressed terms of area
such as square meters for different grades of buildings). A low occupancy rate means
that the market is in a state of oversupply brought about by speculative construction
and purchase. In this context, supply-and-demand numbers can be misleading: sales
demand exceeds supply, but rent demand does not.
3.6 US real estate bubble in history
U.S. history is replete with stories about housing and land booms and bursts. Most
had a common feature; a new territory was opened up, with perceived desirable
economic opportunities. Often more people arrived than could possibly exploit the
resources. Booms thus reflected excess demand by new residents for the supplies of
new housing which was temporarily limited by transportation, gestation and other
costs.
The period of the 1980s and the declines in housing prices in many cities in the early
1990s are now widely looked back upon as an example, even a model, of a boom
cycle that led to a bust. Housing prices in U.S. began rising rapidly in Boston in 1984.
In 1985 alone, home prices in the Boston metropolitan area went up 39 percent. A
pattern of sharp price increases, with a peak around 1990 followed by a decline in
25
The analyze of bubble in Shanghai housing market
many important cities around the world, including Boston, Los Angeles, London,
Sydney, and Tokyo, looks consistent with a bubble.
26
The analyze of bubble in Shanghai housing market
4. Whether bubble exists or not in Shanghai housing market
Although some people treat the rapid growth rate of real estate price as the most
important evidence of a bubble, the definition of bubble in the chapter “bubble
theory” dictates that such increases alone are only necessary but not sufficient
evidence. Additional evidence that relates current real estate prices to their
fundamental determinants is required to solidify any claim of a bubble. Measures
described in the last chapter “bubble theory” have been widely used to support claims
of a bubble.
4.1 Rational factors
In a real estate market, the amount of houses supplied by the developer and the
amount demanded by the buyer are dependent on the market price of the house. The
law of supply states that supply is directly proportional to price, the higher the price of
the house, the more the developer will supply. The law of demand states that demand
is inversely proportional to price, the higher the price of the product, the less the
consumer will demand.
The law of supply and demand states that the market price of a house is the
intersection of buyer demand and developer supply. If the price for a house is at a low
level where consumers demand more of the house than developers are prepared to
supply, there will be a shortage of this kind of house, and buyers will be willing to pay
more for it. The developers will increase the price until it reaches the level where
buyers would not buy any more if the price was increased. Conversely, if the price for
a house is at a high level where the developer would like to develop more than the
buyers will buy, the developers will be willing to lower the price. The price will fall
until it reaches the level where buyers would be willing to pay more for the good.
27
The analyze of bubble in Shanghai housing market
Graph 4–1 the model of demand and supply
4.1.1 Demand in Shanghai real estate market
One of the most important factors that the real estate prices boost is due to the upward
shift in demand. There are many determinants of the demand for housing. Such as
demographic, income, price of housing, cost and availability of credit, consumer
preferences, investor preferences, price of substitutes and price of complements.
Among all these above factors, demographic is the most important one.
Demographic
The core demographic variables are population size and population growth: the more
people in the economy, the greater the demand for housing. As the mayor of Shanghai
said in the year 2003, Shanghai’s population had surpassed 20million in that year.
Since almost every family just has one child in Shanghai by the family planning of
China, the population growth of Shanghai was negative in recent years (positive in
2005). But there is still huge demand for housing because of the large foundation of
28
The analyze of bubble in Shanghai housing market
population and millions of itinerant workers from the other regions of China. In
addition, the average of urbanization rate in global is 50%, the developed countries is
75% and only 38% in China. The rate is increasing by one percent in China annually,
which means there are more than 10million people move into cities. So it’s no wonder
that there’s quite a huge demand for housing in Shanghai housing market with a huge
amount of flow-in population. Meanwhile, with the sharp development of Shanghai,
all the demand for office building, commercial building and the other real estate is
going up along with the demand for housing.
Income
Income is an important factor to demand. From Shanghai statistic bureau, per capita
disposable income of urban households and rural households in Shanghai is
increasing by 10% annually and reached 20668 Yuan and 9213 Yuan respectively in
the year 2006. As described in the second chapter, per capita living area in Shanghai
before 1990 was very small. The increasing income enables more people to be able
and be willing to afford bigger houses to have better living conditions.
29
The analyze of bubble in Shanghai housing market
Table 4–1 per capita disposable income of urban households in main years (1980-2006)
Yuan
Year
Average
per Salaries
Net Income from Property
Transferre
Capita Disposable
Household
d Income
Income
Business
Income
1980
637
551
86
1985
1075
795
280
1990
2183
1548
1991
2486
1780
1992
3009
2138
1993
4277
1994
1
21
613
29
677
3
44
824
3099
4
37
1137
5868
4224
28
54
1562
1995
7172
5002
69
92
2009
1996
8159
5889
87
61
2122
1997
8439
5969
150
69
2251
1998
8773
6004
98
57
2614
1999
10932
7326
156
68
3382
2000
11718
7832
120
65
3701
2001
12883
7975
119
39
4750
2002
13250
7915
436
94
4805
2003
14867
10097
377
130
4263
2004
16683
11422
507
215
4539
2005
18645
12409
798
292
5146
2006
20668
13962
959
300
5447
Note: Per Capita Disposable exclude income from selling properties and social
security expenditure from 2002.
30
The analyze of bubble in Shanghai housing market
Table 4–2 per capita disposable income of rural households in main years
(1990-2006)
Indicators Average
per
Disposable
Capita wages
Income
(Yuan)
Household
Property
Business
Transfer
Income
Income
1990
1665
1066
539
60
1991
2003
1235
681
87
1992
2226
1454
685
87
1993
2727
1662
949
116
1994
3437
2112
1084
241
1995
4246
2734
1183
329
1996
4846
3240
1278
328
1997
5277
3736
1226
315
1998
5407
3869
1185
353
1999
5481
4192
929
360
2000
5565
4310
934
321
2001
5850
4491
967
392
2002
6212
4920
774
518
2003
6658
5284
813
561
2004
7337
5757
886
694
2005
8342
6364
811
1167
2006
9213
6892
766
1555
and
Note: The per capita annual disposable income before 2000 refers to the net income.
From the two tables above, we can see that Average per Capita Disposable Income of
Households in both urban and rural areas is keep increasing year by year. In addition
to the overcrowded condition, people tend to purchase bigger house naturally so that
the demand keeps going up.
31
The analyze of bubble in Shanghai housing market
Price of housing
The price of housing is also an important factor to demand.
The diagram 4-2 shows the effects of an increase in demand in the short run. Since the
demand for housing is increasing in Shanghai’s real estate market, the demanding
curve shifts from D1 to D2. The market reacts with both the price and the quantity
adjustment, so the price P1 goes up to P2 and the supply should also increase from
HS1 to HS2.
Graph 4 – 2 the model of demand and supply
Cost and availability of credit
Because of the huge saving capital of Chinese, the government was always keeping
the interest rate in a pretty low level. The cost of mortgage is thus not high for people
of Shanghai.
Consumer preferences
Chinese people are tend to have their own dwellings. Not like in many countries,
home means a lot to Chinese. There are only a few Chinese would like to live in a
rental room which doesn’t belong to them for a relatively long time. That’s another
important reason that demand went up in Shanghai housing market. Especially for the
people who suffered bad living condition for many years in Shanghai because of the
32
The analyze of bubble in Shanghai housing market
huge population and limited area. Along with the higher income and the rapid
development of Shanghai, no wonder the demand of housing is soaring.
4.1.2 Supply in Shanghai real estate market
Housing supply is produced using land, labor, and various inputs such as electricity
and building materials. The quantity of new supply is determined by the cost of these
inputs, the price of the existing stock of houses, and the technology of production.
As the demanding for housing surging in Shanghai, the investment in Shanghai real
estate market has maintained a growth rate of 20~30% for years. The features are
quick increase in supply, large vacancy rate, fast-rising price and many large flats
which are unaffordable to ordinary citizens.
33
The analyze of bubble in Shanghai housing market
Table 4–3 total floor space of construction and completed buildings (1985-2006)
Year
FloorSpac
of which
Floor Space of which
Constructi
of which
eof
Residentia
Completed
Residentia
on
Residenti
Constructi
l Housing
(10000
l Housing
Completio
al
on
sq.m)
n Rate (%) Housing
(10000
sq.m)
1985
4162.15
2651.52
2909.58
2112.04
69.9
79.7
1986
4874.44
2469.27
2493.93
1790.01
51.2
72.5
1987
4382.4
2658.05
2700.96
1874.9
61.6
70.5
1988
4369.2
2667
2457.34
1758.29
56.2
65.9
1989
3683.77
2048.2
1941.8
1246.58
52.7
60.9
1990
3801.46
2269.06
2138.44
1339.02
56.3
59
1991
3611.53
2157.46
1923.92
1160.61
53.3
53.8
1992
4709.52
2463.79
2608.2
1379.18
55.4
56
1993
4724.3
2142.39
2031.76
1017.54
43
47.5
1994
6720.7
3520.27
2519.09
1349.24
37.5
38.3
1995
10566.42
6195.12
3093.93
1746.82
29.3
28.2
1996
10730.85
5874.26
3254.57
1872.65
30.3
31.9
1997
9955.21
5450.13
3614.19
2179.68
36.3
40
1998
9364.36
5113.52
3364.43
1963.51
35.9
38.4
1999
8364.48
4608.49
3257.57
1731.55
38.9
37.6
2000
8636.31
4804.12
3266.52
1724.02
37.8
35.9
2001
8588.49
5236.93
3215.12
1743.90
37.4
33.3
2002
9425.42
5994.70
3102.53
1880.50
32.9
31.4
2003
11023.24
6974.27
3582.34
2280.79
32.5
32.7
2004
12291.81
7873.44
4932.57
3270.43
40.1
41.5
2005
14477.85
8267.24
4873.82
2819.35
33.7
34.1
2006
14596.49
8085.28
4901.46
2746.80
33.6
34.0
34
The analyze of bubble in Shanghai housing market
Construction completion rate is in the trend of going down, which means the
developers are becoming more and more desired for this market with an optimistic
expectation. This phenomenon could be brought by escalating demand as well as
higher capability of supply.
Cost of inputs
Generally speaking, rapid growth of investment in real estate supply may lead to
inflation. However, the problem of excess capacity in China’s manufacturing sectors
has been serious ever since 1998. As a result, the rapid increase in investment has not
resulted in quick price rise of some materials relevant with real estate. The Shanghai
housing market has found that the low supply elasticity of housing units is an
important factor behind the larger price increases in the market. In particular, real
estate price are much higher than construction costs throughout China.
The price of the existing real estate
Normally, if supply increases rapidly, real estate price won’t go up continuously. This
abnormal phenomenon has to do with the speculative demands of domestic and
overseas investors: first, the rich Chinese people would like to buy real estate as an
investment rather than the place they live in. For example, if they make money in a
country, they prefer buying real estate in a city, if they make money in a city, they
prefer buying real estate in a provincial capital, if they make money in a provincial
capital, and they prefer buying real estate in Shanghai or Beijing. Among these people,
many of them treat the real estate (mainly housing) purchase as an investment. Second,
there’s no restriction on foreigners’ purchase of real estate in China. Some foreigner’s
speculate that the RMB to appreciate, so they convert foreign currency into RMB and
invest them in real estate. For these two reasons, real estate price keeps rising up and
developers are willing to build more buildings even though the prices of the existing
real estate are abnormally high already.
35
The analyze of bubble in Shanghai housing market
Table 4-4 Investment and operation in real estate development in main years
100 million Yuan
Indicators
1995
2000
2004
2005
Total Investment
466.2
566.17 1175.46 1245.86
Investment in Commodity Housing
286.45 476.32 954.24
1094.42
Investment in Land Development
53.19
65.66
25.91
67.77
Of Total Investment
Residence
280.38 408.82 900.67
920.84
Villas and apartment
31.75
40.72
91.39
225.50
Office building
81.74
57.47
83.24
102.18
Commercial Building
32.39
51.51
78.93
102.18
Others
71.69
48.38
112.62
121.23
Newly Increased Fixed Assets
151.06 477.39 825.23
Total Capital Source
670.83 778.16 2137.14 2618
113.48 437.35
1054.02
Balance at End of Previous Year
112
628.12
Sub-total Capital Source of this Year
558.83 664.68 1699.79 1989.88
Domestic Loans
122.63 155.37 358.68
483.03
Foreign Capital Utilized
51.81
28.11
28.25
40.54
Foreign Direct Investment
34.87
16.24
14.21
15.22
Self-Financed Capital
214.53 211.86 417.8
527.78
Other Capital
169.86 269.34 895.06
938.52
Table 4–5 Macroeconomic index in Shanghai (200601—200605)
Index(billion)
1-5 month
Increase rate by the same period last
year
Total capital assets investment
137.919
8.55%
Real estate investment
45.333
-0.21%
Real
estate
investment/total 33%
-7.70%
investment
Source: Shanghai statistic bureau
36
The analyze of bubble in Shanghai housing market
The table above shows that the real estate investment takes up a big ratio in overall
investment in Shanghai, and a little drop down compared to last year.
4.2 The debate about the bubble in the Shanghai real estate market
Sine the year 2004, “real estate bubble” has been developed into a bitter quarrel in the
Chinese real estate market. There are two completely different perspectives: one claim
that there’s no bubble in Chinese real estate market and the real estate price will keep
going up although some problems truly exist in the real estate market; the other claims
that the situation of real estate bubble is already there at a so severe level that people
should pay more attention to it. While talking about Chinese real estate bubble,
Shanghai always will be the focus of debate.
In the year 2005, the central bank announced the first “national real estate finance
report” – Chinese Real Estate Finance Report in 2004. In the report, it said “pay
attention to the bubble level of second handed houses and high level houses in
Shanghai, the speed of real estate price is upward too fast and could make the market
prices deviate from the true value, which causing the real estate bubble. Once the
bubble bursts, the real estate used as mortgage can depreciate a lot and do a great
damage to banks”.
As the first economist in Morgan Stanley, Steve Roach claimed there is no nationwide
real estate bubble in China. But from his acquired information he judged that in the
region of Shanghai there were obvious speculative real estate investments. He also
said that price will go up if the demand goes up and the bubble surfs up if the demand
goes up way higher than the level of true value. He concluded that there’s no bubble
37
The analyze of bubble in Shanghai housing market
in China except for Shanghai.
As the first economist in Morgan Stanley Asian Pacific, Xieguozhong claimed in the
year 2004 that the real estate bubble in China would burst in no longer than one year.
Although it was proved that he made a wrong prediction, it doesn’t mean there’s no
real estate bubble in Shanghai.
4.2.1 Positive viewpoint
The viewpoint which claims there is a bubble in Shanghai real estate market is based
on these factors.
1. The price is too high; the expanding of price is too huge and swift.
From mid-long period, the increase of real estate prices is very much based on the
rules of market. But if the prices surge consistently in short period, it could be the
important sign of bubble. In 2003, housing prices in this city went up 21.35% year on
year; in 2004 the prices went up 15.8% year on year. In the latest years the prices
maintained on a stable growth rate which made the housing prices surge a lot. Before
2001, the disposable income growth was higher than the price growth of houses, but
after the year 2002, the prices growth was much higher than the income growth. The
price to income ratio kept going up.
2. The contradiction of demand and supply
One of the biggest problems in Shanghai real estate market these years is that there
are too much investment put into high level houses such as villas; meanwhile the
supply of low level apartments is not sufficient to meet the demand. In 2004, the
constructing area of high level houses was 9.86 million square meters, with the whole
constructing area 76.31 million square meters. That is to say, the high level houses
stranded for 13%. From the completed area, it also stranded for 9%, which the area of
high level houses and whole houses were 2.63 million and 30.76 million square
38
The analyze of bubble in Shanghai housing market
meters respectively.
3. The real estate investment is too rampant.
The real estate investment is the direct reflection of the real estate supply to the real
estate demand. Too fast growth of investment could cause the speculative demand and
higher prices. The index to measure if the investment is too rampant is by the formula
the growth rate of real estate investment divided by GDP growth rate; normally it
should not exceed 2. In the year 2004, the growth rate of real estate investment was
30.43% which was close to 3 times of GDP growth rate.
4. The speculative demand keeps going up.
From the investigation in 2003, 16% of total transaction of real estate was made by
speculators, closing to the alarming level 20%. To the high level buildings in CBD,
this ratio reached 30% to even 40%. And this ratio is not going down these years.
5. The risk of loan increases.
The loan growth from the banks keeps at a high speed level. In the end of 2004, the
commercial real estate loan growth rate was 41%, standing for 76% of total loan,
which means real estate investment and consumption highly depends on the loan from
banks and makes banks be tied to the fluctuation of real estate market.
4.2.2 Negative viewpoint
The viewpoint which claims that there is no bubble in Shanghai real estate market is
based on these factors.
1. Demand and supply are in equilibrium.
Between the year 2002 and 2004, both the demand and supply were surging in
Shanghai’s commercial houses, with the demand a little higher than supply which
makes the second-hand houses being consumed. In 2002 the completed area of
commercial real estate was 19.84 million square meters which made the growth rate
39
The analyze of bubble in Shanghai housing market
10.7 %., and the sold area of commercial real estate was 19.61 million square meters
which made the growth rate 9.1 %. In 2003 the figures were 25.6 % and 20.5 %
respectively. In 2004 the figures were 38.2 % and 38.9 % respectively.
2. The vacancy rate is going down.
Till the end of 2002, the vacancy area of commercial real estate was 6.77 million
square meters and the vacancy area of commercial residence was 3.7 million square
meters, it was going down by 25.23 %. Till the end of 2003, the vacancy area of
commercial real estate was 5.22 million square meters which made a reduction by
22.83 % and the vacancy area of commercial residence was 2.58 million square
meters which made a reduction by 30.23 %. Till the end of 2004, the vacancy area of
commercial real estate was 3.59 million square meters which made a reduction 31.2
% and the vacancy area of commercial residence was 1.26 million square meters
which meant a reduction 51%.
3. The price growth rate of residential houses has an obvious reduction.
The sold prices of the total real estate in the city grew by 20.1% in 2003, with price
growth rate of commercial houses and residential houses 20.5% and 21.4%
respectively. In 2004 the sales prices of the total real estate grew by 15.8% which had
a small growth drop by 4.7%, the residential houses grew by 15.8% which had a drop
by 5.6%. In the year 2005, this trend kept going. The average price of residential
houses was 6698 Yuan per square meters which increasing by 313 Yuan. The sales
prices of the total real estate in 2005 grew by 9.7% which had a drop of growth rate
by 6.1 percent. The price growth rate of residential houses dropped by 6.6%, to 9.2%.
40
The analyze of bubble in Shanghai housing market
4.3 The discussion about the debate of real estate bubble in Shanghai.
4.3.1 Discussion about the positive viewpoint
From the viewpoint that claims there is a bubble in Shanghai’s real estate market, the
outcome of analysis shows several problems that Shanghai’s real estate market is
facing. These problems could be the signs of bubble and in that case we might
conclude that the bubble is on the way of expanding. But this viewpoint hasn’t given
too much real evidence that bubble exists or given some pragmatic methods to solve
it.
4.3.2 Discussion about the negative viewpoint
From the viewpoint that claims there is no bubble in Shanghai’s real estate market,
people get this idea based on the demand and supply is in equilibrium which makes
the vacancy rate go down. But can we jump to the conclusion that there is no bubble
because of the low vacancy rate? I don’t think so.
In fact there is a quite big danger behind this equilibrium, which is the prices of
houses are beyond most citizens’ capability to purchase. Meanwhile in the market the
demand is still a little higher than supply, the problem is on the demand side. Demand
for houses has two different meanings, one is demand of consumption, and the other
is demand of investment. Real estate is quite different from many goods because it
has a feature of investment so we can’t apply ordinary way to analyze it. The price of
investment is not completely following equilibrium theory. To the investment,
expectation determines whether the demand will go up or down.
4.4 The proof of bubble in Shanghai housing market
The debate of real estate bubble is mainly on housing market, so I will focus on the
housing market to see if there is a bubble. In previous part, we can see very clearly
that because of the rampant development of Shanghai, both demand and supply have
been going up for last decade. Many people would say it’s reasonable to maintain a
41
The analyze of bubble in Shanghai housing market
fast price growth rate with the fundamental. In this part, I will investigate Shanghai’s
housing market with indicator methods to signify whether a bubble exists or not.
4.4.1 Price to income ratio
The ratio of the median home price to median household income is one frequently
employed measure of home ownership affordability. If this ratio is relatively high,
then households should find both down payments and monthly mortgage payments
more difficult to meet, which should reduce demand and lead to downward pressure
on home prices. If this ratio rises above its long-term average, it could be an
indication that prices are overvalued. In fact, in Shanghai the median house price is
15.5 times median household income in the year 2006, surpassing the previous peak
in the year 2005, when there is arguably a bubble in the housing market. The price to
income ratio is affected by three factors, the first is the average price per square
meters; the second is average per capita living area; the third is average disposable
income. Nowadays, the reasonable ratio worldwide is considered to be 3 to 6 times
and some experts from the World Bank say 4 to 6 times.
42
The analyze of bubble in Shanghai housing market
Table 4-6 Figures of price to income ratio in Shanghai housing market
1997
1998
1999
2000
2001
2002
2003
2004
2005
Price index
100
95.7
92.2
90.8
92.7
100.7
122.2
141.5
168.53
Price
4512.37
4318.34
4160.4
4097.23
4182.96
4543.95
5514.11
6385
7604.69
Price (K)
4.51
4.32
4.16
4.1
4.18
4.54
5.51
6.39
7.6
ADI
8439
8773
10932
11718
12883
13250
14867
16883
17351
ADI (K)
8.44
8.77
10.93
11.72
12.88
13.25
14.87
16.88
17.35
Family income (K)
23.632
24.556
30.604
32.816
36.064
37.1
41.636
47.264
48.58
Average area
9.3
9.7
10.9
11.8
12.5
13.1
13.8
14.8
15.1
Family area
43.11
44.97
50.53
54.70
57.95
60.73
63.97
68.61
70.00
House price
194.44
194.26
210.20
224.28
242.22
275.71
352.49
438.41
532.00
Price to income
8.23
7.91
6.87
6.83
6.72
7.43
8.47
9.28
10.95
From Shanghai Statistic Bureau, the average family member was 2.8 between 1997
and 2005. The house area is calculated by discounting average living area.
average disposable income (K)
price (K)
price to income ratio
20
15
10
5
0
1997 1998 1999 2000 2001 2002 2003 2004 2005
Graph 4–3 the situation of per capita disposable income and housing price
43
The analyze of bubble in Shanghai housing market
price to income ratio
12
10
8
6
4
2
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
Graph 4-4 price to income ratio
From the table 4-6 and graphs 4-3 4-4 above we could find out that from 1997 to 2001
the prices of housing was fluctuating consistently while the income was increasing
consistently which made price to income ratio keep going down and reached 6.72 in
2001. Between the year 1999 and 2001, the price to income ratio was at the lowest
level, which accounting for the income growth was higher than home price growth.
But after 2001, with China engaged into WTO and Shanghai succeeded in gaining the
right of holding World expo 2010 as well as the steady development of national
economy, the situation started turning worse. The extent of housing price growth was
beyond the extent of income growth. Especially in the fourth quarter 2004 and the
first quarter 2005, the price grew by 30%. The price to income ratio reached 11 then.
Nonetheless, the whole period 1995 to 2005, there was no big fluctuation, maintaining
at the same level, 9 to 10 more or less. Generally speaking, the increase of home price
and the growth of income are a relatively equilibrium. From the figures above we
could already confirm that there was a bubble in Shanghai housing market if
according to the standard of experts from World bank mentioned above. The
expanding of bubble has been restrained by the policies enacted by government in
2005. But there might be one pitfall of this method as to a new rising market, which
needs to be noticed.
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The analyze of bubble in Shanghai housing market
As a traditional measure, price-to-income ratio has a pitfall. That’s because this
measure based on a stable perspective, which ignores the possibility of income raise.
Once a home is purchased, the cost of home will be locked at such a figure.
Meanwhile, the income could be increasing. In that case, the price-to-income ratio
will keep decreasing, along with the consistent income increasing. From another
perspective, that means the ratio of mortgage to all the income will keep going down.
The home looks extremely expensive to purchase might be not a heavy burden in the
next few years. In developed countries, the traditional index of “price-to-income
ratio” or “deposit to income ratio” can be very good measures for assessing if the real
estate market is healthy, thanks to the small income growth rate, the total income
growth rate generally will not surpass 20% in six to seven years. But people can’t
simply put this measure to a fast developing country such as China, where the growth
rate of income per capita is keeping at 8% annually. If one still studies the home
affordability under stable perspective, there will be a lot of misleading about the real
home affordability and the potential demand in the real estate market and so on.
Taking a dynamic simulation as two tables below, imagine if one median household
living in Shanghai bought a median home with the average price. The price of that
home could be as ten times as their annual disposable income, with the leverage 80%
debt and maturity 20 years, the mortgage would stand for 56% percent of their
disposable income. That looks pretty tough, they might even find themselves be
priced out in the first place. But what if they succeed in buying it? With the income
growth rate from Shanghai Statistic Bureau, as long as this family maintains the same
average growth of disposable income rate, after 4 years, their price-to-income ratio
went down to 6.62 and the mortgage rate started off being under 50%, which in that
case the home was affordable since then. If that family keeps on maintaining the
average growth rate of disposable income, then another 4 years passed, we will find
that their price-to-income ratio now is below 5 as well as less than 30% mortgage rate,
they could find the home price easily affordable.
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The analyze of bubble in Shanghai housing market
Table 4-7 The price-to-income ratio approach dynamically simulated for homes
bought at 1995
Year
Mean
Bottom
10-20% 20-40% 40-60% 60-80% 80-90% Top
10%
10%
1995
9.99
21.32
16.20
13.73
11.26
9.28
7.41
5.39
1996
8.90
18.55
14.44
12.20
9.87
8.03
6.67
4.75
1997
8.58
18.21
13.84
11.48
9.36
7.69
6.28
4.67
1998
8.22
17.91
13.21
11.02
9.14
7.43
6.13
4.52
1999
6.62
12.56
10.35
9.16
7.19
6.17
5.02
3.16
2000
6.26
11.05
10.25
8.11
6.92
5.69
4.68
3.22
2001
5.77
11.17
9.52
8.53
6.80
5.27
4.22
2.54
2002
5.80
11.92
9.51
7.94
5.82
4.62
3.50
2.15
2003
5.01
11.92
9.51
7.94
5.82
4.62
3.50
2.15
Bottom 20%
2004
4.40
2005
3.99
9.62
Top 20%
6.95
5.17
3.84
2.27
Source: Shanghai Statistic Bureau
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The analyze of bubble in Shanghai housing market
Table 4-8 Monthly mortgage payment as share of monthly disposable income for
homes bought at 1995
Year Mean
Bottom
10-20% 20-40% 40-60% 60-80% 80-90% Top
10%
10%
1995 0.56
1.20
0.91
0.77
0.63
0.52
0.42
0.30
1996 0.50
1.05
0.81
0.69
0.56
0.45
0.38
0.27
1997 0.48
1.03
0.78
0.65
0.53
0.43
0.35
0.26
1998 0.46
1.01
0.74
0.62
0.51
0.42
0.35
0.25
1999 0.37
0.71
0.58
0.52
0.41
0.35
0.28
0.18
2000 0.35
0.62
0.58
0.46
0.39
0.32
0.26
0.18
2001 0.32
0.63
0.54
0.48
0.38
0.30
0.24
0.14
2002 0.33
0.67
0.56
0.47
0.37
0.30
0.25
0.14
2003 0.28
0.67
0.54
0.45
0.33
0.26
0.20
0.12
Bottom 20%
2004 0.25
0.54
Top 20%
0.39
0.29
0.22
0.13
2005 0.22
Source: Shanghai statistic bureau
With the analysis above, we can easily get to know that families above median, for
example at top 20%, the price-to-income ratio and deposit to income ratio could
decrease at a faster speed. Families below median, for example at 20% to 40%, if only
they could purchase home with the help of government’s efficient financial measures,
and getting over the hardest time in the beginning several years, along with the stable
growth of disposable income, hopefully they can get themselves affordable with less
than 50% mortgage rate in the year 2000. But the bottom 10% people would always
finding themselves hard to afford the home, they need the government’s help for sure.
The ratio of prices to household disposable income by itself, however, is not a
sufficient metric to evaluate housing affordability. Indeed, home prices do not appear
47
The analyze of bubble in Shanghai housing market
to be linked to income by a stable long-run relationship, possibly because the cost of
carrying a mortgage has varied over time. With the table above, I can’t draw a
conclusion right now about Shanghai is or is not in the midst of housing bubble or
heading for housing bust, but I think it’s safe to say that it requires some argument to
justify such high ratios. As the price to income ratio in US in 1980s, we can find that
the ratio there is way below Shanghai. However, some economists still claim that
there’s a bubble in American housing market at that time, let alone in Shanghai which
with such high ratio figures. Ratios that are far above one-digit figure are worrisome
because they are telling us that the people who live in Shanghai can’t afford to buy a
home that is placed in the same region of the distribution as their income, at least
can’t afford in the first place without considering fast income growth rate.
There is also another fact that need to be considered. Comparing to developed
countries, the ratio of median household are much less in China. Therefore, the price
to income ratio is not enough for get to the conclusion, although the figures above
seem quite volatile. And in the reality, the situation might be even worse.
4.4.2. Growth rate of housing price / growth rate of GDP
The ratio of housing price growth to GDP growth is also an important method to see if
there is a bubble in the housing market. Generally speaking, we could say there is no
bubble as long as the price growth not exceeds GDP growth. This index is designed
according to the meaning of housing bubble to measure housing growth and monitor
the trend of housing bubble. The high index shows that housing growth exceeds
economy growth, which could be a sign of bubble. If the index keeps going up in
some particular period, it means people can’t afford the housing with relatively lower
economy growth which will bring them relative lower income. That will make the
vacancy rate increase and trigger a bubble.
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The analyze of bubble in Shanghai housing market
Table 4-9 The comparison of housing price growth rate and GDP growth rate in
Shanghai
1997
1998
1999
2000
2001
2002
2003
2004
2005
Price index
100
95.7
92.2
90.8
92.7
100.7
122.2
141.5
168.53
Price
4512.37
4318.34
4160.4
4097.23
4182.96
4543.95
5514.11
6385
7604.69
Price growth x
None
-4.3
-3.66
-1.52
2.09
8.63
21.35
15.79
19.1
GDP index
555.73
511.86
674.27
747.09
823.3
913.04
1020.7
1159.61
1241.92
GDP growth y
None
10.1
10.2
10.8
10.2
10.9
11.79
13.61
12.1
100*(x-y)/y
None
-142.57
-135.88
-114.07
-79.51
-20.83
81.09
16.02
57.85
price growth x
GDP growth y
25
20
15
10
5
0
-5
1997
1998
1999
2000
2001
2002
2003
2004
2005
Graph 4-5 the comparison of housing price growth rate and GDP growth rate in
Shanghai
49
The analyze of bubble in Shanghai housing market
ratio of price to GDP
100
50
0
-50
-100
-150
-200
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Graph 4-6 the ratio of housing price growth rate to GDP growth rate in Shanghai
From table 4-7 and graphs 4-5 4-6 above, we could see that Shanghai economy was in
a steady development from 1998 to 2000. The GDP growth rate was maintaining 10 to
11%, while the housing prices were decreasing with a smaller scale year by year.
From 2001, Shanghai housing prices were going up. The price growth rate almost
equals with GDP growth rate in 2002, the development seemed promising. But from
2003 till 2006, price growth rate was way higher than GDP growth rate. In 2003 the
gap was 81.09%. In 2004 the gap went down to 16.02%. Several real estate policies
have been enacted after the gap went up again and hit 57.85% in 2005. From the
analysis above, we could claim that Shanghai housing bubble arised in the year 2003.
Bubble deflated after 2005 because of several policies been enacted and flourish of
stock market although the housing price still kept moving upward.
4.5 Summary
In this chapter from rational factors till bubble tests, we could find that Shanghai
housing price was stimulated to go up by many different factors. Not only caused by
fundamentals but also speculative investment. Clearly, one who supports the negative
viewpoint can construct an argument that housing price increases in Shanghai have
50
The analyze of bubble in Shanghai housing market
been driven by fundamentals. For more than ten years, income growth alone explains
virtually the entire increase in housing prices, and consistent low interest rates have
reduced financing costs. To some people above median households, housing is
actually more affordable than it was one decade ago.
Nonetheless, the analysis indicates that housing price increase much higher than it
should be caused by the fundamentals with people’s strong investment motive and
high expectations of future price increases. The ratio of housing price development to
GDP development is quite high though meanwhile the vacancy rate is quite low, that
means there is definitely speculative investment in housing market. Combining with
the table and graphs in this chapter and the second chapter, we could clearly see the
trace of housing bubble and make sure the bubble was most expanded around the year
2003 when the ratio of housing price growth to GDP growth was highest. The price to
income ratio is much higher than US when they confirmed there was a bubble 20
years ago. Though price to income method has a pitfall which is not quite suitable for
fast developing countries, the proportion of median households is also very small
compared to US. In addition to the ratio of price growth to GDP growth, it was even 3
back in 2003.
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The analyze of bubble in Shanghai housing market
5. Why the bubble exists in Shanghai housing market
5.1 Policy inertia
Looking back on the history of Shanghai housing development, in the 1990’s the
government enacted a series of policies to encourage the development of housing
market. Actually it provided a support political platform for the price increase in the
recent years. The policy from the announcement to being into practice needs time, so
there would be some lags. Besides, the active policies established several years ago
are still making great effect. All these factors result in policy inertia and neutralize
much effect of policies which were set up later by the government which is attempting
to lower the prices of the buildings.
5.2 Financial pitfalls
The defect of both real estate finance and credits caused by the Chinese fragile
financial system is one of the most important reasons why a bubble exists. This factor
is widespread in China especially in Shanghai. As the Chinese bank business is fully
opening to international capital, the government urges the reformation of the
state-owned banks, so the banks are speeding up to solve both the doubtful and bad
accounts for bettering the capital assets ratio. The figures considering the history and
reality show that the real estate loan belongs to the superior credits. So the banks
expand the scale of loan to the real estate, by which reduce the ratio of bad capital
assets. That’s why banks eager to loan to the real estate companies and individual
house buyers.
On the other hand, real estate speculators also need the banks’ support. That’s the
huge demand for the loan of banks. Both the demand and supply bring about the
“perfect combination” of loans. The deposit in China is very large, which makes the
speculators quite easy to get the loan. That all caused the rapid increase of Shanghai
housing price.
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The analyze of bubble in Shanghai housing market
Moreover, there is not much for Chinese to invest in except for real estate, the interest
rate was very low due to the high deposit rate, and the stock and bond were not that
attractive until 2007. Although the stock has been soaring and the interest rate has
risen since this year, the bubble in Shanghai housing market has been set up long
before.
5.3 Undeveloped capital market
The bubble of Chinese real estate market has a close connection with its undeveloped
capital market and especially in Shanghai. On one hand, the stock market can’t attract
the leisure capital as it did one decade ago, which makes the speculators swift to the
real estate market to maintain and even hope to increase the capital. On the other hand,
real estate companies find themselves hard to financing which result from the
undeveloped capital market. The companies don’t have appropriate channel to
financing so that they swift to the legal but not appropriate channel, to speculate in
real estate market and that makes the situation even worse.
5.4 International influence
As the global interest rate goes down wehn the American dollar depreciation and the
international expectation on the upward of Chinese exchange rate, a lot of
international money is surging into Shanghai real estate market. From the aspects of
interest rate, international investors could avoid the risks by purchasing real estate of
Shanghai to benefit on investment. From the aspects of exchange rate, the confliction
on the Chinese exchange rate between Chinese Yuan and American Dollar are getting
intense. There is no doubt that there will be a reformation and the Chinese exchange
rate will go up. The international investors bet on the rising of Chinese exchange rate
to benefit more.
Having relatively open market, the big foundation of population, the accelerating of
urbanization, the APEC meeting in 2002 and will hold the world expo in 2010,
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The analyze of bubble in Shanghai housing market
Shanghai is influenced by all these factors which provide the possibilities of
expanding in real estate markets. The profits are very alluring so that Shanghai
becomes the ideal place of investment for international capital.
5.5 Market expectation
The expectation of rising price is the basic reason that the housing bubble exists.
According to the structure of real estate demand, the rising price of Shanghai housing
market results from the expectation on it. There are two phases in history: first one
took place from about year 2001 to 2003 in which the prices of Shanghai real estate
went upward in a rational way. Since Shanghai succeeded in holding the APEC in
2002 and win out the holding of the World Expo in 2010, these positive factors cause
the expectation that the housing price in Shanghai will rise. In the second period
which dated from year 2003 till now, the price expanding in an irrational way. In the
latest three years, Shanghai housing price nearly doubles. The factors in the second
phase are more complicated and fundamental, not just the simply political or historic
influences. These are the main reasons:
i.
As the economic center of Yangtze River delta, Shanghai has strong influences on the
surrounding districts. On one hand, Shanghai promotes the development of nearby
cities and towns. On the other hand, the development of nearby districts’ economy
brings about more and stronger needs of Shanghai’s high-end services by which
makes Shanghai as the center city further. The high-end services give a big demand
for the persons of talent who belong to the class of high salary, and these people are
expected to want to have the better housing to live in. That’s the reason that the price
surge of Shanghai housing market mainly focus on the high level buildings.
ii.
The price rising of Shanghai housing market brings about the expectation of even
further rising of price. In recent years, China invest a lot in the capital assets such as
iron and steel and the supply did not meet the demand, so that urge the real estate
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The analyze of bubble in Shanghai housing market
price rising away from the rational way. Both the big development and the high price
attract more and more companies that come into this industry which make the
competition more fierce, so the cost goes up and then the high cost bring about the
high price of real estate.
iii.
There are over 20 million people living in Shanghai, the area is more than 600 square
kilometers and the constructive field areas have reached several thousand square
kilometers. Apparently the effect of scale economy with the further expanding of the
city would not be obvious.
iv.
There are many people who don’t want to see the price reduction, so they make the
expectation that the price will still be in an upward way: The government does not
hope the housing price goes down for both the public sake and the private sake. If the
price reduces, the economy of Shanghai will not be as good as before and the income
of government will also go down; the real estate developers don’t want to see the
price reduction. They just can’t accept that because there will be an expectation of a
further price reduction if that comes true; Even the banks don’t want to see that
because there will be crises in their finance system; the real estate owners don’t want
to see that either. There are two kinds of owners. Ones is the speculator, price
reduction will give a strong damage to there fortune. The others is the normal
consumers, lots of them purchase the housing by borrowing money from the bank.
The price reduction will make them have the negative equity.
55
The analyze of bubble in Shanghai housing market
6. Conclusion
This paper has investigated whether there was a housing bubble in Shanghai in the
past few years. The findings first indicate that Shanghai real estate market has
witnessed a great development in past several years and the housing prices seem to
have interacted with market fundamentals, such as disposable income and local GDP.
Then the paper gives an introduction of the real estate bubble and provides several
methods for identifying the bubble. With the methods used the results suggest that
Shanghai seemed to have a housing bubble especially in 2003 as the figures show that
housing was hardest affordable in that year.
Since 2005, central bank enacted several efficient policies to cool down the real estate
market. These policies functioned well and succeeded in making the growth rate away
from its original trend. Though the real estate price still keeps going up higher and
never turned back, the development of national economy and income growth are
accelerating. With all the analysis above it’s safe to say the worst time has passed. We
may find it hard to say if there’s a bubble right now because of the problem of data
available, let alone if it will burst. But with the analysis it is quite safe to say back in
2003 or so there was definitely a bubble.
This study has laid the groundwork for further investigations on the abnormal housing
price phenomenon in Shanghai. There are possible areas for future research. First,
future studies may further work on different methods for comparison, or on direct
estimations of assets’ fundamental value which is proved to be very difficult, if not
impossible, because of the lack of reliable data. This paper, however, is constrained by
resources available. The current data set is used because it is available on the public
domain, which means it is generally reliable and acceptable.
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The analyze of bubble in Shanghai housing market
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