Global Real Estate Ups and Downs

Along with the very modest global economy recovery, most developed countries around the world have started to see their housing markets stabilize or, at least, decline more slowly than past quarters. Most emerging markets, on the other hand, especially in Asian cities, have experienced rapid acceleration of housing prices. This article in the Financial Times (House prices face rollercoaster ride) with this compelling graphic shows the two-track housing markets in these countries. China’s housing prices grew faster than anywhere else – hardly surprising – at a growth rate of 68% in Q1 2010. Major cities in developing countries, such as Beijing, Shanghai and Mumbai, all experienced housing prices increasing at at least 20% in Q2 2010.

While this surge is due in part to the global economy recovery and easing of concerns about deeper recession and continued credit crunch, local political and economic circumstances have much to do with it as well, most importantly the unflaggingly rapid growth in developing economies. Next, high rates of urbanization are driving floods of new immigrants to major cities, not just Tier 1 cities but also Tier 2 and 3, which drive unmet demand for housing and large housing deficits.

To complicate matters, land supply available for real estate development in these cities is often constrained by other factors. Local policies or regulations, underutilized government land or desirable, undeveloped land tied up by developers in land grabs leads to high land prices in cities, especially in the most central zones (see China to clamp down on land abuse nationwide in Reuters on land grabs documenting that in 92 out of 3000 cases, land slated for affordable and low-cost housing was used for other purposes).  This constrains the best development use of this land supply because a developer will require a higher hurdle return to compensate for high land costs. As a result, the supply of well and centrally located affordable or middle-income housing in these cities is often very limited relative to demand.

Strange indeed, then, that talk of a bubble keeps bobbing up. With the Central Bank and financial sector pullback on lending for retail real estate investors and (supposed) crackdowns on developers hoarding undeveloped land, the market is starting to respond with caution, driving average housing prices in Beijing down by 5.2% in July over June.

On that note, this fascinating NBER paper Evaluating Conditions in Major Chinese Housing Markets highlights exactly these downside risks of toppy real estate markets in developing markets. The authors point to the high implied capital gains necessary to justify the current low housing price yields, record high price-to-income ratios underlining lack of affordability, and eye-popping rates of capital value appreciation in the past several years (8 times increase since 2003). Underlining our point about land supply constraints, the authors highlight that land price increases are primarily to blame for this, as well as the complicity of the public sector, especially state-owned enterprises, whose role in bidding up land and hanging onto prime land is well known. This bedtime horror story ends up with a similar shock vis-à-vis the United States’ and other developed countries’ experience. Once investors start to adjust down their expectations of appreciation in capital values over time, the feedback to current prices can be swift and ugly, this model yielding “price declines of over 40% in markets such as Beijing.” This scenario, of course, doesn’t account for government measures to keep demand buoyant by shifting construction to affordable housing.

That said, with the concurrent movement of investment, factories and labor inland, real estate prices in Tier 2 and 3 cities continue to rise rapidly. India is in the same situation as developers find that the next rung of cities are attracting population faster than the Tier 1 cities, which are already busting at the seams with their deteriorating living standards. Developers have already recognized this for some time, focusing on smaller, growing cities as an opportunity to build with fewer environmental and political hassles and more robust demand.

A cautionary poke for the big bad city… artificial land supply constraints and weak regulation can dramatically limit the applicable business models for building in central urban districts, not just diminishing the availability of affordable housing for diverse communities but also cutting into cities’ competitiveness vs. other investment destinations (see this nice redux about India’s cities’ competitiveness at

This is a time bomb, not just for the real estate market, but also for the city and the citydwellers who live there. The time has come for a meeting of the minds between the private and public sector and between investors, developers and citizens. This pattern will only lead to ruin. Responsible property investment is not just about green building or fair labor standards. It’s also about developing with a mind towards larger goals than near-term profit, like transparency, economic development, affordability, livability and competitiveness.

What’s the business rationale for this? Well… let’s wait and ask the last developers in the market left holding the bag (or the half built project or the unmarketable luxury condos) if and when the bottom falls out.

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