Welcome to Shanghai, China, the financial capital of the country.  It is also a hub for commerce, culture, industry and tourism.  Shanghai is a major [...]]]>
The Chinese real estate experience in the past few years has been one of growth, increased growth and now, recently stabilized house prices.  Here we give a history of those years.

Welcome to Shanghai, China, the financial capital of the country.  It is also a hub for commerce, culture, industry and tourism.  Shanghai is a major player in the international market and has the largest shipping container port in the world.  A first time buyer looking for a home near Shanghai would not find one they could afford within an hour’s commute of the city. It is one of the most populated cities in the world, but here we can study in great detail the Chinese experience.

Previously, we spoke about China’s success in creating manufacturing capacity, and with it the creation of better jobs and increased wealth. The key to their success is that their currency, the Yuan (Renminbi) has been pegged artificially lower than its true market value, pegged to the U.S. Dollar.  This creates a situation where Chinese goods look more attractive to U.S. consumers than domestically produced ones. Chinese factories get more orders, and have an opportunity to grow at the expense of U.S. producers.  The market turmoil of 2008 was a symptom of the global economy slowly adapting to this great transfer of wealth from the United States to China.  The realization that the U.S. has lost its greatest source of revenue, that is the discretionary spending of the now waning middle class.

This growth has fueled the Chinese economy, which naturally has caused corresponding increases in the value of real estate. China has become awash in money from investments, as well as income from their trade surplus.

In early 2009, world markets were coming to terms with failed banks like Lehman Brothers and government bailouts of corporations.  General Motors, a former industrial powerhouse was one of many massive corporations that were of concern.  Fears of what could happen under a cascade of failing enterprises touched everyone.  Even China was not immune to the crisis.  They injected over 500 Billon U.S. dollars into their economy in the form of stimulus, and lowered their benchmark interest rate in order to protect their economy, just like everyone else around the world. You had a robust manufacturing, low interest rates, abundant cash flow, great growth potential, and favourable exchange rate, everything was going China’s way, of course there would be tremendous growth! Economic growth that made its way to real estate prices too.

In 2009, the average home price in the largest cities of China increased 3.9% some of those cities saw 1% increases in a single month.  By December of 2009 there was concern that owning property was becoming out of reach of ordinary Chinese people and there was a real fear that there could be a real estate bubble forming.  The government soon created a new restriction on the buyers of second homes.  Buyers would have to come up with a down payment of 30% for any home over 90 meters square and a 50% down payment for any home under 90 meters square.  The ability to apply for a loan for a third home was suspended.

Government Corporations wanted to get in on the money that was being made in Chinese real estate.  Companies totally unrelated to the industry began sprouting a real estate division and then developing residential complexes.  Shipbuilders, oil companies, chemical companies, defense contractors, telecom companies, with no experience, with their huge cash reserves began bidding against each other for vacant land that wasn’t even in a highly demanded area.  This poorly contrived system eventually resulted in the construction of homes that still are vacant, cities that are over built. In some cases the builder would build the residential and commercial buildings of a brand new city and also all the infrastructure like airports. These new cities had such a low population that businesses there would have no hope of developing a customer base to support the various enterprises. Thanks to these bidding wars, in 2010, the average home in China increased 10.3%

In January 2011 Shanghai, and Chongqing started charging a property tax to dissuade ownership in these heavily demanded cities.  They also raised the benchmark interest rate three times. However, the one policy that I believe is the true cause of China finally being able to reduce the high growth has to do with their banks ability to lend money.  They increased the amount of money the banks have to keep on hand out of total deposits.  This policy reduces cash flow in the economy because it reduces the amount of loans the bank can issue.  This one policy more than any other, in my opinion has finally slowed Chinese growth, but it does so at the expense of private enterprise. Banks must now keep 21.5% of all the money they receive from depositors on hand and cannot be used as a loan.

This begs the question: is the result worth the price? It may be that this policy hurts the Chinese economy.  Many businesses require loans, loans that they could only get at private lenders with high interest rates (10% per month!)  Once the owners realized they could not keep up the loan payments, they decided to close their business to escape these loan sharks.

The future for real estate in China: You will see very little to no growth while the restrictive bank policy exists, but the government can remove this at anytime, and we will have the booming, growing China back.  The one thing that China has in its future is a growing middle class that will lead to a corresponding growth in the economy and also real estate.  The government cannot legislate its way out of that.  If they want to slow their growth I would float their currency a bit higher, not too much, and find a balancing act with a lower bank deposit rate.  Slower cash flow will only impede regular Chinese people with their private enterprises that help the economy be more efficient.  They need to let private enterprise prosper if they want to grow their middle class.  Tight money does favour the government corporations, but that is not where the future of China is.  It, like in all nations of the world rests in the hands of the middle class.

· Maximum Mortgage Amortization periods will be reduced from [...]]]> Today Canada’s Federal Finance Minister Jim Flaherty introduced new restrictions to be placed on mortgages insured by the CMHC. (Those are mortgages where the homeowner contributes less than 20% of the purchase price as a down payment.) These new rules will take effect on March 19, 2011.

· Maximum Mortgage Amortization periods will be reduced from 35 years to 30 years.
· On refinancing, you can only borrow against 85% of the value of your home. (Down from 90%)
· Home equity lines of credit will no longer be covered.

The Finance Minister said the reason these changes were necessary was to reduce rising levels of consumer debt. The Governor of the Bank of Canada, Mark Carney has raised similar concerns in his regular statements.

So What’s Going On?

Economic troubles in the United States have forced the U.S. government to print dollars in order to meet financial commitments and to free up money to boost their economy. The side effect of this is that when you put more U.S. dollars in circulation, it weakens the value of the U.S. dollar. This reduction in value has had serious repercussions around the world. In Canada, one of the effects is that the Canadian dollar has strengthened in value against the U.S. Dollar making our exports less attractive to them. Since they are the biggest consumer of our products, this impairs our economy. U.S. products look more attractive to us because of their relative lower price. For example, right now the Canadian dollar is actually worth more than the U.S. dollar it is trading at $1 CAD = $1.01 USD and many Canadians tell me they are interested in investing in U.S. real estate rather than Canadian properties.

It is with this climate in mind, that the Bank of Canada and others in our government are examining Canadian debt, the dollar, international trade, unemployment, inflation and other important components to balance all these factors to make sure our economy remains stable.

Look at the low interest rates we have in Canada, but contrast that with our equally low economic growth. This highlights that low interest rates are not enticing Canadian business to invest. This is a problem.

Canadian consumers are buying with cheap money, choosing to pay later, driving up debt loads. Every dollar that a Canadian receives as disposable income (that is money not allocated to necessities of life like shelter, clothing and food) they owe $1.48 ! This situation is unsustainable, and means in the future we will see increased defaults on debt. This second problem is caused by low interest rates. However, the Bank of Canada cannot raise interest rates to combat this problem.

I was one of those people who believed that once interest rates rose significantly, people would realize they paid too much for their homes and a correction in home prices would begin. It will not happen this way because the Bank of Canada cannot raise interest rates dramatically.

Lets consider the downward pressure the U.S. & Canadian Dollar exchange rate is having on Canadian exporters to the U.S. If the Bank of Canada raised interest rates dramatically, international investors would start putting their money in Canadian banks. This would further increase the value of the Canadian Dollar and put even more pressure on those same exporters damaging our economy.

So What To Do?

The government can’t raise interest rates and they can’t lower them. So they are using these new rules, specific and targeted against a problem in our economy. Some have criticized that the rules are limited in scope and don’t really have much effect in the market place. This is for a reason. They are using these rule changes, like they used to use changes to the interest rate. They will make slow, gradual, incremental changes to bring increased stability to the economy. Slowly, they will make consumers less able to take advantage of low interest rates.

For those of you who still believe the goal of financial regulators is to create economic growth, please think again. If that were true, they have failed miserably. They are not aiming for growth; they are aiming only for stability. So far they have succeeded. Hopefully, these new rules will bring them one step closer to resolving the growing debt we are carrying.