A reverse Phoenix in China real estate

Washington Post:

The real estate market in Phoenix Island, a development project in the Chinese island province of Hainan, was so inflated, so outrageously expensive and unsustainable, that it became known as the Dubai of China. With its palm tree-lined streets, glimmering high-rises and ostentatious sports cars, it even looked a little like Dubai. And now, also like Dubai but maybe more in the vein of south Florida, the Phoenix Island real estate market that drove so much local economic growth has imploded.

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If the national real estate market collapses in China, it would be disastrous not just for China but for the entire world economy, risking a third wave of the global crisis that began with the U.S. financial collapse and worsened with the Euro crisis. Is Phoenix Island an outlier, a crazy market so extreme that it tells us little about China? Is it the start of a major but recoverable setback? Or, in the worst-case scenario, is it the beginning of the end for China’s astounding 20 years of miraculous economic growth?

In some ways (but not all), China is even more exposed to the dangers of a real estate collapse than America was. Washington Post business reporter Jia Lynn Yang pointed out last fall that urban housing stock constituted 41 percent of Chinese household wealth of 2011. The number was 26 percent in the U.S. In other words, Chinese families tend to invest almost twice as much of their money in urban real estate than do American families. So, if you thought Americans were hit hard when that real estate suddenly lost value, it could be even worse for Chinese, who also tend to put much more of their earnings into long-term investments than do Americans. That said, it would also take a bigger drop in prices for the market to collapse, as Chinese buyers tend to put down larger down payments.

And here’s the really scary number: 13 percent of Chinese GDP in 2011 came from real estate investment. 13 percent! If that investment stalls abruptly, as it did in Phoenix Island, the rest of the Chinese economy could follow. That could cause political instability in China and, much more certainly, would set back the global economy.

The problem is that the Chinese tend to put their money in real estate because they perceive it as a safe and reliable investment. This drives up prices, which leads more Chinese to invest, which drives up prices more. But because people are treating housing as an investment, the market is artificially inflated. People buy apartments but don’t live in them. One day, it’s possible that Chinese consumers will wake up and decide that those investment apartments aren’t such safe investments after all, or maybe they’ll just need to free up the cash they used to buy them, at which point they’ll want to start selling. That will lead prices to drop, perhaps catastrophically. If you’re a standard Chinese family with 41 percent of your money tied up in real estate and that real estate loses more than half of its value, as it did in Phoenix City, then it’s like a whole bunch of your money just disappeared.

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That last quoted paragraph reflects the pre bubble US view of real estate in several markets.  Phoenix Island is not that unique.  There are several "ghost" cities in China where huge housing developments sit empty as well as the attached mall properties.  The units are owned by "investors" from other areas who have essentially bought on spec.  BTW, the picture that accompanies this story at the link above does not suggest Dubai to me so much as repetitive chubby dominoes looking ready to topple.

What China has done is turn real estate development into a substitute for economic growth rather than allowing growth to push the real estate market.  It shows a rather naive approach to capitalism.