You've probably heard many opinions that Chinese real estate is in a bubble. However, much of the prognostication has been backed by hearsay and speculation. Below, I go beyond the hypothetical by illustrating the hard data that demonstrates that Chinese real estate is in a bubble. I will go further by anticipating how investors could potentially profit from the collapse of Chinese real estate bubble.
Most investors value residential real estate using a variety of measures. These include: price-to-incomes, price-to-rents and affordability. Essentially, people buy homes when they can afford the monthly payments.
Comparable sales are also often used, but I think this is the weakest form of property valuation. Arguing an asset is worth $x because a similar asset sold for a $x suffers from pro-cyclicality and becomes a self-fulfilling prophecy.
The first three charts below compare property valuations in the US with those in China and a selection of Chinese cities. According to three measures (price-to-incomes, price-to-rents, mortgage affordability) Chinese real estate is vastly overvalued relative to US housing.
The Chinese housing bubble may already be imploding. Assuming declining home prices drag the Chinese banking sector with it (and with the banking sector, local governments and the credit expansion fueling the Chinese fixed asset investment boom deriving Chinese economic growth) broad-based China-related ETFs, such as iShares FTSE China 25 Index ETF (FXI) or iShares MSCI Hong Kong Index Fund (EWH) could decline in value.
