China: Shaping Up to Be the World’s Greatest Real-Estate Bust

T he world’s largest asset class is Chinese residential real estate. The chart below illustrates that the aggregate value of Chinese homes was twice that of the U.S., 50 percent greater than the entire U.S. stock market, double Japan’s total assets, and triple that of China’s entire stock and bond markets. Could it be that the bigger they come, the harder they fall?

Chinese invest an extraordinarily high percent of their wealth in residential real estate (76 percent), compared with 41 percent in Japan and 28 percent in the U.S. Chinese markets provide limited investment alternatives to residential real estate, which contributes to a run-up in prices as the Chinese government’s long-running attempts at debt-fueled stimulus funnel directly into this sector.

The dispersed nature of housing data can vary greatly within countries, never mind between countries. A direct comparison of values over time isn’t available, but one can be estimated from data in the above chart with home-price indices and housing-stock growth (estimated by household growth.) Estimates for total residential value in current dollars for the three largest economies appear in the chart below:

During Japan’s 1990s real-estate bubble, the total value of Japanese homes surpassed that of the U.S., but by 2000 that had fallen back below the U.S. and has stagnated ever since. Chinese home values surpassed those of the U.S. during the Great Financial Crisis (GFC) and haven’t looked back, although the premium to the U.S. narrowed to 45 percent.

The previous two charts utilize the total dollar value of homes for a standard of comparison. Local-currency home value, however, is especially important to each country’s inhabitants (and may say more about local economic conditions). The following chart shows average home values in the U.S., Japan, and China indexed to their 2017 levels:

Home prices in Japan rose 84-fold after 1955, but they suffered a strong, prolonged downturn beginning in the 1990s and never fully recovered. U.S. home prices also took a significant, sharp downturn following the GFC but rebounded rapidly. In the Bank for International Settlements data ending in 2022, China had a couple of property downturns, but they were shallow and short. The current downturn may be more severe.

Perspective on the three economies’ home-price volatility comes from a drawdown measure, the variance of value from its previous high point. When index measures rise to new highs, the drawdown is zero and becomes negative only when prices fall. The following chart measures percentage drawdowns for the respective local currency Home Price Indices:

The severity of Japan’s real-estate depression is evident in the chart, down over 45 percent from its peak and still 25 percent lower in nominal terms more than 30 years later. The U.S. GFC also was extraordinary, a 31 percent decline over five years with full recovery only after eleven years. China has had two significant downturns in home values, each about 5 percent, with one lasting two years while the other is ongoing.

This article began valuing total residential value in dollars for comparison between economies, and this approach is repeated here to compare the drawdowns. The following chart measures drawdowns for total residential-home value in dollar terms with yen and yuan converted to dollars at historical rates:

Japan’s maximum total drawdown of $5.6 trillion is eclipsed by the U.S. GFC total of $7.7 trillion. Surprisingly though, China’s downturn earns the prize, weighing in at $11.4 trillion. The mere 6 percent downturn in yuan of home prices is compounded by depreciation of the Chinese yuan, and the greater value of Chinese residences in 2015 compared with U.S. homes in 2005.

The preceding chart depicts nominal changes in dollars at the time but makes no allowance for inflation and foreign-exchange fluctuations. The next chart uses real home prices for each local currency, adjusted for inflation and converted to dollars at today’s exchange rate:

Adjusted for inflation and foreign-exchange fluctuations, the U.S. takes the lead for biggest real residential decline, coming in at $11 trillion, compared with China at $7 trillion and Japan bringing up the rear with $5 trillion.

So, the title for biggest real-estate bust is divided between the U.S. and China, but could the future see a unified crown?

Both markets appear overvalued relative to income. The U.S. has pulled back from 30 percent above historical norms to 20 percent. Home prices, measured by the Case-Shiller index, have fallen, while income has risen (due to inflation). U.S. home prices have begun recovering, up 4 percent in May from the February low, which was down 5 percent from June 2022, netting to a 1 percent decline eleven months from the peak. On the other hand, U.S. home prices performed quite comparably just before the GFC; eleven months after the July 2006 peak, prices were down just over 1 percent.

China’s residential market has been widely considered grossly overvalued. One analysis concluded, “Fundamentals are 30% lower than the observed market prices, suggesting the presence of a potential housing bubble.” Another found overvaluation relative to incomes of more than 50 percent.

Critical to any bubble is participants’ belief in ever-rising prices. Chinese home prices are falling now, so that bubble may have burst. The Chinese Communist Party is frantically trying to rekindle the same speculation that caused the bubble in the first place, but this hair-of-the-dog-that-bit-you nostrum is an unlikely cure. Given its higher starting point and greater downside, China seems likely to capture the undisputed title of world history’s greatest real-estate bust. This splitting hangover is likely to plague the Chinese economy for years, if not decades, to come.