Share on facebook
Share on twitter
Share on telegram
Share on whatsapp
Share on linkedin
Share on print
Share on email

Risk Watch: Skyrocketing Rents Signal a Deepening of China’s Economic Woes

◎ Whenever the central bank releases liquidity, the funds usually flow to the property markets.

Skyrocketing housing rental prices have become a hot topic in China recently. Property rental and sales companies have been accused of bidding up leases and inflating rent prices through various unscrupulous tactics.

According to property search engine Fangtianxia, the annual rental price of housing in 17 popular Chinese cities rose by over 8 percent between February 2017 and May 2018. Of the 17 cities, prices rose 19.5 percent in Shanghai, 15.5 percent in Shenzhen, and a whopping 25.9 percent in Beijing.

The backdrop:
On Aug. 17, several Beijing municipal departments, including the housing development bureau, the financial bureau, and the taxation bureau, summoned the heads of major housing rental companies like Ziroom, Xiangyu, and Dangkegongyu for a meeting. At the meeting, the rental companies were told that they must not use financing funds to snatch up apartment leases; must not drive up rental prices by monopolizing leases; and must not encourage landlords to terminate contracts to suit their apartment grab.

On the same day, Hu Jinghui, the vice president of rental company Woaiwojia, told the media that competitors like Ziroom and Dangkegongyu have been spoiling the property rental market by buying up apartment leases at prices that are 20 to 40 percent above the market value and renting the apartments out for even higher prices. On Aug. 18, Hu reportedly told a group of friends that Woaiwojia had dismissed him after a competitor’s chairman called his boss. The following day, Hu Jinghui held a press conference to talk about his firing, a move that ignited social debate.

On Aug. 20, the heads of 10 prominent property rental companies promised that they wouldn’t raise rental prices at a symposium organized by the Beijing’s real estate agency association. The companies also pledged to put out over 120,000 apartments on the market to stabilize prices.

The big picture:
Recently, the People’s Bank of China (PBoC) released significant amounts of liquidity in hopes of providing greater financial support for small and medium enterprises amid a weakening economy. However, commercial banks and financial institutions are not active in making loans.

Our take:
Why rental costs are rising
1. Supply and demand determine prices. The rise of rental prices in first-tier cities, however, is not due to an influx of outsiders. Official data shows that the population of long-term residents in Beijing (minus 30,000) and Shanghai (minus 75,200) have decreased at the end of 2017. Instead, it is the shrinking housing rental supply that is driving prices up.

The decrease in housing supply is due to the Chinese Communist Party’s (CCP) policies such as regulating rentals to groups, partitioning of apartments and basements, and the expulsion of the so-called “low-end population” and the demolishing of their dwellings in late 2017 (link).

Taking Beijing as an example, a large number of shantytowns, rental complexes, and industrial apartments in suburban areas have been demolished in recent years. These housing developments used to house large numbers of migrant workers. In 2017, a total of 59.85 million square meters worth of housing was demolished, while total housing constructed in 2016 was only 35.94 million square meters. The problems of the housing supply reduction in Beijing is compounded by the fact that most of the “low-end population” cannot afford to rent the newly constructed apartments.

2. Whenever the PBoC releases liquidity, the funds usually flow to the property markets. New housing policies (a freeze on prices, the imposition of a resale period, etc.) have “semi-frozen” first and second-hand property markets, while second-hand housing in Beijing and Shanghai can only be sold at a reduced price. The phenomenon of skyrocketing housing rentals is the result of funds seeking monopoly advantages in the property markets.

Since 2013, funds entering the property markets were being invested in long-term rental apartments. By the end of 2017, there were over 300 housing rental companies in Beijing, Shanghai, Guangzhou, and Shenzhen managing more than 2 million rooms.

This January, Ziroom announced that it had completed a 4 billion yuan Series A financing round. In June, Dangkegongyu announced the completion of a 70 million yuan Series B+ financing round.

After housing rental companies obtain financing, they proceed to buy up and hoard apartment leases, renovate apartments to raise their value, and use an N+1 payment model (upfront payment equal to total rental months plus 1-month deposit) to drive up rental prices.

3. At the end of 2017, the average rate of returns for housing rentals in China’s first-tier cities was 1.5 percent. Assuming housing and rental prices remain unchanged, homeowners require about 70 years to break even on their investments.

If the Chinese authorities go ahead with a planned property tax, then apartments cannot appreciate in value. When rental returns cannot make up for the tax, then homeowners would start selling their property. In this scenario, the property market would collapse, bad bank debts would soar, and a systemic financial crisis would be triggered.

The CCP does not want housing prices to skyrocket, yet it does not dare to let prices plummet. Hence, its only option is to tolerate rising rental prices to prevent housing prices from dropping. This way, the CCP can proceed to levy a property tax and use economic means to drive away the “low-end population” from the first-tier cities.

Rising rentals, however, would end up escalating, and not resolving, the CCP’s self-inflicted troubles with housing prices (see “Social risks”).

Financial risks
Most housing rental companies will guide tenants to take non-mortgage loans to pay (the N+1 model) for their sublease. Tenants end up making monthly payments plus interest to the rental companies or online lending platforms. The rental companies then bundle the loans as asset-backed securities, and earns the difference from the loan interest. The companies rely on high turnover to cover the cost of expanding their operations.

After securing ample funding using the above method, the housing rental companies proceed to buy more leases, renovate apartments, and raise rent. When occupancy rates dip, the rental companies offer discounts to attract tenants.

For example: Presuming that Beijing has 7.5 million apartments and housing rental firms divide each apartment into two smaller “apartments” (larger apartments can be divided into many smaller units), then there would be at least 15 million rooms for rental. If each unit is rented out at the average price of 2,000 yuan per month, then the rental companies stand to receive 48,000 yuan upfront out of a 2-year sublease from online lending companies; an average rental price of 5,000 yuan would translate into 120,000 yuan upfront. And if a housing rental company gains 10 percent of the rental market, it stands to take between 7.2 billion yuan to 18 billion yuan in rental fees at one go.

If the hypothetical housing rental company mentioned above uses financial derivatives and is triple leveraged, then it might at once be handling funds of over 21.6 billion yuan. And the scale of housing rental financing in Beijing could be greater than 216 billion yuan. When this highly leveraged model of generating funds is repeated on a large scale across the country, China will develop another P2P-type financial risk. The risks are real: In March, rental company Shanghai Aigongyu’s “capital chain” broke; in April, the capital chains of Changsha Youzuke and Cres & Asia Residence Group were reportedly in danger.

Social risks
According to an August 2017 report by China’s largest recruitment platform, 84.2 percent of fresh graduates need to rent apartments, and Beijing’s rental prices at the time amounted to 67 percent of their average monthly salary.

Skyrocketing rental prices directly affect young workers who cannot afford to buy houses on their salaries. When rents go up sharply, they would be forced to look for a job in another area. And when the workers start leaving in droves, the companies that hire them may have to close down. This vicious cycle would further weaken China’s economy.

The above scenario, if it unfolds, would ultimately threaten the CCP regime. According to China’s National Bureau of Statistics, the country’s permanent urban population was 813.47 million in 2017 while the urbanization rate was 58.52 percent. When compared with 2007, China’s urban population had grown by 200 million people. If the young people in first and second-tier cities are forced by circumstances to return to their rural hometowns, they will likely have difficulties looking for jobs and encounter livelihood problems. If the Sino-U.S. trade war is not resolved or escalates, the prices of food and other commodities would be driven up. The combination of large numbers of unemployed young people and price hikes would pose a severe threat to the CCP.

Search past entries by date
“The breadth of SinoInsider’s insights—from economics through the military to governance, all underpinned by unparalleled reporting on the people in charge—is stunning. In my over fifty years of in-depth reading on the PRC, unclassified and classified, SinoInsider is in a class all by itself.”
James Newman, Former U.S. Navy cryptologist
“Unique insights are available frequently from the reports of Sinoinsider.”
Michael Pillsbury, Senior Fellow for China Strategy, The Heritage Foundation
“Thank you for your information and analysis. Very useful.”
Prof. Ravni Thakur, University of Delhi, India
“SinoInsider’s research has helped me with investing in or getting out of Chinese companies.”
Charles Nelson, Managing Director, Murdock Capital Partners
“I value SinoInsider because of its always brilliant articles touching on, to name just a few, CCP history, current trends, and factional politics. Its concise and incisive analysis — absent the cliches that dominate China policy discussions in DC and U.S. corporate boardrooms — also represents a major contribution to the history of our era by clearly defining the threat the CCP poses to American peace and prosperity and global stability. I am grateful to SinoInsider — long may it thrive!”
Lee Smith, Author and journalist
“Your publication insights tremendously help us complete our regular analysis on in-depth issues of major importance. ”
Ms. Nicoleta Buracinschi, Embassy of Romania to the People’s Republic of China
"I’m a very happy, satisfied subscriber to your service and all the deep information it provides to increase our understanding. SinoInsider is profoundly helping to alter the public landscape when it comes to the PRC."
James Newman, Former U.S. Navy cryptologist
“Prof. Ming’s information about the Sino-U.S. trade war is invaluable for us in Taiwan’s technology industry. Our company basically acted on Prof. Ming’s predictions and enlarged our scale and enriched our product lines. That allowed us to deal capably with larger orders from China in 2019. ”
Mr. Chiu, Realtek R&D Center
“I am following China’s growing involvement in the Middle East, seeking to gain a better understanding of China itself and the impact of domestic constraints on its foreign policy. I have found SinoInsider quite helpful in expanding my knowledge and enriching my understanding of the issues at stake.”
Ehud Yaari, Lafer International Fellow, The Washington Institute
“SinoInsider’s research on the CCP examines every detail in great depth and is a very valuable reference. Foreign researchers will find SinoInsider’s research helpful in understanding what is really going on with the CCP and China. ”
Baterdene, Researcher, The National Institute for Security Studies (Mongolian)
“The forecasts of Prof. Chu-cheng Ming and the SinoInsider team are an invaluable resource in guiding our news reporting direction and anticipating the next moves of the Chinese and Hong Kong governments.”
Chan Miu-ling, Radio Television Hong Kong China Team Deputy Leader
“SinoInsider always publishes interesting and provocative work on Chinese elite politics. It is very worthwhile to follow the work of SinoInsider to get their take on factional struggles in particular.”
Lee Jones, Reader in International Politics, Queen Mary University of London
“[SinoInsider has] been very useful in my class on American foreign policy because it contradicts the widely accepted argument that the U.S. should work cooperatively with China. And the whole point of the course is to expose students to conflicting approaches to contemporary major problems.”
Roy Licklider, Adjunct Professor of Political Science, Columbia University
“As a China-based journalist, SinoInsider is to me a very reliable source of information to understand deeply how the CCP works and learn more about the factional struggle and challenges that Xi Jinping may face. ”
Sebastien Ricci, AFP correspondent for China & Mongolia
“SinoInsider offers an interesting perspective on the Sino-U.S. trade war and North Korea. Their predictions are often accurate, which is definitely very helpful.”
Sebastien Ricci, AFP correspondent for China & Mongolia
“I have found SinoInsider to provide much greater depth and breadth of coverage with regard to developments in China. The subtlety of the descriptions of China's policy/political processes is absent from traditional media channels.”
John Lipsky, Peter G. Peterson Distinguished Scholar, Kissinger Center for Global Affairs
“My teaching at Cambridge and policy analysis for the UK audience have been informed by insights from your analyzes. ”
Dr Kun-Chin Lin, University Lecturer in Politics,
Deputy Director of the Centre for Geopolitics, Cambridge University
" SinoInsider's in-depth and nuanced analysis of Party dynamics is an excellent template to train future Sinologists with a clear understanding that what happens in the Party matters."
Stephen Nagy, Senior Associate Professor, International Christian University
“ I find Sinoinsider particularly helpful in instructing students about the complexities of Chinese politics and what elite competition means for the future of the US-China relationship.”
Howard Sanborn, Professor, Virginia Military Institute
“SinoInsider has been one of my most useful (and enjoyable) resources”
James Newman, Former U.S. Navy cryptologist
“Professor Ming and his team’s analyses of current affairs are very far-sighted and directionally accurate. In the present media environment where it is harder to distinguish between real and fake information, SinoInsider’s professional perspectives are much needed to make sense of a perilous and unpredictable world. ”
Liu Cheng-chuan, Professor Emeritus, National Chiayi University