China’s Housing Market Has Plenty of Space but Not Enough Buyers

China had 3.5 billion square feet of finished but unsold apartments in February, according to Wind, a data provider. That is equivalent to around 4 million homes, according to some estimates. It is also the worst oversupply in China since 2017, when it was in the midst of a “slum clearance” program meant to boost demand for new housing by tearing down old, dilapidated buildings.

Around a third of all newly completed apartments in 2022 were unsold, the highest percentage since 2015, calculations by property consulting firm China Real Estate Information Corp. show.

The overhang is most acute in smaller cities with populations of a few million people or less, economists say. After a long building boom, the more than 640 cities labeled as “third tier” in China now have nearly 80% of China’s total housing stock, according to a paper published last year by economists Kenneth Rogoff and Yuanchen Yang. Demand in those cities is weaker than in bigger markets such as Beijing and Shanghai, where populations and job markets have grown faster.

It would take nearly six years for one well-known third-tier city, Beihai, to absorb its stock of unsold homes, compared with seven months in Shanghai and nearly two years for Beijing, according to China Real Estate Information estimates.

On average it would take 20 months to absorb the excess housing supply in the 50 cities that China Real Estate Information monitors, the firm said. The U.S. currently has a 2.9-month supply of existing homes, according to the National Association of Realtors, and an 8.2-month supply of new homes, according to U.S. government data.

In February, new-home prices in “top-tier cities”—Beijing, Shanghai, Shenzhen and Guangzhou—rose 1.7% from a year earlier. Prices in third-tier cities dropped by 3.3%, though the pace of decline has slowed from previous months, according to data from China’s statistical bureau.

Overall, new-home prices across 70 major cities rose 0.3% from the previous month, after declining month-over-month since August 2021.

If China fails to stabilize home prices in its lower-tier cities, which are home to about two-thirds of China’s urban population according to one estimate, it will likely damp household confidence and consumers’ willingness to spend in many parts of the country, limiting the extent of China’s overall economic recovery this year.

In the longer run, the need to absorb the market’s excess housing could mean a prolonged period of depressed new-home construction, depriving China of one of its biggest growth drivers and job creators. New-home construction is also critical for China’s heavily indebted local governments, which rely on income from land sales to developers to balance their budgets.

The need for real-estate construction in third-tier cities will need to shrink by roughly 30% between now and 2035 to avoid further oversupply, Mr. Rogoff and Ms. Yang concluded in their paper in September.

Third-tier cities appealed to some property buyers before the pandemic because their home prices were typically much lower than in China’s bigger cities. Speculators swooped in from across China, in some cases snapping up multiple units and leaving them empty, expecting investment gains. Developers ramped up construction to meet anticipated demand.

But Beijing’s efforts to wipe out speculation have collided with unfavorable demographics and other problems in smaller cities to make them less attractive now.

In Beihai, a coastal city in southwestern Guangxi province known for its beaches and balmy climate, the dwindling number of travelers during the pandemic depressed sales, according to local property agents.

Average home prices in the city, nicknamed “China’s Miami” with a population of 1.9 million, fell to around $54 to $67 a square foot at the end of 2022, from around $108 to $121 in 2019, said a salesperson at a local property agency.

The lifting of China’s zero-Covid rules late last year brought tourists back into town during the Lunar New Year in January. Yet prices haven’t recovered to prepandemic levels, the salesperson said, because there are fewer speculative buyers.

One local resident who owns two properties said she isn’t counting on much of a rebound, though she believes people still want to move to the city.

“There has already been a glut of homes in cities like Beihai,” she said.

Owners in some other third-tier cities are pessimistic. Chen Yong, who owns two apartments in the northeastern city of Qinhuangdao, estimates that about 40% of the units in his compound are vacant, based on the number of apartments he sees with lights on at night, and how many homeowners are active in an online chat group.

“There are too many empty apartments out there,” said Mr. Chen, who works for a state-owned oil company. “I simply can’t see any reason for prices to surge anymore.”

Demand has snapped back quickly in some big cities, after many places in China lowered mortgage rates and offered other subsidies to attract first-time home buyers. In Shanghai, sales of existing homes rose to the highest level in February in seven months, according to data from Lianjia Research Institute.

Economists at ANZ Group said in a research report that China’s property sector was bottoming out, and that its gradual recovery would contribute as much as a half-percentage point to China’s gross domestic product growth in 2023, after dragging on the economy in 2022. It expects overall GDP growth of 5.4% in China this year.

ANZ said that even if the property recovery continues, annual sales will still likely only reach 90% of prepandemic levels.

Many forecasters believe the housing glut will persist in some cities, unless the government does more to stimulate demand, though doing so could lead to more speculation, which the government is reluctant to encourage.

Between 2010 and 2020, demand for residential properties in urban China averaged 18 million units a year, according to Goldman Sachs. As China’s population ages and demand for replacement properties wanes, that number will drop to 6 million units a year by 2050, its estimates show. In 2022, China’s urban population grew at the slowest pace in 42 years.

“We do think the peak has passed,” said Hui Shan, chief China economist at Goldman Sachs, adding that she expects annual demand for new homes to drop steadily in the coming decades.

The market could gradually absorb some of its excess stock if developers continue to scale back on launching new projects and give priority to selling existing units, said Betty Wang, a senior economist at ANZ Group. The temptation to increase construction as the market recovers could be strong, however.

Beijing could also try to reduce the oversupply by knocking down more old buildings and encouraging the renovation of existing units rather than building new ones. That wouldn’t be strange in China’s marketplace, said David Wang, head of Asia economics at Credit Suisse, because the average life expectancy of housing in China is only around 35 years, much shorter than in the U.S.