Why Shanghai Real Estate Is The Most Obvious Bubble Ever

The whole world felt the reverberations of China imposing leverage limits on its banks. Regulators there are clearly freaked out by the heat of its economy.

Meanwhile, Jim Chanos and Thomas Friedman are going back and forth about whether China is a bubble, and whether there's money to be made shorting it.

So we thought we'd adjudicate the question.

Our answer is yes, China's real estate is the most obvious bubble ever. More obvious than the Dubai bubble in fact.

Property values are rising dramatically.

Even residents find it peculiar:

Gloria Gu paid $483,000 for an apartment near Shanghai’s financial district so her 3-year-old son could attend one of the city’s best kindergartens. Six months later, a similar place in her building sold for $615,000.

“Prices are way past reasonable,” said Gu, 31, a food company manager who bought her three-bedroom, 140-square-meter (1,507-square-foot) apartment in the Pudong area in May. “The market is too good to be true.”

Buyers are afraid they'll "Miss the boat".

Borrowers are maxing out all available lines of credit, fearing that they might miss out on this extraordinary opportunity. Luo Yan and her husband took out the maximum amount of money possible according to China Daily:

Thirty-year-old Luo Yan and her husband raced to complete the purchase of a three-bedroom apartment in Shanghai with the help of an 800,000 yuan ($117,000) mortgage. The amount they borrowed was the maximum they qualified for.

"I am afraid that if we don't do something now, we will certainly miss the boat," Luo said.

Joe Zhou, research head at property consultants Jones Lang LaSalle, said in the following months, "we expect house prices will remain at a high level, bolstered by increasingly strong demand and limited supply."

Image: Flick

Prices are way out of whack compared to global standards.

Buyers feel they can confidently own a home no matter the cost. Even when the numbers look deadly:

One clear clue (regarding the rising real estate prices in China) is that the average price-to-income ratio in Beijing has reached 27:1, five times the world average, according to data from the Bureau of Statistics of the Beijing Municipality. In addition, the average price-to-rent ratio neared 500:1 in the city, far above the international alarm threshold of 300:1, which sends out a clear signal that the foundation of the real estate boom is losing stability.

Image: Flickr

Incomes can't keep up with rising property values.

Home prices are outpacing incomes, which smells a lot like the U.S. housing bubble:

Statistics from Goldman Sachs showed that over the past six years, housing price hikes have outpaced income rises by 30 percentage points in Shanghai and 80 percentage points in Beijing. In Beijing, the housing price of per square meter is as much as a resident's seven months' salary on average.

Image: Flickr

Lending has been growing like crazy, fueling the bubble

While every other country is struggling to recover from the recent economic crisis, China's economy is charging ahead

Michael Pettis: Next year we will almost certainly see growth of over 8%, and the total amount of new lending will be determined by whatever credit expansion Beijing requires to get there. This means that the external environment, the increase in trade tensions (the recent “Buy Chinese” provisions announced for government procurement will almost certainly make things worse), and the impact of inventory build-up, among other things, are going to determine what amount of domestic credit expansion we will need.

Since no one can accurately predict any of those things, it is pointless to predict loan growth next year. One thing that will almost certainly happen, as my friend Logan Wright told me yesterday, is that banks will rush to lend early in the year, so we should be prepared for shocking new loan numbers in the first quarter which will moderate quickly over the rest of the year.

Image: AP

There are also demographic factors.

Due to the shortage of women, men in China feel they need to buy a home in order to get married.

(Picture via Flickr user Zingaro)

It's not just about residential property. Commercial real estate is on fire too.

Despite fears of an imminent bubble, investors are still buying up commercial real estate properties. All the big banks are getting involved, as if the U.S. housing bubble had never occurred:

It's a reasonable point to ponder in a city where the price of residential property has risen nearly 20% over the past 12 months. But judging from the flurry of deals being done by some of the world's most sophisticated global investors, clearly not everyone thinks the boom has peaked.

Morgan Stanley Real Estate Funds teamed with local developer Shanghai Yongye Enterprise Group and two Singaporean partners in June, 2003, to pony up $90 million for a high-end apartment complex in downtown Shanghai called Jinlin Tiandi. In January, Macquarie Global Property Advisors of Australia paid $98 million to buy 95% of Xin Mao Tower, a 20-floor luxury office building. And in April, developer CapitaLand Ltd. of Singapore announced that Goldman, Sachs & Co.'s (GS ) real estate division, Whitehall Funds, had paid it $107.6 million for Pidemco Tower, a 24-story commercial building in Shanghai's central business district.

"The fundamentals in commercial property in Shanghai are very positive," says James Quille, CEO of Macquarie Global Property Advisers in Hong Kong. "And there is a well-trodden path in terms of how capital is structured and repatriated."

Image: AP

And people are burning themselves in protest of rapid development.

The drive to build property is so enormous and aggressive that some people have lit themselves on fire to protest forced land appropriation.

But it doesn't seem to be slowing anything down.

The indifference to this is classic moral amnesia.

Nevertheless, some are starting to smell a rat.

China could be the next Dubai, says Jim Chanos. Note that he has a pretty good track record of spotting bubbles.

China doubters are getting called idiots

(See Thomas Friedman in today's New York Times)

Goldman Sachs is starting to sell too

The bank just dumped some Shanghai property (Remember, these were the guys who even saw the US housing bubble popping!).

And of course, what would a bubble city look like without lots of interesting-looking buildings. Like this one

And of course a space-age one.

And this cauldron-shaped stadium.

We're even getting gaudy visions of what Chinese cities could look like.

Here's a rendering of what Shanghai will look like if it adds more giant, architecturally awkward towers. Dubai anybody?

Of course, there's the requisite shoddy construction.

Here's a hallmark of bubble real estate. The construction of buildings is total garbage.

The government is aware of the issue

The government is ostensibly trying hard to prevent a financial bubble, warning banks to increase their deposits and capital on hand in a bid to control lending.

They're also putting restrictions on property purchases. From The Washington Post:

"Any resident trying to purchase a second home in China will require a minimum 40% down payment, which isn't a half bad idea considering some of the deals cut here in the U.S. in recent years."

Image: Flickr

They can't do much since they're caught in huge a catch 22.

Those waiting for real change may have to wait awhile to get it. The Chinese government has no intention to substantially slow the pace of economic growth. Analyst Clement Luk of Centaline Property Agency Ltd.:

China’s leaders won’t make major policy changes because they are preoccupied with economic growth and social stability, overriding concerns that rising property prices are forming a bubble, said Clement Luk, an analyst at Centaline Property Agency Ltd. in Shanghai.

“The government is clearly in a dilemma,” Luk said. “It wants to address the surging property prices and concerns on bubble-bursting, yet it dares not take drastic measures for fear of hitting the market too hard.”

Image: Flickr

So it's obvious that there's a bubble. But the problem is..

Any bubble can go on A LOT longer than you might think.