For anyone living in west London – most of us journalists lack the cash, mind – a greater number of Chinese businessmen can be seen living in the area, rubbing shoulders with their Arab and Russian counterparts. It’s not yet the Great Sino Invasion. In aggregate, more wealthy foreigners purchased expensive London properties last year than UK residents. But, according to Knight Frank, Chinese buyers accounted for a modest 2.8% of all buyers of high-end London property between 2012 and March 2013, compared with Russians, the largest foreign buyer base, at 8.5%.
From this low base, it’s not too difficult to predict an upcoming Sino spending surge for all the ‘wrong’ – bling – reasons: trophy assets, inflating prices, as Chinese buyers reap rental income, with London’s steady performance in the global crisis nurturing the dangerous perception prices will only go up.
What’s more, while China is imposing restrictions on asset purchases in its red-hot local property market – through fiscal redress and prudential measures – the UK government has thrown caution to the wind with an upcoming Help-to-Buy scheme, helping to inflate prices across the board and boosting upward safe-haven pricing expectations.
Against this backdrop, the following OECD chart makes for sober reading, throwing into sharp relief how the UK housing market is the eighth over-valued in all OECD countries.
House prices relative to rent are overvalued by – hold your breath – a whopping 31% and 21% relative to incomes, according to the OECD.
Foreign buyers, low policy rates, lack of housing supply and now fiscal redress have all fuelled the mania.
As income inequality increases in the UK – amid the inequities caused by globalization – it’s difficult to disagree with Indian economist professor Raghuram Rajan’s argument that fiscal policy to fuel housing bubbles will perennially hold the financial system under siege, an argument he outlined brilliantly in the 2010 tome Fault Lines: How Hidden Fractures Still Threaten the World Economy.
However, could things get a lot worse, from the perspective of a prospective UK buyer
, aka a generational jihadi
? One big factor to watch: China’s liberalization of its capital account.
Potential Chinese investment is huge. Even if 1% of the richest 1% of China’s 1.3 billion population decided to invest in London, that would amount to 130,000 sales, according to Capital Economics last year. By contrast, between 2010 and 2011, UK Land Registry data show that around 90,000 properties were traded a year in London, underscoring the huge impact Chinese buyers could have on the modest supply of high-end housing in London in the medium-term.According to Bain, "the number of Chinese high net worth individuals (HNWIs)—defined as individuals with at least 10 million RMB (approximately $1.6 million) in investable assets—grew to more than 700,000 at the end of 2012, more than doubling since the end of 2008, and on pace to increase an additional 20% this year".
But the biggest barrier to Chinese demand remains the country’s exchange controls, and the pace of monetary liberalization should shape the pace of Chinese investment.
In theory, individuals might legally convert only $50,000 out of renminbi annually while Chinese tourists or business travellers are limited to $5,000 in cash per trip. In practice, the very rich find ways to dodge these restrictions, as evidenced by overseas Chinese demand for real and financial assets.
Nevertheless, a relaxation of these controls and the growth of Chinese wealth accumulation would surely turbo-charge demand for Chinese housing. While US housing is cheap, don’t under-estimate the premia bestowed by the Chinese on Britannia Inc.
One anecdotal data point: the number of Chinese students at UK universities is up almost 70% in just five years.
China capital account
While marginal demand from Russia has been triggered by political forces as oligarchs seek a safe haven for offshore holdings, the key issue to look at when determining marginal demand in China is capital account liberalization. Bearish research shops such as Capital Economics – and the likes of Michael Pettis – don’t see that happening for at least a decade.
However, intriguingly, at the 2013 International Monetary Policy Conference, in under-reported comments, People’s Bank of China governor Zhou Xiaochuan said the economy is poised for greater liberalization, as evidenced by the recent strengthening of the renminbi.
The new, strong RMB policy has taken place amid a greater focus on rebalancing the economy. Chinese officials have publicly acknowledged the diminishing returns to public sector investment on growth and the need to re-tool its growth model in favour of boosting domestic consumption, necessitating fiscal, monetary and banking reforms.
The alternative narrative is bearish for reform and thus negative for the projected tidal wave of Chinese capital into London housing.
Capital Economics sums up the bearish analysis: “Our interpretation of the decision to allow a burst of appreciation is that policymakers hoped it would ease appreciation pressure on the currency by bringing the renminbi closer to equilibrium.
“Success would be signalled by the spot rate converging with the reference rate. But that has not happened. The renminbi continues to sit each day at the strong end of the trading band.”
The report adds: “Policymakers have settled on speculative inflows as the prime reason for the continued upward pressure. The apparent extent of export over-invoicing signals that there is something in this.
“But it is not the whole explanation. In our view, the renminbi remains well below its market value and the upward pressure therefore reflects more fundamental forces.”
In sum, it states, “continued upward pressure on the renminbi highlights that the conditions are not yet in place for substantial loosening of the capital account”.
While liberalization is a political issue and not the subject of this post, it's clear that from a low base, Chinese demand for London property could soar in the medium-term and out-strip supply, with a cascading effect on already-high London house prices, more generally.
Watch out.