- Accelerated cleanup of distressed developers and other policies will help smooth the path to a smaller, more sustainable role in the economy
By Henry Hoyle and Sonali Jain-Chandra
Real estate has long been important for China’s economy, driving its rapid growth in recent decades and accounting for as much as 20 percent of activity. This reliance has, however, been accompanied by the buildup of significant risks.
Home prices became significantly stretched relative to household incomes in the decade before the pandemic, in part because consumers preferred to invest their considerable savings in real estate given the scarcity of attractive alternative savings options. Expectations of continued increases in home and land prices allowed property developers to borrow rapidly, with land sales providing crucial revenue for local governments.
More recently, the authorities have appropriately focused on containing risks and helping the sector transition to a more appropriate and sustainable size. They took resolute action to rein in excessive developer borrowing and other property sector risks after the start of the pandemic. Real estate activity has since contracted sharply, and most recently the authorities have aimed to boost rental housing, expand affordable housing, and upgrade under-developed urban neighborhoods.
With the property downturn in its third year, progress in downsizing the sector has been rapid in some respects. Housing starts have fallen by more than 60 percent relative to pre-pandemic levels, a historically rapid pace only seen in the largest housing busts in cross-country experience in the last three decades. Sales have fallen amid homebuyer concerns that developers lack sufficient financing to complete projects and that prices will decline in the future.
At the same time, key property sector vulnerabilities have yet to be addressed, pointing to ongoing risks to sustainability. Many developers have become non-viable but have avoided bankruptcy thanks in part to rules that allow lenders to delay recognizing their bad loans, which has helped mute spillovers to real estate prices and bank balance sheets. Home prices have also decreased only modestly in part because some cities have sought to limit price declines through rules and guidance on listing prices.
China’s housing market faces additional pressures in coming years from structural factors, in particular demographic change. The need for additional new housing will diminish in coming years as the population declines and urbanization slows. Large public subsidies in the previous decade helped millions of people move to newer housing from older buildings lacking modern amenities. Such demand will likely be more limited as depressed land sale revenues have tightened local government fiscal constraints and fewer residents live in older housing.
Facing these cyclical and structural adjustment pressures, housing investment is poised to fall further and likely remain subdued. We recently projected new real estate investment into the medium term based on several scenarios for the evolution of fundamental demand as well as the impact of the overhang of inventories and other supply-side pressures. In these scenarios, our analysis shows, real estate investment would likely fall 30 percent to 60 percent below its 2022 level, rebounding only very gradually. This would be comparable to major housing downturns in other countries with similarly sizable slowdowns in starts.
Increases in spending on affordable housing and urban redevelopment that are planned this year could help offset some of the investment decline. But this spending is not likely to sufficiently reduce the large overhang of housing inventories held by troubled developers.
A shorter and smoother transition for the real estate sector is achievable, however. Allowing more market-based adjustment in home prices and quickly restructuring insolvent developers will help to clear the overhang of inventories and ease fears that prices will continue to gradually decline. Rules allowing banks to avoid recognition of bad loans to developers should be phased out.
The authorities should also support viable developers and tighten rules to prevent future build-ups of risk. Insuring homebuyers against the risk that developers fail to complete purchased homes could help restore confidence and ease sales pressures for developers. Stricter escrow rules for the use of presale financing would also help improve legal protections for homebuyers. A nationwide property tax and improved pension or other saving options would help reduce households’ need to invest in housing. Fiscal reforms that close local governments’ structural mismatch between revenues and spending obligations will also be needed to reduce their reliance on land sales and property activity.
Henry Hoyle is an economist in the IMF’s Asia and Pacific Department.
Sonali Jain-Chandra is the IMF mission chief for China.
