The Chinese government has been tightening the screw on the domestic residential market. But has it worked? James Buckley finds out

In April 2010, the Chinese government introduced a series of intensive  monetary policies aimed at deflating the country’s  housing bubble and improving affordability. Over two years on, has the residential market moved past the crisis point that attracted global attention and anxiety?

Over the past couple of years, the government’s efforts to improve affordability seem broadly to have been successful, as house prices have fallen while incomes have continued to rise.

In China’s 35 biggest cities, the price-to-income ratio peaked in 2010, exceeding nine. It is now heading down to its lowest-ever level and by the end of 2012, the affordability ratio could drop below 7.5. The highest affordability ratios in 2010 hovered in the high teens and surprisingly were not recorded in the tier-one cities of Beijing, Shanghai and Shenzhen. In addition, popular holiday and retirement destinations such as Sanya, Zhuhai and Hangzhou became severely unaffordable. It was these ‘unaffordable’ cities, that account for a quarter of national sales that made the headlines.

On a nationwide basis, however, China’s affordability in 2010 suggested that there was no nationwide property bubble with the affordability ratio at 5.5, lower than Australia’s and only a little higher than the UK’s.

So what is a fair affordability benchmark in China? The traditional measure of housing affordability, which compares average house prices to household incomes, can make China’s housing affordability look frighteningly high by developed country standards. The World Bank and United Nations view a ratio above 3.1 as moderately unaffordable and a ratio above 5.0 as severely unaffordable.

China’s high affordability ratio should be viewed with some important considerations in mind. First, headline housing price-to-income ratios for China are high because most housing sold on the open market targets a higher-than-average income household. Second, average incomes are probably understated due to poor reporting, especially for higher income groups, and, third, wealth transfers and hidden subsidies from the 1998-2003 privatisation of housing have boosted affordability. This also helps explain why China has been able to sustain rapid growth in housing sales without a dramatic increase in leverage.

Based on the above factors, we believe a fair unaffordability benchmark in China should result in a price-to-income ratio of about 8.

Affordability measures based on mortgage payments can also look high. Based on a 2011 mortgage rate of 6.9%, up from 4% in 2008, and a 30% down-payment ratio, the monthly mortgage payment on an average house would be 60% of average income, up from 41% in 2008. However, in reality, mortgage payments are much lower because households generally make much larger down payments – often 50% in the major cities and there is a significant proportion of housing that is paid in full in cash. 

China’s urban population has grown significantly, increasing by 296 million people between 1998-2011, according to CEIC. About 45% of this increase comes from rural hukou holders who live and work in the cities for more than six months of the year (the threshold to be counted as resident by the census). It is usually very difficult for these people to achieve the legal status and rights of urban residents. They do not live fully urban lives and tend to have lower-income jobs and are segregated from the rest of the population, living in extremely dense collective housing at their place of work or in slums. Few can afford to rent a modern apartment and almost none will own their own apartment. It is this group of people that remain locked out of urban society and no closer to being able to afford their own home.

The government-led boost in the construction of low-cost housing since 2009 will gradually help to address the shortage of suitable homes for migrant workers. The 12th five-year plan called for 36m affordable houses to be built by 2015, of which 6m have already been completed and 14m are under construction.

Are we past the crisis point? Given the central government’s diverse array of policy instruments, which allow it to micro-manage the housing cycle, fears of a crisis were unrealistic.

In 2012, the policy tools that were tightened in 2010-11 are being relaxed at the margin as the balance of concern shifts to supporting economic growth. As house prices become more affordable and policy continues to support first-time buyers, we expect market sentiment to improve and sales to pick up towards the end of 2012.

James Buckley is executive director and fund manager at Tan-Eu Capital