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Short communication

Are house prices too high in China?

Ling SHEN
School of Business, East China University of Science and Technology Meilong Road 130, Shanghai 200237, China
a r t i c l e i n f o a b s t r a c t
Article history:
Received 10 November 2010
Received in revised form 15 September 2011
Accepted 24 March 2012
Available online 12 May 2012
This short note defines a new measurement of housing affordability in terms of permanent
income. Using this new measurement, we find that housing affordability in China is very
strong relative to other developed economies, although the ratio of housing prices to current
income in China is much higher than those of developed nations.
2012 Elsevier Inc. All rights reserved.
JEL classification:
C43
E25
E64
R31
Keywords:
Housing affordability
Price-to-income ratio
Growth
China
With house prices soaring in key cities, more and more investors and economists worry that China has the next great real
estate bubble waiting to be burst.
1
The Chinese government is worrying, too. In recent months, many regulation policies have
been implemented in order to stop the rising trend of house prices in Chinese cities, for example, increasing downpayments to
40% for Chinese families buying a second home, stopping new loans for a third home and forbidding selling apartments to non-
residents of the cities.
Many of these arguments and policies have mentioned two basic pieces of information. First, new house prices in 70 large and
middle-sized cities have been increasing very rapidly over the past decade. In particular, new house prices grew by average
annual rate of 23.5% in 2009.
2
Second, the housing price-to-income ratio in urban China is much higher than the average level of
developed nations. For instance, the report the Analysis of Real Estate Trends in Shanghai by Li, Xunlei
3
reports an average ratio
of 10 for China's largest cities. Similarly, the Economic Blue Bulletin by the Chinese Academy of Social Sciences also shows that the
housing price-to-income ratio reached 8.3 for urban residents in China in 2008.
In addition, on January 19, 2010, the National Bureau of Statistics of China published the 2009 National Real Estate Market
Situation that shows the national average new house price was 4695 CNY/m
2
in 2009. Thus, an apartment of 100 m
2
costs about
470,000 CNY. According to the National Bureau of Statistics, the per capita disposable income of urban residents in 2009 was
17,175 CNY, while annual household income was 51,525 CNY for a family of three. Thus, in 2009 the average housing price-to-
China Economic Review 23 (2012) 12061210
We would like to thank Prof. Guoqiang Tian and the Editor for their helpful suggestions. All possible errors are, of course, mine.
E-mail address: vwlde@hotmail.com.
1
For example, Daily Finance reported Global Economy's next threat: China's Real Estate Bubble on January 5, 2010 by Charles Hugh Smith; CNN senior writer
Chris Isidore worried Is China another real estate bubble on April 15, 2010 on CNN Money.com; and the Wall Street Journal even earlier proclaimed China's
Housing Bubble Trouble on November 20, 2009 by Andrew Peaple.
2
Data source: the National Bureau of Statistics of China.
3
Li, Xunlei is the Director of Research Institute in Guotai-Junan Securities Co., which is one of the biggest in China.
1043-951X/$ see front matter 2012 Elsevier Inc. All rights reserved.
doi:10.1016/j.chieco.2012.03.008
Contents lists available at SciVerse ScienceDirect
China Economic Review
income ratio was 9.1 for urban residents in China, which is approximately consistent with the above data. By contrast, according
to Demographia International (2010), which computes median housing price-to-income ratios for 227 regions, the comparable
national data are 2.9 for the US, 5.1 for the UK and 6.8 for Australia.
These data have been widely quoted. However, the theoretical underpinnings of the concept of affordability have received
little attention from academics. Given the housing price-to-income ratios quoted above, it is easy to arrive at the conclusion that
China's house prices are much less affordable than are those of the US, which may then be amplified to the existence of a large
bubble in the Chinese real estate market, giving rise to public misunderstandings. However, if we take a dynamic point of view
to examine China's housing affordability and consider differences in the real estate tax system, we may come to different conclusions.
This note constructs a new measurement of the housing price-to-permanent income ratio through which we can better
compare housing affordability among regions with different growth rates. Then, we apply our methodology to data on China and
on developed countries.
The literature on housing affordability tends to focus either on the ratio of house prices to current income or on the proportion
of income to mortgage repayments (e.g., Gan & Hill, 2009; Stone, 2006). In addition, previous studies have mostly discussed the
distribution of affordability, in particular for low income families (Hulchanski, 1995; Kutty, 2005). Since the housing reforms in
1998, the Chinese housing market has attracted more and more concerns among academic researchers. For example, Sato (2006)
discusses housing inequality and housing poverty in urban China in the late 1990s, while Wang, Yang, and Liu (2010) shed light
on the impact of urbaneconomic openness onreal estate prices in 35 Chinese cities. Further, Gan, Yin, and Zang (2010) investigate the
impact of housing reforms on the consumption of durables in China. However, none of these studies measures housing affordability
using an international comparison.
We consider a representative agent living infinitely in an economy with a nominal growth rate g that has a current income y
0
.
The interest rate is r. Hence, for gr, his/her present value of the income in N periods is:
y
0
1g
1r
_ _
N
1
1g
1r
1
_

_
_

_
For gbr, the permanent income is y
0
1r
rg
_ _
N. For g>r, the permanent income approaches infinity. If g=r, lifetime income is
Ny
0
. Because housing choices are likely to be made based on lifetime income rather than on current income,
4
we construct a
housing price-to-permanent income ratio (PPIR) instead of the ratio of house prices to current income (PCIR). Theoretically, the
PPIR is consistent with the permanent income hypothesis. Hence, it is better than the PCIR to measure housing affordability
because it takes into consideration income growth.
Denition 1. The house price to permanent income ratio (PPIR) is defined as:
X
y
0
1g
1r
1
1g
1r
_ _
N
1

X
y
0

where X is the house price.


Because
X
y
0
_
is the PCIR, the factor is the ratio of the PPIR to the PCIR, which depends on g, r and N. If the annual growth rate
of income is the same as the interest rate, the factor is equal to
1
N
= . For a comparison among different regions, it is reasonable to
assume that N is equal for all; hence, the comparison of PPIRs is the same as comparing PCIRs for the case of g=r.
For gr, it is also possible to use the PCIR instead of the PPIR for comparisons if these regions have exactly the same growth
rates and interest rates. However, Table 1 shows that they are different in general. The annual growth rates in nominal GDP and
lending interest rates during 19902009 for selected developed economies and China are shown in Table 1.
We find from above table that lending interest rates are similar for these economies, except Australia and New Zealand.
Further, GDP growth rates (as the proxy of income growth rate) are similar except in China and Ireland. In particular, these two
economies have a greater GDP growth rate than lending interest rate. Hence, we are able to apply
rg
1r
to calculate the PPIRs for
these economies except China and Ireland.
For China and Ireland, we cannot apply
rg
1r
because g>r. Intuitively, we cannot assume that the annual growth rates in
income for these two economies can stay at such a high level forever. Instead, we assume that they grow at the current growth
rate g for N periods and that the growth rate then falls belowr to be equal to the average level of the other five economies, namely
4.75%. Hence, China and Ireland have a permanent income:
y
0
1g
1r
_ _
N
1
1g
1r
1
_
_
_
_
_
_
1 g
1 r
_ _
N1
1 g

rg

_
_

_ 1
where
5
g =4.75%. For N=15, the comparable values for these two economies are 0.097 and 0.031, respectively (Table 2).
4
Quigeley and Raphael (2004) mention this, however, they do not consider it in a formal framework.
5
See Appendix A.
1207 L. Shen / China Economic Review 23 (2012) 12061210
From this new point of view, although the UK has a higher PCIR than the US, its affordability is higher because of the higher
economic growth rate and lower interest rate. Moreover, Australia and New Zealand are less affordable from both perspectives,
although they have high economic growth rates, too. This is because these two economies have high interest rates.
The novel result lies in China. Because of its extreme economic growth as well as a relatively low interest rate (compared with
the average level of other economies), its housing affordability is extremely high in terms of the PPIR (i.e., the value of the PPIR is
extremely low). However, it has a very low housing affordability in terms of the PCIR (9.1). This dramatic result comes from
different implicit assumptions: the PCIR comes from a static viewpoint, whereas the PPIR stems from a dynamic one. As China's
growth behaves differently relative to developed economies, we should take the growth rate into consideration. Of course, this
consideration (PPIR) implicitly assumes that the current growth rate of income (13.28%) and the interest rate (7.72%) are
sustainable in China for at least N years (e.g., N=15). Thus, we can test the robustness of this result in two aspects: N and r.
First, even if China could only grow at this rate for 10 years (N=10), its housing affordability (PPIR=0.134) is still similar to
that of Australia and New Zealand. Table 3 shows that the qualitative result still holds when N varies from 5 to 30. Another aspect
to understand the case of China is to test whether high housing affordability is sustainable if the interest rate rises. For example,
we can assume that the interest rate rises to the level so that rg is same as the average level of the other five economies except
Ireland, namely 3%. Then, the PPIR of China is 0.235, also similar to that of NewZealand. Table 3 also shows similar calculations for
when the interest rate varies from 14.28% to 18.28%.
From the above discussion, we know that we can get different judgments about housing affordability when we use different
measurements, namely the PPIR or the PCIR. It is difficult to say which is better in general. For those economies growing at similar
rates and with similar interest rates, the PCIR is a good simplified version of the PPIR. Both produce similar results. However, for
those growing at different rates, the permanent income hypothesis implies that the PPIR is able to measure housing affordability
better than can the PCIR. In practice, investors use these ratios to estimate the potential housing bubble. Hence, it is of interest to
see which one can make better predictions using historical data.
Chinese statistical yearbooks have reported average new apartment prices per m
2
every year since 1997. Hence, we can
estimate the PCIR by assuming a 100 m
2
apartment and a family of three (as above). From 1997 to 2009, the growth rate of
disposable income of Chinese urban residents was 10%, and we assume r =7%. Because this annual growth rate was successfully
achieved for more than 10 years, we can use Eq. (1) assuming N=10 to calculate historical PPIRs.
FromTable 4, we knowthat the PCIR in China was even higher in the past decade. Hence, if we would use the PCIR to estimate the
possible housing bubble, we would conclude that China had a great bubble 12 years ago. An investor at that time was not worried
because the PPIR (0.16) was not high compared with those of developed economies (0.060.26). If an investor did buy an apartment
on the basis of this judgment in 1997, he/she would find that his/her own PCIR decreased rapidly from 12.9 to 3.88
6
by 2009. In fact,
we can divide the past 12 years into two periods. The first one is from 1997 to 2003. In this period, the annual growth rate of income
was 8.3% and house prices rose by 2.8% every year. Hence, the PCIR decreased from 12.9 to 9.3. The second period is from 2003 to
2009. Although house prices grew by 11.5% every year, income grew at a similar level. Hence, the PCIR was stable. We thus cannot
conclude a housing bubble in China simply by comparing the Chinese PCIR with those of other developed nations.
Nowwe turn to the real estate tax system. In the US, a typical case of developed economies, there is a real estate tax for owning
a house, which is % of the current value every year. However, there is no such user fee in China.
7
This difference implies that US
6
If he/she bought an apartment in 1997 at 1997 prices, his/her apartment price is xed from then on. However, his/her income increased to 17,175 CNY over
the next 12 years. Hence, in 2009, his/her PCIR is 3.88 not 9.1. This is important for the investor who borrows from the nancial market when he/she buys an
apartment.
7
China announced such a tax reform at the beginning of 2011. In Chongqing and Shanghai, some owners whose houses are particular large will pay an
additional real estate tax.
Table 2
PPIRs and PCIRs.
Source: PCIRs are quoted from Demographia International (2010). China's data are from the estimation on page 1.
Australia Canada Ireland New Zealand UK US China
PCIRs 6.8 3.7 3.7 5.7 5.1 2.9 9.1
PPIRs (I) 0.21 0.06 0.26 0.08 0.09
PPIRs (II) 0.031 0.097
PPIRs (I) are calculated by the form =(r g)/(1+r) for those countries r >g. For Ireland and China, PPIRs (II) are calculated under the assumption that they
retain their current growth rates for 15 years, which then fall to the average level, namely 4.75%.
Table 1
Growth rates in nominal GDP and lending interest rates (19902009).
% Australia Canada Ireland New Zealand UK US China
r 9.40 6.12 6.05 10.20 6.01 7.00 7.72
g 6.03 4.39 7.81 5.12 4.38 3.83 13.28
rg 3.37 1.73 1.76 5.08 1.63 3.17 5.56
Notes: r is the lending interest rate and g is the annual growth rate in nominal GDP (in USD). All data are derived from the World Bank Databank. http://data.
worldbank.org/.
1208 L. Shen / China Economic Review 23 (2012) 12061210
house prices are not the total cost of owning a house. Hence, in order to compare housing affordability in China and the US, we
construct a second ratio, namely the total housing cost-to-permanent income ratio (TPIR).
Denition 2. The total housing cost to the permanent income (TPIR) is defined as:
X Z
y
0

where Z is the present value of real estate tax.


For the simple case where X is constant over time, Z X

r
, TRIP PPIR 1

r
_ _
. If we assume =2% for the six economies
mentioned in Demographia International (2010), housing affordability in China is even higher relative to others (Table 5).
As housing is non-traded and inherently local, talking about affordability at a national level is not convincing enough.
Therefore, I follow Demographia International to compare two main Chinese cities, Shanghai and Beijing, with seven other
metropolises in the abovementioned developed countries. We calculate the growth rate of income for those metropolises in
developed countries using data from Demographia International Annual reports (20062010), and continue to use the above
interest rates because they are country-specific. For China, we collect data from statistic yearbooks (20062010). The results are
shown in Table 6.
Similar to the comparison at the national level, it seems that there were housing bubbles in Los Angeles and in the two Chinese
cities in 2005 in terms of PCIRs. Their higher PCIRs imply that the housing in these regions is much less affordable relative to
elsewhere. However, we come to different conclusions in terms of PPIRs. Chinese cities show a greater housing affordability
because of higher growth rates of income (about 11.3%). If an investor in Beijing in 2005 had believed PPIRs, instead of PCIRs, and
indeed bought an apartment, he/she would find that the value of his/her apartment had increased by 19% per year for the
following five years. Some may argue that by using PPIRs, investors in Los Angeles might come to the wrong conclusion, because
house prices there decreased at an annual rate of 6.3% for the next five years. The reason for this lies in the calculation of PPIRs (I),
which implies that the current growth rate is sustainable forever. This is obviously not true for Los Angeles. Hence, if we use PPIRs
Table 3
The robustness test of the case of China.
N 5 10 15 20 25 30
PPIR 0.188 0.134 0.098 0.073 0.055 0.041
r 14.28% 15.28% 16.28% 17.28% 18.28%
PPIR 0.080 0.158 0.235 0.310 0.385
Notes: we only change the value of N from 5 to 30, while the PPIR varies from 0.188 to 0.041, which is similar to that of developed economies. If we raise the
interest rate to 14.28%, or even to 18.28%, the PPIR still shows us that Chinese housing affordability is similar to that in Australia and New Zealand.
Table 4
PCIRs and PPIRs in China over the past decade.
Source: data are derived from the Chinese Statistic yearbook (2010): http://www.stats.gov.cn/tjsj/ndsj/2010/indexeh.htm.
Disposable income of Chinese urban residents (CNY) Average new apartment price per m
2
(CNY) PCIR PPIR
1997 5160 1997 12.9 0.16
1998 5425 2063 12.7 0.16
1999 5854 2053 11.7 0.15
2000 6280 2112 11.2 0.14
2001 6860 2170 10.5 0.13
2002 7703 2250 9.7 0.12
2003 8472 2359 9.3 0.12
2004 9422 2714 9.6 0.12
2005 10,493 3168 10.1 0.13
2006 11,760 3367 9.5 0.12
2007 13,786 3864 9.3 0.12
2008 15,781 3801 8.0 0.10
2009 17,175 4695 9.1 0.12
Notes: the PCIR=(new apartment price
*
100)/ (income
*
3); the PPIR is calculated by assuming g=10%, r =7%, N=10 and g =5%.
Table 5
PPIRs and TPIRs.
Australia Canada Ireland New Zealand UK US China
PPIRs (I) (II) 0.21 0.06 0.031 0.26 0.08 0.09 0.097
TPIRs 0.255 0.08 0.08 0.31 0.106 0.116 0.097
Notes: PPIRs are from Table 2, while the TPIR is from TRIP PPIR 1

r
_ _
, which reflects the difference in real estate tax systems.
1209 L. Shen / China Economic Review 23 (2012) 12061210
(II) instead of PPIRs (I), by assuming the current growth rate can continue for five years and then decrease to the average level,
namely 3%, PPIRs have a normal conclusion.
We conclude from this new measurement of housing affordability that China's housing affordability is relatively high if we
consider the PPIR instead of the PCIR. The key factors are the high economic growth rate and lowinterest rate in China. If we were
to call it a bubble, it would be interesting to test whether it would be sustainable if the low interest rate rose or the high growth
rate declined. The above results show that Chinese housing is still affordable compared with New Zealand and Australia in terms
of the PPIR. We believe that this novel result is useful for better understanding the case of China and other rapidly growing
economies.
Appendix A
We consider an economy with current income y
0
, growing at g>r for the first N periods and then the growth rate falls to g' br.
Then, the present value (PV) of the permanent income is as follows:
PV

N1
t0
y
0
1 g
1 r
_ _
t

tN
y
N1
1 g

1 r
_ _
tN1
y
0
1 g
1 r
_ _
N
1
1 g
1 r
_ _
1
y
N1
1 g

rg

_ _
y
0
1 g
1 r
_ _
N
1
1 g
1 r
_ _
1

1 g
1 r
_ _
N1
1 g

rg

_ _
_

_
_

_
:
References
Chinese Statistic yearbook (2010). http://www.stats.gov.cn/tjsj/ndsj/2010/indexeh.htm
Demographia International (2010). http://www.demographia.com/
Gan, Li, Yin, Zhichao, & Zang, Wenbin (2010). The impact of housing reform on durables consumption in China. China Economic Review, 21, 5564.
Gan, Q., & Hill, R. J. (2009). Measuring housing affordability: Looking beyond the median. Journal of House Economy, 18, 115125.
Hulchanski, J. D. (1995). The concept of housing affordability: Six contemporary uses of the housing expenditure-to-income ratio. Housing Studies, 10(4), 471491.
Kutty, N. K. (2005). A new measure of housing affordability: Estimates and analytical results. Housing Policy Debate, 16(1), 113142.
Quigeley, J. M., & Raphael, S. (2004). Is housing unaffordable? Why isn't it more affordable. The Journal of Economic Perspectives, 18(1), 191214.
Sato, Hiroshi (2006). Housing inequality and housing poverty in urban China in the late 1990s. China Economic Review, 17, 3750.
Stone, M. (2006). What is housing affordability? The case for the residual income approach. Housing Policy Debate, 17(1), 151184.
The 2009 National Real Estate Market Situation. Published by National Bureau of Statistics of China. http://www.stats.gov.cn/
Wang, Songtao, Yang, Zan, & Liu, Hongyu (2010). Impact of urban economic openness on real estate prices: evidence from thirty-five cities in China. China
Economic Review, http://dx.doi.org/10.1016/j.chieco.2010.08.007
World Bank Databank. http://data.worldbank.org/
Table 6
PPIRs and PCIRs at a city level in 2005.
Sources: Data on non-Chinese cities are from Demographia International. PCIRs are from its annual report (2006), and the growth rate of income is calculated from
its reports (20062010). The interest rate is from the World Bank, as in Table 1. China's data are from various Chinese statistical yearbooks (20062010).
New York Los Angeles Toronto London Dublin Sydney Auckland Beijing Shanghai
PCIRs 7.9 11.2 4.4 6.9 6.0 8.5 6.6 10.5 10.8
Growth% 2.56 4.81 0.22 1.56 5.91 1.2 3.8 11.28 11.32
PPIRs (I) 0.328 0.229 0.243 0.289 0.008 0.639 0.385
PPIRs (II) 0.393 0.155 0.141 0.144
PPIRs (I) are calculated by the form =(r g)/(1+r) for those countries r >g. For Beijing and Shanghai, PPIRs (II) are calculated under the assumption that they
can keep the current growth rate for 15 years, which then falls to the average level, namely 3%. For Los Angeles and Dublin, N=5.
1210 L. Shen / China Economic Review 23 (2012) 12061210

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