PROPERTY BUBBLE BY VIVIAN NI

By Vivian Ni

Apr. 4 – Mumbai and Shanghai, as the financial centers of the world’s two biggest emerging economies, have witnessed their property markets go through a similar path over the past decade – seeing an astonishing price surge, experiencing the turbulence during and after the Global Financial Crisis, carrying the similar concerns over housing bubbles that exacerbate domestic inflation, and facing the social sentiment of the masses that cannot afford the expensive properties.

Mumbai is turning into one of the most expensive cities to live in among all the cities in the developing world. And as the Indian government has started to take measures to curb inflation, many property developers are now faced with fund shortages. A number of analysts and economists believe Mumbai’s property market will see an oversupply between 2012 and 2013, and predict that real estate prices will go down in the near future. Similar with India, the Chinese government has also issued a series of restrictive regulations recently in a bid to suppress property prices. However, both the Chinese people and the Shanghai local government do not seem to be very confident that the measures can thoroughly clear the bubble in the housing market. Whether Shanghai’s property market will finally become more affordable to people still remains a question.

Property market cap growth in Shanghai and Mumbai – a similar pattern
Both cities have experienced significant property price increases stepping into the 21st Century, and witnessed two major rounds of prosperity before and after the recent financial crisis. Although Shanghai’s property market started its boom a bit later than Mumbai’s, the price increases over such a short period have been just as intense.

Along with the strong economic growth and rapid urbanization, Mumbai’s real estate market started the price surge in 2000. By 2002, residential property in Mumbai was already worth 85 times of the city’s annual average income; while by 2006, the property value reached 100 times the average income.

A slightly overheated property market emerged in Shanghai in 2004, when house sales surged by 22 percent from a year earlier. However, some new government regulations released in 2005 restrained such an upward trend right away. The restriction that made buyers “wait and see” led to a strong growth in housing demand later in 2006 and 2007. Total house sales soared by 47 percent in 2007 from a year earlier, and average prices almost doubled the levels seen in 2000.

The Global Financial Crisis in 2008 hit both India and China’s property markets, but did not totally stop the market value growth in Mumbai and Shanghai. In India, although the domestic demand for luxury housing decreased by 50 percent, and demand for affordable housing fell by 10 percent that year, the Indian National Housing Bank’s property price indicator Residex still showed a moderate price index increase of 4.5 percent in Mumbai in the second half of 2008, compared to the first half.

Property prices in many major cities in China dropped during the second half of 2008, according to the China Real Estate Index System, but Shanghai’s prices still went up by 2 percent in nominal terms and remained at the same level if the inflation factor is counted.

The two cities’ property markets welcomed their second spring that came with the economic recovery and government stimulus packages to revive the economy. Residential property developers in India were encouraged to build large land inventories and by the fourth quarter of 2010, Rs.120 billion (US$2.7 billion) has been spent on such projects. In 2010 alone, property prices in Mumbai picked up by 60 percent. A rate like US$5.1 million (or US$17,000 per square meter) is typical for a 300 square meter luxury-used apartment in the city’s prime areas.

After the financial crisis, the Chinese government launched an RMB4 trillion (US$585 billion) stimulus package with allocations for housing and infrastructure projects, various favorable tax treatments to property buyers, and relaxed lending policies to both buyers and developers. The Shanghai market thus experienced a quick recovery, seeing an average 19 percent month-on-month increase between March and July, 2009.

How big is the housing bubble?
The soaring housing prices have been blamed as a major contributor to both India and China’s high inflation rates. India reported its inflation rate at 8.82 in February while China’s stood at 4.9, with concerns that its April consumer price index may exceed 5 again.

Property markets in emerging economies like China and India are also ideal destinations for speculators. The massive amounts of cash that have been invested into the market considerably lift property prices and exacerbate inflation.

While Mumbai’s property market was ranked as the 10th most expensive worldwide and Shanghai’s ranked 35th last year, the housing affordability in the two cities – if measured by income to price ratios – is typically low compared to other developed cities in the list. Disregarding the lending rate factor, an Indian citizen that earns an annual income at Mumbai’s average 2009 level of Rs.125,000 (US$2,812.8) will theoretically spend 369.3 years without any other consumption to afford a 75-square meter apartment that is worth US$1 million in South Mumbai. Shanghai’s houses are more affordable compared to Mumbai, but a Chinese citizen that makes Shanghai’s average 2010 annual income of RMB31,383 (US$4,868.6) still has to save 52 years without any other consumption to afford a 75-square meter apartment, according to 2010’s average per square meter house price level RMB22,261 (US$3,404.1) released by the government.

The low rental yields can be another indicator to show the size of the housing bubble in both cities. Statistics for 2010 show that Mumbai’s rental yields stand between 3.5 percent and 4.6 percent and Shanghai’s only 3.7 percent. The numbers that are usually tied up with the supply – demand conditions also revealed – to some extent – the real affordability of the market.

Will property prices fall?
In Mumbai, the expectation for its property market to decline is strong. In fact, prices have already started to drop in some areas of the city, such as Parel, Lower Parel, Mahlaxmi, Bandra East, Andheri East, Goreagon East, Mulund and Kurla. The overall price level has already seen a 20 percent correction from the peak level.

Lack of confidence in Mumbai’s property market also shows in the capital market. Major Indian property stocks have fallen by 27 percent in the past three months, warning people of potential risks brought by the expanding current account deficit and solvency issues.

The major factor that may lead to another 15 percent to 25 percent price fall in Mumbai’s property market is the fund shortage developers are currently suffering from. Many developers have started to offer discounts to buyers, hoping to mobilize fund inflows through increasing sales.

The funding channels for property developers in Mumbai are decreasing, as the Indian government is determined to curb inflation and banks continue raising their lending rates. The stock prices of India’s ICICI Bank and HDFC Bank have seen around 11 percent falls during the past three months, indicating the possibility that many Indian banks have been “tapped out” and it will become increasingly difficult for property developers to obtain loans from banks.

On the other hand, the speculation on a property oversupply in the near future is increasing. The U.S.-based real estate consultancy Jones Lang Lasalle believes that “the overall sentiments of the market and the consistent rate of new project launches in Mumbai give a clear indication of an impending oversupply by 2012.” Such a prediction will very likely lead to another round of property price falls.

The Shanghai market is faced with many similar challenges. Property developers are looking to raise more funds from channels other than banks, since the waiting-for-sale floor space has tied up a huge amount of funds, the lending rates have been going up, and some Chinese banks’ deposit-to-loan ratios are approaching the minimum reserve requirement.

Statistics from China CEIC Database show that by the end of June 2010, the waiting-for-sale floor space had reached 192 million square meters, tying up RMB1.6 trillion (US$244.7 billion) of funds.

After the People’s Bank of China lifted the reserve requirement ratio (RRR) to a record high of 20 percent in March, several major commercial banks such as China Merchants Bank and Bank of Communications are running out of their lending capabilities and may face a shrunk balance sheet if China raises the RRR again.

In addition to the fund shortage, the Shanghai property market may also need to watch out for a potential reversal in the supply-demand relationship. Demands are falling with the increasing down payment requirement for buyers, restrictions in loan issuance, and the introduction of property tax.

Despite all these challenges, the property price trend in the Shanghai market remains unclear. Various private equity funds still seem to be optimistic on Shanghai’s property market, providing property developers with a new avenue to raise funds from. The local government, often commented as being “knee-deep” in the housing bubble and gaining a great deal from land sales, did not specify any statistical goals in its latest 2011 property price control proposal, but only mentioned that it will try to keep the property price increase rate lower than the city’s GDP and average income growth rates.