Chinese Real Estate Is a Bubble, Not a Disaster

NEW YORK ( TheStreet) -- The state of the Chinese real estate market recently caught the attention from U.S. investors, as highlighted by the recent CBS "60 Minutes" report.

And the debate can get pretty emotional quickly, with charges of treason thrown in no less, as shown in this disastrous talking-past-each-other "debate" between two professors on CNBC.

Since saying Chinese real estate is not a bubble risks being labeled Beijing's lapdog by Prof. Peter Navarro, especially if you're of Chinese descent, I'll be intimidated into not saying it's not a bubble. I repeat, Chinese real estate market is a bubble. It's just not a disaster for most of the world, including most people in China. Is this politically correct, Prof. Navarro?

There's plenty of data and argument on English media not yet destroyed by Chinese hackers illustrating why it is a bubble so I'll skip that and just focus on why it's not a disaster.

Prices have gone up a lot in recent years in what's loosely called Tier-1 cities, which includes Beijing, Shanghai, Guangzhou, Shenzhen, and maybe a few others like Hangzhou, depending on whom you ask. These are the primary political and economical hubs in the well developed coastal area. The increase of 20% in parts of Beijing in recent months (anecdotal evidence only -- the official site for Beijing's real estate prices mysteriously lacks the data for October and November 2012) raised quite a few eyebrows, especially.

Such rate of increase is simply mathematically unsustainable. But there're clearly real demands beneath the hysteria, simply due to the tremendous benefit of working and residing in these mega-hubs. Such benefits are severely distorted and deeply unfair, causing all kinds of long-term social and economic problems. But that's another topic, years or decades down the road.

Price in those mega-hubs may go down a bit, but will not crash in any significant fashion. The government wants to avoid that. It pains me to admit the power of governments anywhere, any time, but in this case they got it. If these markets show any sign of crashing, all the governments (central and municipal) need to do is to gently lift residency restrictions (one of the remaining, really regressive policies in China today). There are easily many tens of millions of eager people all over the country to jump in, even though I think it is completely irrational, despite the benefits, and therefore do not approve.

The Tier-2 cities, generally speaking the provincial capitals and the remaining central-government-direct-report cities (Tianjin, Chongqin), are more or less in balance in my opinion. Again, my main rationale is the supply of demand in each city's lower rungs on the sociopolitical ladder.

The Tier-3 and lower cities, or at least with tremendous over-building problems, are where the trouble lies. These would be the ghost cities many western reports have been obsessing with, meaning that the bubbles there have already burst. Some of the over-building goes way beyond the realm of plausibility. This is due to the combination of the local governments' obsession with nominal GDP numbers and the moral hazard, the blind belief by developers, investors, and local banks that whatever the government supports will never fail. I'm not sure if more ghost cities would surface.