• The Chinese real estate bubble is only the most recent in a long series of crises that have affected global markets over the past century, from the U.S. to Japan.
• Predicting whether a real estate market is in a bubble or at high risk of one is extremely difficult. Still, there are certain indicators that signal caution.
• From the construction boom to the collapse of the Evergrande giant: let’s examine what’s happening in China and how the Beijing government is responding.
• In today’s hyper-connected world, the effects of a crisis in one country can quickly spill over into others. That said, for now, the risk of a global housing bubble appears to be easing.
• From the European Central Bank’s warnings to the risks tied to “shadow banks”: here’s why it’s worth keeping your guard up.

Inside the Dragon’s bubble

China is near. So went the title of a well-known film from the 1960s. But just how near is it, really?

China’s real estate bubble has been unsettling Beijing for some time now — and raising concern around the world about its possible ripple effects. The collapse of the Evergrande giant – along with worrying signs from Country Garden and Zhongrong – has shaken the markets. As the Chinese government attempts to “deflate” the bubble, many are wondering whether China’s real estate crisis might have a global impact in such an interconnected world. For now, the risk in Europe remains low, partly due to inflation. But the real variable to watch is the time factor.

What is a Real Estate bubble? Definitions and past cases

The Chinese real estate bubble is merely the latest in a long series of market crises that have shaped the global economy over the past century — a recurring theme in financial history. Among the most notable examples:

• Florida in the 1920s
• Japan in the late 1980s and early 1990s
• The U.S. in the early 2000s, which contributed to the global financial crisis of 2007–2009 and impacted housing prices across most developed economies¹

In economic terms, a bubble refers to an abnormal increase in the price of an asset that is not justified by market fundamentals. It’s typically accompanied by high trading volumes, followed by a dramatic collapse when the bubble bursts. This phenomenon is often amplified – sometimes even accelerated – by financial speculation.

In simple terms, a housing bubble begins when demand in the real estate market spikes, driving up property prices far beyond justifiable levels. On one hand, investors rush in seeking profits. On the other, weak or stagnant economic growth can lead to a growing imbalance between supply and demand. As property prices outpace the real value of the assets, average buyers are priced out of the market. Eventually, prices crash and the bubble bursts – often triggering broader financial turmoil. Eventually, the bubble bursts — leading to a steep drop in property values and triggering wider financial consequences.

The Real Estate Bubble and the “time factor”

One key feature of real estate bubbles – whether in China or elsewhere – is how hard they are to predict. Not because analysts lack insight or experience, but because identifying real estate bubbles in advance is inherently complex. Most observers only recognize them once they are already formed – or are about to burst. China is a case in point. There are indicators that should raise red flags: imbalances in the real economy, an overinflated construction sector, and a widening gap between real estate prices and average income. Still, determining whether a market is in a bubble — or at serious risk of becoming one — is a major challenge. It requires a thorough understanding of the current landscape and informed predictions about how the market will evolve. The time factor plays a big role. Unlike stock market bubbles, real estate bubbles don’t reveal themselves in real time. The consequences of transactions — such as property purchases and title deeds — often only become evident after a delay. This time lag makes it harder to spot the warning signs and slows down recognition of the bubble itself.

China’s Real Estate Bubble: What’s Going On

The time lag is particularly evident in China’s case. While the crisis is making headlines today, warning signs have been sounding for at least a couple of years. Real estate bubbles share certain characteristics, but each case is unique.  In China’s case, the past three decades — and especially the last fifteen years — have seen an unprecedented construction boom, driven by economic and demographic growth. This has led to massive urbanization.

• According to a 2019 survey by the People’s Bank of China, home value makes up 59% of total household wealth. Mortgage loans account for 12% of the total. These are similar to figures seen in the U.S. before the 2008 subprime crisis and in Japan in the 1980s.
• Across multiple sources², real estate is estimated to represent between 18% and 30% of China’s GDP – closer to the upper end of that range.

Excessive demand fueled China’s property sector to over-leverage. Developers took on debt, shifting part of the risk directly onto buyers. At the same time, local governments approved an ever-growing number of construction projects — often regardless of actual demand — because land sales and leasing generate over a third of their total tax revenue.

As a result, the real estate sector expanded uncontrollably, setting off a kind of vicious cycle. In short, China’s property market relies on economic growth to manage its debt, while the broader economy, in turn, depends on a booming real estate sector to keep growing.

COVID-19’s impact and the Evergrande Crisis

China’s real estate troubles began surfacing in the second half of 2021. Home sales slowed, partly due to economic uncertainty, partly due to pandemic restrictions.

Slower sales meant reduced cash flow for heavily indebted developers – most notably Evergrande, which filed for bankruptcy in the U.S. in August, burdened with an estimated debt of over $300 billion. Chinese banks began cutting back on mortgage lending in response to tighter regulations, causing construction to slow dramatically and sparking protests and mortgage payment boycotts.

Today, most analysts agree that the Chinese real estate bubble is gradually deflating. This is largely due to stricter regulation introduced by the Beijing government to manage debt issues. Many believe that China has the resources to avoid a short-term crash and is prepared to accept significant economic and social costs to achieve long-term structural improvements.

Risk of contagion outside China? Not exactly…

So, back to our original question: how close is China? The real estate bubble is, of course, a domestic issue for the country. Still, in a hyper-connected world, a crisis in one nation can send shockwaves across others. Is there a real estate bubble risk in Italy or Europe? What lies ahead for the global market?

According to UBS’s latest Global Real Estate Bubble Index³, the risk is declining worldwide. The index, which analyses residential property prices in 25 major cities globally, shows that real estate market imbalances have significantly decreased. Only Zurich and Tokyo remain in the “bubble risk” category (compared to nine cities in 2022). Milan, notably, is considered fairly valued. From mid-2022 to mid-2023, real house prices dropped by an average of 5% across the surveyed cities – and further declines are expected. UBS attributes this shift to the current economic climate, particularly the surge in inflation and interest rates following the pandemic and the war in Ukraine.

Staying alert

All good, then? Well, almost. The “time factor” still matters, and it remains difficult to predict exactly when and how a bubble might burst. In Europe, subtle signs of an emerging bubble persist beneath the surface. In its Financial Stability Review⁴ published last July, the European Central Bank issued a stern warning about the real estate market, pointing to “clear signs of vulnerability” in the sector. It cited “declining market liquidity and price corrections” as key concerns. While the focus is more on commercial real estate than residential, it’s still a situation that requires vigilance. Especially considering the potential risks posed by so-called shadow banks – whose exposure to real estate markets remains difficult, if not impossible, to quantify.

NOTE
¹ For further reading: The Housing Bubble and the 2007–2009 Financial Crisis in the U.S., Consob
² Sources: K.S. Rogoff and Y. Yang (2020), Peak China Housing, NBER Working Paper 27697; CaixaBank Research; National Bureau of Economic Research; The People’s Bank of China
³ UBS Global Real Estate Bubble Index 2023
⁴ Financial Stability Review, May 2023, European Central Bank (ECB)