China is taking decisive steps to create a dual housing market system, in line with the "common prosperity" mantra of top leader Xi Jinping. 

Beijing is set to significantly revive "subsidised housing" for low wage-earners in cities, while carving out the current housing market or "commodity housing" for the well-off urban middle class.

According to an exclusive report by the state-run Economic Observer Net, Central Document 14, recently distributed by the State Council, looks to return to the practice of government and public units selling or renting baozhang fang  or “subsidized housing” to their workers.

The document seems to be the detailed policy follow-up from a July Politburo meeting, when China's top leadership urged local governments to build and supply more affordable housing, promote "urban villages" in mega cities and revitalise idle properties.

As this latest housing reform takes shape, Beijing's approach could be summarised as "guarantee the low-end and marketise the high-end".

The Singapore solution

A Singapore-style approach, wherein basic housing is offered by the state at affordable rates but a private housing market also thrives at the upper end, could help solve China's dual dilemma. 

China's policymakers want affordable housing for lower income citizens while needing the consumption boost powered by profits made in the high-end market.

As part of his dictum "houses are for living in, not for speculation" Xi identified providing affordable housing as a priority. But that goal remained elusive for a variety of reasons. Corruption is one of them. In a previous flirtation with affordable housing more than ten years ago, low-cost flats were built on the public dime. Many ended up in the hands of government officials or people with the right connections. 

The practice of state-owned enterprises providing all workers' housing was phased out after the mid-1990s, when most of China's urban housing stock was privatized. But starting around 2008, amid public discontent as rising real estate prices made apartments unaffordable, China launched a variety of initiatives to promote construction of affordable housing. 

Ironically, the previous drive to build affordable housing was associated with former premier Li Keqiang, whose sudden death last month prompted some pointed comparisons with Xi. Li's former classmate was an admirer of the Singapore model. 

'Liberating' ill-gotten housing

Under China's latest scheme, local governments must transform idle or unwanted properties into affordable housing. This is likely to include purchasing back (or just simply acquiring) low-cost properties currently in officials' hands. It also involves repurposing unsold properties from developers that are in trouble or want to sell.

And how will it identify these ill-gotten homes? In the spring of this year, after a ten-year effort, China announced that it had completed the unified registration of property assets.

Corrupt officials who bought subsidised properties or properties far in excess of what they could afford, based on their monthly income, now have nowhere to hide.

Localities and state-owned enterprises should also build new affordable housing and take charge of the distribution, management and repurchase, according to the reported document. They can use land recovered from developers that was approved for construction but not yet built on, or local government land allocations rather than commercial land sales. 

Funding for the latest round of affordable housing construction is expected to come from three key sources: central government subsidies and the issuance of special purpose bonds, as well as loans from the housing provident fund, which is a mandatory, tax-funded savings account that citizens can only tap for housing-related purposes.

If it works this time, the provision of affordable housing to lower-income Chinese would meet a central goal of Xi's 'common prosperity' slogan. But it could adversely affect struggling local governments. 

Allocating more land for the development of affordable housing will lower building costs substantially, but will also leave a large financing gap for local governments.

Selling land rights and the associated property taxes have been a key source of income for local governments. But land rights are estimated to account for between 30-50% of the final cost of housing and other land related fees and taxes another 15-20%. Eliminating these costs makes building affordable housing feasible.

Market housing to be revived?

And what about shangpin fang or “commodity housing”? Document 14 says that the other goal is to " return commodity attributes to commercial residential housing, meet the demand for improved housing, promote the stabilization of land prices, housing prices, and expectations, and promote the transformation and high-quality development of the real estate industry".

Enodo assesses that this directive allows well-off urbanites to invest and trade again in properties in the "commodity housing" market. 

We have argued that a reversal of the mantra of "houses are for living in, not for speculation" would be a major positive for the economy. Document 14 appears to suggest this may now be the case for the rich and the high-earners, but we reserve judgement until the document itself becomes available.

The political pressure to avoid 'speculation' in housing has contributed to the depressed housing market, which in turn has played a huge role in suppressing consumer confidence.

Xi's fallacy in demanding low housing prices and railing against those who treated housing as an investment asset was that, in a market system, when house prices decline this does not necessarily induce those who could not afford before to buy. Moreover, his statements and the subsequent hit to urban household wealth were instrumental in causing household precautionary savings to shoot up and mortgage borrowing to crash down.

China does suffer a glut of high-end housing in some locations, and a resumption in property trading will not immediately result in a price rebound in all areas. Declining house prices could continue to impact spending, especially in over-built provincial cities. 

Moreover, those households waiting for the unfinished "commodity housing" they bought, will continue to worry until it actually gets delivered. The authorities have prioritised supporting developers to finish these projects but this efforts remain a work in progress.

But in a liberalised private housing market, the most prosperous cities will see their housing prices recover fastest,  hopefully triggering renewed confidence across the nation.

This reform plan could also finally make it possible to roll out the long-trialed property tax in the "commodity market". 

Conclusion 

The private housing market has been one of the key drivers of the Chinese economy and the most trusted asset for households since the 1990s. Beijing needed to address China's overreliance on the real estate market and lack of affordable housing in relation to its stated goals. But Beijing cannot meet its other aim of a consumption-driven recovery until it allows the private housing market to trade freely again.

Allowing a dual housing market is a savvy approach for Beijing. It allows private housing to function as a store and generator of household wealth for the upper classes, while ensuring ample supply of affordable housing for those of more modest income.

Getting the new system off the ground and changing perceptions will be no mean feat. Next up the Party-state must also come up with a comprehensive plan of how to transform local government financing and address the so-far intractable problem of rising local government debt burden.

But if Enodo Economics is correct in our interpretation of the latest housing initiative, it could portend an important inflection point for the economy and markets.