Resist real estate mania: Lessons from the Chinese property meltdown

Many people are fascinated by investing in real estate. The typical middle-class dream is to buy three houses: One to live in, one for a child, and one as an investment. Land enthusiasts say “the thing about investing in land is that they aren’t making any”.

The case for land investment, however, is a bit dubious. There aren’t enough people in India to use the land area. If we generously assume each individual uses 100 square metres totally (across residential and commercial), the land required for the full population of 1.4 billion people is 4.2 per cent of the Indian land area. There are not enough people in the country to utilise the enormity of India even when we have budgeted a total land use of 4,600 square feet per family of four and a floor space index of only one.

Most adults in India were taught about the problem of excessive population growth in their childhood. But there has been a sea change in Indian fertility. The total fertility rate (TFR) has dropped from six in 1964 to two in 2022. We do not know enough about the sources of this decline to make projections, but something remarkable is afoot. At every stage in India’s history, the demographic transition has happened at a bigger pace than projected. The southern states have TFRs lower than Germany’s. We should say: The thing about investing in land is that they aren’t making enough people.

For personal financial thinking, it’s good to remember that in the past 20 years, the Nifty has gained by about 26 times. It is diversified, transparent, and liquid while real estate is not. Some of the excessive focus on real estate investment comes from households that are uncomfortable with listed firms, accounting data, exchanges, and depositories. One household at a time graduates to equity investing, and this induces a structural headwind against real estate prices in the future.

At a deeper level, consider a car. Can a car have a prce appreciation? That’s a silly idea because any increase in the price of a car will just induce a supply surge. Once we break free of the idea that land is scarce, real estate is just a pile of bricks, steel, and glass. Any price surge will kick off a supply response, which kills off the possibility of sustained price appreciation.

This is more than just a question in personal finance. Real estate mania can exert important adverse consequences for entire economies. The accent on real estate is one ingredient of the failure of the China model.

From the early 1980s, Chinese households over-emphasised real estate. China never got a great period of building financial markets, as happened in India during 1992-2017. Chinese households were burned repeatedly when they tried to diversify into financial assets, and retreated into real estate. Global diversification for households was blocked by the government, which intensified investment in real estate. Policymakers participated in the real estate game with interlinkages into city financing. The Chinese policy philosophy is one of control, and such desires of policymakers led to repeated episodes of “stimulus” for the economy through waves of real estate financing.

For decades, thinkers called out the problems of real estate mania, but most people just focused on immediate profits. In time, things soured. The average household has 1.5 houses, and the demographic outlook is worse than what we face in India. Vacant houses in China are now way beyond the (troubling) Bombay levels. There are entire ghost towns in China, filled with vacant real estate. All parts of the real estate game — investors, lenders, developers, governments — are facing adverse consequences and the real estate sector is holding back the economy. The one thing worse than a rapid bankruptcy process (that would impose massive losses on lenders and households) is a slow one, where there is a drag upon the economy for years. In China, the problems of real estate are now a dark cloud on household sentiment.

These ideas have important implications for policy reasoning in India. We did well in India with a period of high capability in financial policy and institution building, which gave a strong foundation of an equity market, derivatives trading, foreign investors, etc. This created a gradual process of households learning how to operate in financial assets, gradually stepping out of the real estate ways. We trifle with financial-sector development at our own peril.

The terrible home price to income ratio emanates largely from urban policy. The best environment for the people is where rental or purchase prices of real estate are low. The people should be able to easily afford low-income housing at the 10th percentile of urban income. When the rental cost on the household budget is low, wages will go down, so firms will face lower costs and obtain greater competitiveness on a global scale.

To get to this, vast areas of land should go into vertical development, creating a flood of supply. This would give low purchase or rental prices. An array of policy limitations today holds back the supply of real estate. Policymakers must reverse these, creating conditions for a vertical and horizontal expansion of cities. China’s example shows the importance of healthy mechanisms of urban financing, ie a slice of goods and services tax to the city and property tax, as opposed to linking city finance to a hoped-for real estate boom.

There is a connection for this approach into financial policy. The stance of financial policy must not be to prevent lending against the field of real estate. It must be to support the financing that induces ample supply, which will keep real estate prices down. This includes removing restrictions against foreign real estate developers and foreign financing for real estate development. Capital controls on outflows must be eased so that households can diversify into global assets, which will help diminish the attraction of investing in real estate in India.

The writer is a researcher at XKDR Forum