Comparison of Real Estate Bubbles in China and Japan, and Prospects for the Chinese Economy

1――China's Real Estate Market Continues to Decline

The slowdown in China's real estate market persists, with house prices gradually decreasing. Chart 1 illustrates the prices of existing houses in 70 cities, as reported monthly by the National Bureau of Statistics, indexed to December 2010 (=100). Prices peaked at 133.60 in July 2021 and have since declined to 121.68 in December 2023, a decrease of nearly 10%. During the late 2014 to early 2015 period, amid a previous shock, prices dropped by about 5%. However, the current decline is more pronounced, with no signs of stabilization.

This downturn is mirrored in sales figures. Real estate sales plummeted to 1,117 square kilometers in 2023, approximately 60% of the peak seen in 2021. Historically (Chart 2), sales dipped by around 10% during the global financial crisis (2008) and the China shock (2014–15), but recovered to pre-shock levels within a few years, continuing to rise thereafter.

[Chart -1]Trends in Used Housing Prices/[Chart -2]Real Estate Sales Area in China

However, the current decline is more severe. Additionally, in the housing sector, which accounts for over 80% of real estate sales (by area), inventory (including in-process inventory) is accumulating. Should the current sales slump persist, it could take several years to clear this inventory alone.

The real estate sector was once a key driver of the Chinese economy. Real estate growth, as measured by GDP, averaged 10.3% annually in the 1990s and 10.7% in the 2000s, with double-digit growth becoming the norm. However, real estate growth slowed to 4.7% in the 2010s, and it declined by -3.9% compared to the previous year in 2022, followed by a -1.3% decline in 2023, marking the second consecutive year of negative growth (Chart 3). Consequently, many real estate developers are facing financial instability. Despite the Chinese government's introduction of the "Article 16¹" measures in November 2022, aimed at providing financial assistance, the effects of these measures were temporary, and real estate-related loans remain stagnant (Chart 4).

The current real estate downturn in China bears resemblance to the real estate bubble burst that Japan experienced in the 1990s. This article compares and analyzes the real estate bubbles in Japan and China, and subsequently delves into the future of the real estate bubble in China.

[Chart -3]Real Growth Rate by Industry/[Chart -4]Trends in for Real Estate Development

¹ The People's Bank of China and the China Banking and Insurance Regulatory Commission issued a notice on November 11, 2022, to fully support the stable and healthy development of the real estate market through finance. They announced 16 support measures in six areas, including stabilizing loans to real estate developers, providing special loans to ensure the reliable delivery of housing, encouraging asset management companies to support financially troubled real estate developers, and protecting the interests of mortgage users.

2――Real Estate Bubble in Japan

Before delving into the real estate bubble in China, let's first examine the real estate bubble that occurred in Japan. A real estate bubble typically refers to an inexplicable surge in real estate prices, likened to a "bubble" due to its fragile and unsustainable nature. In this section, we will describe the stages of a real estate bubble: the "Formation" stage, during which real estate prices soar and the bubble expands, and the subsequent "Collapse/Cleanup" stage, when the bubble bursts, leading to bankruptcies among real estate developers, non-performing loans burdening banks, and other related consequences.

1| Formation Stage of the Real Estate Bubble in Japan
The real estate bubble in Japan began to take shape around 1987. According to data from "Land in Tokyo" published by the Tokyo Metropolitan Government (Chart 5), the price per 75 square meter of an apartment in the Tokyo 23wards area was 41.85 million yen (6.7 times the annual income) in 1986. However, it surged to 66.08 million yen (10.3 times the annual income) in 1987, 94.2 million yen (14.2 times the annual income) in 1988, and 107.85 million yen (15.8 times the annual income) in 1989.

This surge was fueled by the "land price myth," which asserted that land prices would always rise. Following the Plaza Accord in 1985, Japan experienced a sharp appreciation of the yen, prompting Japanese companies to enhance their ability to cope with the strong yen by expanding overseas production and cutting costs through streamlining and automation. Additionally, the Bank of Japan lowered its discount rate five times to address the economic downturn caused by the strong yen, leading to a structural shift from reliance on external demand to domestic demand. With low interest rates, Japan witnessed a speculative boom known as "Zaitech," with real estate emerging as a favored investment option.

Examining the historical trends in land prices in Japan (Chart 6), we observe that while prices experienced periodic declines, they generally continued to rise over the long term, rebounding after a few years. Moreover, the growth in land prices consistently outpaced the growth in consumer prices and wages, reinforcing the notion of the "land price myth."

Consequently, real estate developers spearheaded a surge in real estate investments, while general corporations actively acquired real estate, and ordinary individuals began investing in condominiums with borrowed funds. Financial institutions provided financial backing for these speculative activities. As a result, Japan as a whole became complacent about high prices, leading to an unprecedented rise in real estate prices.

[Chart -5]Housing Prices and Annual Income Multiples in the Tokyo 23wards/[Chart -6]Japanese Land Price Comparison with CPI/Wages

2| Collapse/Cleanup Stage of the Real Estate Bubble
The real estate bubble in Japan reached a turning point around 1990, with land and condominium prices peaking in 1991 before starting to decline². Several factors contributed to this decline: (1) an increase in the official discount rate and subsequent rise in long-term interest rates since 1989 (Chart 7), (2) revisions to the tax system following the enactment of the Basic Act for Land , and (3) regulations such as "total volume control," which limited the growth rate of loans to the real estate industry (excluding loans to public housing development institutions) to prevent it from exceeding the overall rate.

As prices began to fall, real estate developers, corporations, and individuals began to withdraw from the market, akin to rats fleeing a sinking ship. By around 2000, land and condominium prices had returned to pre-bubble levels (1986), and Japan's real estate bubble had finally burst.

Subsequently, Japan embarked on a cleanup effort to address the aftermath of the real estate bubble. Financial institutions reduced lending to the real estate industry under total volume controls. Real estate developers, who had been expanding their real estate investments using loans from financial institutions, faced declining asset values due to falling real estate prices and increased costs from rising interest rates on their liabilities. To manage this, they resorted to fire sales (selling properties below cost) to repay debts and began restructuring their balance sheets. Similarly, corporations and individuals who had leveraged investments (investments using borrowed funds) also adjusted their portfolios. The forced selling of properties led to a wave of bankruptcies among real estate developers, and some corporations faced bankruptcy despite profitability in their core businesses. Many individuals also went bankrupt due to their debt obligations. Non-performing loans at financial institutions surged, leading to financial instability, prompting institutions to reluctant lending, causing a credit crunch (Chart 8).

[Chart -7]Japan's Official Discount Rate and Long-term Interest Rate/[Chart -8]Housing Prices&Non-Performing Loans

In an effort to mitigate this financial instability, the Japanese government injected public funds into financial institutions. Consequently, government debt, as a percentage of GDP, which had been declining, bottomed out at 63% in 1990 before starting to rise (Chart 9). As the Japanese government implemented large-scale economic stimulus measures to revive the ailing economy, government debt further increased. Despite the low number of individuals purchasing homes for personal use, high-interest mortgages dampened their willingness to spend. Following the bursting of the real estate bubble (1991–2000), the real growth rate averaged an annual increase of 1.3%, a significant decline from the 4.5% increase seen in the previous decade (1981–90) (Chart 10).

[Chart -9]Japanese Goverment Dept(5 of GDP)/[Chart -10]Japan's Real Growth Rate befor/after the Bubble Collapse

² The timing of the decline in land prices varied among regions. Around 1988, when land prices began to decline in Tokyo, they increased in metropolitan and regional areas such as Osaka and Nagoya. This was because funds were flowing into areas where prices were lower than in Tokyo.

3――Similarities and Differences Between China's Real Estate Bubble and Japan's

[Chart -11]Housing Prices Annual Income Multiples in Shanhai

1| Degree of Bubble
During Japan's bubble period, as mentioned earlier, housing prices in the Tokyo metropolitan area surged inexplicably, becoming unaffordable for the average person. How does China compare?

To assess this, we calculated the annual income multiple in Shanghai. The average annual wage in Shanghai, as reported by the National Bureau of Statistics, was 191,844 yuan in 2021. With an average of 1.45 workers per household in 2012, the combined annual wage is estimated at 278,174 yuan. In contrast, the housing price in Shanghai stands at 40,974 yuan per square meter, with an average housing area per capita (urban area) of 39.8 square meters in 2021 and an average of 2.84 persons per household in 2012, resulting in an estimated combined housing price per household of 4,631,404 yuan. Based on these estimates, the annual income multiple is calculated at 16.6 times (Chart 11). This is nearly identical to the 15.8 times seen in 1989 for the Tokyo metropolitan area, indicating an inexplicable rise in housing prices in Shanghai. Internationally, a ratio of 4 to 6 times the annual income is considered reasonable.

A similar calculation for areas outside of Shanghai City (Chart 12) reveals that Xizang Autonomous Region, Guizhou Province, and Xinjiang Uygur Autonomous Region fall within the reasonable range (4 to 6 times). However, Beijing is more expensive at 18.8 times, exceeding Shanghai City, with a national average slightly higher at 7.6 times. While China exhibits significant regional disparities due to its vast land area, housing prices in major cities like Beijing and Shanghai are notably higher, indicating an extremely high degree of bubble.