By Clay FisherThe sheer volume of misinformation and crowd-think surrounding China's real estate market is staggering. It seems the entire U.S. media has convinced itself a bubble exists, yet when we read what's printed, there's very little in the way of facts provided. Yet few controversies can be as important to Wall Street. China's real estate market is the backbone of its domestic economy. The sector's strong demand of late has helped China become the backbone of the world's economic recovery. Any meaningful "stumble" by China's real estate market could have ominous affects on the developed world's recovery. Recently I read an article proposing the bubble theory and attempting to claim that because the ratio of real estate prices to incomes in Beijing was 27-1, Beijing real estate was so overvalued that if in Manhattan, the average price of an apartment would be $3.4 million. The notion is simply ridiculous and uses clear apples-to-oranges comparisons that lack an understanding of the differences between Beijing and Manhattan. The only way this comparison becomes fair is if Manhattan residents paid a 10% income tax rate (and no property taxes) while seeing the real purchasing power of their incomes rise overnight by at least 50%. I expect to see pigs fly in Manhattan first. Comparing real estate in Beijing to Manhattan is not difficult. If you believe what you read in the press, the results will surprise you. The only fair method for comparing relative valuation and affordability is to compare the ratio of after-tax incomes for an average couple to the price of the average real estate in each city, and then attempt to adjust for the real purchasing power of each couple's incomes. Here we go.
The average worker in Beijing earns approximately 49,000 yuan ($7,184) per year, meaning a couple earns 98,000 yuan ($14,368). Most Chinese don't pay income tax --only 20% do. Income is taxed individually and not on a household basis, so each individual is less likely to hit higher marginal tax rates. Yet, at this income level, by my estimates the average Beijing couple would pay approximately 10.2% in income taxes amounting to just over 9,800 yuan or ($1,437), leaving after-tax income of about $12,931 per couple. In China, there is no annual property tax. As further evidence, income tax as a percentge of GDP is less than 3% in China and just under 9% in the U.S. The average person in China pays only a fraction of what U.S. citizens pay. This compares to an average household income of $126,000 in Manhattan, according to Census Bureau estimates for 2006-8 (which are artificially high because they don't include the massive loss of Wall Street bonuses that occurred in 2008-9). The obvious difference is the average Manhattan couple will forfeit a much larger portion of their income to all the various governments that tax them, including the city, which will make them pay a stiff annual property tax (estimated at $19,500 for a single-family residence in 2010). I suggest after paying federal, state, local and property taxes, and even after taking into account the extraordinary benefit of the deduction of mortgage interest, the Manhattan couple would be lucky to escape with 65% of their gross income, or $81,900. At this rate, the Manhattan couple earns after tax 6.3 times the Beijing couple in nominal terms.
The price of real estate in Beijing has been strong, with an average hovering around 18,000 yuan per meter squared, or approximately $240 per square foot. Quite to the contrary, the price of Manhattan real estate is still in the doldrums. Manhattan has lost more than 25,000 financial jobs during the financial crisis and has been without the support of Wall Street bonuses in 2008-9. As any Manhattan real estate agent will tell you, Wall Street bonuses are the lifeblood of Manhattan real estate. Until recently, Manhattan real estate has lacked its bonus lifeblood to support itself and has fallen 10%-15%. Nonetheless, good old Manhattan real estate averages $1,320 per square foot (according to the New York real estate industry) or 5.5 times that of Beijing real estate, and yet the Manhattan couple earns 6.3 times that of the Beijing couple after tax. (Note here we're using an artificially high Manhattan income number but a depressed real estate number, making the example all the more conservative.) On a nominal basis and relative to incomes, the relative price of Manhattan and Beijing real estate seems to be fairly close, even giving the Manhattan couple the income boost of a Wall Street bonus but depressed real estate prices. Naysayers might prefer using the median price in Manhattan to account for Manhattan's extreme high end, instead comparing Manhattan's median price per square foot of $768 to Beijing's average leading to a 3.2 times multiple over Beijing. But comparing an average to a median is clearly an apples-to-oranges comparison and unfairly takes the "bubble" out of Manhattan's real estate market. In addition, virtually all of the real estate being sold in Beijing is "new construction" where the buyer pays for that "new apartment smell," while the average in Manhattan is for older/existing real estate, which typically comes at a discount to new construction. Smaller apartments make Beijing real estate all the more affordable for its residents by comparison. When you adjust for the new construction effect, the current depressed state of Manhattan real estate, along with the relatively small apartment sizes, Beijing's real estate looks relatively affordable by Manhattan standards.
Most economists adjust GDP and income by what's called purchasing power parity (or PPP). Economists attempt to adjust up the incomes of some countries to account for their lower cost of living in an attempt to show their real purchasing power. Most adjustments I've seen estimate the real purchasing power of China's income to be more than twice the nominal amount. Said differently, that average Chinese couple has twice the real purchasing power their nominal income implies because their relative cost of living (including real estate) is lower. It is estimated that almost half of the average Beijing worker's income is actually purely disposable. When you adjust for this fact and that the Chinese couple can easily divert more income to real estate as they choose, because other expenses are lower, it makes Beijing's real estate relative to income seem much more affordable. Naysayers cite examples of young Chinese citizens having difficulty affording/purchasing real estate. Welcome to the reality of the developed world. While on an extended stay in Madrid, I remember first learning how culturally normal it was for professionals in their early to mid 30s to live with their parents while attempting to save enough to afford the heavy cost of a first real estate purchase. But almost 25% of purchases in China are made with 100% cash because the Chinese have saved and invested. The minimum down payment allowed in China is 20%. The average purchase is being made with 50% cash down, meaning that far from what you may have read, the purchases driving the real estate market in China are being made not with outlandish credit, but with more cash than comparable purchases in the U.S. Beijing's real estate market is driven by less levered Chinese cash buyers with rapidly rising incomes. What bank wouldn't want to lend to them?
We have a pretty good feel for the pace of income growth in the U.S., but in China incomes grow like a weed. Nominal incomes in China are expected to nearly double over the next six years. While given the much larger average Chinese down payment, the initial hurdle for a Beijing couple to get into an apartment may seem to be higher, the truth is real estate bought today will be much more affordable relative to income over the next six years as China's income per person doubles. Simply said, in today's nominal dollars and relative to income, Beijing may seem about as expensive as Manhattan if you don't account for the purchasing power of incomes. but the experience of the average buyer in Beijing as a result of real PPP and the expected doubling of incomes over the next six years means real estate purchased now in Beijing will be much less expensive for the average Beijing couple than for their New Yorker counterparts. The adjustment of incomes using PPP to reflect real purchasing power does not account for currency changes. Its widely believed that the Chinese yuan is undervalued by something approximating 40%. As the yuan slowly appreciates over time, it guarantees that Chinese incomes will continue to benefit from the increasing purchasing power of their incomes as foreign goods become increasingly cheaper. (Granted there could be a huge risk to falling incomes if the yuan were to appreciate to quickly). And, as Chinese incomes grow quickly over time the relatively inexpensive price of Beijing real estate at $240 per square foot will rise to world norms. Even in relatively inexpensive real estate markets in cities like Lisbon and Warsaw today the nominal price of real estate is approximately 50% more expensive per square foot than in Beijing. Not only does Beijing look relatively affordable as compared to Manhattan today, over the next six years today's prices will prove outright cheap for Beijing residents by comparison. Clay Fisher, an independent investor, comes from from a long line of investors. His grandfather, Philip Fisher, was a legendary growth-stock investor who pioneered the concept of growth-stock investing along with T. Rowe Price. His father, Ken Fisher, is a Forbes columnist, CEO of Fisher Investments and a member of the Forbes 400. Clay Fisher previously worked as a buy-side analyst for investment bank Robertson Stephens and later with Feshbach Brothers. He was executive vice president and co-founder of The Private Client Group, a division of Fisher Investments, which is now the majority of his family's business, where he spent most of his career.