Economics
If house prices are allowed to fall freely, how much will house prices fall?

December 13, 2023

Recently, Suzhou City has released a bombshell to rescue the real estate market. If the developer’s selling price is lower than the recorded price, the regulatory authorities will not impose any restrictions on the extent of the price reduction. In other words, developers can lower prices and promote sales according to their own wishes, and the government will no longer intervene in the pricing power of enterprises.

For the national real estate market, the freedom to lower prices for new homes is a very important signal, indicating that housing prices will squeeze out the bubble, and the true level of housing prices will gradually surface.

It is well known that local governments are always very sensitive to the price reduction behavior of developers. Due to concerns that significant price reductions may trigger negative chain reactions and even lead to a collapse of the local real estate market, many local governments do not allow developers to make large price reductions. Even in cities where there is severe oversupply, there are strict regulations on the extent of price reductions, such as not being allowed to be lower than 10%-15% of the recorded price.

However, in the current downward cycle of the real estate market, such price reductions do not reflect the true price level. Many real estate projects need further price reductions to stimulate transactions. Under the local government’s limit order, many developers have to indirectly lower prices, such as offering property management fees or giving away gold with home purchases.

If any developer dares to make significant direct price reductions, it may be classified as a “malicious price reduction.” In May of this year, two real estate developers in Kunshan City, Jiangsu Province, reduced their prices and were penalized by the local Housing and Construction Bureau. The reason given was “unauthorized significant price reductions for sales, disrupting market order, and causing factors of social instability.” The Housing and Construction Bureau also emphasized that local real estate companies should take it as a warning and consciously maintain the order of the real estate market. Violators will be strictly dealt with.

However, although administrative measures can deter individual enterprises, they cannot ultimately stop the overall downward trend of the market. Moreover, distorting normal pricing behavior in the market through administrative will can lead to even greater negative effects.

With the continuous decline of the real estate market, more and more enterprises face enormous cash flow pressures. If developers are not allowed to lower prices for promotional purposes, many developers will face the risk of cash flow disruption and debt default, leading to more and more unfinished real estate projects. This will give rise to social issues that ultimately require government intervention.

In addition, the real estate crisis will also spread to the banking system, potentially triggering a large-scale financial storm. Real estate has always been seen as the gray rhino of the Chinese economy. If developers experience cash flow disruptions due to the inability to lower prices, the gray rhino of the real estate market may become a reality. Only by allowing price reductions for new homes can the current stalemate in the real estate market be broken and prevent the further escalation of the real estate crisis.

As the negative consequences of restricting price reductions become more apparent, the attitude of regulatory authorities is beginning to loosen. In August of this year, the Ministry of Housing and Urban-Rural Development’s official media, “China Real Estate News,” published an article titled “Real Estate Financial Risks Intensify, Expecting Adjustments and Optimizations of Policies to be Implemented as Soon as Possible (Translated).” The article stated, “Developers should be given greater autonomy in pricing, allowing them to engage in self-rescue through price reductions and quickly recoup funds.” The icy restrictions on price reductions are showing signs of melting.

More importantly, restricting price reductions by developers will ultimately impact local governments. Because the real estate industry’s model has always emphasized rapid turnover, if developers cannot quickly sell their inventory of properties, the inventory will continue to accumulate, and developers will lack funds to acquire land and develop new projects. This will greatly impact the fiscal income of local governments.

In 2022, the nationwide land transfer fees decreased significantly by 30%. This year, the land market continued to cool down, and the land transfer revenue in the first three quarters decreased by another 20% compared to the low base of the previous year. In some places, the decline even exceeded 40%. The consequences of unsold houses have finally affected local governments, causing pain for some local governments that heavily rely on land finances.

In this context, many local governments have to make a choice: whether to maintain housing prices or prioritize land revenue. Different local governments are showing divergence in their approaches.

Some local governments choose to continue to maintain housing prices. At the end of November, a real estate project in Chengdu reduced prices by 40%, which was characterized by the local management committee as “suspected of disrupting the normal order of the real estate market” and its record was temporarily suspended. However, more local governments have started to relax regulations on price reductions. In August of this year, a real estate project in Zhuhai conducted a half-price promotion, and the local Housing and Construction Bureau stated that “the price reduction approach taken by the project is a reasonable market behavior” and allowed the price reduction.

Suzhou’s lifting of price restrictions on developers sends an important signal to the national real estate market. With its GDP ranking 6th in the country, even Suzhou, with its economic strength, has started to prioritize land revenue over housing prices. This indicates that many other local governments are likely to face the same choice, and it is expected that more local governments will lean towards prioritizing land revenue.

As more and more local governments begin to lift restrictions on price reductions for new homes, it will have a significant impact on the national real estate market. The current domestic real estate market is largely in a stalemate because prices have not fallen sufficiently, resulting in a rapid decline in transaction volume. The reason prices have not fallen sufficiently is directly related to the restrictions on price reductions for new homes.

In the new home market, the pricing of new homes is highly influenced by administrative power, deviating significantly from the true market price. Even the seemingly market-based pricing of second-hand homes is inevitably affected by the pricing of new homes because if new home prices do not decrease, it largely supports the pricing of second-hand homes. The limited decrease in second-hand home prices in many cities is mainly because many sellers of second-hand homes currently do not have financial pressure and are unwilling to significantly reduce prices proactively.

However, once restrictions on price reductions for new homes are lifted, housing prices in the country will face a reprice shock. Many developers are under significant debt pressure, and they will increasingly choose to reduce prices significantly to recover funds. If they do not reduce prices significantly, many developers will face the risk of bankruptcy.

If new homes experience significant price reductions, it will eventually impact the second-hand home market as well. If second-hand home prices remain high, the limited number of buyers will flow into the new home market. Even sellers of second-hand homes who are not in dire need of money will have to reduce prices proactively under the pressure of price reductions in the new home market.

VIEWS BY

Xie Jiu
Editor of Sanlian Lifeweek Magazine
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