China Real Estate Report Q1 2010

China's once-booming property market has experienced a difficult year. Signs of recovery now being seen across the market could also be signs of overheating as the enormous state stimulus package reignites speculation and contributes to overcapacity.

A glut of premium office supply in Beijing and Shanghai is likely to depress market conditions for at least the next 12 months. These conditions have led to a slowdown of office construction, as developers wait for demand to catch up with supply. Vacancy rates remain high, at above 20% for Grade A office space at the end of Q209. Occupiers, seeking to take advantage of the situation, have played landlords against one another, driving down rental costs.

This state of affairs might not last. October's economic data continued to support China's V-shaped recovery. Fixed asset investment (FAI) shows no signs of slowing down, rising by 33.1% y-o-y year-todate in October. Retail sales also accelerated, expanding by 16.2% year-on-year (y-o-y) from 15.5% in September. Overall, the data points towards continued acceleration in real GDP growth and we expect the economy to expand in excess of 10% in Q409.

While the government's massive stimulus investments are helping in some respects, they could exacerbate the problem of overcapacity in the medium term. With the authorities attempting to maintain a low unemployment rate through investing in labour-intensive projects, fixed asset investment (FAI) has also soared. FAI in the January-August period totalled CNY11.3bn, and was up by 33.0% y-o-y, with the August figure up 70.3% y-o-y. The government has warned recently that overcapacity, exaggerated by the stimulus measures, could create instability in terms of increased bankruptcies, unemployment and rising non-performing loans. The impact of rising bad debts in the banking system will also act as a drag on investment spending as loan growth slows sharply.

The housing market is showing signs of overheating. According to the National Development and Reform Commission, urban housing prices climbed in October by 3.8%, their fastest growth in over a year. On November 22 the newspaper of China's central bank, the Financial News, published an editorial warning that rampant speculation in the property market was inflating an asset bubble. It urged the government to scrap those elements of the stimulus plan that were contributing to this trend, for instance state support for downpayments and mortgage rates (see Real Estate Market Overview, below). In other words, as in other parts of its economy, China's real estate sector is unbalanced by the overbearing presence of the Chinese state. We shall be watching the sector carefully for signs of volatility in the coming months.