Starting from mid-2017, a number of major cities implanted price caps on residential sales to rein in runaway home prices. The caps require developers to adhere to local government price guidance on newly launched units in order to obtain pre-sales permits. Guidelines are even more stringent in Tier 1 cities such as Beijing and Shanghai, whereby the average price of one new phase must be lower than the previous phase in the same project.

Are home prices really falling?

Price caps were originally intended to provide price stability and cool potentially “overheated” housing markets. Since its implementation, media reports evidence falling average sales prices in many Tier 1 and 2 cities. However, there’s a catch. Governments often hold sales registration for new units from the online database to control headline prices. Moreover, developers often opt for lower interior fit-out standards to maintain margins at capped prices. Others raise the cost of parking to make up for the price cap. So are home prices really falling?

Unintended Consequences

While China’s home purchase restrictions work to suppress demand, government-imposed price caps simultaneously fuel speculation as buyers look to scoop up new units at below-market value. In many cases, nearby secondary units sell at higher prices than capped primary units, presenting an arbitrage opportunity for speculators.

In Shanghai’s Pudong District, 3,000 people queued up to make deposits for just over 400 new units in a project developed by COFCO – a SOE developer in China – where prices were capped at RMB 80,000 per sqm, about 20% lower than it would otherwise sell for. Another Shanghai project, Lakeville Luxe in Xintiandi, attracted 385 buyers seeking the right to purchase 118 apartments with average prices capped 15% lower than the developer’s expectation. More than half of which were non-occupier investors. So to speak, price caps have resulted in a surge in speculative demand, unforeseen and unintended by local governments.

With price caps imposed, developers are also less inclined to offer superior products by lowering fit-out standards to improve margin.

More to achieve on households’ deleveraging

China has undergone a deleveraging campaign for three years as the country aims to mitigate financial risk associated with high debt and overcapacity. Corporate investment across industries has reduced but a growing concern is the nation’s fast rising household debt. Outstanding household debt has risen from 36% of GDP in 2014 to 49% in 2017, as shown in the chart below. The main component of household debt, growth in mortgages does not only add risk to the economy but also cannibalizes consumption.

All in all, price caps create perverse incentives for investors and developers which work to undermine the health of the residential market in the longer term. Other measures such as increasing down payment requirements will serve better in suppressing investment demand and deleveraging.

Source: CEIC

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