In the U.S., it was a housing debacle that unleashed the deepest crash since the Great Depression. Lured by teaser rates, folks who couldn’t afford a home left their apartments and bought a ranch, colonial, or condo. Builders kept selling to a new class of speculators who didn’t live in the sprouting subdivisions but kept watching the “value” of their empty abodes jump as nearby homes sold at higher and higher prices. When rates reset, millions of families who had moved from tenant to owner could no longer make the monthly nut. So heavy was the glut that the investors couldn’t find renters to cover mortgage payments and taxes. Millions of strapped homeowners sent their keys back to their lenders in a flood of “jingle mail” as foreclosures flooded the market.
As the “for sale” signs multiplied, housing prices dropped from October 2006 to February 2012 by 28%. The crisis sank Lehman Brothers, and saddled the banks with steep losses that crunched credit for consumers and companies. It took over a decade from the start of the downturn, until mid-2017, for home prices to return to their bubble highs. Adjusted for inflation, your house shed 30% of its value over those 11 years. GDP dropped sharply, and the economy’s output didn’t regain pre-crisis levels for around 30 months.
Now, a prominent international economist is predicting that China will experience a disaster that mirrors the dynamics of the U.S. meltdown, but promises worse. He’s Robert Z. Aliber, retired professor at the University of Chicago’s Booth School of Business. I was fortunate to take a class from the distinguished scholar his students affectionately reference as RZA while an MBA candidate in the 1970s. Among RZA’s many accomplishments are a book coauthored with former Secretary of State George Shultz (Guidelines, Informal Controls, and the Marketplace) and the twin successes The International Money Game and its follow-up, The New International Money Game, two of the most entertaining and insightful introductions to the arcane workings of global finance.
Aliber has expressed his China outlook in one of the private newsletters he sends to fellow economists, business associates, and former students. I’m privileged that RZA allowed me to share his insights with Fortune readers. Aliber’s views are shocking and controversial, but the parallels to the U.S. collapse that I covered in depth convince me that his case is well founded. Many of the metrics Aliber cites are the same ones that I highlighted as early as 2004 to forecast that the looming cataclysm. Only the measures in China are even further out of whack. Indeed, if he’s right, the Chinese miracle is on the brink of spiraling into a long decline—at the same time many observers warn that the most populous of all nations is poised to supplant America as the world’s top economic power.
Hitting a ‘great wall’ on apartments
Aliber begins by riffing on Andy Warhol’s immortal quip that “in the future, everyone will be world-famous for 15 minutes.” The economic equivalent, he says, is that “every country grows rapidly for 40 years.” Aliber recounts that China has enjoyed four decades of “brilliant economic achievements” that have lifted 300 million to 400 million of its citizens from huts in farming villages to modern high-rises in its cities, almost 70 of which boast populations of over 1 million. But for Aliber, the countdown is running on China’s span of economic superstardom. The reason: the coming collapse of the high-flying apartment sector that has fueled its jackrabbit growth. As Aliber memorably puts it, “China’s economy is hitting a great wall.” The immovable object that will stop its march for glory cold is the towering overhang of apartments that can’t find buyers.
The failure of property finance firm Evergrande, he says, marks a key bellwether. “It was a predictable event, not by name, but because the property developers that had expanded most rapidly would be the first to fall when prices stopped increasing,” the economist observes. The Chinese government just reported that in September, housing prices went flat month over month for the first time since February of 2020. Aliber believes the state’s numbers are overly rosy, and values are already dropping. For Aliber, the haymaker is a confluence of a Brobdingnagian supply of unsold apartments, investors’ realization that the music’s stopped, and the slowdown in workers’ flow to the cities that provided durable demand for live-in housing, as opposed to betting on unoccupied condos over stocks or bonds. That trend is anything but durable. He cites four “incontestable facts about the property market” that signal the start of a devastating cascade.
First, China’s cities harbor “tens of millions of vacant apartments.” Aliber’s best estimate: an astounding 40 million to 60 million units sans resident owners. Chinese citizens bought these flats as a store of value. Apartments provided the primary channel for the nation’s extraordinarily high rate of savings. More and more Chinese bought apartments not as family homes, but as investments—a hallmark of the U.S. craze. New waves of buyers kept stoking prices in double digits, convincing owners they could always find someone to pay more than they did. Developers prospered erecting residential towers catering to absentee buyers. Today, says Aliber, China’’s cities feature 15 to 20 empty apartments for every 100 occupied by owners or tenants. But the glut keeps building: Another 20 million flats are advancing in the construction phase, and will reach what’s already a super-swamped marketplace over the next two years.
The second reason really grabbed this writer. Aliber notes that values are incredibly high versus the fundamentals, the gravitational forces that govern where real estate prices will settle following periods of frothy enthusiasm or excess pessimism. Specifically, apartment prices are extremely elevated versus rents and household incomes. The number that astounded me, and looked scarily familiar, was the ratio of prices to rents, what we’ll call the P/R multiple. It indicates whether housing is under- or overvalued, the function the price/earnings ratio serves for equities. Aliber reckons that the rental “yield,” the yuan that tenants pay each year as a share of the selling price of the units, is between 1% and 1.5%. That puts the P/R at between 66 and 100. In 2004 and 2005, as the housing bubble was growing, I studied what the measure was signaling in a piece coauthored with Mark Zandi, chief economist at Moody’s Analytics. We found that if the long-term average of annual prices to rents in a superhot, Sunbelt market was traditionally 25 to 1 and it had soared to 40 to 1, a crash was at hand. Our view was that prices would trend back to a 25 multiple, not stay at 40 or jump to 50, as the bulls predicted.
Either rents had to explode or prices had to fall, we posited. The former was a virtual impossibility. Rents don’t boom; they rise slowly with household incomes, or maybe a tad faster. The predictable outcome was that prices would collapse, pulling the price-to-rent yardstick back near the historic norm. That’s what happened. But Zandi and I were only seeing multiples in the 40 times range, even in the most overheated metros. Ratios of up to 100 are much more terrifying, and indeed presage a far harder fall than the U.S. suffered in the great housing deflation.
Third, Aliber points out that the frenzy made apartment construction a backbone of China’s high growth. He cites that China has been building 10 million new units annually over the past 15 years, and that spending on those projects accounted for 10% of its GDP. By contrast, in the U.S., multifamily construction contributes only about 5% of national income.
Fourth, a key engine of real, durable demand, as opposed to betting on a one-way elevator, is fading. “The migration from the countryside to the cities has more or less ended,” says Aliber. “There are relatively few people left on the farms between the ages of 6 and 65.” He adds that the population in China’s cities will actually decline via a combination of low birth rates and the waning exodus from the countryside. The cities’ appeal for well-paying jobs will fade over time. Workers in Vietnam and Bangladesh make many of the same products as China at lower wages. That competition will curb future employment in the city factories, and possibly cap paychecks.
A cascading disaster is at hand
Apartment owners who once believed, Aliber argues, now doubt that “there are an unlimited number of greater fools who will continue to pay ever higher prices for apartments.” Hence, formerly hungry buyers will cease amassing new flats. As inventories of unsold apartments keep swelling, the banks will demand that developers pay down their underwater loans. Those developers will stop purchasing raw land from local governments, causing a steep decline in their receipts. Sales of all the materials that go into building apartments, from cement to rebar to glass, will tumble. The government, Aliber predicts, will “adopt a million regulations to limit price reductions” and provide massive bailouts for lenders.
Relentlessly rising apartment prices exerted a powerful wealth effect. Chinese consumers kept feeling richer and richer, spurring them to spend freely on consumer goods, an emblem of the fastest ascent in world history. That golden goose will perish. “The sharp decline in household net worth will lead families to rebuild wealth, so that spending on autos and other durables and travel will decline,” writes Aliber.
A fall in apartment output from from the current 10 million units a year to 5 million would reduce GDP growth by three percentage points, Aliber predicts. That scenario, or even worse, is likely since it would take 10 years to sell the tens of millions of excess apartments to people who actually live there. That scenario recalls the South Florida condo explosion in the run-up to the 2007 calamity. The overbuilding was so immense that it took a decade to unload the units sitting buyer-less. In all those years, developers built just a tiny number of new condos. That decline in new construction proved a gale force headwind to the Florida economy.
All told, Aliber predicts that China could enter “a recession that could last eight or 10 years.” He forecasts that GDP growth will rarely go over 2%, and in some years, will turn negative. RZA’s view is unorthodox and contrarian. But the signs of a fast slide are building. Is the balloon more inflated than the floater that imploded 15 years ago in the U.S., as Aliber believes? If he’s right, it won’t take long to hear the pop. For sweeping damage to an economy, the U.S. wipeout proved that a real estate crash is the worst crash possible. It may prove the great wall that ends what appeared an unstoppable quest to fashion the emperor of all economies.
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