小北的不老歌

Of boom and bust

I’ve been watching the housing market in China for a while and reading about the conflicting predictions (and the supposed reasons supporting these predictions) of the direction of the price. I tend to think that, based on the ridiculously high price-to-rent ratio alone, this is a huge bubble waiting to pop, but would love to be proven wrong.

My simplistic thinking is as follows. Economists like to think in terms of long-term equilibrium and the short-term distortions that depart from and return to the equilibrium. For consumers, the long-term choices are: owning a residence versus investing the same amount of money and renting a residence using investment income. The long-term equilibrium should be that the consumer is indifferent between the two.

Some may say that Chinese families prefer to own rather than rent. Notwithstanding the fact that currently “land ownership” under Chinese law is equivalent to a 70-year fixed-term assignable lease, I am willing to discount the rent option to account for the preference, but that does not explain the large disparity between the price to purchase and the price to rent we currently see in the housing market in China.

Some argue that there’s this “inelastic demand” for housing and limited supply. They overlook the fact that the only thing “inelastic” about demand for housing is that people need basic housing, whether by owning or renting. An example illustrates the point. It is indisputable that food, like housing, is a basic necessity, and there is a certain element of “inelasticity” to it. But the inelasticity ends at the basic food supplies, which can be purchased from the market as needed. No one would argue that the demand in higher quality food (e.g., organic food) is inelastic, or that to ensure a constant supply of food one must own the land that produces it. Same with the housing market. Demand for basic housing is inelastic, but demand for housing in a desirable neighborhood or a convenient location is not. And people can fulfill the need for housing by purchasing piecemeal from the market (i.e., renting), much like going to the food market every week for food supplies, without owning the piece of property that produces the commodity.

Yet some say buying a residence is a good investment. I think this may be true for those whose investment portfolios are sufficiently large and diversified. But for someone who needs to invest his life savings (and those of his parents), i.e., many prospective buyers in the housing market in China constituting the so-called “inelastic demand,” I am not sure if putting all one’s eggs in one basket is a wise decision. Most people would never borrow a large sum of money from the bank to invest solely in the real estate sector of the stock market, yet many are willing to do exactly the same and invest in just one or two properties, the value of which is affected by even more factors and subject to even higher volatility than the real estate sector as a whole. It’s a risky investment that may pay off handsomely, as has been the case in the past several years, but the tide can turn quickly, as we’ve seen in the real estate markets and stock markets elsewhere.

The only thing left, I think, that would explain the high housing price and relatively much lower rent, is speculation. And when the market goes up on nothing else but broad-based speculation, it’s called a bubble. People speculate that the housing prices will go even higher, so they now buy and hold in the hopes of making a profit later by reselling. And when they buy, they inflate demand and drive up the price, so even those who do not buy for speculative purposes and has no need to buy immediately now feel an immediate need to buy before the price goes up too high, further inflating the immediate demand (at the cost of weakened future demand).

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Separately, I’ve been thinking about the legal market in China lately. The job market there (and here in New York) now is very much different from when I started law school and interviewed for jobs. But for Chinese law students here in the US, I think the outlook is even better than before.

Again, look at this from a supply and demand perspective. Demand for U.S. trained, bilingual Chinese attorneys who are willing to commit to Asia will only increase over time as the cross-border transactions increase in both number and complexity. Supply will remain low because of (1) the language barrier, and (2) the cost of the legal education, neither of which is likely to change in the foreseeable future.

Language. Law school and law firm work is language-intensive. I think the Chinese students who are most likely to succeed in law school are the English majors (or those who have a far better command of the English language than the average non-English majors) and those who have lived in an English speaking country for some time. I have seen non-English majors coming directly from China doing very well in U.S. law schools, but they are the rare exceptions rather than the rule.

Cost. Three years of JD now cost at least 180k without financial aid. (One year of LLM is less expensive, but the LLM degree is also a lot less marketable.) This is still a very large number for a lot of Chinese families. The AccessGroup loan program that used to be available to foreign law students without US residents as co-signers was terminated recently. So even fewer Chinese students can afford (or borrow enough) to attend law school than before.

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I guess there is a lot of truth in “buy low, sell high,” after all. The housing market is high, the legal market is low. Thinking of which one to buy into and which one to sell out of?

Comments (5)

  1. Xiao

    Well written!

    My mom is a big fan of real estate investment (though not a big investor) and she strongly believes that the housing market in Shanghai will stay high.

    When I argued that the housing market in China was distorted as indicated by the high price-to-rent and price-to-income ratios, she responded with the “inelasticity” argument as well as the government-wouldn’t-let-it -fail reasoning. She added that “you guys who are abroad for too long no perceive the Chinese society accurately!”

    Well, I don’t think I am away for too long. On the other hand, I agree with her that we are less sensitive to the mentality of the market , than those residing in China. And as you said, mentality or “speculation” is what keeps the market rising now in China. The distance may make one more sober, but it can also cost one the opportunity to profit from the bubble.

    Then I told my mom how the housing market collapsed in Japan after decades of booming as well as the current recession in U.S. . She was much acceptive of such substantive evidences, but still remained optimistic about the housing market in Shanghai.
    I guess many people (even my mother) somehow recognize the existence of the bubble. However, the problem is that when a bubble is growing, the only way not to lose is to ride with the bubble, and to get away before it bursts. Judge Posner made a similar point when he gave a talk on the Great Recession in our school last year.

    So there it is. Life is full of boom and bust. Knowing that it is a bubble doesn’t help too much. What’s really important is that you get in and out at the right moment, before other people.

    The good thing is that my net worth is a huge negative now so I don’t need to worry about investment for the time being lol

  2. littlenorth

    Interesting. And I am glad we think alike. Sometimes I wonder if I am missing the big picture here. Though I also wonder if people hoping to ride the boom should invest in the shares of the real estate developers or real estate sub-index or REITs rather than directly in real estate. There is less risk that way due to the diversification, an enlarged upside potential (similar to my earlier hypo of why many invest in gold mining companies rather than directly in gold in a gold boom–and think about the 80% stock market rally this year), and presumably a lead time advantage when the bust comes (I am guessing it would take a bit of time for a sustained drop in housing prices to be reflected in the stock price of real estate developers). In any event, committing one’s savings in a single product in a single sector for investment purposes just doesn’t seem right.

  3. Poly

    I made the same arguments to my parents in 2004, and I lost all my credibility as an investor.

  4. littlenorth

    Indeed… I wonder what the price-to-rent and price-to-income ratios were back in 2004 though.

  5. LNfans

    是否有买房的刚性需求要分情况来看,以北京为例
    A北京人
    a1 两代以上有北京户口的人: 刚性需求小 (有计划时代福利分房,旧换新,拆迁房等,基本上能保障三口之家有房住)
    a2 第一代有北京户口的人(新移民): 刚性需求大 (主要是在国家机关、国企等单位工作的大学毕业生。这些单位现在也要靠买商品房解决住房问题,或单位团购或个人购买、单位补贴。这类人毕竟要在北京活下去,还要把外地父母接到北京养老,所以一人必买一套。)

    B外地人
    b1 在京工作的 刚性需求中 (其实买房或租房都可以,取决于他们是否想最终落户成为a2)
    b2 全国的有钱人,比如山西煤老板等 刚性需求小 (买房主要为了投资。批发买房,不差钱!!)

    现在b2炒房,使a2和想成为a2的b1不得不当房奴。假如泡沫破了,a2毕竟是铁饭碗,不会损失太大。b2的损失就是因果报应了。

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