How China's property bubble burst

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Would you take this gold bar in exchange for buying a house? How about this phone? A new car maybe?

It might seem absurd, but these were just some of the actual incentives being offered to Chinese homebuyers in 2023. Property developers, such as the gold bar-giving Huafa Tianfu, were forced to get creative as they became increasingly desperate to attract sales.

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Stories like these were just the tip of the iceberg in a crisis that involved hundreds of billions of dollars in developer debt, trillions of dollars in local government debt, and at least tens of millions of empty apartments.

China’s real estate market is relatively young, only a few decades old. Private property didn’t really exist in the country until the 1980s. When the People’s Republic of China was founded in 1949, the Communist state did away with private land ownership, declaring that land belonged to all Chinese citizens. Homes were instead allocated to residents in cities through a socialist welfare housing system.

When China began opening up and reforming its economy in the late 1970s, there were virtually no private homeowners in the country. But that was about to change.

China’s economic experiments in the 1980s were largely successful. Citizens began making good money from the businesses they were setting up, and its cities grew as more people migrated from rural areas. However, there wasn’t enough housing to accommodate this influx.

To solve this, the state began housing reforms. In 1988, it started privatizing and commercializing public housing, offering tenants the chance to buy their units at very low prices. By 1998, the government announced the end of public housing altogether. While in 1979 virtually no one owned their home, by the early 2000s, 80-90% of households in China owned their homes, with over 20% of households owning more than one.

So, where did it all go wrong?

In China, like any market, real estate prices are driven by supply and demand. External elements like inflation, government policies, and interest rates can also affect the balance. Although China is still a Communist country, the state owns the land where cities are built. However, in its 1988 reforms, the government separated land usage from ownership and gave local governments the right to sell land-use rights to private and state-owned enterprises. This became a major source of revenue for local governments, making property taxes unnecessary.

Many economists agree that the seed for the current housing crisis was planted in 1994 when Beijing overhauled its tax system. The central government wanted a bigger cut, which left local governments scrambling to find new revenue streams. Land-use sales became a key source of income.

The demand for housing in the 1990s skyrocketed as 150 million Chinese citizens moved into urban areas. Local governments profited massively from selling land-use rights, and by 2010, land revenue made up nearly 70% of local budgets. The housing boom helped fuel China's rapid economic growth, with property values reaching $60 trillion at their peak.

But the market wasn’t sustainable. In China, homebuyers are often required to advance large sums to developers before construction even begins. Developers like Evergrande used these advances to fund new projects. As long as property prices kept rising, the system worked. But when debt grew out of control, cracks began to appear.

Chinese President Xi Jinping recognized this and in 2020 introduced the Three Red Lines policy, capping the amount of debt developers could accumulate. Companies like Evergrande failed to meet these criteria, causing a funding shortfall for ongoing projects.

Demand for housing also dropped after the COVID-19 pandemic. Millions of people left urban areas, young Chinese faced high unemployment, and housing affordability became one of the worst in the world. China's aging population further contributed to declining demand.

By the end of 2023, home prices had dropped to their lowest point in a decade, shaking investor confidence. While the government and developers have tried to manage the crisis, as of January 2024, the real estate sector still carried $8.9 trillion in outstanding debt, representing 25-30% of China’s GDP.

What happens next in China’s property market will be closely watched, not only by its citizens but by the world.