Chinese capital allocations to real estate

During the financial crisis of 2008, I mistakenly thought part of the Chinese stimulus package would be the creation of various real estate finance vehicles (ie REITs, CMBS), but this is not happening. In fact, the reverse appears very much the Chinese government's current course of action. The question is how the central government plans on diverting the real estate market in the near future.

A massive amount of capital has already found its way into real estate; the stimulus package caused capital to move in the following direction, from government-sponsored banks -> large corporates and state-owned enterprises -> real estate. Due to lower global consumption, many companies were almost forced to take on loans without a need to invest or re-invest in factories or the like. Due to strict capital controls, this abundance of capital has only two outlets in China, real estate and public equities. Real estate has become the beneficiary of choice for both individual and corporate investors with perceived capital gains. This flow of capital to amateur real estate players has caused several bubble-like phenomenon, one of which is the sale of new Grade A office and multi-use developments by strata-title. In the residential property market, soaring apartment prices have caused middle-class angst and concern. One manifestation has been the popular Dwelling Narrowness television drama.

The government is responding; both to appeal to the masses worried about housing costs and to counter a speculative commercial market. Recently, the government has taken steps to reduce flows to real estate, including an order to slowly push large SOE's with non-real estate core businesses to exit real estate positions. In addition, the government continues to change capital gains taxes with an eye on reining in speculation. It remains to be seen whether the central government can control local governments in respect to new developments and new supply of real estate; local governments are a big beneficiary themselves of a booming real estate market through land auctions.

Real change will happen as the central government directs a guanxi (connections) driven business into a professional-managed industry. Part of this requires more mature financial markets, and talk of a Chinese REIT is still just that, talk. The government continues a comment period with major law firms and financial institutions. The next presumed step will be to allow insurance companies to invest in real estate. Presumably, the introduction of government-sponsored institutional investors (in this case, insurance companies), will encourage the creation of professional asset managers who will operate real estate for long-term yield, not short-term capital gains. In fact, this may be the central government's preferred strategy, since presumably the central government will maintain stronger supervision of insurance companies rather than public-listed REITs.