Property prices in China rose 12.4% in May, the second-fastest pace on record, according to the National Bureau of Statistics. So there's little sign yet that the government crackdown on speculation is averting an asset-price bubble. This is barely down from April’s steaming 12.8%.

But not so fast! The news from China is frankly contradictory. 

Housing sales in numerous Chinese cities are down 40% on six months ago, according to Soufun.com, the prestigious Beijing-based real estate consulting firm.

Some say the property market is paralyzed with fear. Investors are focused on whether the government will impose new taxes on residential property, a move being discussed by big cities, including Shanghai and Chongqing. 

A recent Wall Street Journal report argued that the Chinese authorities had over-reacted. "What's really dampened the market is the uncertainty. That overhang is what's driving everyone to wait," Kevin Yung, executive vice president of IFM Investments Ltd. told the WSJ.

Yung's company runs the Century 21 real-estate agency franchise in China. "We think this could last another three to six months," he said, a rough forecast shared by other industry executives.

Yung tells the WSJ his business is seeing plenty of traffic: People are still looking at apartments and asking about prices.

But many are holding off final decisions, and will likely need prices to come down before they take the plunge into home-ownership.

"We think prices are going to come down, probably by about 20%, but it will happen over time because this adjustment is driven more by policy than demand," he said.

And that’s the nub – policy-driven housing prices.

Powerful interest groups are paralyzing China's macro policy, notes ex-Morgan Stanley analyst Andy Xie:

  • Local governments consider high land prices their tax-revenue lifeline.
  • State-owned enterprises don't want interest rates to rise.
  • Exporters are vehemently against currency appreciation.

“The main purpose behind asset inflation is that the government can tax it,” says Xie. “It provides a place for people to chase their get-rich-quick dreams and is popular as long as the market goes up. It also offers insiders who have disproportionate influence to play the game at the expense of little people. It is no coincidence that China's policies have been so pro-asset-inflation in the past few years.”

“High land prices and low interest rates have become the pillars for the state sector… Essentially, Chinese people have made gains on wages but lost big on housing affordability and interest income. This situation shows the state sector is too big, and not efficient enough to survive on market forces alone. The macro dilemma really reflects structural problems,” says Xie.

He fears that the feeling that ‘the state is really in control’ is causing complacency, and that eventually, when the state loses control, a massive housing crash will follow.

“China's asset bubble has probably grown more quickly than any in the past,” says Xie. “The stock of residential properties, works in progress and land banks may be worth three times the gross domestic product, or about 100 trillion yuan (US$14 trillion). Their value was negligible seven years ago. The ratio of residential property value to GDP in Beijing and Shanghai is similar to Hong Kong's in 1997. Their rental yields are also similar to Hong Kong's then. In addition, the mainland has created a unique phenomenon of empty flats: I suspect the number is 10-20 million.
 

“When China's bubble bursts, there will be considerable economic damage. But many in China want to keep the bubble where it is – not expanding, not shrinking. Yes, government officials are the best and the brightest in the country.

“Combined with the nation's size, they have been able to maintain situations that seem unreal from a market perspective. This has cultivated the enormous popular faith that the government can get what it wants. But the longer the market is distorted, the bigger the eventual payback.”

You have been warned! 

Supporting material for this piece included:

Bloomberg report on price rises

Real Estate Channel's Alex Finkelstein

Andy Xie's usual breathless and un-paragraphed prose