BRR Network member Edward (Ned) Hill recently spent some time touring China and reports back from Guangzhou, with his colleague Haifeng Qian. Their travels took them to South China University of Technology in Guangzhou, Tsinghua University in Beijing, and Jilin University in Changchun in late April. Here he discusses how one city in China grapples with the press to develop amid entrenched land-use regulations and property rights.
We were not alone in our China-made Honda Odyssey minivan as we tour Guangzhou. There were China-made Audi A6s, locally assembled Camrys and Yaris’ from Toyota, as well as people hauling goods on bicycles, trikes, and motor scooters.
It is interesting seeing the tug of war between the planners of the new CBDs with wide boulevards and exclusive high rise office parks, but no residential high rise buildings and no real street level retail (just a high-end underground mall connected to the Four Seasons Hotel and a large parking garage) and the more mixed neighborhoods of high-rise apartments with active street-level neighborhood retail.
We know people are working in those high rises but the streets are empty in the middle of a workday in Guangzhou’s new CBD. At the same time of day the sidewalks team in the older mixed neighborhood. Of course this is China, so new is less than five years old, and old is less than 15. Then in the real old shopping neighborhoods where the streets are nearly alleyway-wide you just hang onto your wallet. Well, these older neighborhoods are where the 20-30 year old mid- high-rise apartment buildings are and where the future of land use, property rights, and the ending of an asset bubble will be determined.
The entire issue of land ownership is confusing at first blush. Let’s start with recent buildings. Property rights exist. Residents have property rights to the apartments they have purchased for 70 years. They can sell the apartments if they want. However, the state owns the land the apartment building sits on in perpetuity, but it does not appear that a ground rent is charged. Developers are sold the right to develop the property; these development rights are called “land transfer fees.” This is a one-time charge that is assessed for the construction of new buildings. These fees go the local government. There is no land, or ground, rent charged by the government. These observations lead to two questions that we pose after describing the supply of older (pre-reform) apartment buildings.
The second part of the apartment market consists of apartments that were built before real estate reforms began. These older apartment buildings look tired; they are typically 20-30 year old 5-20 story buildings that are worn out. Some of these buildings have been transferred into private properties (with a 70 year ownership clock), but there are also buildings sitting in urban villages, which are owned communally. However, communally ownership does not mean that eviction is easy. It is quite difficult and small “p” political.
The family that occupied an apartment in an urban village at the time of economic reform has rights to it, even if they rent it out to others (the renters are frequently temporary residents in the municipality). People maintain control over the apartment in the expectation that the old neighborhood will be marked for “regeneration” by the municipality. In effect, they are waiting for the local government and developer to come knocking. Because they can be well compensated and move out with keys to new apartments–and not one for one, but multiple apartments. The family that is lost in the shuffle is the temporary resident of the city.
The local government gets the land transfer fee from a developer. The “owner” of the apartment in the urban village gets at least one and at times more than one apartment to own and lease out. And the temporary resident goes into the rental market. This has to contribute to a hard asset bubble—one unit is removed from the supply, multiple apartments are constructed on the old building’s footprint at greater density than the old building, and the owner of the rights to the old apartment is once again a landlord.
The documented land-transferring fees in 2010 totaled 2.7 trillion Chinese yuan, roughly 7% of GDP and they underwrite a large fraction of the budgets of municipalities in the country. This explains why local governments are so reluctant to curb the housing price appreciation or meter development. This means that local government is hooked on property development to fund its budget.
So the elements of the asset bubble in the property market has a number of contributing factors:
- The municipal government has a positive incentive to keep developers busy and adding supply—their operating budgets depend on land transfer fees;
- To entice those with rights to the older apartments and urban village houses to move keys to a number of apartments are turned over;
- During the post-reform time period property and apartment values have only gone up, pushed by demand for better housing, growing incomes of an expanding middle class, and migration to the city by temporary workers.
- Rather than save in accounts with regulated deposit rates in local banks that are at or below the inflation rate, and given limited options of high-return investment in China, the history of apartment appreciation is alluring.
- What is a mystery is where is the developers’ money coming from and how are they (or are they) hedging against a bubble?
This is the description of a growth machine and you can substitute Las Vegas for Guangzhou and the dynamic is the same. What occurs if in-migration slows? How quickly is it slowing?
Growth in the major cities may be slowing and development pressure is shifting west to inland cities. What is visible to the naked eye is the asset bubble. The evidence is all around: rents being cheaper than the annualized cost of purchasing; speculative buying is rampant; and there are signs of vacancies in the new office projects. The open market started in Guangzhou in 1978. It is also where the downside of a dynamic market can appear. But timing the burst of bubble is hard to do.
There are several questions that are unanswered:
- What happens to ownership at the end of 70 years? Does the value of the property start to fall as the time of ownership rights shortens (What is the value after 50 years or 60 years?) Will there be de facto ownership that can be passed on (inherited) due to the politics of eviction?
- What is the future of municipal budgets when development slows and land transfer fess stop coming into the municipal coffers?
- Will there be some form of land rent or Henry George style land tax charged by the municipality as a substitute for the revenue from a smaller stream of land transfer fees?
- How will a municipal land rent or land tax be capitalized into the value of housing? It is much easier to institute the tax or rent in a rising land market than in a declining market.
- Who holds the mortgages? Will large down payments stop defaults (meaning that the size of the down payment has to be smaller than the speculative premium in the apartment’s value)? What level of default can a building sustain and still allow the building to be maintained? Will questions being currently asked in Florida and Nevada be asked in Beijing, Shanghai, or Guangzhou?
Hill is Dean of the Maxine Goodman Levin College of Urban Affairs at Cleveland State University. Qian is Assistant Professor of Economic Development