Unintended consequences of property cooling policies
In their study on China’s Housing Purchase Restriction policy, Qian, Tu, Wu and Xu (2022) observed post-policy capital misallocation which eventually resulted in significant trading losses.
26 June 2024
Residential real estate is a highly coveted prize. Over the years, the slew of property curbs rolled out by the Singapore government to cool overly bullish demand bears testament to its tremendous popularity – and also to the exceptional resilience, of both the asset and its buyers. Despite numerous disincentives, homebuyers return in sufficient numbers, together with a hefty debt appetite, to trigger yet another round of property curbs. The latest set of property cooling measures was introduced in April last year.
But what drives demand against such odds? As Qian, Tu, Wu and Xu (2022) highlight in their working paper “Unintended consequences of demand-side housing policies: Evidence from household reallocation of capital”, a possible explanation lies in the tendency for households to extrapolate from the historical performance of residential real estate without paying heed to obvious market shifts.
It is only a matter of time before such unfounded optimism will lead to sobering outcomes, as reality eventually sets in. In their study, Qian et al. observed how households reallocated capital into the stock market following the implementation of the Housing Purchase Restriction (HPR) policy in China. In the wake of the HPR, housing demand plummeted, and market analysts promptly downgraded their assessments of listed real estate developers. Yet, as if in defiance, findings showed that investors affected by the HPR exhibited a tendency to channel their money to real estate stock. In an attempt to use property stocks as an alternative for betting on housing price growth, those investors eventually experienced significant trading losses.
Background
Following the Global Financial Crisis, the Chinese government issued a series of stimulus policies for the housing market, which included a historically lowest mortgage interest rate, higher credit accessibility for developers and lower tax rates for housing transactions.
Amid an expansionary fiscal and monetary environment, house prices increased by over 40% countrywide between December 2008 and March 2010, and almost doubled during the same period in top cities such as Beijing and Shanghai.
To curb spiralling prices, the Chinese government in April 2010 announced the HPR. Beijing was the first city to implement the policy in May 2010. Lanzhou followed next, and by November 2011, 45 cities in China had implemented the HPR.
Though policy details varied by city, in general, all the HPR cities imposed restrictions for two groups of home buyers, with the explicit target of curbing investment demand. First, the HPR policy barred non-local residents from any home purchase in the city. Specifically, a person was qualified for home purchase only if he had local household registration, or had lived in the city for an extended period (5 years or longer for most cities).
Second, local residents were also prohibited from purchasing multiple homes in the city. In most HPR cities, such as Beijing, Shanghai, and Shenzhen, a local resident could not purchase additional dwelling units if he already owned two units in the city.
Empirical design and data
The staggered implementation of the HPR across geographically dispersed cities in China over a period of nearly two years allowed Qian et al. to adopt an event study approach i.e. observe pre- and post-policy implementation behaviours without the need for a control group. The premise here is that if investors affected by the HPR exhibit similar behaviours across different times, locations and economic environments, then there is evidence to suggest that the HPR is causing such behaviours.
Individual-level stock investor account and trading activity data were obtained from a leading stock brokerage company that had 150 branches in the 45 HPR cities, and accounted for between 2% and 4% of market share in the country. Before April 2015, each individual investor could, by law, only hold one stock account in mainland China – the data therefore captured the entire stock holdings of sampled individuals involved in the study.
The treatment group consisted of investors that fulfilled the two conditions of: (i) holding a stock account in a branch of the brokerage company in an HPR city, and (ii) being born in that HPR city. The rationale is that the housing investment demand of investors in the treatment group was on the overall crimped by both the implementation of the HPR in their home cities and by high information and transaction frictions for housing investments elsewhere. In other words, treated investors were left with excess capital looking for alternative investment opportunities.
To further corroborate their findings, the researchers created a falsification group. This group consisted of non-local investors residing in HPR cities who had previously migrated from non-HPR cities. While disallowed from buying property in their current HPR city, unlike the treatment group, these investors had the option to invest in property within their hometown cities.
Findings
Qian et al. observed a large and significant increase in stock market participation following HPR after controlling for time and location fixed effects.
Compared with four weeks before policy implementation, the weekly number of new stock accounts opened by the treatment group increased by nearly 60% during the four weeks following HPR.
Furthermore, cash inflows to existing stock accounts (i.e. those opened between 2000 and 2009) by the treatment group also increased by about 333 RMB per account-week during the four weeks after HPR.
In contrast, stock account opening behaviour and the cash inflows remain unchanged for investors in the falsification group.
The behaviours of the treatment and falsification groups furnished good evidence that capital – which would otherwise have been used for property purchases – was reallocated into the stock market. The researchers estimated that about 58.3% of households’ housing investment capital, approximately amounting to 33 billion RMB, was channelled to the stock market after HPR.
Qian et al. additionally found that local investors who opened stock accounts prior to the HPR were 72.9% more likely to purchase real estate stocks in the 12-week window after HPR, compared to the period right before the policy. This tilt in investment preference was however absent in the falsification group.
The observed pattern among treated investors was prevalent across a wide spectrum of investor demographics: the post-HPR propensity to invest in real estate stocks was equally strong across different age groups, by gender or by wealth. The researchers found a strong effect for more experienced investors with a longer account history compared to less experienced investors.
In other words, the trading behaviours did not arise from a subgroup of investors who lacked financial sophistication or literacy. Instead, the findings were consistent with the hypothesis that affected households do not adjust their expectations downwards on future house prices, but chose to use the stock market as an indirect way of betting on real estate.
The consequences of unrealistic optimism
Following the HPR implementation, treated investors experienced a decline in their stock portfolio performance over the next year compared to the year before the policy. The average monthly cumulated abnormal return (CAR) was significantly lower – by 0.55 percentage points – than that in the pre-HPR period.
Notably, this decrease was even more pronounced for their real estate stock holdings. The average monthly CAR for real estate stocks in the affected investors’ portfolio in the post-HPR period was 0.72 percentage points lower than the pre-HPR period, and such a loss was significantly higher than that of their non-real estate stock holdings.
Policy implications
While demand-side property cooling regulations may be effective in achieving their intended objectives, capital reallocation following policy implementation could generate negative outcomes, as Qian et al.’s study discovered. Research findings suggest that policymakers may need to adopt a wider perspective beyond the immediate property market, and also explore ways to manage inelastic household expectations that appear to be oblivious to market signals.
Inefficient allocation in the capital market can also create distortions in the real sector as well. As money stubbornly flows into real estate stocks in spite of negative signals, developers may be lulled by the additional liquidity to further expand amid a market that is already contracting. Possible consequences include supply overhang, downward pressure on prices, and subsequently a compromised ability to repay debt and equity holders.
Qian, Wenlan is the Ng Teng Fong Chair Professor in Real Estate and Professor of Finance and Real Estate at the NUS Business School.
Tu, Hong is a professor at APEC Study Center of China at Nankai University.
Wu, Jing is a professor at the Department of Construction Management, Tsinghua University.
Xu, Weibiao is a senior lecturer at the Singapore University of Social Science.