A shift in developers' strategy to build smaller instead of bigger, should boost residential property affordability.
At first sight, residential properties in the top Chinese cities are hard to afford: Shanghai, Beijing and Shenzhen have home price/household income ratios of over 20x. Homes are expensive in nearly all international gateway cities, and high price/ income ratios have not stopped China achieving home ownership of 90% of households or more.
However, residential affordability does look like a problem. One reason for high home prices in the top Chinese cities is that average private apartment sizes are similar to those in most other international cities. If more apartments with average net size of about 45 square metres (sqm) were available, as in Hong Kong SAR1, Colliers believes affordability would improve.
"Rather than slash prices, we think Chinese developers should aim to build more smaller units."
The prices of many Chinese and Hong Kong property stocks have fallen recently, reflecting both the problems of the indebted developer Evergrande and concern that the Chinese authorities may press housebuilders to cut prices. However, home prices and values per sqm are not the same. Rather than slash prices, we think Chinese developers should aim to build more smaller units.
Furthermore, residential property and commercial property are not the same. The forces supporting the values of office and logistics assets in China remain strong. We may see near-term selling of investment assets as indebted housebuilders try to raise funds. There may also be some reappraisal among international investors and valuers of the appropriate risk premium for Chinese property assets, causing upward pressure on cap rates. However, problems in the residential sector do not, of themselves, imply a long-term reduction in Chinese commercial property values.
Homes in all major international cities are hard to afford, notably top Chinese cities
We have analysed residential affordability for major Asia Pacific and western gateway cities using the widely accepted price/ income ratio. Our preferred definition of this measure compares the average home price to average annual household disposable income (post-tax income).
Traditionally, cities with ratios of above 3 times have been considered hard to afford.
The price/ income ratio has its limitations in China. This is because many Chinese buy houses not only with their own income, but with the income and savings of an extended family, including parents, grandparents and siblings. This explains why China has surprisingly high levels of home ownership – perhaps over 90% of households.
Still, the price/ income measure cannot be ignored.
Regarding home prices, we have used approximate average sizes of private apartments for sale, including both primary and secondary properties and based on city-wide data rather than data for prime districts. We have then estimated an average home price for each city based on either published prices per sqm or typical transaction prices at the average size level.
"Measured by price/ income, Shenzhen, Beijing and Shanghai rank among the least affordable major cities... with ratios of over 20 times. These figures reflect both high average apartment prices and low average household disposable income in the top Chinese cities."
Regarding household incomes, we have used averages from Oxford Economics – defined as aggregate household post-tax income divided by total households, taken from national or regional accounts. Median household income, where median is the mid-point between the high and low ends of a data set, is an important statistic. However, median income data are not readily available for Chinese cities.
Measured by price/ income, Shenzhen, Beijing and Shanghai rank among the least affordable major cities in our sample, with ratios of over 20 times. These figures reflect both high average apartment prices and low average household disposable income in the top Chinese cities.
Due to wide income disparity, we have measured affordability in Hong Kong using both average and median household income; Hong Kong on a median basis also shows a ratio of over 20 times. Since no city in our sample has a ratio of below 5 times, they all show high home unaffordability by traditional standards.
The Australian and western cities in our sample would also mostly look much more expensive using median household income, with ratios of up to 13.0 times for Vancouver and 11.8 times for Sydney2. Even so, high home prices in the top Chinese cities do look like a problem.
Homes in the Chinese cities would be easier to afford if apartments were smaller
Using transactions data3, Colliers estimates that the average gross private apartment size is between 88 and 98 sqm across Beijing, Shanghai and Shenzhen. We have converted these figures to net or saleable area using an assumed efficiency ratio of 75%.
As shown below, average net apartment sizes in the Chinese cities are comparable to those in most other international gateway cities, except Hong Kong.
We estimate the average gross price per sqm for a Shanghai apartment at nearly RMB51,500 (USD7,960). Given an average gross size of about 89 sqm, this implies an average home price of RMB4.58 million (USD707,915).
As noted, this equals 20.3 times estimated 2021 average household income in Shanghai of RMB225,400 (USD34,840). The ratios would be higher for Beijing and Shenzhen.
What would happen if average apartment sizes in the Chinese cities were smaller?
The average net apartment size in Hong Kong is about 45 sqm – equivalent to 60 sqm on a gross basis at 75% efficiency. In Shanghai, assuming the same price per sqm, this size implies an average home price of RMB3.09 million (USD478,000).
Such a home price/ income would be 33% lower than our estimated actual average, and equals 13.7 times the average household disposable income. Performing similar calculations for Beijing and Shenzhen gives price/ income ratios of 15.1 times and 17.8 times, respectively.
Although still elevated, these levels are less extreme. We thus believe that residential affordability in the top Chinese cities would improve if more smaller apartments were available.
The Chinese authorities appear to agree with our view. Certain local authorities have already imposed a “70/90” requirement, meaning that 70% of a new residential development needs to consist of units of under 90 sqm (gross), especially in Shanghai and Beijing. In continuing to focus on 2 to 3-bedroom apartments with an area of around 100 gross sqm, developers may be responding to the recent social policy of encouraging families to have more children.
However, average household size in the Tier 1 mainland Chinese cities of 2.3-2.7 is actually slightly smaller than in Hong Kong (2.8). We believe developers should consider a more explicit strategy of supplying more smaller apartments in the top city markets.
Evergrande situation does not imply that Chinese property values are sure to fall
The share prices of many Chinese and Hong Kong property companies have fallen sharply recently as problems have mounted for Evergrande, the indebted housebuilding group which is one of the largest Chinese property developer by sales. In our opinion, this price performance reflects two factors in particular.
The first factor is concern about the gearing levels and business models of other Chinese property developers. This concern may be well-founded. We estimate that 19 Chinese developers fail at least one of the “three red lines” financial tests introduced by the People’s Bank of China and the Ministry of Housing in 2020. These 19 include Evergrande and one other developer which fail all three tests.
The second factor is concern that the Chinese authorities may put pressure on developers to reduce residential property prices. On this point, we observe that unit prices are not the same as values per sqm.
Rather than slash unit prices, we believe that Chinese developers should focus on building more smaller apartments in the top cities. Such a strategy would not only boost affordability and follow policy goals, but also support the aggregate value of developers’ residential inventories.
More broadly, we should emphasise that listed Chinese developers are predominantly housebuilders, and that prospects for residential property have only indirect implications for commercial property.
"We believe that Chinese developers should focus on building more smaller apartments in the top cities. Such a strategy would not only boost affordability and follow policy goals, but also support the aggregate value of developers’ residential inventories."
The forces underpinning the values of Chinese office and logistics assets include strong economic recovery from last year’s COVID-19 recession (which has driven a sharp rebound in office leasing in Shanghai and Beijing), continuing urbanisation, rapid growth in domestic e-commerce, and robust trade volumes. While Chinese economic growth momentum moderated in Q3 2021, these forces have supported firm investment demand and are unlikely to weaken significantly.
Chinese residential developers tend to own commercial properties (mostly offices) as investment assets. Indebted housebuilders may seek to raise capital by selling such assets, causing near-term pressure on commercial property prices. However, evidence from China suggests that asset sale strategies are not working well because the three red line limits prevent many other developers from raising their liabilities, meaning that they are not in a position to purchase.
The Evergrande situation may also cause some reappraisal among international institutional investors and valuers of the appropriate risk premium for Chinese property assets, just as it seems to be causing a reappraisal of the appropriate risk premium for Chinese and Hong Kong equities. This may push commercial property cap rates upwards, with adverse implications for asset valuations. However, problems in the residential sector do not, of themselves, imply a long-term reduction in Chinese commercial property values.
1Special Administrative Region [of the People's Republic of China]
2Source: The Demographia International Housing Affordability 2021 Edition
3Source: CREIS, Colliers
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