China's real estate sector is ailing. The recovery after the coronal shockdowns has failed to materialise and the housing market in particular is feeling the blows. But how important is this sector really to the Chinese economy? Real estate and construction are important for financial stability in China, says Mali Chivakul, emerging markets economist at bank J. Safra Sarasin.

In Chinese cities, many people own homes. The percentage of homeowners in China among city dwellers (64% of the total population) has risen to 96%, according to China's central bank. The available floor space per capita is around 40 square metres. This is on par with European countries.

Most recent estimates show that total domestic real estate activity in China contributed 23% to total demand in 2021. Real estate and construction account for about 20% of urban employment. This sector is also considered systemically important: important for financial stability.

Real estate-related debt accounts for about 25% of bank assets and about half of it is linked to local governments.

Many structural disruptions

Housing demand has been much higher than what fundamental demand (driven by household formation and upgrade demand) would suggest. On the other hand, the supply of property development is controlled by each local government. Local officials tend to build a lot because real estate activities and infrastructure investments (which support property development) help them achieve their growth targets and revenues.

This building boom, along with easier access to mortgages, was the hallmark of the last boom (before 2022). When affordability deteriorated, local governments usually turned to administrative measures to control demand and prices. These measures are also used during downturns. The best-known measure is restrictions on property purchases. Other measures are price controls. It is difficult to compare house prices at the national level because house prices vary widely from city to city and region to region. Moreover, there are many administrative measures in place in China, making it difficult to gauge the real market.

Many homeowners

With little price appreciation currently expected, speculative demand has already fallen significantly. Fundamental demand will be driven by household formation, urbanisation and upgrade demand. The first two have slowed down significantly in recent years due to an ageing population, lower marriage rate and already high urbanisation. Having a son is one of the determinants of having more than one home.

Growing demand is usually driven by an expansion in family size or the desire for a newer home. The former (fertility rate) fell sharply during the pandemic years, while the latter will depend on employment and income prospects.

More moderate price adjustment

We think the government will bet on a lower future housing supply to allow for a more moderate price adjustment. China's financial sector cannot afford a large downturn, given the amount of debt secured by real estate. We expect economic growth to be weak over the next 2-3 years (closer to 4%).

Higher government spending, especially to support households, may ease the downturn. A reform of the fiscal relationship between local and central governments and a clean-up of non-performing real estate may accelerate the recovery.