Shanghai property about to pop?

Shanghai''s complex residential market comes under pressure.

An unusual aspect of the Shanghai property market is that residential house prices are within striking distance of the richest countries of the developed world, while the average per capita disposal income (defined as gross household income minus tax and social security contributions) of Shanghai is around $1000 dollars per year.

The average house price per metre in Shanghai is around $600 per square metre. So a typical newly-constructed two-bedroom, 100 square metre flat going for $60,000 is the equivalent of 60 years of disposable income.

The gulf between income and price is a striking disconnect that is causing some analysts to see the government's recent tightening of the credit taps as the trigger for a 'multi-year decline in prices of up to 50% in top end housing," according to one consultant, whose firm views on city corruption and incompetence make him reluctant to reveal his name.

Shanghai is a city whose property market shows many contradictions.

It is a city where 65% of the population already owns at least one property. Yet after the huge burst of house buying in the late 1990s and early this century, the rocketing nature of house prices, which have doubled on average in the past two years, is making it almost impossible for normal white collar workers to get a foot on the property ladder. Shanghai property is now more expensive than Beijing, despite having a lower per capita income and a more liquid and sophisticated market.

"The first-generation of house buyers were given company housing at a fraction of its original value by their work unit, as well as generous tax breaks. This helped fuel the bubble, but is making it difficult for the next generation," ponders one observer.

Others are concerned that demand is now beginning to decline, with the number of second hand transactions down 50% in May of this year on the level for March. Another possible sign of decreasing demand is the rumour that huge amounts of speculative money from the notoriously speculative city of Wenzhou has been leaving Shanghai ever since last year in search of easier pickings.

Nor is demand likely to pick up amongst local residents, according to some.

"Everybody that could possibly buy a flat has bought one, or several, and many people that shouldn't have bought a flat have done so as well," adds one long-term Shanghai consultant.

The Shanghai market was given tremendous impetus between 1999 and 2003 when the city government took the extraordinary step of permitting the money spent on a flat to be completely written off against income tax.

"That was at least three years longer than could possibly have been justified," says one analyst, adding that it was in essence a huge transfer of the city's tax income to the developers.

The effect was of course to encourage anybody with the income to binge on buying properties.

As a result, many observers see the property market as exhibiting the classic signs of a bubble which is now being pricked by the government's new austerity programme.

Sam Crispin of Crispin Property Consulting has mixed feelings about the market. Bullish on long-term prospects, he is concerned the authorities are utilizing excessively crude methods to regulate the market.

"The single biggest worry is government intervention," he says.

The government has introduced new regulations including a 50% cap on the amount of one's monthly salary that can be paid towards a mortgage and limits on acquiring additional properties.

One method by the banks is brutally simple. When contacted by a prospective buyer for a mortgage, the bank's assessor knocks 20% off the value, even if it has been freely agreed by the two parties, and offers a much lower mortgage.

"These measures don't discriminate between types of buyers - everybody gets clobbered and the market tanks," points out Crispin.

The quality of city officials, especially the older generation, as well as the efficacy of inspectors from Beijing, are also under question.

Officials are often poorly educated, with little understanding of the subtleties of the real estate business. Some observers say these are being slowly phased out and replaced by technocrats. Still, some of the more bizarre aspects of the property market have not yet been revised, despite some huge scandals occurring in the nexus between city officials, bankers and developers.

"Very little has changed despite the scandals. You still have the situation where the city doesn't have to accept the highest bid when selling government land, and lots of 'brown paper bag' transactions whereby well-connected developers get land at a below the market rate," says one observer.

Another phenomenon, which could undermine Shanghai's image as the best-run city in China is the growing traffic problem, which many see as being a by-product of the frantic housing market. Shanghai has just 300,000 cars compared to Beijing's two million, yet the traffic situation is getting out of control. It can only get worse if the central government prevents the city government from controlling the flow of traffic through selling off licenses for as much as $5000 apiece.

Shanghai is different in layout to Beijing, having much more of a modern, European feel about. However, along with the absence of Beijing's still-Stalinist outline, goes a much higher degree of concentration which make the city in some respects more similar to Calcutta than Paris.

A characteristic of the Shanghai housing market, which encourages speculation is the lack of long-term financing.

Bank loans are typically granted for five years, and only rolled over if the developer has got unusually good relations with the bank - since the government tries to keep financing at that tenor.

The result is that developers try to move in an out in five years maximum. It also gives rise to the pre-sale phenomenon whereby developers boost their financing by selling the properties before they are built. Often, the rights to buy become tradable themselves, adding to the fever.

Buyers used to make a certain profit by snapping up the properties at the pre-sale stage and selling them on completion to time-pressed owner-occupiers.

Pre-sales were originally sold at discounts to the prevailing market price to remove the need to for expensive marketing campaigns. But that situation has undergone a 360% about turn in recent months. Now, pre-sold houses are often sold at the same level as the prevailing market price and high pressure marketing techniques have played a full part in whipping up a bubble atmosphere.

What ultimately kills off a bubble, say experts, is when the first-time buyer is priced out of the market. Without the support of that vital segment, the pyramid breaks down and momentum is lost. The first-time buyers may initially mortgage themselves to the hilt to achieve their dream of owning a house. But sooner or later as the bubble builds up and prices soar it becomes impossible for them to buy.

It is this non-speculative middle class element that will suffer most when they market reduces them to negative equity. Negative equity is disastrous for property markets, say experts, since it makes impossible for momentum to get going again as nobody can trade up the housing ladder. That is what happened in Hong Kong during the go-go years previous to the Asian Financial Crisis and the dotcom boom and many households still have not recovered.

Yet is the doom and gloom justified? With up to $50 billion of FDI pouring into China every year, much of it to Shanghai and its environs, booming local and foreign factories raising salaries, as well as a tide of rural and urban migrants lapping against the city walls, it seem unlikely demand will remain suppressed for long.

"The times of making easy money are gone," concludes Crispin, "but there are too many factors in favour of this market to ignore it."