Why China’s new measures to rescue the property crisis might fail

On 17 May, China announced a new policy package to address the property downturn. Among the measures introduced, one standout initiative was the establishment of a new relending facility worth 300 billion RMB by the People’s Bank of China (PBOC). 

This facility supports local governments in purchasing excess housing inventory and converting them into affordable housing through locally owned state firms. The relending quota of 300 billion RMB is to be matched by an additional 200 billion RMB from financial institutions so the total new bank credit the new programme will drive is 500 billion RMB. 

The goal of Beijing’s housing destocking plan is at least threefold. First, it wants to send a signal that the government will act as a buyer of last resort in the housing market, hoping that this will restore buyer confidence. Second, it is to provide indirect funding support for financially distressed developers who can then use the funds to pay down their debt and finish their unfinished projects. Third, it is to increase public housing supply, though it is probably more costly for local governments to purchase housing inventory from developers than to build public housing from scratch.

But this strategy is unlikely to be successful. In fact, since the policy package was announced in mid-May, both housing sales and prices have continued to drop through end May. Some observers worry that the size of the new relending facility is too small relative to the actual level of excess housing inventory out there.

There are various estimates, but most suggest that lowering inventory to a healthier level will require multiple trillions RMB in public funding. In fact, central bank officials have already signalled that there is room to raise the quota in the future if there is a need.

However, the new programme will likely garner little interest from banks and local governments because many of them do not have strong incentives to participate, and therefore, even the modest amount of funds available under the new scheme will not be used up. 

This is not the first time that the Chinese central bank has created such tools to support the government’s housing destocking efforts.

In January 2023, the PBOC launched a loan support programme for rental housing purchases in eight pilot cities with an aggregate quota of 100 billion RMB, encouraging financial institutions to extend cheap loans to local governments planning on purchasing excess housing inventories via local state firms and converting them into either commercial or affordable rental units. But the funds made available under the programme were barely used despite its low cost. By the end of the first quarter this year, only 2 billion RMB, or 2% of the programme’s quota had been used. 

The new central bank relending facility for affordable housing will likely have a similar fate. A major problem with the design of both programmes is that there is a mismatch between where the demand for affordable housing is and where most excess housing stock is.

In third-tier and fourth-tier cities where the problem of excess housing stock is the most severe, demand for affordable housing is modest. In first-tier and some second-tier cities where housing affordability is a serious issue, demand for affordable housing is stronger, but there may not be much excess housing stock for local governments to purchase and turn into public housing in the first place.

What this means is that the programme will only work in regions where there is both demand for affordable housing and an excess housing inventory. However, it is likely that only certain second-tier cities fit these criteria, while most smaller cities with massive excessive inventory will be left aside. This also explains why all the pilot cities in the central bank’s rental housing support programme initiated last year were all second-tier cities. 

Another reason why financial institutions and local governments may be hesitant to respond to Beijing’s initiative is that rental yields in major Chinese cities are likely too low to cover the financing costs.

For financial institutions to be willing to extend loans to local state firms planning on purchasing excess housing inventory and turning it into affordable housing either for rent or sale, the underlying projects must be commercially viable. Most Chinese banks are already seeing a rise in nonperforming loans and a drop in their net interest margins largely because of the property downturn. As a result, they are becoming increasingly sensitive about their asset quality and profitability. 

The interest rate that the central bank charges on its one-year-term loans to commercial banks under the new affordable housing scheme is as low as 1.75% and these loans can be rolled over four times. Given the central bank’s relending facility only supports 60% of the principal of eligible loans, banks will need to bring in additional funds from other sources (presumably with higher cost) when extending loans under the scheme, meaning their actual funding cost would be higher. 

However, the runaway housing prices in major Chinese cities relative to household income mean that rental yields, the annual rental income relative to the market value of a property, are very low.

According to data from the Chinese property agency Centaline, the average rental yield of secondary homes in the four first-tier cities as of May 2024 is 1.64%, which is even lower than the funding cost of the central bank’s new relending facility. In second-tier cities that are mostly provincial capitals, yields are just slightly higher. In Chengdu and Tianjin, for example, the ratios are 1.73% and 1.87% respectively. 

Presumably, rental yields of public housing units are substantially lower than those of commercial real estate. Given there will be vacant homes and other costs associated with the operation of affordable housing projects, the actual returns will be even lower and may not be enough to cover the cost. For those affordable housing units for sale, whether their sale prices will be high enough to cover the cost is also an open question. 

All this means such affordable housing projects may not be commercially viable despite the low funding cost, unless local governments can purchase housing inventory at heavily discounted prices or are willing to provide generous subsidies to the operating state firms.

But if prices are set too low, developers may not be willing to sell. Moreover, given housing prices are still declining across the country, some local state firms, like household buyers, will likely put off buying housing inventory in anticipation of further price drops. 

The deteriorating fiscal situation of local governments is likely another constraint. At most 80% of the investment in any affordable housing project can be bank loans and at least 20% has to be equity, according to Chinese government regulations, which means local state firms will have to bring in their own funds when purchasing inventories from developers and converting them into public housing.

Many state firms will rely on financial support from local governments. But most local governments in China are seeing their revenues plummet amid the property crisis and are unable to provide meaningful support. 

The most recent policy package also encourages local governments to buy back land plots previously sold to developers. But given their fiscal situation, the incentives for them to do such repurchases is almost nonexistent, unless the central government is willing to step in and provide greater fiscal transfers to localities. 

A fundamental problem with Beijing’s housing destocking plan is that it fails to recognise the scale of China’s housing oversupply problem.

One estimate shows that more than 60% of China’s housing stock is in third-tier cities, but aggregate population in those cities and thus housing demand is already starting to shrink because of population outflows and rapid ageing. The new destocking plan will bring little benefit to those smaller cities. And the many “ghost cities” will remain ghostly. 

On the national level, overall housing demand is bound to be slow and eventually decline in the long run, as the pace of urbanisation slows and the overall population shrinks. Even if local governments manage to buy some excess inventories now and convert them into affordable housing, many localities will likely struggle to find renters and buyers.

But without sufficient and sustainable housing demand, these investments will end up being wasted, adding to the already high debt burden of local governments and their state firms, and becoming non-performing assets on the balance sheets of banks. 

Related: Real estate sector in China’s first-tier cities still in a slump | Market jitters continue as China steps up economic stimulus measures