(Shi Yu/China Daily)
Urbanization and upgrading needs will create an estimated demand for 6 billion square meters of housing from 2017 to 2021. This will keep the investment in housing growing at around 5 percent in real terms over the next five years. Investment demand, however, may lead to overbuilding and derail China's rebalancing and industrial upgrading agenda. The Chinese leadership therefore needs to promote reforms by introducing a property tax, which will be an integral part of any long-term solution, preferably implemented in a revenue-neutral manner.
Housing investment has grown rapidly over the past two decades, leading to a significant improvement in living conditions in China. Housing reform introduced in the 1990s allowed the development and sale of homes based on commercial principles. In the past two decades, the investment in residential housing development has grown by an average of 19.2 percent per year. As a result, the urban living area per capita more than doubled to 36.6 sq meters of gross floor area in 2016 from 17 sq m in 1996. With per-capita living area increasing by about 0.8 sq m each year, China can close the gap with the average in the European Union in five years.
The housing sector has become too big to fail. Real-estate investment accounted for over 10 percent of the economy last year. The International Monetary Fund has estimated that the real-estate and construction sectors together contributed 33 percent of China's GDP growth in 2013 if upstream and downstream sectors are included. Bank lending to the real-estate sector totalled 26.7 trillion yuan ( trillion) last year, or one-quarter of banks' total credit outstanding. In addition, real estate is used extensively as collateral for corporate borrowing, and a major housing-market correction could undercut the value of the collateral.
Signs of property bubbles have prompted the government to introduce tightening measures since the fourth quarter last year, likely to lead to slower housing investment in the near term. Following the stock-market correction in 2015, housing prices soared by about 30 percent in Tier-1 cities last year. The government adopted city-specific measures late last year to contain property bubbles through restrictions on purchases, sales, prices and mortgages. Price increases have moderated in recent months, but at the cost of suffocating market activity.
Real demand, however, can sustain decent housing investment medium-term. Urbanization continues to bring roughly 20 million people from rural to urban areas each year. Many existing migrant workers are living in very poor conditions. Most of the homes built before the 1990s lack modern amenities, and the demand for upgrading remains strong. We estimate that urbanization and upgrading needs will create at least 6 billion square meters of housing demand from 2017 to 2021.
We expect residential housing investment to grow by at least 5 percent per year over the five years. Demand is likely to be met by existing housing inventory and new commercial and social housing. At the end-of last year, the total residential gross floor area waiting to be sold was roughly 400 million sq m. We forecast that 6.5 million units of social housing will be completed each year, based on the average of the past three years. Our calculations suggest that about 4.4 billion sq m of living area needs to be completed by developers in order to meet demand over the next five years, which requires new starts to grow by an average of 6 percent and gross floor area under construction to grow by about 5 percent each year, according to our residential housing investment model.
The challenge is to contain investment demand that may cause overbuilding. Given China's relatively closed capital account, housing remains the preferred investment vehicle for households. The risk-adjusted return from housing investment has been much higher than from other forms of investment, such as stocks and bank deposits. This has fuel-led households' desire to own multiple homes. This has artificially increased housing demand, pushing prices higher and stimulating investment.