Warning signs: Joseph Gyourko on a Chinese slowdown and real estate risk

The Wharton expert sees a lesson for Australian regulators?

Joseph Gyourko is a globally renowned academic, author and consultant analyst in property markets. He is the Martin Bucksbaum professor of real estate, finance and business economics, and public policy at The Wharton School at the University of Pennsylvania, where he has been director of the Samuel Zell and Robert Lurie Real Estate Center since 1998. Gyourko spoke to Julian Lorkin for BusinessThink.


An edited transcript of the interview follows.

BusinessThink: Nothing is as guaranteed as a bricks and mortar investment – except, as we found out in the West, when a global recession meant that prices tumbled. Now investors are getting increasingly nervous about the Chinese market. Joseph Gyourko has been studying both the risks in China and also what happened in the US during the property crash in 2008-09. Let's start with those numbers from the Chinese market – it's shown dramatic growth hasn't it?

Joseph Gyourko: It has been an incredible boom over a decade-long period. In Beijing, land prices – a market I study – are up 1000%. They've literally been growing 27% to 28% compounded per annum.

But China, [like] the US, is a big country and a diverse country. Not all markets are growing like Beijing, so there's a lot of variation, but in general there's been a big boom. In the property markets, house prices on average growing by 20% a year, per year, over the past decade with a big range from 3% to 4%, to much higher, to Beijing's level in the high 20s.

BT: And there's obviously been a lot of development – we've heard of the Chinese "ghost cities" where they've been built before people are willing to move into them. Is that rampant in China or is it just one or two cases?

JG: I think it is not rampant. It's certainly not rampant if you go to the big east coast cities – the east region cities in China. You do not see ghost developments or anything approaching ghost cities inside Beijing, Shanghai [and so on]. Even in central region cities – Wuhan and the like – [ghost cities] don't exist. So I think that's a bit overstated.

What is actually worrisome is the amount of new supply that's come on everywhere, and one of the things some co-authors and I in China and at the National University of Singapore have tried to do is measure how much new supply has come on. And in Jiangjin, and the like – Wuhan, Dalian, places like that – it really does look like supply has begun to outpace demand by a considerable amount, and that's where I would worry about price adjustments – whenever supply outpaces demand.

BT: And looking at that risk, [is there] the potential or possibility of the boom turning into a bust?

JG: I think the issue in China – why there is going to be a correction in many markets – simply comes from the slowing of growth. Think about it. If you are a property developer in China, you would have been experiencing 10% annual economic growth per year for a large number of years. That basically signals to you to build a certain number of units, because you expect a 10% growth. Well, it's down to at least 7.5%.

'I think there’s a view [in] China that it can never bust, because they've had this remarkable growth for a decade. It can bust. We’ve proved it in the US'


My personal belief is that it's going to fall below that, which means national economic growth is down somewhere between 25% to 40%, depending on how low you think GDP growth is going to be. That's a big economic miss. With 6% to 7% growth, you need far fewer units than you do at 10% growth. That's the essence of the problem, that's the genesis of where I think the correction is going to come.

Where I worry again, is in the interior markets: the Wuhans, Chengdus, Jiangjings, Dalians, where you see the slowdown in growth. So we don't need as many units and the fact that we probably have oversupply is amplified in these markets, where supply has been growing faster than demand for a number of years. That's where I worry most about price adjustments – which is a nice way of saying price declines.

BT: In fact, you almost have to look at why people have been in investing in the Chinese property market? Is it for the capital gain, or just for the rental returns and hope that they are not one of the people stuck with large vacancy rates?

JG: Well, I'm not so sure it's not something else, which is: If you're a Chinese national, where do you put your money?  Until very, very recently, you could only do a couple of things. One is you could buy a housing unit, two is you could park your money in a state-owned, enterprise-operated bank and get a guaranteed negative 2% to 3% real rate of return.

In my home country – the US – we practise financial repression now with great vigour, basically as an aid to the banks. The Chinese are past masters at it, they've been doing it for a long time, so saving in a bank is not going to be a good investment. My co-author, until very recently, could not invest in the S&P500. He could invest in Shenzhen or Shanghai exchanges, but if you look at the data from those, they tend to levitate for odd reasons.

So I think a lot of Chinese, until very recently, when both those markets have boomed, have been hesitant to put their money in stocks. That only leaves real estate. And the bad news I have for all of my Chinese friends is: In the US we've proved you can do worse than minus two or minus three. If conditions deteriorate enough, you can do well worse, so that's worrisome to me also. I think there's a view, when I visit China, that it can never bust, because they've had this remarkable growth for a decade. It can bust. We've proved it in the US.

BT: What happened in the US in 2008-09 was certainly dramatic. You've studied the 20-year cycle that really started in 1993, wasn't it? Are there any real lessons there that should be learned both in China and in Australia?

JG: The US is not similar to China in an important respect: when our boom lasted 10 years, roughly from the mid 1990s to 2005-06, it was a decade-long boom. Prices doubled in real terms. In the US, unlike China, we leveraged up. Households took on more and more debt, our household sector became much more risky, and when the market began to really bust in 07, and those investments really turned bad with the great recession in 08 and 09, many households were under water on their homes. It was their primary asset, and because they had so much debt it only took small drops in prices to make them have negative equity in their homes, and then we had big price drops.

That's not going to happen in China because they have equity in their homes. So I think any bust would play out very, very differently in China. The bust in the US threatened our banking system immediately and caused dramatic repercussions and Federal Reserve interventions to recapitalise the banks and the like. In China there's equity. Their problem is different but still I think it's severe.

BT: But, as you said, many people in China don't believe there would be any possibility of a bust; they just believe that things will keep on growing as we proved they don't.

JG: There's a great faith that the government will somehow figure it out. I do believe that, and again, the Chinese government is very powerful in terms of this intervention and the like. But still, if supply is greater than demand and there is a negative shock to your economy for whatever reason, prices will fall. This is what you and your colleagues and I teach in intermediate economics, and China's not immune to that.

BT: So finally, the real lessons for Australia. I think Australia seems almost parallel to what was happening in the US. There, a lot of people were obviously heavily leveraged, with big mortgages and heavily exposed to interest rate rises. In Australia at the moment, house prices are going up quite dramatically and people are continuing to bid more and more. In some areas in Sydney, we are seeing house price growth rising by 20% or 30%. Is there a warning there with what happened in 2008?

JG: There are lessons. One, when you see really high price-growth rates that you've mentioned – 20% – they can't last. Because, what's the national growth rate of the economy in Australia?

BT: On average GDP rate, 2.5% to 3%.

JG: 2.5%. So that says house prices in that area are growing at 10%  – ten times national growth. That can't last for long. So that's how you sort of base this. How it will fall out in Australia I think depends on job creation. If you think a lot of Australian jobs are linked in some way to growth in China, then you would be more worried, rather than less worried.

If it is the case that many of them are highly leveraged, it will not take a big fall in prices to turn them into negative equity investors in their house, and the like.  Were I a regulator of banks in Australia, if I saw slowing in China – which I see – I would be increasingly worried and trying to encourage deleveraging in Australia. That would be my lesson. That's the risk.


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