Why China’s property market is getting scary

July 31, 2016

By Ansuya Harjani, CNBCGlobalPost Writer

A general view of the numerous apartment buildings after sunset on Feb. 22, 2013 in Beijing, China.
Feng Li

Worries that China's home market is over heating are spreading beyond mainland policymakers — who recently unveiled a slew of cooling measures — with key industry players including the head of the country's largest real estate developer warning of huge risks in the sector.

Wang Shi, CEO of Vanke said on CBS News' "60 Minutes" show over the weekend that China's property sector was already in a bubble state.

China has seen a boom in the property sector recently, with some cities seeing a 10-fold increase in prices, that have driven the average home buyer out of the market. According to estimates, the cost of a home in Shanghai would be around 45 times the average resident's annual salary.

Shi added that if the property bubble were to burst, it would be a "disaster," with a plunge in home prices sparking an "Arab Spring" type social unrest.

Real estate is among the most popular investment vehicles in the country, given volatility in the domestic equity markets, so a steep decline in prices would impact millions of local investors.

The Chinese government announced last Friday measures to curb speculative demand and stabilize prices. It called for stricter enforcement of a 20 percent capital gains tax on home sale profits and asked cities with fast property price increases to raise the down payment requirement and mortgage rates on second homes.

This spooked investors dragging the Shanghai property sub-index 9.3 percent lower on Monday, its biggest daily loss since 2008, as property analysts predicted a 10 percent drop in home prices over the next three to six months.

The outlook for China's real estate sector has serious implications for the commodities market and growth in the world's second largest economy. Property investment accounts for over almost 14 percent of the country's gross domestic product (GDP).

China economist Patrick Chovanec said the heavy construction pipeline in the housing sector was the "biggest concern" in his outlook for the market. The construction boom in recent years, for example, has led to the emergence of so-called ghost towns, or uninhabited townships.

The ratio of residential floor space under construction to floor space sold is rising, in 2012 for every one square meter of space sold 4.4 square meter was under construction, a record high. Before the global financial crisis, in 2008, for example, this equation stood at 3.9.

"We would have to see consistently strong demand to absorb what's in the pipeline," Chovanec told CNBC in a recent interview.

Dariusz Kowalczyk, senior economist, Asia ex-Japan at Credit Agricole, however, is not concerned about oversupply conditions in China.

"Urbanization ensures demand in the cities will remain strong because that's where everyone wants to move," he said.

In addition, "The government has been skillful enough to introduce measures that won't lead to a market crash. It's likely prices will stabilize or gains will slow, but we don't have a housing market crash in our central scenario for China."

According to Ren Xianfeng, an economist with IHS Global Insight, a meltdown in the country's housing market would only be caused by two things: a severe slowdown in the economy and/or sharp deleveraging.

"It's not going to take place any time soon, but it's a risk that's building," she said.