China's Real Estate Market Is Falling – And Might Take the Dragon With It

For a decade, China has been the place for investors looking for rapid growth and sky-high prospects.

Now, however, the residential real estate bubble looming ominously on the horizon may now be beginning to weigh down the Chinese economy as a whole.

Case in point: Two weeks ago the Chinese government, aware of at least some disturbance in the property sector, announced a 20% capital-gains tax.  This new tax was mainly in an effort to reduce some of the rampant investor speculation in the market, which has been one of several reasons behind a rising bubble.

The following Monday (March 4^th), in response, the Shanghai Composite fell 2.5% in the morning while the Hang Seng dropped by 1%. The Hang Seng Properties Index has fallen 5.25% so far this year.

The residential real estate market in China is bloated, over-expanded, and artificially propped up by a government that is ignoring insufficient demand in favor of inflating GDP numbers.  The evidence is in the form of countless cityscapes littering the Chinese countryside – entire cities fully constructed but virtually vacant, with few residents and even fewer prospects for anything approaching normal occupancy.

Construction in the real estate sector creates jobs and is made possible by widely-available credit that is a product of a controlled currency and an increasing trade surplus. As credit continues to become available, real estate developers use it to build and expand, creating jobs but also creating an excessive surplus of supply that would cripple prices in a normal market.

As it stands now, the prospect of a bursting real estate bubble in China is as disturbing as the memories are of the American real estate crash of 2007 – except that this bubble could be even worse due to the overstrained and weakened nature of the global economy.

For traders who have turned to China as a source of almost-endless growth stocks across several key industries, the prospect of a real estate collapse is terrifying.  Such a collapse – assuming it follows a similar trajectory to the American crash five years ago – would not only devastate the properties sector but also cause a significant ripple effect through other Chinese industries.

Even other markets would be susceptible. The need for certain industrial imports would decline, which would impact Australia (especially mining stocks); corporations with significant investments in China’s industries – or dependent on Chinese exports – would also suffer, dragging down their respective exchanges.

And since China has become a key cog in the global economy, an implosion in the real estate sector would have an outsized impact on anything from stocks and exchanges to currency, trade, and even geopolitics.

All of that is bad news, to put it lightly.

The timeline for a bursting of the bubble – if one occurs – is still unclear.  The Hang Seng is only down 1.78% over the past three months, and is up 6.55% over the past 52 weeks. Clearly, the market has been able to withstand the real estate sector’s drag on the economy, which is proof that the sector has yet to reach critical mass.

Of course, drawing from the U.S. market’s status in 2007 right before the bubble popped – it was at an all-time high – a Hang Seng in the black is far from a sign of safety and security.

Investors with long positions in Chinese equities and any global securities tied to Chinese imports or exports should evaluate their positions over the next 12 months in case the residential market begins to boil over.  One key indicator will be the health of Chinese lenders; like American banks that have been damaged as a result of the 2007 collapse (and those are just the ones that are still in existence), Chinese lenders are incredibly vulnerable.

Considering the Chinese government’s measures so far to mitigate the bubble have been largely ineffective, the prospect of a crash is becoming more likely with each passing quarter.

Simon Campbell, who lives in Miami, FL is an expert in the real estate market. He is recognized among his peers as an expert in foreclosures. For more real estate tips check his blog or follow him on Google +.