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SOVEREIGN MAN

Blame Kevin Costner for China’s real estate bubble

July 6, 2011
Wuhan, China

[Editor's note: This missive was sent in from our partner Tim Staermose in China]

 Blame Kevin Costner for Chinas real estate bubble

Maybe the Chinese politburo has been watching too much deep cable, and, inspired by Kevin Costner’s Field of Dreams movie, decided to churn out a bunch of empty cities. As it turns out, though, if you build it, they won’t come… and if you’ll forgive the movie analogies, these empty developments across China are turning into fields of nightmares.

I’ve been quite bearish on China lately. There are so many reports about how the Chinese economy is going to lift the world out of recession, and insatiable Chinese demand for commodities will deliver permanent good times in resource-rich countries like Australia.

I suppose that if you’re sitting on a few trillion dollars in reserves and decide to dump a lot of it into your domestic economy, it’s good for growth… at least for a while. But China is doing the 21st century equivalent of digging ditches during the day and filling them up at night.

We’ve all seen the videos of Chinese ghost cities and bridges to nowhere, but I wanted to put some boots on the ground and check it out for myself.

I started my trip In Guangzhou, and it didn’t take me long to find the first example of what I call China’s “build it and they will come” philosophy of economic growth.

Guangzhou has this new district of glitzy office towers and apartment buildings in the Tian He district called “Pearl River New City.”

It is SEVENTY percent vacant!  Prices are DOUBLE what they are in the older section of town which most people prefer living in, because there’s actually nice established neighborhoods with stores, businesses, restaurants and so on which remain affordable to average people.

Untitled 300x225 Blame Kevin Costner for Chinas real estate bubble

They’re still building stuff in this “New City.”  Here’s a sign that showed half a dozen of the buildings with their respective heights proudly displayed.  The whole thing only sprang up in the past few years ahead of the 2010 Asian Games which were held here in Guangzhou.  In fact, they built a brand new stadium just for the opening ceremony!

Among all the impressive new skyscrapers in the Pearl River New City, I saw at least two 5-star international hotel brands– Hyatt and Westin.  I think you’ll find that if you call them and pose as a conference organizer, they have PLENTY of rooms available.

Beneath the surface (literally) this whole new district may not be so impressive.  During heavy rains, the area floods.  Apparently the developers were not as careful about what they built underground, and the drainage and sewerage systems leave something to be desired.

Traffic was light while I drove around the area with prominent local friend; he pointed out that IF the buildings were all occupied, the sheer number of people who’d be coming and going would probably cause a traffic snarl of epic proportions.

So who’s buying all of these units? Developers keep building because people keep buying, right?  They’re all mostly investment properties. Chinese real estate “investors” don’t actually care about rental yield at all.  Indeed, most of them deliberately let their properties sit vacant.

They buy apartments as an inflation hedge and are prepared to hold them as long as it takes to sell at a profit. As the theory goes, there’s always a greater fool out there willing to make an even dumber financial mistake.

I get the feeling some of the recent buyers in Guangzhou may be waiting a very long time.
The supply of rental property in Guangzhou is so vast that rental prices are roughly half as much as it would cost you to service a mortgage on the same property.

These observations– rental yields that don’t come close to covering the mortgage, empty buildings, bold advertisements heralding the grandeur of these projects, rising construction costs, cutting corners on infrastructure, etc. are all classic bubble indicators.

And as I’m going to explain in the coming days with even more boots on the ground reports, this is a bubble that’s bound to pop soon. Stay tuned.

About the author: Born to a Danish father and British mother, in Dar Es Salaam, Tanzania, Tim Staermose has led an international life since the day he was born. Growing up, he also lived in Egypt, Denmark, and Singapore, before eventually settling in Australia, where he completed his education and took out citizenship. Since then he has also lived and worked in Hong Kong, and Manila, Philippines, in the field of equity research — both for a bulge-bracket Wall Street investment bank, and for an independent investment research firm. Today, when not traveling the globe looking for investment and business opportunities for the Sovereign Man community and catching up with his diverse, multinational group of friends, he divides his time between Hong Kong, and the Philippines.

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  • clickoff

    Interesting article.  I spent the last 2.5 years in China (my wife is from Wuhan) and lived in Zhuhai (Guangdong Province).  I watched them build the stadium for the games.
     From what I learned living there, many people buy apartments for retirement and also to leave an inheritance for their children.  But I can attest to the fact that many building are vacant (or nearly so) and there is even a corruption angle here.Many of these empty apartments belong to government officials who receive them as a sort of bribe to get the projects approved.  I have never been able to substantiate this claim but I heard it from many local people.   

    Again, no proof but lots of talk and rumors. 

    FWIW, I miss living in China, the people are really wonderful and open, there is a very rich culture, 50+ different ethnic groups and terrific food.  And last, but not least, a 5000+ year history.

  • Dave26027

    Simon: this isn’t related to this article but, you’ve got to see this if you aren’t aware of it..  terrorwithindoc.com     I was in Chicago yesterday and listened to an interview with the lady this happened to. FREAKIN UNBELIEVABLE !

  • http://www.capitalistexploits.com Chris

    Spot on Tim. 

    I’ve always believed that the size of any given bubble can be measured by the divergence between cash flows and asset values those cash flows support. 

  • John Lloyd

    I have to say I’m a little confused or should I say wary? The economies that didn’t really feel the effects of the Great Recession were ones with high exposure to China. Chile, Aussie, Singapore, etc…If the Chinese bubble pops and the reasoning seems quite sound, the effects on the global economy would be nothing short of catastrophic. I don’t see how any country could avoid depression after such an event. Where oh where should we plant our flags, Tim/Simon? I hear Jupiter is having a lovely storm right now…

  • Arty

    Having worked in Dubai for a year this is exactly the situation there. The newly built buildings meant for offices are sitting empty. Abu Dhabi is only safe because it has OIL… 

    If you travel roughly 150kms to Abu Dhabi from Duabi; the rent is SKY HIGH – i.e. US$1,000+ per month for just a tiny studio apartment. Whereas, for the same amount you can get a 2 bedroom (with a BIG Hall) + 2.5 bathroom + Kitchen + maid’s room + gym + swimming pool + central location in Sharjah in a really nice building. And even get a 3 or 4 bhk for the same amount if you scale down your expectations.Plus, almost all real estate companies and most construction companies are blacklisted by the banks there.*Abu Dhabi – Dubai – Sharjah (are located side-by-side in this order)

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