Tag Archives: housing

[REVISED] Who Touched My RMB?

It’s always interesting to see how economic predictions and financial manipulations fail in China. The ridiculously high population/resource ratio turns China into a hungry giant that can easily overturn any rules: the Wall Street tycoons lost to Chinese housewives during the “gold battle”; Chinese government tried to stop the housing market’s craziness but ended up being one of the biggest obstacle to the success of taming the market. The list goes on and on.

And now it’s the RMB issue again. Bear with me if this topic is becoming increasingly boring for you. As the RMB’s behavior is totally going against the theory, it’s tempting to looking into the reasons behind all the weirdness.

Ever since the year of 2005, RMB has been appreciating internationally while depreciating domestically.

rmb_exchange_rate

Picture source: XE

rmb_inflation_rate

Picture source: Trading Economics

As explained clearly in this about.com thread, the value of a currency should be synchronized domestically and internationally. On one hand, when the exchange rate of RMB goes up, in theory, the demand of RMB will increase, leading to a decrease in the amount of liquidity, therefore the inflation will be alleviated, and eventually the value of RMB will go up. On the other hand, a higher value of RMB attracts investment from oversea, which will lead to a higher demand of RMB in the foreign exchange market and therefore drive up its exchange rate. However, historical data suggested differently: internationally up, domestically down. Why?

It’s a known fact that RMB was long undervalued in the foreign exchange market because of the government’s intervention. As Beijing gradually loose the leash, the exchange rate is bound to increase. So it must be the inflation, which comes from within the country, that’s causing the mismatch problem.

About the inflation, the government claims that “there exists measurement error that skews the statistical data”, and “the CPI data doesn’t fully reflect the reality”. Of course these official speech is too ambiguous to be believed, let alone the “CPI misreporting” can be interpreted both ways. As I see it, this inflation is due to the governments’ over-manipulation to the economy.

This manipulation is not the usual fiscal and monetary policy we’ve seen everyday. The level of governmental intervention in China is much higher than that. Since it’s difficult to explain this in theory, I’ll demonstrate it with China’s “land finance” example.

By constitution, all lands of China are owned by the central government. Therefore, Chinese government has control over the real estate pricing. To stimulate the local economy, local governments make huge spending every day, which almost always yields to budget deficits. To compensate the deficit, the most effective way is to sell the lands that are owned by the government. This is when things get crazy: since the government has control over the lands’ price, it can sell a certain piece of land at an extremely high price. And thanks to the heated housing market, there’s always a buyer. As a result, the price of houses almost doubles every year. House owners’ pockets are therefore inflated. The liquidity drastically increase in the market, and hence the inflation.

This kind of government intervention to the economy is not something foreseeable from the textbook, and the “land finance” is merely one piece of the puzzle. In a not-so-liberal economy, the government’s overexertion of its power to gain short-run benefit is clearly bringing problems to the economy. The mismatch of RMB value is one such example. What’s next? How to prevent these problems from happening in the future? Beijing needs to give better answers to these questions.

Mortgage Beginning to Thaw?

Mortgage lending, which was the main cause of the financial crisis of 2008, is finally making its comeback. The role it played in the Financial crisis of 2008 is that subprime loans were being made and mortgages were being securitized. The market became too saturated with these Mortgage-back securities, or MBS’s, and the market popped. The asset lost all liquidity and people lost their equity. This created a credit freeze. According to the Wall Street Journal, mortgage lenders are regaining confidence in the housing market. Standards are still high, but lenders are accepting lower credit scores and reduced down-payment requirements. The reason why banks are doing this is because they believe that lending to borrowers who do not have perfect credit or can pay large down-payments will help generate future profits.

At the same time, the Senate has proposed a new reform for mortgage lending. In a nutshell, the risk would be taken on by private investors, as opposed to taxpayers. A New York Times article mentions that the main purpose of the bill is to decrease government involvement in mortgage lending. It would promote private capital in this sector. The government would sell a secondary insurance on MBS’s. This way, the first loss would be taken by the private sector, and it would reduce the need for government intervention. The downside is that this means that borrowers will be subject to higher interest rates because private investors need compensation.

The Washington Post provides another reason why we should be optimistic about the housing market. Foreclosures with positive equity has been on the rise. In the third quarter of 2013, this was at about 24%. Today, it is at 35%. In other words, more than a third of foreclosures have positive equity. The article attributes this to timing. It is important to know that the process of foreclosure can take a long time. This can be a year, or even longer than that. During that time, prices can vary to a great degree at that time. Home prices have been rising sharply. This means that more and more people who foreclosed have gained equity during the foreclosure process.

What to make about all of this? It seems that the housing market has a bright future. We learned a lot of important lessons from the financial crisis of 2008. The bursting of the housing market taught us about subprime lending the hard way. The higher standards can help with the prevention of a crisis like this in the future. Housing prices are rising, therefore people’s equities are on the rise. This makes mortgage lending more attractive to lenders. Therefore, they are more able to earn profits. Furthermore, if there were to be a crisis, this new proposal in the Senate could be like insurance against it. The government would not need to making the same kind of bailouts that it did in 2008. Another housing burst would cause the same kind of budget deficit that we saw in 2008

China’s Wealthy Developments

In the growing economy that is China’s, many people are quickly getting very rich. As has been discussed on this blog in the past (for housing-bubble speculations), developers in China have been aggressively building homes/apartments for some time now. And many of these new constructions are quite luxurious and are targeting wealthy individuals. One developer that is doing exactly this, is Pan Sutong. And instead of offering just luxurious homes, he is marketing the idea of a luxurious lifestyle altogether. “Pan describes the lifestyle he’s packaging for China’s elite, based on fast horses, haute cuisine and fine wine.”

The project is taking shape at Fortune Heights, an “ultraexclusive” gated community in the city of Tianjin. This city is a 35-minute train ride from Beijing. The project will consist of 64 mansions, which will feature cellars stocked with first-growth Bordeaux, gold shower heads, and a views of the Tianjin Goldin Metropolitan Polo Club. Which brings in the most notable feature of the project: polo. As opposed to the popular apartment buildings which overlook golf courses, this project’s unique element will be the polo club it overlooks. It’s stocked with more than 200 top-quality ponies from Argentina and Australia. In January, the club hosts the Snow Polo World Cup, which fields top international teams. Pan acknowledges that polo is not a very popular sport in China, but emphasizes that this lifestyle is what wealthy people are looking to experience. He suggests that residents will enjoy looking out their window and watching the polo matches.

The mansions are part of a $5 billion monster project in Tianjin. The whole project spans 89 hectares (220 acres) and is expected to contain a 117-story office building, an upscale shopping mall, a glamorous theater, convention center, and dozens of apartment buildings. Four of the apartment buildings are almost sold out.

William Lin, an Internet entrepreneur based in Tianjin, says that “as the Chinese make more money, they will need to know which kind of high-class lifestyle they should follow.” This quote is particularly interesting and it reflects the tone of the article in Bloomberg. As China continues to grow, and many people continue to get increasingly rich, they are creating the wealthy lifestyle for other wealthy individuals to follow. And this makes sense when we consider the rapid growth experienced in China, relative to other countries. In the United States, there has always been a significant wealthy population that has been setting “examples” for other wealthy people throughout time. In China, perhaps this practice hadn’t developed until now, when wealthy people are looking to mold the idea of a wealthy lifestyle.

Apartments Could Be The Future Trend

While the housing market has continued to rise, there have also been a great share of new apartments being built for our generation. As college students begin to disperse around the country and graduate students leave their parents homes, there is truly a greater demand for rental apartments. In fact, it is at the highest level in at least four decades. The job market continues to show signs that improvements are being made as well. Not only are apartments higher in demand, but this shift is from many trends. Mortgage credit is still tight and many have high student-debt loans.

While this may sound great for the economy, we are also facing a problem: the supply of new apartments has not kept pace with this increase in demand. Along with young adults moving into these apartments, this generation is having fewer children and having them later in life so need less space right now. Also, at the same time, many of the baby-boom generation are moving into retirement homes. It’s is a mix of good and bad news for the housing market, especially for single-family-home construction and multifamily homes.

Some economists like Jordan Rappaport, an economist at the Federal Reserve Bank of Kansas city “projects that by the end of this decade, single-family-home construction will top out somewhere around its pre-housing-boom level of roughly 1.3 million new homes a year.”

The bad news for single homes is the fact that adults in their 20s may just decide to stay in their apartments for the many years to come. Devon Stansbury who is 24 and currently lives in Dallas is a great example. “I see [renting] for five years at the very minimum, maybe even up to 10. I am single, just focusing on my career. If something goes wrong here, maintenance will take care of it. And I feel safe.”

Not only will this be a problem for the housing market in the next decade, but there is a growing belief among architects and designers that all urban parking garages should be built into apartments. With more and more people trying to save money, whether it be on transportation and location, parking garages that are refurbished into apartments is possibly a great opportunity for the future.

“Cities can take the lead by rewriting zoning and building codes to require garage developers to meet the minimal adaptability requirements. As for the developers themselves, Fisher says they’ve been very receptive to the idea, perhaps because they see a less-car dependent future coming.” Although there are many scenarios presented here, there is still a while until we see many cities working on this.

But could this affect the future of the housing market permanently? Will there be a strong decrease in demand for housing in the next 5-10 years? As of now, we will see the normal trends and small shifts towards a higher demand for apartments. Hopefully the parking garage option and help the supply of apartments in the future.

(Revised) China’s Housing Market

There are many things that one can attribute to the recent curb in China’s growth. One of the most important factors is China’s housing crisis. This crisis is unlike any other. China has a housing surplus. One would wonder how this is possible in a nation with a population in the billions, but it is certainly real. The reason why is that there is a large amount of homes that are too expensive for the ordinary citizen. These homes can only be afforded by the wealthy. The New York Times mentions that the reason why prices are so high is because there is a strong demand and weak supply for homes in the urban areas, which is where these surpluses occur. Using the basic supply and demand model, one can see that the two ways of increasing the price level in a market are by decreasing supply (shifting the curve to the left) and increasing demand (shifting the curve to the right). When both of these are at work, the prices skyrocket. Once these prices are as high as they are, then fewer people are able to afford them, so the surplus is created by unused homes.

According to the Wall Street Journal and CNBC, this housing market is beginning to cool down. The sign of slowed growth is the deceleration of housing prices. This is a red flag for investors. They developed these properties, but now their values are decreasing. This means that these real-estate investors are losing money. Why should we care about Chinese real-estate investors losing money? The reason why their loss is important is that they most likely borrowed money from banks to make these investments. By selling the properties they developed, they make money and can repay their loans to the banks including the interest charged. When these investors lose their money, they are less likely to be able to repay the banks that administered the credit. If something like this were to happen to thousands of creditors, then the banking sector would suffer a devastating blow. These banks would not have money, therefore China would endure a liquidity decrease. This is obviously the worst case-scenario.

All of that being said, banks are becoming more cautious about who they provide credit to. Property development is a very risky area of investment. If a bank lends money for a faulty project, there will be two consequences: debt and more unoccupied homes.

China’s Housing Market

Recently, China has been showing signs of its growth slowing down. According to the Wall Street Journal, one of the most important and most recent signs is that the growth in housing prices has been decreasing. The New York Times reported on this too. According to CNBC, new home prices in 70 major cities in China saw decreased growth.

In my opinion, this could be very important. One of the biggest problems that China has been facing is that there is a surplus of housing, but prices are too high for them to be affordable. Ordinary people have a hard time purchasing homes. If this trend with housing prices continues, then the cost of living may become more affordable, and the housing market will be infinitely better than it is right now. At the same time, this could be negative for investors. With decreases in housing prices, then their returns will also go down.

It seems that if housing prices were to change, a lot of other changes would happen in the second round. It is important to know that a large part of a person’s net-worth is the value of their home. If these changes in housing prices were to occur, mortgages would need to be recalculated, therefore net worth too. A lot of Chinese homeowners could lose some of their net worth without doing anything. In other words, they would become poorer. This is another way of showing decreased returns for investors. A person who purchases a new home is an investor because a home is an asset. That person will most likely have to pay off a mortgage. Owning a home is the same as investing in it, so when its value decreases, then the owner is losing money.

The important thing to take away from this is that, despite the slowed down growth, China’s housing market is between a rock and a hard place. Right now, there is an oversupply of houses in China, but the prices are so high that ordinary people cannot afford them. If the prices were to go down, then investors would lose money and people would be losing portions of their net worth. It seems that those people would be worse off if the prices were to be more affordable to the ordinary people. If the prices were to remain high, those who cannot afford these empty homes would not be any better or worse off. This issue has many sides, and is very hard to find a perfect solution for

 

Who Touched My RMB?

It’s always interesting to see how economic predictions and financial manipulations fail in China. The ridiculously high population/resource ratio turns China into a hungry giant that can easily overturn any rules: the Wall Street tycoons lost to Chinese housewives during the “gold battle”; Chinese government tried to stop the housing market’s craziness but ended up being one of the biggest obstacle to the success of taming the market. The list goes on and on.

And now it’s the RMB issue again. Bear with me if this topic is becoming increasingly boring for you. As the RMB’s behavior is totally going against the theory, it’s tempting to looking into the reasons behind all the weirdness.

Ever since the year of 2005, RMB has been appreciating internationally while depreciating domestically.

rmb_exchange_ratePicture source: XE

rmb_inflation_ratePicture source: Trading Economics

As explained clearly in this about.com thread, the value of a currency should be synchronized domestically and internationally. On one hand, when the exchange rate of RMB goes up, in theory, the demand of RMB will increase, leading to a decrease in the amount of liquidity, therefore the inflation will be alleviated, and eventually the value of RMB will go up. On the other hand, a higher value of RMB attracts investment from oversea, which will lead to a higher demand of RMB in the foreign exchange market and therefore drive up its exchange rate. However, historical data suggested differently: internationally up, domestically down. Why?

It’s a known fact that RMB was long undervalued in the foreign exchange market because of Beijing’s control. As Beijing gradually loose the leash, the exchange rate is bound to increase. So the problem must come from within the country. About the inflation, the government claims that “there exists measurement error that skews the statistical data”, and “the CPI data doesn’t fully reflect the reality”. Of course these official speech is too ambiguous to be believed, let alone the “CPI misreporting” can be interpreted both ways. As I see it, the mismatch of RMB’s value is a result of human intervention, or rather, government intervention.

This is not the usual fiscal and monetary policy I’m talking about. The level of governmental intervention in China is much higher than that. A rather prominent example is China’s “land finance”. Since all lands are owned by the central government by constitution, Chinese government has control over the price of every piece of land. To stimulate the local economy, local governments make huge spending every day, which almost always yields to budget deficits. To compensate the deficit, one of the most effective ways is to sell the lands the government owns. This is when things get crazy: since the government has control to the lands’ price, it can sell a certain piece of land at an extremely high price. And thanks to the heated housing market, there’s always a buyer. The buyer acquires the land at a huge cost, and naturally he’ll transfer the cost to customers. Therefore, the housing price is driven through ceiling. With the housing market heats up, there comes hot money. With the price of houses almost doubles every year, house owners’ pockets get inflated. The liquidity drastically increase in the market, and hence the inflation.

This kind of government intervention to the economy is not something foreseeable in the textbook, and the “land finance” is merely one piece of the puzzle. In a not-so-liberal economy, the government’s overexertion of its power to gain short-run benefit is clearly bringing problems to the economy in the long term. The mismatch of RMB value is one such example. What’s next? How to prevent these problems from happening in the future? Beijing needs to give better answers to these questions.

From “Public Bathroom Debate” to “Human Factors”

Background: China Housing Bubble (since 2005): by the year of 2011, estimates by property analysts state that there are some 64 million empty properties and apartments in China and that housing development in China is massively oversupplied and overvalued, and is a bubble waiting to burst with serious consequences in the future [Wikipedia].

Like in all the over-heated housing market, buying a house in China has become a huge burden to average households. It can easily cost a middle class family 10 years worth of income to buy a 1,000 sqft apartment in big cities like Beijing. This craziness lasted for years and finally drew the central government’s attention by 2007. A seemingly powerful “affordable housing” program was therefore created.

However, the affordable housing was never really affordable for the low-income families. Because of the equally good construction quality and surprisingly low price, there’s a huge gap between the houses’ true market value and its regulated price. As a result, wealthier people regarded the houses as investment opportunities. The price was driven through ceiling again.

While the government had tried all policy tools, Yushi Mao, a widely respected Chinese economist, dropped a bomb onto the media. “Affordable housing shouldn’t have private bathrooms”, said Mao, “only houses with public bathroom can stop rich people from loving them.” These words drew a massive condemnation onto him almost immediately. The society blames him for not feeling compassion to the poor.

Despite morally suboptimal in its first appearance, Mao’s words made perfect sense as a direct solution to the problem. It was the false incentive created by the profitability of the affordable houses that attracted the wrong crowd. Since the public-bathroom-only apartments are less desirable by the wealthier people, they are valued much less than the normal apartments and houses. With a value matching its targeted price, the profit gap of an affordable house becomes much smaller. Therefore, the incentive of for-profit buying is eliminated. With little incentive, the wealthy people would no longer be interested in these houses.

A good lesson to learn here is that while less obvious in the numbers and graphs, psychological effects and social effects also plays important roles in economics. Small tweaks like “public bathroom” can sometimes make a huge difference as well. Instead of referring to the powerful financial tools and trying to kill a bug with nuclear weapon, sometimes it’s much easier and more effective to address problems with “human factors” in mind.

 

Growing Scarcity in Rental Housing

BN-BH993_VACANC_E_20140131124826

 

An article on Wall Street Journal introduced that after peaking at just above 11% in 2009, rental vacancy has fallen sharply in the wake of the housing collapse and recession. As we can see from the above figure, the rental vacancy rate has been decreasing during 2012 and 2013. The situation seemed to be worsening as the rental vacancy rate in Q1 2013 was almost the lowest since 2006. What could we tell from this? The decreasing rental vacancy rate would increase the rental prices, leading to the decrease in households’ disposable income, and also making more people considering of buying houses.

Firstly, as the rental housing becomes more scarce, the rental prices would rise. From the figure below, we see that the the slope of rental price is sharper after 2011. The median asking rent for vacant units in October through December was $746, up 3% from $724 a year earlier. This is because the higher demand and tighter supply of units are lifting the house rental price up. In this situation, landlords have the most benefits that the rising house rental price may be greater than the house depreciation. fredgraph (32)

 

Secondly, the rise in rental housing would also decrease households’ disposable income. A separate report from the Commerce Department Friday showed disposable income, adjusted for inflation, fell 0.2% in December from November, marking the second drop in three months. When spending more on house rent, families have less money left to save or to spend for other usages. Students or new grads would be affected most because they are living separately from their family houses. In addition, the families that could not afford buying a house would also suffer.

Thirdly, when people notice that the rental payment increases, they will consider to buy instead of throwing a large amount of money paying for the rent. Why is it smarter to buy rather than to rent? Unlike rent, a fixed mortgage can’t go up (even if inflation does). Moreover, mortgage rates are quite low recently, therefore, lock in a low monthly payment will protect the family from paying an increasing amount of house rental payment. In addition, homeowners can take tax deductions that they can also deduct eligible expenses (for example, certain energy-efficient improvements) and some cases can avoid federal taxes on earnings from the sale of a home.

In conclusion, the decreasing rental vacancy rate would life up the rental prices, leading to the decrease in households’ disposable income, and also making more people considering of buying houses.