By staff reporter Yang Binbin

After two years of explosive growth in property values, even the most optimistic real estate developer in China foresees a correction ahead.

The market has already cooled since China’s central bank and banking regulator last September jointly issued credit tightening policies, affecting property buyers and sellers. Since then, property prices in major and second-tier cities have flattened. And transaction volume in the fourth quarter sharply declined.

The latest figures from the National Development and Reform Commission and National Statistics Bureau show property prices in 22 cities including Shenzhen and Guangzhou have dropped significantly. Meanwhile, transaction volumes in Beijing, Shanghai and Chongqing have fallen significantly, although prices have not.

A softer market had been long awaited by the government, which first initiated macro adjustment policies for the real estate industry in 2003. But, ironically, each new measure including the latest cool-down effort can be a catalyst for a new round of property price hikes. So the immediate question is, how long will this correction last?

A focus of debates over where property prices will go is a sentiment that the price falloff since the end of 2007 will spark an industry turnaround. Pessimists, though, think China will repeat the 1997 Asia Crisis if this sentiment causes investors to flee the market and pushes down property prices.

A close review of central government policies indicates that a downturn is the last thing Beijing and property developers expect. Such disbelief explains the government’s hesitancy toward property price controls and its repeated stress on an intention to “stabilize property prices” instead of “reduce prices.” Once the industry is about to turn downward, a bailout policy would be quickly implemented and many affiliated “fast brake” financial tools lifted. Thus, wrangling between the market and policymakers can be expected in 2008.

Tightening credit for property buyers and sellers may cool market fever, at least temporarily. However, real estate financing issues are a root cause of the overheating.

Wu Xiaoling, vice governor of the central bank, pointed out in 2005 that a key problem for domestic real estate financing is not the credit line but a narrow, concentrated channel for financing. Banks alone are now the main sources of financing and bear most risks. What China lacks is a multi-channel finance mechanism through which risks can be spread and shared among different sectors.

The real estate market’s ups and downs in 2007 provided support for Wu’s argument. And although two years have passed since Wu’s statement, the real estate financing system has yet to change.

The government, as the biggest beneficiary on the land supply chain, has a conflict of interest in its obligation to oversee the real estate industry, which contributes 10 percent to the gross domestic product. On one hand, the government is not bold enough to really rein in credit, but on the other it can’t ignore the property market bubble without intervening. A subtle psychological balance means that the goverment’s rein-in policy is more like tapping the brake than slamming to a halt, since no one is ready to pay the costs of a full stop.

An analysis by Everbright Securities concluded that a change in government attitude is needed for any policy correction to succeed. The current policy goes a little too far. So if government policy loosens at all in the second quarter 2008, a market revival will quickly follow.

Wang Deyong, an analyst at Citic Securities, looks at the government’s adjustment policy as a result of competition among different industry players. The next adjustment, he said, would only be sustainable if it is a flexible system for balancing various powers. In this way, once a special interest has its needs satisfied, it would have to yield to other parties.

Another variable for 2008 is the push for affordable flats and houses for low-income families. After the State Council issued “suggestions to ensure housing for urban low-income families” in August 2007, sentiments among potential buyers intensified in anticipation of a large supply of affordable housing. Meanwhile, commercial property sales in Beijing and Shenzhen declined last year compared with 2006.

Developers are also reacting to tightening credit and stock market financing with more conservative bidding for land. For example, local governments in Beijing, Shanghai and Guangzhou have failed to attract adequate bids at several land auctions since December, which points to a possible property shortage in the near future. Industry insiders are worried about another “revenge-style” price hike if there is an inadequate supply of property after investors turn upbeat again and prices fall.

The root of this concern dates to early 2004, when the central government implemented a policy aimed at curbing property prices, especially in Shanghai. However, after several months of falling prices, local property prices went through a monthly 10 percent surge in the second half. Whether history will repeat itself in 2008, or even 2009, is a concern weighing on the minds of policymakers.