The Inflation Hedging Ability of Real Estate in China

By Zhou, Xiaorong; Clements, Sherwood | Journal of Real Estate Portfolio Management, September-December 2010 | Go to article overview

The Inflation Hedging Ability of Real Estate in China


Zhou, Xiaorong, Clements, Sherwood, Journal of Real Estate Portfolio Management


Executive Summary.

The investigation of the inflation hedging ability of real estate is very timely in view of the current widespread rising inflation expectations in the People's Republic of China. An autoregressive distributive lag (ARDL) cointegration technique is used to examine the long-run relationship between inflation and Chinese real estate prices. The study covers the time period from 2000 to 2008, which is after the privatization of real estate in China. Overall, no long-run equilibrium relationship between real estate price changes and inflation rate is found. Thus, Chinese real estate is not an effective inflation hedging asset.

(ProQuest: ... denotes formulae omitted.)

Prior to 1980, China utilized a welfare housing system, whereby a residential home is not a commodity purchased on the open market, but instead is distributed by the government to dwellers as a form of welfare with low rent. Subsequently, senior leader Xiaoping Deng called for market reforms that started an unparalleled renovation of the Chinese housing system from a welfare-oriented housing system to a market-based system. These reforms included the elimination of the current government housing distribution and the development of a private housing market. The marketbased system has been implemented in several stages over the past two decades with homeownership promotion experiments conducted in selected cities beginning in 1979.

The market-based system was not nationalized in 1988. However, the plan was delayed in 1989 because of the political events such as the Tiananmen Square demonstrations. Reintroduced in the early 1990s, the Chinese government established a housing finance system to facilitate home purchases on the open market and by 1998 the Chinese government formally announced the end of the welfare allocation of housing. Cao (2009) notes that the Chinese government's approach to change from a welfare-based approach to a market-based approach for housing has been guided by pragmatism and gradualism. This led to a steady expansion of residential production capacity, resulting in an increase in the standard of living for the Chinese people.

After 1998, residential housing became one of the most important assets in an individual's investment portfolio. Additionally, the housing industry has played a substantial role in the Chinese economy. According to the 2000 Census, the homeownership rate reached 72% in cities and 78% in towns respectively (Li and Huang, 2006). The floor space of newly-built housing in urban areas increased from 188 million square meters in 1985 to 477 million square meters in 1998 (Guan, Feng, and Zeng, 2001). According to the data provided by the National Bureau of Statistics of China, housing prices remained steady with an annual growth rate up to but not exceeding 2% from 1998 to 2001. However, since 2003, the growth rate increased substantially, with an average of 7.6% for the following five years.

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. Thus, real estate provides an inflation hedge when the general price levels rise and the returns of real estate (including price appreciation and rent) increase accordingly. The People's Republic of China, a country with a high savings rate, is under pressure from these high inflation expectations (Lo, 2009). Investors are expected to find an asset that could safeguard this possible threat from inflation. China's real estate market recovery after the 2008 recession, partially due to high inflation expectations, has garnered the concerns of both the government and academia. According to a recent survey by a local newspaper in Chengdu city, when faced with the upcoming inflation, 60.90% of the subjects claim that they would consider making real estate investment to hedge the risk.1 Clearly, from the Chinese consumer's point of view, real estate has the ability to hedge inflation risk. …

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