On July 30th 2014, the State Council released a guideline on the long expected hukou (household registration) reform, a step towards free migration from the country’s rural areas into its urban centres as part of China’s 2020 urbanisation plan. There is no doubt that this reform is crucial to China’s economic growth and structural reforms for the next ten years. Many even viewed this as an effort to revive the currently subdued housing market, particularly in the tier II and III cities. In the long term, the hukou reform could be a driver of housing demand. In the short to medium term, however, we believe its impact on the housing market will be minimal for two major reasons:

• First, hukou reform will take place in a gradual way. According to the announcement, the government will relax restrictions on hukou registration in small and medium-sized cities (with population of less than five million), while large cities will see no major changes in hukou registration and may even face the possibility of tighter regulations. People have access to the social safety net – education, medical care, pensions, municipal administrative functions – in the city where their hukou is registered, and these services are of better quality in the large cities, which remain restricted, than in the small cities and rural areas. Since these benefits, along with market forces like better paying jobs, drive migration into cities, and the differential between the rural areas and the small cities is relatively small, hukou reform will not result in large-scale migration in the short term.
• Second, as an asset class, buying a home requires substantial wealth accumulation. For those new immigrants, it will take years to accumulate enough savings to afford a new home after they move into the city.

The recent loosening of Home Purchase Restrictions (HPRs) in tier II and III cities will help boost residential sales in these cities in the short term to some degree. But for a meaningful and sustainable recovery of the housing market, banks need to adjust their mortgage policies as the market is primarily driven by first-time homebuyers and upgraders with mid-to-high level incomes who are sensitive to mortgage availability and mortgage rates. It was reported that banks have been gradually relaxing their mortgage policies after the central bank urged them to do so in May. Coupled with price discounts from developers, we expect to see sales steadily increasing as we head into the seasonally strong September-October period.

Over the medium term, lower tier cities are likely to see housing supply continue to increase. The challenge many of them will face is if a combination of demand from rising incomes and immigration – potentially supported by hukou reform – doesn’t increase as fast. We expect developers to adjust their strategies by changing the mix of units in their projects to include more affordable housing, particularly in the form of smaller unit sizes, but ultimately they may also have to accept lower unit prices as well in order to shift the supply. In contrast, the tier 1 and 1.5 markets look healthier given their strengthening attractiveness to skilled workers and fast expanding middle class.

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