Alex Clark

Schemes Bubbles And Crashes

12.5.15

The Future of the US Real Estate Market

Do investment bubbles end without disastrous repercussions? History tells us no. The 1860s

railway mania, the 1920s stock market boom and the dot com bubble tell the story of frenzied

speculative investment followed by periods of economic recession or even depression. History tells us

that economic success and misery are inextricably linked. Therefore, the recent boom of Chinese

investment in US real estate makes one ask, “when will the crash follow?” This mania cannot continue

indefinitely. However, its link with economic calamity cannot only be explained in terms of a bust

following a boom. In fact, the fear of economic disaster in China is a major catalyst of Chinese

investment in US real estate. In other words, a bust could be causing a boom. Moreover, unlike previous

real estate booms, much of the Chinese binge on US property is fueled by cash, not credit. Will this real

estate bubble have a different outcome compared to the credit-based Japanese speculation in US

property during the 1980s? Since the boom of Chinese investment in US real estate is ongoing, no

certainties exist on its future consequences. Despite future uncertainties, one concludes this current real

estate boom is both immense on scale and distinguishable from previous bubbles. Therefore, this story

adds another layer of nuance to the analysis of societal behavior in the speculative economy.

Chinese investment in high-end US real estate is lucrative enough to have a significant impact on

long-term US real estate trends. The statistics surrounding this group’s US investments are impressive to

say the least. In 2014, 80% of all new homebuyers in Irvine, California were Chinese (Durden 2015). This

demographic spent $28.6 billion on US real estate in the last fiscal year, making it the largest

demographic of foreign buyers in this market. For 14 homes in the United States that sold for $1 million

or above, one of those homes was sold to a Chinese buyer in 2014 (Searcley and Bradsher 2015). This

demographics’ contribution to the overall health of the US real estate market cannot be overlooked. For

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example, the Chinese are fueling a growing economy of affluence in San Francisco. Last month, the city

by the bay was ranked as the most sought after US real estate market (McIntyre 2015). San Francisco is

also the most popular destination for Chinese investors in US real estate. 20% of buyers of US real estate

in the region have a “Chinese connection.” One might claim that Silicon Valley tech giants have a far

greater impact on high end US real estate here. However, Chinese investors have one distinctive

advantage over this group. The Chinese usually buy in readily available cash whereas US tech giants have

much of their assets tied up in investment portfolios. In fact, 69% of all Chinese home purchases in the

US were in cash in the last fiscal year (CBS News 2015). Therefore, when a high end townhouse in San

Francisco is put on the market, a Chinese customer will be most appealing to the realtor. However, this

rapid transformation of the real estate market is not local or regional: it’s national. As wealthy Chinese

individuals buy up properties in America’s coastal cities, they are also expressing interest in middle

America. Chinese businessman, Zhang Long, is currently transforming Canyon Lake Ranch, a former

corporate retreat center, into a subdivision of 99 mini mansions catered toward Chinese buyers

(Searcley and Bradsher 2015). The US housing market has rebounded since the calamity of 2008 and real

estate booms in Dallas and San Francisco show that Chinese investors deserve some credit for this

transformation.

The influence of this wealthy demographic raises a concern familiar with most economic

bubbles. The common fear is that booming speculation conceals the true weaknesses and flaws of the

economy. In this case, the booming real estate market in the US is not indicative of the economic health

for the vast majority of the American people. When one sees new housing developments in Dallas or

expanding suburbs in Palo Alto, a false impression indicates that an era of prosperity is back in full swing

for the American people. On the contrary, US real estate lacks a significant base of middle-income

American homebuyers. The wallets of middle income households are becoming increasingly thin. From

2009 to 2014, the bottom 99% of income earners captured only 42% of all income growth (Ye Hee Lee

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2015). The disparities between the rich and poor become more striking in terms of wealth. The bottom

50% of US income earners own 2.5% of the Nation’s wealth while the top 1% owns 33.8% of it (Lubin

2015). These facts make a painful realization abundantly clear. The prospect of home ownership remains

a fantasy for a vast majority of the US population. This demographic lacks the assets to be part of a

vibrant home-owning class. Only the wealthy, of which Chinese investors are beginning to compose a

significant portion, can give the illusion of a vibrant and prosperous housing market. The current bubble

of high end Chinese real estate creates a mirage to hide lurking unease and concern, a feature common

in all speculative manias. For example, the growing housing market in 2008 foolishly made Americans

think they were richer than they truly were. Almost everyone could acquire the loan to buy a house, but

income inequality had steadily been rising since the 1970s. Only when the housing market crashed did

Americans realize they were living beyond their means in homes they couldn’t afford (Clark 2015). The

Chinese have pumped up high end US real estate, but this false optimism distracts from a recurring

problem of Americans lacking assets to be part of a prosperous housing market.

Chinese investment in US real estate hides not only economic well-being of the middle class but

also the economic well-being of the nation as a whole. The American dream of rising from poverty to

success is an engine of idealism that fuels American capitalism. Ironically, to achieve the American

dream one might be better of being Chinese than American. While the United States prides itself as a

nation where any immigrant can arrive to achieve prosperity, doesn’t it also pride itself as a nation

where her poorest citizens can make a proud living? If the new housing developments in Dallas and Palo

Alto were the fruits of both Chinese investment and American middle class labor, the American dream

would be a universal reality for Americans and foreigners alike. The truth is that economic prosperity

exists in America, but Americans themselves are highly unlikely to achieve it. The Chinese speculative

bubble in US real estate is a story of globalism in the 21st century. This ideology allows a wealthy

businessman in Beijing to transfer his assets with ease into San Francisco penthouse. This potential of

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globalism creates the false image of a strong nation state yielding prosperity to its own people. On

economic and political terms, the Chinese speculative bubble enforces the idea that a boom’s prosperity

is deceptive. In terms of globalism and income inequality, the Chinese speculative bubble is a flashpoint

of debate for the world’s future path.

When will the deception surrounding this speculative real estate bubble come to an end? As

stated, such deception is typically realized during the bust. Indeed, Americans only realized their

investment in real estate was a waste as their home values collapsed in 2008. When will the bust in

Chinese investment occur? To answer this question, one must examine the causes of this mania and

how likely such causes are to sustain future economic growth. While this speculative binge creates a

false economic deception in America, it is the result of harsh economic realizations in China. The

atmosphere of growth and optimism that transformed China into the superpower of the 21st century is

beginning to turn sour. Wealthy Chinese investors no longer see their nation as welcome place to store

their assets. The Chinese economy has not experienced annual gdp growth rates of over 10% since 2010.

This statistic is daunting considering that Chinese gdp grew by 14% in 2007. The Chinese Government

already recognizes that the country will need to make a transition to an economy no longer defined by

breakneck growth rates. Finance Minister Lo Ji Wei said in an official statement on the People’s Bank of

China website, that an annual gdp growth rate of 7% is “the new normal” (The Market Mogul 2015).

China’s economy is at a markedly slower pace of growth. The easy question to ask is why.

Wei’s assessment of “the new normal” recognizes an uncomfortable truth pointed out

by economic anthropologists like Richard Robbins. Indefinite high rate economic growth is impossible. A

society has limited resources that gradually become depleted to maintain economic growth. Forests are

cleared for infrastructure, Coal is mined to fuel electricity grids and land becomes cultivated for

agriculture. Growth depends on finite resources of the commons. At the same time, such growth is

necessary to pay off debts. For example, a factory owner is motivated to buy more factory equipment to

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create higher outputs of product and thus be free of his or her burdensome bank loan. The factory

owner also has to take out another loan to buy equipment that can yield higher production outputs. The

enterprise can only expand through an accumulation of capital. Such capital is obtained through

extracting the commons’ limited resources and debt. Once people like the aforementioned factory

owner cannot obtain further capital to expand, debt becomes unpayable. Then, the factory owner must

give up assets and wealth to pay off debt. The parable of the factory owner is a microcosm of economic

contraction resulting from society’s inability to perpetuate debt due to the limited commons which

serve as the foundation for economic capital.

China’s response to the inevitability of halting economic growth is frightening. The

government has set a new target growth rate of 7% and it is stretching the economy’s resources thin.

The Chinese government is currently infusing the most massive stimulus into the economy since the

2008 financial crisis to meet this growth objective. The stimulus is a government expenditure of 10

trillion yuan or $1.57 million over the next two to three years (Bloomberg: 2015). The prevailing hope is

that economic growth will result from the government’s growing debts. For example, more

infrastructure will be built from this stimulus. This investment hopefully leads to more commerce being

conducted, more citizens participating in the economic marketplace and more shared prosperity. That

prosperity hopefully creates tax revenue to pay of the government’s debts. Massive stimulus and debt

shows even modest 7% annual gdp growth remains a difficult objective for the Chinese government. If

the stimulus cannot achieve such growth, economic contraction and unpayable debts will ensue. This

massive expenditure will at most create modest growth. Such growth cannot pay back massive debts

incurred through one of China’s most ambitious stimulus programs to date. Although “the new normal”

is an ongoing economic policy with uncertainties remaining over its success and failure, this policy

illustrates that the Chinese economy faces a long term problem of growth not paying for debt.

Chinese investors recognize the government’s difficulty of

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alleviating faltering growth rates. These wealthy citizens have responded by moving their assets out of

the country. "They want a safe place to park their assets," Wei Min Tan, a real estate broker in New

York, said. "A lot of my clients were not expecting the Chinese economy to be strong indefinitely. A lot of

them started moving assets to safer countries a few years ago” (CBS News 2015). For the wealthy

Chinese, the matter of economic bust is now an inevitability in their country. As long as these feelings of

unease persist in China, the high- end US real estate market only stands to gain further investment from

abroad. Once again, the motif of prosperity concealing economic despair is prevalent in this speculative

bubble. This time, a new twist has emerged. The sequence is no longer boom and bust, but rather bust

and boom. Unlike 2008, US real estate benefits from the collapse in a housing bubble since it will take

place in a different country: China. Globalism allows wealthy Chinese to transfer their assets with ease

which in turn allows an economic crisis in one part of the world to create economic prosperity in

another. On the contrary, if China maintains a smooth transition to a new economic model then

speculative bubble in high end US real estate will begin to deflate as Chinese investors gain confidence

in their own economy. Given a long term problem of growing, unpayable debt, “the new normal” may

fail to bring long-term economic security to China, making wealthy Chinese investors more afraid of

their nation’s economic health. Moreover, as some wealthy individuals stop investing domestically,

businesses fail to grow. Therefore, more investors will be afraid of keeping their assets in faltering

Chinese companies. A negative feedback loop could ensue as capital flight of some investors causes

capital flight of more investors. This domino effect of panic in a weakening economic bubble could be

very powerful in causing wealthy Chinese to move their assets to the currently stable American real

estate market. Of course, the success or failure of “the new normal” remains to be seen, but its impact

will help determine the fate of the Chinese speculative bubble in US real estate. As of now, wealthy

Chinese investors are ill at ease over the state of their economy. Therefore, one can expect a

continuation of Chinese investment in expensive US real estate in at least the short term.

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Uncertainties remain as to

when the Chinese speculative bubble in US real estate will end. As stated, the future of this bubble is in

large part dependent on the ambiguous future of the Chinese economy. However, it will end as all

speculative bubbles do. In the late 1980s, Japanese real estate investment was running rampant in the

US as Chinese investment is today. However, flow of investment capital ceased following the collapse of

the Japanese economy in 1991. In the late 1980s, low interest rates and low tax rates fueled real estate

speculation in Japan. Land at the Ginza 4 Chome intersection in Tokyo traded at ¥90,000,000 per square

meter or $750,000. In fact, value of the Japanese Imperial palace allegedly exceeded the value of all land

in California (Housing Japan 2011). With such high real estate values at home, Japanese investors

overestimated real estate values abroad. In 1989, Mitsubishi purchased Rockefeller Center and 14 large

office buildings in New York as an extension of its real estate practices in Tokyo where it owned and

leased several properties very successfully. Mitsubishi and other unit trust owners of Rockefeller center

carried a $1.3 billion mortgage for the property. To Mitsubishi, this cost was inexpensive compared to

properties in Japan. Furthermore, these investors predicted Rockefeller Center would be the American

Ginza 4 Chome where real estate values seemed to be ceaselessly rising. Such assumptions doomed

Mitsubishi’s investment in Rockefeller center. In 1994, real estate values in New York fell by 40%. The

Japanese failed to attract a sufficient revenue stream of tenants as demand began to sour. When the

lease came for renewal, Mitsubishi had a gap of $460 million between rental income and mortgage

payments. In 1995, Mitsubishi entered bankruptcy and eventually foreclosed (Farrell 2008: 424-5).

Mitsubishi’s story encapsulates the boom and bust of Japanese real estate investment in the US during

the 1980s. Understanding the Japanese speculative

bubble can help us gage the long term economic fallout of Chinese investment in US real estate.

Japanese economic success of the 1980s made an expansion of overseas investment possible. Japanese

banks enthusiastically provided credit to finance such ventures. EIE International, a Tokyo-based

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electronics corporation went into massive debt by becoming the largest Japanese real estate owner in

Oceana. Its holdings were valued at $15 billion. EIE international hoped the value of its foreign property

would increase to the point where debt could be paid off and the property could be sold to new

investors for a profit. However, the overseas properties did not rise in value and the Japanese banks that

financed EIE suffered a major loss (Farrell 2008: 426-7). The contrast between Japanese credit and

Chinese cash illustrates the contrast between optimism and pessimism. Chinese investors need to move

their cash out of China and store it in a sanctuary immune from domestic woes. A stable US real estate

market and a less frightening government make our nation a safe place for Chinese investors fleeing a

dire economic prospects. In the 1980s, Japanese banks had seen unprecedented economic success at

home and they wanted to expand on that success by diversifying investment portfolios . Companies such

as EIE International presented the perfect opportunity for such expansion on behalf of Japanese

financial institutions. Once international property did not meet expectations both the banks and the

economy suffered. In other words, Chinese Pessimism will prove less disastrous than Japanese

optimism. While wealthy Chinese can suffer real estate losses, the effect for the most part will not ripple

to financial institutions. As stated, 69% of Chinese investors purchase US real estate with cash (CBS

News 2015). Japanese banks proved too optimistic in fueling an overseas real estate boom so that the

fallout went beyond individual investors. As Japanese overseas investments suffered, the domestic

repercussions were severe. Banks such as the Long Term Credit Bank dissolved due to staking excessive

credit in risky real estate. In 1989, the Long Term Credit Bank of Japan was the 9 th largest company in the

world. As its various domestic and foreign investments lost value, the bank failed (Knufken 2009). In

short, while the Chinese bubble will burst as the Japanese bubble did, its fallout will be less severe given.

Chinese investment is occurring predominately on an individual level whereas 1980s Japanese

investment occurred on an institutional level. The story of Japanese speculation in US real estate bodes

both a positive and negative outlook for current Chinese investors. It provides a warning to Chinese

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investors in teaching that speculation booms must come to an end. It also teaches that cash puts less

economic actors at risk and manages the negative impacts of a speculative bust. Of

course, the future of China’s speculative boom in US real estate remains uncertain in numerous aspects.

The failure of “the new normal” economic policy could heighten anxieties of wealthy Chinese investors,

driving more of them to US real estate. However, the Chinese economy could possibly regain strength

thus dissuading foreign investment. Moreover, the US real estate market could lose value and become

less appealing to Chinese consumers. This outcome drew away Japanese investors from US real estate

during the early 1990s. Despite current uncertainties, the Chinese investment bubble embodies an

uneasy tension between economic prosperity and economic misfortune. On the surface, one sees

expanding affluence in places like Dallas as Chinese investors buy up mini mansions. One also sees a

current of unease in China driving such economic expansion in America. Additionally, this bubble helps

conceal the persistent societal ill of income inequality in the US. Understanding the present day

speculative economy involves discovering economic sickness behind supposed economic health. The

Chinese craze for US real estate gives one to understand the underlying persistent economic woes facing

China, the United States and the global economy.

Bibliography

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