Special：Xing Talk—Celebrities Interview

Despite of Chinese central government’s year-long effort to stabilize housing prices, they continue to soar. The real estate financing is making up an increasingly large part of the country’s financial sector and as a result, the health of the real estate financing is of critical importance to the health of China’s economic development. Is there too much risk involved? What would be the particular challenges? Recently, Xing Zong, a rising 5th year Ph.D. student took an exclusive interview with Wharton Prof. Gyourko.



About Prof. Joseph Gyourko
Dr. Joseph Gyourko, Martin Bucksbaum Professor of Real Estate and Finance. He is also the director of Samuel Zell and Robert Lurie Real Estate Center at Wharton School, University of Pennsylvania. He graduated from University of Chicago with a Ph.D. degree in 1984. Prof. Gyourko’s current research focuses on real estate finance, urban and real estate economics and housing markets.

Xing Zong: Prof. Gyourko, the soaring investments in the real estate sector in China have prompted the government to sound the alarm for a few years. In your opinion, what are the criteria to judge whether there is too much bubble involved?

Gyourko: Let me start by defining a bubble. I think of a bubble existing when there is no rational basis for believing the underlying supply and demand fundamentals for an asset such as housing are strong enough to support current prices. Unfortunately, there is no consensus about how to identify whether a bubble exists before the fact. For example, it was only after the collapse in the prices of technology companies a few years ago that we realized a bubble had existed in the tech sector in the U.S. Something similar is happening in certain condominium markets here right now. However, there are factors that should make you suspicious that prices may be overvalued, even though you cannot readily prove a bubble exists. One is appreciation rates well in excess of historical averages. Unless you can explain why trend growth would be higher than normal, you should be suspicious. Another is the ‘newness’ of the sector. Investors in the U.S. were fooled about the tech bubble because the rise of the Internet was very new. That made it hard to determine how large growth in the sector would be and what prices could be charged. It was only after a period of years that this information became more readily known, and once it did, prices fell. Finally, I think you should look to whether there is any real cash flow being generated by the asset. This was an important factor in the tech bubble. If there is little or no existing cash flow, but very high rates of appreciation, you should be suspicious. At the end of the day, investors need cash flow, not just capital gains.

Xing Zong: So you are making comparisons here between the real estate industry and IT sector. Besides the factors you just mentioned, another critical issue is to understand whether the house is for basic needs (living) or high level needs (investment). How do you differentiate between the two?

Gyourko: Housing is both a consumption and investment good, so the two cannot be completely separated. I live in my house and it provides important services for my family, but it also is one of my largest assets. I believe most people overemphasize the investment part of housing and underappreciate its importance in providing housing services that families need to consume on a daily basis. I am not an expert on the Chinese property markets, but in the U.S., I always recommend that people focus on the consumption aspect of housing when they are making a decision to purchase a home. I suspect that is good advice for Chinese families, too. Housing is a very durable good and you are likely to live in it for many years. Hence, you should want to live it if you are going to buy it, not just value it for its investment growth potential. In addition, the housing market tends to be less liquid than the stock or bond market, so you are taking on liquidity risk as a household if you are purchasing mostly for speculative or investment reasons. At the household level, I have long believed that there are better ways to speculate or invest than in the housing sector.