LIKE the many months before it, July was a gloomy one for the US housing sector.

New results show a 3.5 percent month-on-month fall in existing home sales in July, to 4.67 million from 4.84 million.

Over in the world's other property hot spot - China - a different, but potentially no less perilous, story has been unfolding, according to Joseph Gyourko, director of Wharton's Zell/Lurie Real Estate Center.

In a paper published last year with Yongheng Deng, director of the Institute of Real Estate Studies at the National University of Singapore, and Jing Wu, a visiting research fellow at the institute, Gyourko probed China's rising house prices, which in Beijing, in particular, have been "nothing short of extraordinary."

Since the publication of their paper titled, "Evaluating Conditions in Major Chinese Housing Markets," the three real estate experts have continued to monitor prices in China, while widening their scope beyond the major cities of their initial work.

With their latest findings being prepared, Gyourko spoke with China Knowledge@Wharton about the risks China's property investments face and whether any lessons can be gleaned from the bursting of the US property bubble.



Q: Does the longevity of China's rising property prices play into the argument that the country isn't actually facing a property bubble?

A: It's precisely because prices have been increasing for such a long time that I'm worried. One of the problems in the US was that the good times lasted for a long time - we had a boom from 1996 to 2006-2007- before things really started to crater. China has almost had that long of a period of rise.

The other big worry that I have with China, at least in the big coastal cities, is that middle-income families can no longer afford the typical housing unit. That is a similarity with the US.

It's a clear warning sign and we should have seen it in the US. When a proper middle-class household cannot afford housing because it's simply too expensive relative to their income, that tells you the market is being supported by some sort of speculation. That should worry everyone from Chinese regulators to you and me, because we all need China to grow.



Q: Is the government responding in ways that you agree with?

A: I view it as a healthy sign that the government is willing to try to intervene, to stop what looks like a bubble. I also view it as quite sane and proper for the government to require more equity for purchasers. It's a very good policy and we should have had it in the US. If you really want to bet on this market, you need to put some of your own money in.



Q: For the business community sitting outside China, why should we care about its possible property bubble?

A: It's a big sector, in an economy that's a big driver of global growth. The estimates are that real estate in general is about 12 percent of China's GDP. In the US at the height of the boom, it looked like it was about 6 percent to 7 percent.

There's the potential affect on the real economy to consider. Private housing accounts for around one-third of the buildings completed by China's construction industry. That industry constitutes around 5 percent of the country's GDP and consumes roughly 40 percent of all steel and lumber produced in China.

A lot of people are counting on China's growth to drive our export industries and so on.

Q: Were there any surprises in your research?

A: I was very surprised by how much land prices had increased, at nearly 800 percent in the case of Beijing. Price-to-rent ratios in eight large markets, including Beijing's, increased from 30 percent at the beginning of 2007 to 70 percent by early 2010.

As for price-to-income ratios, our research found that they were at their highest-ever levels in cities like Beijing, Hangzhou, Shanghai and Shenzhen. Those are big numbers.

That's one of the reasons why I believe there is some type of bubble, or euphoria, that has developed in China. It's virtually impossible to see fundamentals growing that fast.



Q: Are there any lessons that Chinese investors can take away from what you're observing in post-bubble US?

A: The big part of the bubble bursting in the US is over, but I think it will take a few years, not quarters, for the US to recover.

We still have a big supply/demand imbalance. We grossly overbuilt and we have unoccupied housing. We have this big backlog of foreclosures since the sharp rise in 2009 clogging up the system. As long as that supply overhang exists, you should not expect any significant recovery in American housing.



Q: Has there been any similar bubbles in the past where we've seen that?

A: We didn't have any cases until recently. We haven't seen bubbles akin to what happened in America, Spain or Ireland - they just haven't happened in the last 30 or 40 years.

To understand why bubbles can last a while, look at the US, at cities like Phoenix or Las Vegas. Those markets grew like mad because there was huge demand. There was huge population growth and substantial income growth - real demand drivers.

You see that in every major Chinese market. It's not like it's completely crazy.

They've got real demand drivers. The question is, have they built enough homes so that prices aren't pushed up so much, and have prices become so high that the typical household can't afford it?

My worry derives from the fact that the Chinese are building a lot of homes, and prices are unaffordable. At that point, I view it as unstable.



Q: How are Vegas and Phoenix doing now?

A: Very badly. Prices continue to fall. The good news is that the biggest part of the bubble has now burst. But in those cases, we now know that a lot of those purchases were made with very little equity. There have been a huge number of defaults. Their economies are weak because of that and are very still depressed. That's where equity really matters



Q: Do you see any changes among any of the players - from the regulators to consumers - that give you confidence that the US aren't repeating the same mistakes again and again?

A: You've certainly seen a huge drop in home ownership rates, which means that at least some people who were able to get credit in the past despite being weak borrowers aren't able to get it now.

But you still see the Federal Housing Administration has a 25 percent market share and is giving out 97.5 percent loan-to-value mortgages.

So there is still an arm of the government that is actively propagating very risky mortgages with very little equity. We're a bit schizophrenic.

The private markets have almost exited the mortgage market. But the government is still engaged in a policy that allows for highly leveraged home purchases. It's like Dr Jekyll and Mr Hyde.



Q: What would be a best-case scenario for China at this stage then?

A: That the government intervention requiring more equity works and you see air coming out of the balloon in a controlled fashion over the long term so that households can handle it, and you see a long period of time when prices are down or flat.

Borrowers won't be happy, but there won't be a financial crisis. What you fear is a precipitous drop very quickly, with defaults on the underling loans.



Adapted from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the original and full version, please visit: http://bit.ly/ohSyI0