Japan – USA – China: The Next Real Estate Bubble?

An asset bubble is caused by investors bidding up the price of an item to unrealistic levels that do not reflect realistic market principles of return on investment or profit expectations.

A prime example of an asset bubble is the dot-com bubble of 1998 to 2000. Internet companies seemed to spring up overnight with over inflated values and unrealistic expectations. People poured money into the stocks of these dot-com companies, not because they were legitimate business opportunities, but because they perceived that the value of their stock would continue to rise indefinitely.

Irrational exuberance is a term that can best describe the motivation of people that put their money into a stock of a company that would deliver groceries door to door by FedEx or other dot-com ideas of that era. These companies operated at a loss to gain market share and growth. But that cannot go on indefinitely and it didn’t.

On March 10, 2000 the technology heavy NASDAQ market peaked at 5132.52. What followed was the spectacular failure of most of these startup companies and huge losses for their investors.

A real estate bubble is caused by a disconnect between the actual or real value of a property and the perceived value based on an overexcited market that bids up or inflates property values.

A collapse of a real estate bubble in Japan set off a recession in the 1990’s. It took Japan’s economy more than a decade to resume noticeable growth. It became aptly named as the “lost decade” in Japan.

According to a December 25, 2005 New York Times article:

JAPAN suffered one of the biggest property market collapses in modern history. At the market’s peak in 1991, all the land in Japan, a country the size of California, was worth about $18 trillion, or almost four times the value of all property in the United States at the time.

Then came the crashes in both stocks and property, after the Japanese central bank moved too aggressively to raise interest rates. Both markets spiraled downward as investors sold stocks to cover losses in the land market, and vice versa, plunging prices into a 14-year trough, from which they are only now starting to recover.

When the bubble burst (as all bubbles eventually do) the Japanese real estate market lost between 50% – 80% of its value, according to various sources.

As we all know, the US real estate market suffered a similar fate.

The US real estate bubble was inflated by a spectacular rise from 1997 to 2006, led by cheap credit and the momentum of large-scale market speculation. Prices reached unsustainable levels and the US housing bubble’s eventual collapse triggered the “Sub Prime Mortgage Crisis” and eventually the “Global Financial Crisis of 2008”.

Real estate markets across the US suffered by varying degrees but it can be said that California, Arizona, Nevada and Florida were some of the worst affected states.

In fact, a closer look at the state of California really shows the carnage that that state suffered from the collapse of the US housing bubble. The devastating impact shows regional losses as high as -74.55% in May 2009 from a highpoint back in August 2007.

In our current system, free market economies are always subject to cycles. Markets go through periods of economic expansion (growth) and contraction (recession) dictated by market forces with both internal and external factors.

The Global Financial Crisis of 2008 created what some are now calling “The Great Recession”. Every developed country in the world was affected to various degrees. Real estate markets plunged with the western banking system on the verge of collapse.

Every country rushed in emergency measures to prevent an economic depression. Massive government spending in the major developed countries ensued. But the world looked to the strength of Asia and in particular, China to reignite the global economy.

China responded with a massive stimulus package and cheap loans to maintain and promote economic growth. China could easily afford it with its huge $2.3 trillion dollar US foreign exchange reserves.

By late 2009 global real estate markets not only stabilized, but posted growth and recovery in some countries. Both the US and Canada posted strong fourth quarter existing home sales increases.

World economic activity moved back to positive territory and China appears to be leading the way forward.

Jacynthe Cote, chief executive officer of Rio Tinto Alcan, the worlds largest aluminum company recently made the following statement in a Jan 22, 2010 Bloomberg article regarding Chinese demand:

Cote, who declined to provide a specific forecast for 2010 demand, said it would be pushed higher by countries such as China increasing economic output.

“The drop has been fairly significant” in countries of the Organization for Economic Cooperation and Development, Cote said. “In China, there is no sign left of recession. They are already at full speed, back to their peak and growing.

So it appears that China’s stimulus package and economic policies had a very positive impact. However, was the Chinese stimulus too much of a good thing? Is the Chinese economy now overheating and rising too fast?

In recent news articles and media commentary, the ugly term “Bubble” is being used far too often to describe the current condition of the real estate market in China.

Both Japan and the US suffered huge negative market impacts with real estate bubbles? Will China suffer the same fate?

A story in Daily Finance on January 5, 2010 offers these comments:

Analysts in China are concerned that this tremendous rise in construction, lending and speculative buying — housing starts nationwide rose 194% in 2009 — is blowing a bubble that could burst in 2010, taking down everyone who jumped into the game in 2009: homeowners, banks, developers, stock markets, and local governments.

The central government is also concerned. In late December, China Premier Wen Jiabao made a widely publicized comment that “property prices have risen too quickly.” He vowed to impose new limits on speculative borrowing, such as raising the deposit requirements to purchase raw land to 50%.

With real estate prices rising by 57% in a matter of months in 2009, some Chinese districts definitely appear to be going down the same path as Japan and the US. The Chinese real estate market looks to be definitely trending in a “bubble” direction.

These rapid price increases are not sustainable and the Chinese real estate market will react negatively. The severity of the markets reaction will determine whether we call it a “Bursting Bubble” or a “Cooling Trend.”