Is Real Estate the Achilles' Heel of China?

Executive Summary

The debt-to-GDP ratio in China has increased significantly over the past five years, and it appears that much of the increased leverage has occurred in the real estate sector. With property prices starting to move lower, some analysts worry that a debt-inspired collapse of the Chinese economy is at hand. A financial collapse in the world’s second largest economy, should one occur, clearly would have negative implications for the rest of the world.

In our view, a collapse of the Chinese economy that begins in the real estate sector is not imminent. The Chinese real estate sector draws its financing from many different sources, including equity and down payments from end users, and the Chinese banking system does not appear to be overly exposed to real estate. Moreover, property prices would need to drop much further before the real estate sector was technically insolvent.

That said, the American experience of the past decade shows that the implosion of a house price bubble does not necessarily happen overnight, and the ultimate financial crisis may not occur until a few years after property prices begin to decline. Although we do not lose sleep at the present time worrying about a financial crisis in China, property price developments in that country certainly are on our radar screens. Stay tuned.