Inside China’s troubled real estate market

Data released this week by China’s National Bureau of Statistics suggest that the country’s real-estate deflation—soon to enter its fifth year—accelerated in May. New-home prices in 70 large and medium-size cities fell 4.3% year-over-year in May, compared with a 3.5% year-over-year drop in April. Existing-home prices fell 7.5%, compared with April’s 6.8% drop.

This shouldn’t be a surprise, since Xi Jinping’s government started engineering a correction in the overheated property market in August 2020. Except that more recently Beijing has gotten cold feet. This spring it tried to correct the correction.

The central bank last month started offering credit subsidies of 300 billion yuan ($41 billion) to encourage state-owned enterprises to buy residential units worth 500 billion yuan to rent out as affordable housing. This kitty, plus removing the minimum on mortgage interest rates (previously 3.5%) and reducing down-payment requirements for house purchases, was supposed to put a floor under the market.

Mr. Xi was heeding increasingly desperate calls from within and outside China to do something to arrest the decline of real-estate prices. Many economists and probably Mr. Xi himself assumed he’d be able to do so. The historical precedent was the enormous credit stimulus plan Beijing rolled out to shield its economy from the worst effects of the 2008 global financial crisis. This led to a mountain of debt but also staved off a recession—and may have indirectly helped pull the West out of the ditch.

When Beijing launched the latest real-estate support plan last month, the main debate among economists was whether it was large enough. But as it becomes clear that the plan may not be working, another worry is coming into view: Chinese households might not care.

The way individual Chinese think about the economy and their prospects appears to be changing. This is most obvious in the housing market, where malaise appears to be setting in. At 22%, the proportion of urban households that expect house prices to fall further in the coming quarter is higher than it’s been in at least a decade. By contrast, the proportion of those who expect prices to increase is currently at a 10-year low of 11%.

As households have reconciled themselves to falling property prices, other attitudes have changed. The proportion of Chinese telling surveys that they want to save more—meaning stashing cash in an unproductive low-interest bank account—has soared to around 62% from 50% when the property deflation started in 2020. The proportion of people saying they want to spend more has dropped to around 23% from around 28% before the pandemic. Consumer confidence has fallen off a cliff since 2022.

This bell can’t be unrung. Even if Mr. Xi eventually succeeds in putting a floor under the property market, the middle class now is on notice that house prices can go down. The consequences of this shift could be profound, because an expectation that property prices will always increase is the bedrock on which China’s modern political economy was built.

This belief drove households to overinvest in housing, fueling an enormous construction industry. The wealth effect created by ever-rising property prices became a crucial ingredient in the consumer confidence China needs to cultivate to rebalance toward consumption and away from exports and wasteful public works as drivers of economic growth. A similar wealth effect became embedded in the government’s finances, as local governments across the country created overleveraged investment funds to pour money into real estate.

It’s common to blame dips in consumer sentiment on Mr. Xi’s draconian pandemic lockdowns. Yet as time passes and the economy still doesn’t recover from the pandemic shock—at least not at the pace observed in Western economies—it starts to look as if China’s problems lie elsewhere and are more serious. If Beijing can’t rely on real-estate confidence to fuel economic expansion, what can it rely on?

The answer in other countries has been productivity growth. Property markets across the world are beset by dysfunction, but while price declines aren’t common in the West, they also aren’t unknown. Market economies can thrive despite some background risk of future property-price declines because market economies tend to rely on productive investment and the resulting wage gains to buoy consumption, rather than leaning exclusively on housing wealth effects to bolster confidence.

Mr. Xi is weaning China off the housing wealth effect, but he’s struggling to devise an alternative. His insistence on increasing the state’s role in the economy doesn’t augur well for the sort of productivity growth China needs in a post-housing-boom world. If Mr. Xi can’t count on housing and won’t nurture the productive economy, expect China’s malaise to linger.